After an extended period of weak performance, the stock price of Brown-Forman Corporation (BF.B, Financial) finally rallied by more than 10% after management assured investors that the company was on track to get back on the growth trajectory. After the rally, Brown-Forman's valuation still hovers around a historically-low level. In this article, I will analyze the challenges Brown-Forman has faced since the end of the COVID-19 pandemic and share the reasons why I am optimistic about the improving fundamental growth of the company.
Brown-Forman has experienced the perfect storm during the past few quarters
Prior to FY2024, Brown-Forman has experienced net organic sales growth for ten consecutive years. The growth rate was particularly strong for FY2022 and FY2023 due to pent-up demand during and after the COVID-19 pandemic.
Early signs of trouble started to appear in the fourth quarter of FY2023 when the growth rate of net organic sales decelerated. In the second half of FY2024, Brown-Forman's net organic sales started to flatten. This trend continued during the first half of FY 2025, when Brown-Forman's net sales declined by almost 5% year-over-year, and organic net sales growth was flat year-over-year.
In my opinion, Brown-Forman has experienced the perfect storm since the end of the pandemic.
First of all, on the consumption side, there was a huge boom in unexpected demand as a result of the pandemic, which then led to supply chain issues after the boom. Spirits distributors built up inventory levels in order to meet the demand. At the same time, major spirits brands all took the demand boom opportunity and raised their prices. Consequently, the distributing channel was loaded with high-cost inventory after the boom while consumer demand waned. This is the most significant short-term challenge for the industry.
Secondly, the rise in RTD (read-to-drink) and non-alcoholic beverages has taken some market share from spirits. For instance, it was reported that hard seltzer High Noon, which was launched by the wine company E&J Gallo, became the leading spirits brand by volume in the US for both 2022 and 2023, with over $1 billion in annual sales. As a response, spirits companies such as Brown-Forman and Diageo (DEO) had to promote their own RTD drinks. However, because the gross margin on RTD drinks is much lower than spirits, the volume growth of RTD drinks such as Jack and Coke erodes gross margins for Brown-Forman. This is both a short-term and long-term challenge for the spirits industry.
Thirdly, consolidation has taken place in the distribution channel, which has been going on for more then two decades. An industry veteran has predicted that the consolidation trend will accelerate due to the need to boost efficiency and profitability. Distributor and retailer consolidation may exacerbate the short-term headwind for Brown-Forman.
The worst is likely over for Brown-Forman
After a tough FY2024 and first half of FY2025, it looks like Brown-Forman is well-positioned to return to growth.
First of all, historically, past channel inventory challenges were all cyclical. The channel inventory level will normalize as the industry works through the excess inventory. In addition, macro pressure may ease a little if the Fed further lowers interest rates. Both factors are tailwinds for Brown-Forman's net organic sales growth. It is especially noteworthy that organic net sales for Jack Daniel's accelerated significantly during the most recent quarter after several quarters of decline. As Jack Daniel's is the most important brand for Brown-Forman, the turnaround of Jack Daniel's brand bodes well for the company over the next few quarters.
Secondly, Brown-Forman still has plenty of opportunities in terms of premiumization across its portfolio of brands. In whisky, Brown-Forman still has untapped pricing power for Old Forester, Woodford Reserve and Jack Daniel's. In tequila, Brown-Forman also has a strong portfolio with iconic brands such as El Jimador and Herradura. Brown-Forman's management commented on the most recent earnings call that "the premiumization trend continues with higher-priced tiers growing in value and gaining share. The growth in the $40 and above price tiers are driven largely by the US whiskey and tequila categories".
Last but not least, Brown-Forman's tequila business is facing short-term headwinds both in the US and in Mexico due to competitive and macroeconomic factors. However, in the long term, it is expected that the tequila category will continue to grow globally. In addition, during the tequila boom, agave prices soared, which put margin pressure on tequila producers. This trend is now reversed as agave over-planting has resulted in excess supply. Consequently, agave prices will likely come down, which is a tailwind for the gross margin of Brown-Forman's tequila business.
From a valuation standpoint, even after the recent rally, Brown-Forman's cyclically adjusted Shiller P/E ratio is still near an all-time low. The following graph clearly shows that it is very rare for the company's Shiller P/E ratio to dip below 20, which only happened three times since Brown-Forman became a public company. The undervaluation is undeniable.
Conclusion
In conclusion, Brown-Forman Corporation's fundamentals have shown early signs of a potential turnaround despite industry-wide challenges. With the normalization of channel inventory, premiumization opportunities in both whisky and tequila, and favorable long-term growth prospects for its tequila business, the company is poised to get back to growth in the near future. Meanwhile, Brown-Forman's valuation is still at historically low levels. I think at the current price, Brown-Forman is an attractive investment opportunity with limited downside and plenty of upside.
