Jack Daniel's whiskey owner Brown-Forman lifted its full-year profits guidance on Tuesday (8 December), exceeding expectations and moving analysts to raise their fair value estimate on the firm. Michelle Russell examines the results and market reaction.

Joel Bloomer, an associate director of equity research at Morningstar, said the Kentucky-based wine and spirits maker "navigated well" in the second quarter as shares rose as much as 6.2% to touch a year-high of US$55.47 on Tuesday morning, before falling back to $52.91 by midday.

"Brown-Forman's profitability through the first half of its fiscal year is ahead of our expectations, so we're increasing our fair value estimate slightly," Bloomer said.
"This management team continues to impress with its meticulous brand management and focus on returns on invested capital."

The maker of Jack Daniel's and Finlandia vodka benefited from spending less on advertising and lower wage costs for the six months to the end of October, boosting net profits by 16% to US$286.6m.

Profits rose 3% to $147m in the second quarter, while operating profits rose 15% and 2% for the half-year and second quarter respectively.

Analysts, on average, expected a profit of just 84 cents per share, according to Thomson Reuters.

"Net, the upside was not high quality and the 19% reduction in advertising spending in (the fiscal first half of the year) raises questions, but as expected, fundamentals do not appear to be getting worse," JP Morgan's John Faucher said in a research note.

He affirmed his "neutral" rating on the stock.

However, while Brown-Forman raised its fiscal-year earnings forecast to a range of $2.95 to $3.15 a share from $2.60 to $3 a share forecasted in June, the firm, which also owns Southern Comfort whiskey and el Jimador Tequila, continues to be hurt by weak demand.

The company reported a 5% fall in net sales for the half-year, to $1.63bn from $1.72bn. The decline slowed to 4% in the second quarter.

For the six-month period, sales growth of Jack Daniel's, Gentleman Jack, el Jimador tequila and ready-to-drink beverages was offset by declines for Finlandia vodka and Southern Comfort.

In recent times, the whiskey maker has relied on its overseas business to offset lackluster sales at home. While it saw net sales gains in Australia, Germany and France, demand was weak in Poland, the US and South Africa.

Brown-Forman cut costs earlier this year and has been offering discounts to attract consumers, however on a conference call earlier this week, chief financial officer Don Berg warned of "intense" price pressure on the US spirits market as the holiday season takes offer.

The company said it "remains concerned about the impact on consumption from a soft on-premise channel, consumer trading-down and heightened competitive activity".

"There's no doubt we've seen more and more pressure, particularly on the pricing side," said Berg, who is also executive vice president of Brown-Forman.

"Two of the five largest suppliers have really taken down their price mix, anywhere around 2% - that would be Diageo and Pernod - whereas the other three, across [Brown-Forman], Fortune Brands and Bacardi have continued to try and find ways to create additional value to the pricing mechanism," said Berg, citing recent Nielsen data.

While distilled spirits were seemingly bulletproof a few years ago as consumers switched to them from beer and other forms of alcohol, they have not been immune to the economic downturn.

And although consumers are not necessarily drinking less, it seems they have continued to trade down to cheaper, lower-margin brands in the recession and are now consuming more at home.

Bernstein analyst Trevor Stirling said the US spirits market has continued to deteriorate, but highlighted some positives.

"The US spirits market contracted in October, with shipments in the NABCA (National Alcohol Beverage Control Association) states falling 2.1%. Trends on premium brands continue to be negative, but mix seems to be declining at a slower rate," Stirling said in a note today (11 December).

"Mid market brands, such as Captain Morgan and Smirnoff, are now showing marked improvements, although Smirnoff's has come on the back of heavy promotional activity," he added.

Brown-Forman said that it believes that the on-premise business will eventually stabilise and growth will return, "although that certainly is not in sight yet".

Both Berg and Brown-Forman's CEO, Paul Varga, said that they remain optimistic that consumers in North America will return to levels of premiumisation seen in spirits before the economic downturn.

"Hopefully over time we'll get back to that point," said Berg. "But I think it'll probably be pretty gradual. From some of the data that we've seen recently, two of the categories doing particularly well at the higher end are whisk(e)y and Tequila, which suits us very well."

Varga said that emerging markets around the world were likely to recover a taste for premium spirits more quickly.

Morningstar analyst Bloomer said he expects some of the more substantial bottom-line improvement to be sustainable in the long run, but eventually some advertising spending will have to be reinstated to maintain brand awareness.

"By not sacrificing brand quality through aggressive pricing and maintaining customer awareness through ready-to-drink products, Brown-Forman has positioned itself well for the eventual return of on-premise consumption and discretionary spending in general," he added.