EUR 850.00 For Business Accounts Only

Morningstar | Tariffs Weigh on Brown-Forman's Margins but Underlying Growth Solid; Shares Nearing FVE

As expected, the impact of tariffs weighed on wide-moat Brown-Forman's second-quarter results, with underlying net sales growing 3%. We attribute the comparatively soft top-line growth to the cadence of inventory buy-in (with an increase in the first quarter due to tariffs, primarily in Europe), rather than a loss of momentum across the firm's portfolio of premium whiskey and tequila brands. As evidence, underlying sales growth in the first half stood around 5%, which is closer to our full-year estimate of 7%, and included a 2% contribution from price/mix (in line with our full-year outlook). We plan to temper our forecast for the year to incorporate a negative foreign exchange impact and a greater degree of gross margin contraction from tariffs, but expect these revisions will be more than offset by the time value of money since our last update. As a result, we don't expect a material change to our $45 fair value estimate and are holding steady on our outlook for around 5% net sales growth and mid-30s operating margin longer term.

Gross margin in the first half contracted 100 basis points to 66.4%, with 30 basis points of this decrease due to tariffs (which began to impact profitability during the second quarter), and an additional 40 basis points due to the adoption of a new accounting standard. Management expects tariffs to erode full-year gross margin by around 200 basis points (versus nearly 68% in fiscal 2018) as it has chosen to largely absorb costs to maintain pricing in line with competitors not subject to tariffs, which should support its trajectory of volume growth. We also contend the firm will be able to leverage the brand equity of Jack Daniel's family to take pricing in certain markets, which should help ease margin pressure over time. Moreover, we expect premiumization trends to support pricing, with underlying depletion growth of 19% in Brown-Forman's superpremium American whiskey portfolio materially outpacing the 6% rate for whiskey overall.

From a geographic perspective, sales were fueled by continued strength in emerging markets, which along with travel retail, now account for more than a fifth of the business. Emerging markets posted 10% underlying sales growth in the first half, on top of a 15% increase in the prior-year period, while travel retail grew 14%. This is well above the 3% growth seen in the United States and 5% growth in developed international markets.