Brown-Forman Initiating Coverage

7/27/2019 Brown-Forman Initiating Coverage

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North America United StatesConsumer Beverages

28 March 2010

Brown-FormanReuters: BFb.N Bloomberg: BF/B US Exchange: NYS Ticker: BFb

Whiskey, neat; initiate at Buy

Marc Greenberg, CFAResearch Analyst

(+1) 203 863-2355

[email protected]

Andrew Kieley, CFAResearch Analyst

(+1) 212 250-7817

[email protected]

Fundamental, Industry, Thematic, Thought-LeadingDeutsche Bank Company Research's Product Committee has deemed this workF.I.T.T. for investors seeking differentiated ideas. Here our beverage analystsinitiate coverage of Brown-Forman with a Buy rating, while assessing positivetrends in US spirits category relative to beer.

Forecasts and ratios

Year End Apr 30 2008A 2009A 2010E 2011E

1Q EPS 0.61 0.69 0.81A 0.87

2Q EPS 0.83 0.94 0.99A 1.08

3Q EPS 0.75 0.68 0.80A 0.85

4Q EPS 0.62 0.58 0.56 0.62

FY EPS (USD) 2.81 2.90 3.16 3.42

P/E (x) 19.9 17.6 18.1 16.8

Dividend yield (%) 4.2 2.2 2.1 2.2

Deutsche Bank Securities Inc.

All prices are those current at the end of the previous trading session unless otherwise indicated. Prices are sourced from local

exchanges via Reuters, Bloomberg and other vendors. Data is sourced from Deutsche Bank and subject companies. Deutsche

Bank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firmmay have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single

factor in making their investment decision. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1.

MICA(P) 106/05/2009

FITT Research

BuyPrice at 26 Mar 2010 (USD) 57.29

Price target 64.00

52-week range 58.01 - 38.32

Price/price relative

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3/07 9/07 3/08 9/08 3/09 9/09

Brown-Forman

S&P 500 INDEX (Rebased)

Performance (%) 1m 3m 12m

Absolute 8.2 7.5 43.0

S&P 500 INDEX 5.7 3.5 43.2

Stock & option liquidity data

Market Cap (USDm) 8,466.2

Shares outstanding (m) 147.8

Free float (%) 100

olume (26 Mar 2010) 81,600

Option volume (und. shrs., 1M avg.) 3,750

Implied & Realized Volatility (3M)

0%

20%

40%

60%

80%

Nov 08 May 09

Realized Vol Implied Vol (ATM)

Company

GlobalMarketsResea

rch

Fundamental: Jack Daniels Alcohols strongest Americana brandThoughtful, consistent, long-term global investment behind the iconic whiskey itmade famous underpins our constructive view of Brown-Forman. Amidst beercategory decline (and in particular brand Budweiser), the old guy from Tennesseehas maintained growth. High-single-digit EPS growth, compelling ROIC, consistentreturn of cash and attractive long-term growth support out Buy rating, $64 TP.

Industry: Spirits leaders are focused on brand loyalty, beer on profitsRational beer duopoly (ABI and MillerCoors) matters little to consumers choosingbrands. Our research portrays spirits leaders as more innovative, promoting more,establishing loyalty with younger consumers. Our downgrade of TAP today factorsin domestic margin erosion as investment re-accelerates, pricing erodes.

Thematic: BF can win the marathon, if not the sprintBrown-Forman should continue to raise exposure to growth markets abroad andsegments at home gradually, via new distribution, brand acquisition, innovation.This approach may not make every quarter clean, but sustains a strong franchise.

Though Leading: Treated like a shareholder? YepRecent legacy of closely held or family controlled alcohol beverage companiesgives pause regarding the benefit from strategic deals like MillerCoors, formationof ABI, and various iterations at Constellation over the years, owing to both sharevolatility and limited return of cash. In contrast, Brown-Forman treats investors likefamily: 10-year annualized dividend growth: 9.4% (40% payout ratio), 10-yearshare price appreciation: 228% (12.6% annualized).


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28 March 2010 Beverages Brown-Forman

Deutsche Bank Securities Inc. Page 3

Fiscal year end 30-Apr 2007 2008 2009 2010E 2011E 2012E

Financial Summary

DB EPS (USD) 2.51 2.81 2.90 3.16 3.42 3.72

Reported EPS (USD) 2.51 2.81 2.90 3.16 3.42 3.72

DPS (USD) 0.93 2.36 1.12 1.18 1.25 1.36

BVPS (USD) 10.24 11.27 12.07 13.04 14.66 16.23

Valuation Metrics

Price/Sales (x) 3.1 2.6 2.4 2.6 2.5 2.4

P/E (DB) (x) 22.4 19.9 17.6 18.1 16.8 15.4P/E (Reported) (x) 22.4 19.9 17.6 18.1 16.8 15.4

P/BV (x) 5.0 4.8 3.9 4.4 3.9 3.5

FCF yield (%) 3.6 5.7 5.9 5.3 5.5 6.3

Dividend yield (%) 1.7 4.2 2.2 2.1 2.2 2.4

EV/Sales 3.4 2.9 2.6 2.8 2.6 2.4

EV/EBITDA 14.6 12.8 11.7 11.6 10.4 9.4

EV/EBIT 15.7 13.8 12.6 12.6 11.1 10.1

Income Statement (USDm)

Sales 2,806 3,282 3,192 3,196 3,301 3,448

EBITDA 647 737 716 773 840 897

EBIT 603 685 661 716 785 839

Pre-tax profit 586 644 630 687 751 810

Net income 390 435 439 469 502 543

Cash Flow (USDm)Cash flow from operations 355 534 491 490 510 577

Net Capex -41 -47 -37 -45 -53 -58

Free cash flow 314 487 454 445 457 519

Equity raised/(bought back) 27 -212 -45 -153 -93 -143

Dividends paid -143 -362 -169 -174 -182 -196

Net inc/(dec) in borrowings 595 -172 -6 -233 0 0

Other investing/financing cash flows -1,059 9 -13 0 0 0

Net cash flow -266 -250 221 -115 182 180

Change in working capital -80 28 -18 -41 -53 -30

Balance Sheet (USDm)

Cash and cash equivalents 369 119 340 225 407 587

Property, plant & equipment 506 501 483 471 469 469

Goodwill 670 688 675 675 675 675

Other assets 2,006 2,097 1,977 1,974 2,005 2,044

Total assets 3,551 3,405 3,475 3,345 3,556 3,775

Debt 1,177 1,006 999 766 766 766

Other liabilities 801 674 660 652 650 667

Total liabilities 1,978 1,680 1,659 1,418 1,416 1,432

Total shareholders' equity 1,573 1,725 1,816 1,927 2,140 2,343

Net debt 808 887 659 540 358 178

Key Company Metrics

Sales growth (%) 14.8 17.0 -2.7 0.1 3.3 4.4

DB EPS growth (%) 8.1 11.9 3.0 9.1 8.1 9.0

Payout ratio (%) 36.6 83.2 38.5 37.1 36.3 36.2

EBITDA Margin (%) 23.0 22.5 22.4 24.2 25.4 26.0

EBIT Margin (%) 21.5 20.9 20.7 22.4 23.8 24.3

ROE (%) 24.9 26.3 24.8 25.1 24.7 24.2

Net debt/equity (%) 51.4 51.4 36.3 28.0 16.7 7.6

Net interest cover (x) 37.0 16.5 21.3 24.9 23.4 29.0

DuPont AnalysisEBIT margin (%) 21.5 20.9 20.7 22.4 23.8 24.3

x Asset turnover (x) 0.9 0.9 0.9 0.9 1.0 0.9

x Financial cost ratio (x) 1.0 0.9 1.0 1.0 1.0 1.0

x Tax and other effects (x) 0.7 0.7 0.7 0.7 0.7 0.7

= ROA (post tax) (%) 12.4 12.5 12.8 13.8 14.5 14.8

x Financial leverage (x) 2.0 2.1 1.9 1.8 1.7 1.6

= ROE (%) 24.9 26.3 24.8 25.1 24.7 24.2

annual growth (%) -0.3 5.9 -6.0 1.1 -1.5 -1.9

x NTA/share (avg) (x) 10.1 10.7 11.7 12.6 13.8 15.4

= Reported EPS 2.51 2.81 2.90 3.16 3.42 3.72

annual growth (%) 8.1 11.9 3.0 9.1 8.1 9.0

Source: Company data, Deutsche Bank estimates

Model updated:26 March 2010

Running the numbers

North America

United States

Beverages

Brown-FormanReuters: BFb.N Bloomberg: BF/B US

Buy

Price (26 Mar 10) USD 57.29

Target price USD 64.00

52-week Range USD 38.32 - 58.01

Market Cap (m) USDm 8,466EURm 6,319

Company Profile

Brown-Forman is an alcohol beverage company in thepremium spirits and wine categories. Leading spirits brandsare Jack Daniel's, Southern Comfort and Finlandia, andFetzer and Korbel in wine. Brown-Forman biggest geographicmarket is the US, but it has an increasingly international

presence. Key non-US markets include the UK, Australia,

Mexico, Poland, Western Europe, China, Japan, Russia.

Price Performance

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Mar 07 Sep 07 Mar 08 Sep 08 Mar 09 Sep 09

Brow n-Forman S&P 500 INDEX (Rebased)

Margin Trends

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07 08 09 10E 11E 12E

EBITDA Margin EBIT Margin

Growth & Profitability

232424252526262727

-5

0

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07 08 09 10E 11E 12E

Sales growth (LHS)

Solvency

0

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0102030405060

07 08 09 10E 11E 12E

Net debt/equity (LHS)

Marc Greenberg, CFA

+1 203 863-2355 [email protected]


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Page 4 Deutsche Bank Securities Inc.

Investment thesis

Strong portfolio, growth, total return opportunity

We initiate coverage with a positive view of BFs brand portfolio, growth outlook, steady totalshareholder returns (among the best in CPG), and high ROIC which warrants premium

valuation comparisons to Coke are altogether fair. BF runs a focused portfolio of attractive

brands flagship Jack Daniels is one of the strongest US brands with consumers, anchors

US distribution, provides a platform for International growth and effective innovation.

Premium tequila brands (Jimador, Herradura) represent a faster growth opportunity, while

Finlandia has performed well globally. While BF has some lagging value brands, within the

portfolio these are monetizable to fund growth. Overall the portfolio is narrower than global

competitors, but focused and compensates for smaller scale. Our survey work also

demonstrates a modestly more positive spirits outlook among US retailers, and we perceive

an improving opportunity as beer weakens, as spirits innovation/promotion are better and as

beer cost-cuts to glory. This creates a wide berth for spirits companies to win consumers.

The second key leg of our thesis is an underappreciated and substantial International growth

opportunity, which balances off the more mature US. As Jack, Finlandia and the tequila

brands expand abroad, global profits have reached parity with the domestic side and are

growing faster. Long-term profit upside is considerable, despite quarterly/FX volatility.

Finally, BFs offers long-term investors an excellent track record of steadily compounding

total returns and attractive FCF. 10-year EPS growth 9-10%, EBIT growth 8%, dividends 9%,

and ROIC at 16-17% warrants premium valuation. While multiples appear somewhat high vs.

peers, we believe it is justified by high margins/returns, barriers to entry, FCF generation, and

global growth opportunity. We see valuation support from the outlook for stable high single

digit earnings growth and defensiveness of those estimates, as well as balance sheet

flexibility. Although BFB is likely to be viewed by investors as defensive, we would expect

significant multiple inflation if consumer spending reaccelerates. Our estimates for Q4 2010

and 2011 are generally conservative, in light of soft near-term consumer spending, trade-

down, competitor promotion, but our bias would shift with economic and/or category pickup.

Overall we look for 8% EPS growth in FY11 and high single digits annually in future years.

Although BF is a controlled company and Class B shares lack voting rights, we do not

believe they should carry a discount, since stewardship of patient family shareowners is

driving steady total return. However we also do not believe shares should embed any M&A

premium (despite being an attractive target), given family interest in independence.

$64 DCF valuation

We value BFB shares on a DCF-basis, and arrive at $64/share. Key assumptions are 10-yearEBITDA growth of 6%, WACC of 8% (post-tax cost of debt of 4%, 5% risk-free rate, 6%

equity risk premium, levered beta of 0.5, cost of equity of 8.2%), and perpetuity growth of 1-

1.5% (below long-term GDP growth given maturity of spirits industry). $64 valuation equates

to EV/EBITDA of 12.2x (FY11E), P/E of 18.7x, in-line with LT average of 12x EBITDA, 19x P/E.

Risks

Key risks are slower than expected volume growth, deterioration of brand equity or

ineffective marketing. Slower growth could also result from consumer trade-down, trade

inventory adjustments, or economic weakness abroad. Other risks would be more aggressive

price promotion in spirits, FX volatility, regulatory changes, higher excise tax, M&A activity.


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Table of Contents

Executive summary ........................................................................... 6US spirits overview ......................................................................... 12Limited economic sensitivity, solid demographics ...................... 16

Vodka dominates category growth ............................................... 20Brands come first within a fragmented market............................ 24Alcohol innovation trends............................................................... 313-tier system & regulation .............................................................. 35Brown-Forman overview ................................................................41Company innovation ....................................................................... 51Channel checks: JD strong amid trade down ...............................54The global story is bullish............................................................... 66A great financial picture..................................................................76Valuation: 14% upside potential, initiate at Buy........................... 85Risks..................................................................................................88


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Executive summary

We initiate coverage with a Buy rating $64 target price (18.7x FY2011 forecast of $3.42). We

believe Brown Formans Jack Daniels brand provides an excellent foundation for global

growth and high returns that warrants premium valuation, based on three factors:

High returns, exceptional track record of value-creation: Forecast ROIC is 17%. 10-

year EPS growth 9-10%, profit growth 8%, dividend growth 9%, with annual share price

appreciation of 12.6%. The view of a mature one-brand company seems quite difficult to

square with these results thats because it is incorrect, in our view.

You dont know Jack thoughtful leadership: Gradual inroads into global expansion

opportunities have steadily lifted the profit split close to 50-50 US/non-US, with

significant opportunities ahead. Jack Daniels brand (est. 47% US volume, 20% global)

has been a strong platform for premium innovation (Single Barrel, Gentleman Jack,

Woodford Reserve). BFs Herradura tequila and Finlandia vodka acquisitions brought in

quality brands in attractive segments, while divestment of non-core assets (wine,

luggage, jewelry) has focused the portfolio towards higher profitability. BFs long-term

approach may create quarterly volatility, but the payoffs have been lucrative over time.

Improving outlook for spirits category as beer weakens: The spirits category has

boosted innovation and promotion to stabilize top-line growth through this difficult

economic period. Conversely, we fear the beer industry has substituted cost-cutting and

price increases for brand development at the exact wrong time, presenting a wide berth

for leading spirits players to capture consumers. Our research highlights consumer

migration away from leading beer brands as they try new things and look for value. Our

retailer surveys indicate expectations for improving category momentum and generally

constructive outlook for BF.

1. Domestic spirits business is attractive

The US spirits category represents just 6% of the US beverage alcohol market by volume,

but is arguably the most structurally attractive, with superior LT consumption growth vs. beer

and high price points/margins in the premium segment. Although volume growth trails wine,

focus on leading premium brands creates attractive economics for leading brandowners.

Importantly, we believe the recent volume deceleration in beer -- the largest alcoholic

category in volume and value owes in large part to an overt profit focus, and has opened

the competitive door to brand-focused wine and spirits companies. In our view, it is not

oligopolies that ensure sustained profit growth, but brand investment. Spirits and wine could

win tremendous share by outshining the US beer industry in one critical area consumer

excitement and appeal.


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Figure 1: Est. Brown Forman volume contribution by brand

JackDaniel's,

47%

Canadian

Mist 17%

Southern

Comfort,14%

EarlyTimes,

6%

Finlandia,3%

Gent.Jack,

2%

ElJimador,

2%

Source: Impact, NABCA, IRI, DB estimates, NABCA

broadening consumer acceptance of spirits

Our research on the US spirits market demonstrates broadening acceptance. For instance,

our November 2009 survey of 1,010 consumers on alcohol consumption (see Whats

Facebook Drinking) indicated that 89% consume spirits, matching the popularity of beer.

We also found that while preference is highest in the 20-30 age group, spirits consumption is

robust across all age groups, and fairly even across male/female.

DB survey: Despite trade-down, retailers are optimistic on spirits outlook

Down-trading to lower-priced categories remains a key risk. Forty six percent of large format

retailers in our survey expect some degree of trade-down, while 17% expect to see things

improve and trend back to premium-lead positive sales mix. While a significant 30% of

sample still expects sales to remain flattish versus 2009, the majority (54%) expects growth,

and only 16% expect declines. This reflects improved confidence, particularly in light of

continued trade-down pressure, and we believe is a better outlook vs. consensusexpectations.

2. BFs domestic strategy has driven outperformance

In the US, new distribution channels and effective innovation/extensions have driven growth

of the flagship brand, despite not being a vodka the dominant driver of spirits category

growth for the last 30 years.

Whiskey, leave the bottle

Our prior consumer work indicates that taste is by far the dominant decision driver for alcohol

brands (cost ranks much lower). Both are favorable factors for lead brand Jack Daniels,

which scores high on taste and among the most popular of any spirits brand. In our 2009survey of alcohol brand preference, Jack Daniels ranked in the top 3 for spirits brands

mentions, above its overall #5 spot in US spirits, and close to the top scoring equity brand

Grey Goose. Despite economic challenges, BFs successful investments to drive super-

premium brands such as Woodford, and Gentleman Jack validate the primacy of taste for

consumers. Declining value brands in the portfolio are able to be monetized towards growth

elsewhere.


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Figure 2: Brown-Forman Whiskey brand growth estimates : 2000-2010E

24%

9% 8%

3%1%

4% 4%

10%

5%

0%

5%

10%

15%

20%

25%

Source: Deutsche Bank estimates, company data, Impact

Acquisition of the Casa Herradura high-end tequila brands in FY07 added a long-term

growth outlet to complement slower growth bourbon. US tequila growth is underpinned

by expanding awareness, particularly of smoother high-end products, growth of the Hispanic

population (although estimated 80% of tequila drinkers are Caucasian). Much of the growth

also falls in the super premium and luxury categories, in which BF is a major participant. BF is

the fourth-largest global tequila producer (Euromonitor) based on its presence in the

US/Mexico market. El Jimador is BFs largest tequila brand and fastest grower. It is

attractively priced at the higher end of the segment ($24-25) a premium to category leader

Jose Cuervo. Consumer value proposition owes to a low relative price point for a 100%

agave product. Jimador depletions are +6% YTD for BF globally, and have nearly doubled in

size since the acquisition.

3. International opportunity is underappreciated

We believe BF geographic diversification is generally misunderstood in the investment

community (perhaps in part due to limited financial segment disclosure by the company). We

believe this is one of the most overlooked pieces of the growth story. Outside of Coke, BF

offers the most international exposure among beverage companies we follow.

BF markets in 135 countries (23 of which have case sales over 100k).

We estimate more than 50% of revenue came from outside the US last year.

Growth rates are higher than at home.

Global expansion

Although US remains the single biggest sales market (48% of revenue), importance of

International has increased significantly in the past few years. Management initiated a

strategy to expand globally in the mid 1990s non-US sales were less than 30% in FY03

(before the Herradura acquisition), and have grown steadily since that time. In FY08, non-US

sales exceeded US for the first time. This primarily revolves around Jack Daniels, but

Finlandia had produces strong global growth rates, with a tequila opportunity still ahead.


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Equivalent to US spirits profits, and growing

Although we believe the International profit contribution is slightly below the 50% revenue

contribution because of lower margins (we estimate International EBIT at 46% of total,

matching US Spirits), it is the larger growth driver. We believe it should continue to grow

within the profit mix, based on higher volume opportunities as BF gains scale. We therefore

believe a single-minded focus by investors on the US (or even more keenly, Jack Daniels in

the US) is an extremely short sighted perspective.

Figure 3: BFB brand volume 2009E (mn cases) Figure 4: Volume CAGR, INTL vs. Total (2005-09E)

0

1

2

3

4

5

6

7

8

9

10

JackDaniel's Finlandia Southern

Comfort

Canadian

Mist

NonUS

US

10.1%

5.6%

3.4%

7.8%

2.9%

0.8%

0%

2%

4%

6%

8%

10%

12%

Finlandia JackDaniel's Southern

Comfort

International

Total

Source: mpact,NABCA, IRI, company data, DB estimates Source: Impact,NABCA, IRI, company data, DB estimates

Sound growth strategy

BF focuses on growing awareness and distribution of its brands in each market, and in some

cases, the category itself (i.e. tequila in Russia). Management expects International to

outgrow US over time, particular through opportunities in BRIC economies, Eastern Europe,

Asia, Latam, France and Australia. A key determinant will be the longer-term

premiumization/trading-up by foreign consumers similar to what has been evidenced

domestically over the last 10 years. As global premiumization is much less prevalent, we seeplenty of runway for BF brands abroad. In our view this trend is supported by the expanding

global middle-class growth highlighted by KO, PEP and most other global CPG companies

(although more challenging in alcohol vs. soft drinks). Of course, such exposures also elevate

volatility introduced by global macroeconomic factors, a greater skew to on-premise

consumption, execution in newer markets, foreign regulation, and currency.

4. US spirits poised to win vs. beer

Innovation presents a great share of stomach opportunity for spirits

We believe spirits have a fundamental share of stomach opportunity with US consumers

as leaders in beer have seen new product pipelines dry up, suggesting dangerous risk to any

beer investor or management seeking to cost-cut to prosperity. Consumers need a reason tobuy a product, or else they start to go away. As wines constant product flow is to a degree

systemic (new grapes, varietals, regions, etc.), the break-through potential squarely lay in the

hands of spirits and smaller craft beers at present.


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Figure 5: Alcoholic Beverage Category innovation: 2008-2010

New Product New Packaging Range Extension TotalSpirits 215 49 94 358Wine 398 71 68 537Beer 233 83 152 468

0200400600800

1,0001,2001,4001,600

Source: Mintel

Three-year innovation data from Mintel suggests greater volume of innovation in wine and bysmaller brewers, compared to a more concentrated and focused innovation strategy in

spirits. Much of the spirits industry innovation has focused on growth categories, primarily

white spirits, while whiskey has concentrated on high-end brands where growth still exists.

Brown Forman has successfully leveraged its leading whiskey franchise

Jack Daniels brand has served as a rich global foundation in a bid to extend growth. This has

included the flavored RTD Country Cocktails line, pre-mixed Jack and Cola (which has grown

particularly well in Australia), and premium bourbons (higher-priced Gentleman Jack, Single

Barrel). Beyond bourbon, more recently the company has rolled out flavored varieties of

Finlandia, and SoCo ready-to-pour cocktails. Of the major US line extensions we were able to

track with IRI data above, BF has a good track record of growth on bourbon products, and all

expect Country Cocktails gained ACV distribution and held or increased price points over the

past five years. We believe these products may present an effective strategy to address

ongoing consumer thrift, even once the economy improves.

Trends are gradually improving availability of spirits

There is some gradual progress in the US against more restrictive state laws the Distilled

Spirits Council states that 36 states now allow Sunday sales (with 14 of these having passed

since 2002), and a broader trend of modernizing spirits regulations across states over the

past five years, which clearly is to the benefit of spirits companies.

Initiate coverage with Buy Rating, $64 price target

BF does not use a formal growth model for top line, profits and earnings, but alludes to its

impressive 35-year 11% growth rate as a guide. We may see higher levels of volatility goingforward as global exposure ramps it comes with the new territory but dont expect it to

take short-cuts or protect against and odd quarter or two. Coupled its relatively generous

cash distributions, the shares are meant for investors looking to the next generation (like the

family that controls it).

Forecast: Balanced 5% top-line growth: We assume inflation-based US pricing and

modest volumes, with a few points of International volume growth per year and flat

pricing as modest pricing is offset by negative mix and promotion to drive growth. On a

year-to-year basis, there is likely to be some FX volatility against our forecasts, but

upside may come from renewed economic growth in developed markets.


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Mid-to-high single digit EBIT growth: Operating profit growth and margin

improvement have been fairly consistent long term, and we forecast growth in mid-to-

high single digits. This is based on mid single digit revenue growth and modest annual

margin expansion. It is also somewhat conservative vs. the long-term track record.

Strong free cash generator: We estimate EBITDA conversion to free cash flow (defined

as OCF less capex) at 40-67% annually over the past five years. Capex ($50-70mn p.a., 2-3% of revenue), working capital and interest expense are limited, and tax rate has

steadily declined (which we expect to continue as International grows). On a FY10

revenue base of about $2.5bn (ex-excise tax), we forecast FCF of about $450m.

Leverage is conservative, creating scope for higher returns to shareholders. Despite

undertaking bigger share repurchases the past two years ($262mn in FY08-09), paying a

$204m special dividend in 2008, increasing dividends to maintain 35-40% payout ratio,

financial leverage has declined and is fairly low. Leverage peaked in FY03 (net

debt/EBITDA of 1.7x) and we project 0.7x by YE10.

DCF value of $64: We value BFB shares on a DCF basis, and arrive at $64/share. Key

assumptions are 10-year EBITDA growth of 6%, WACC of 8% (we based this off post-

tax cost of debt of 4%, 5% risk-free rate, 6% equity risk premium, levered beta of 0.5,

driving cost of equity of 8.2%), and perpetuity growth rate of 1-1.5% (below long-term

expected GDP growth given relative maturity of spirits industry). Our $64 valuation

equates to an EV/EBITDA multiple of 12.2x (FY11E basis), FCF yield of 4.8%, and a P/E of

18.7x. This is essentially in-line with long-term 10-year historical averages of 12x EBITDA

and 19x P/E. Although BFB is likely to be viewed broadly by investors as defensive and

not as favorable in higher economic cycles, we would look for significant multiple

inflation if consumer spending does reaccelerate.


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US spirits overview

The U.S. spirits industry offers some of the most dynamic trends and attractive

economics in the alcoholic beverage sector, with a low to mid single digit growth

profile, high profit margins, and favor from the younger demographic. Cocktails have

made their mark on U.S. society, both on and off-premise, and spirits will remain one

of the most attractive categories in consumer products as flavor and brand innovation

continue to broaden, and spirits gain increasing acceptance, particularly at the high

end, among the younger consumer demographics. On a segment basis, beers waning

appeal appears to be spirits segments gain, as industry leaders have favored brand

growth as opposed to merely profit growth within the largest beer companies

Anheuser Busch Inbev and Miller Coors.

Broad & expanding consumer appeal

The US spirits category represents just 6% of the US beverage alcohol market by volume,

but is arguably the most structurally attractive, with superior LT consumption growth vs. beerand high price points/margins in the premium segment. Although volume growth trails wine,

the segment has renewed growth with focus on leading premium brands, creating attractive

economics for leading brandowners. Importantly, we believe the recent volume deceleration

in beer -- the largest alcoholic category in volume and value owes in large part to an overt

profit focus by the leading players, and has opened the competitive door to brand focused,

wine and spirits companies. In our view, it is not oligopolies that ensure sustained profit

growth, but brand investment. Spirits and wine could win tremendous share by outshining

the US beer industry in one critical area consumer excitement and appeal.

Figure 6: US alcohol consumption by volume (2010E) Figure 7: US alcohol consumption CAGR (2000-2010E)

Beer,

82%

Wine,

10%

Spirits,

6%

RTD&

Other,

2%

3.4%

2.9%

0.8%

0.3%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

WineSpiritsTotalAlcoholBeer

Source: Impact, Beer Institute, DISCUS, DB estimates Source: Impact, Beer Institute, DISCUS, IRI, Euromonitor, DB estimates

Building consumer awareness on-premise leads to

Cocktailing is a mainstay of the U.S. on-premise environment. The spirits industry therefore

relies heavily on this channel by as a trial occasion for consumers, given a greater tendency

to try new flavors and combinations in a single-serve setting. On-premise is a primary playing

field for building brand equity and consumer recognition. We expect acceleration of the

spirits category to continue over the long-term, as many of the previously established trade-

up and demographic trends continue long after the current recession.

Spirits will likely remain one

of the most attractive

categories in consumer

products as flavor and brand

innovation continue to

broaden, and spirits gain

increasing acceptance,

particularly at the high end,

among the younger

consumer demographics.

On-premise is a primary

playing field for building

brand equity and consumer

recognition.


13/96



Secular improvement in spirits underpins Brown-Formans prospects at home. Additionally,

the factors below enable a favorable growth outlook:

Growing young adult acceptance as an alternative to beer.

Expanding distribution.

Tactical company marketing strategies.

Premiumization.

Figure 8: US spirits volume (mn cases) Figure 9: High-end & super-premium % US spirits vol.

146 150 153159 165

171 177184 187 189

195

0

2040

60

80

100

120

140

160

180

200

220

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010E

3.5%5.7%

13.2%

19.2%

22.3%24.3%

23.0%

0%

5%

10%

15%

20%

25%

30%

1970 1980 1990 2000 2005 2008 2009

Source: Impact, DISCUS, IRI, Euromonitor, DB estimates Source: DISCUS

broadening consumer acceptance of spirits

Our research on the US spirits market demonstrates broadening acceptance. For instance,

our November 2009 survey of 1,010 consumers on alcohol consumption (see Whats

Facebook Drinking) indicated that 89% consumer spirits, matching the popularity of beer.

We also found that while preference is highest in the 20-30 age group, spirits consumption is

robust across all (legal) age groups. Spirits consumption matches up fairly evenly acrossmale/female, showing broader and less compartmentalized appeal than we had expected.

Figure 10: DB survey -- Which types of alcohol do you

drink?

Figure 11: DB consumer survey -- Do you drink spirits?

Beer Wine Spirits

Yes 89.2% 88.3% 88.6%

No 10.8% 11.7% 11.4%

0%10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2024 2530 Over30

Idrink 91.4% 87.7% 80.4%

Idonotdrink 8.6% 12.3% 19.6%

0%10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Source: Deutsche Bank November 2009 survey of 1,010 US consumers Source: Deutsche Bank November 2009 survey of 1,010 US consumers


14/96



Risks & limitations

While the high-level growth trends look good for spirits and per capita consumption has been

increasing, we still have to consider longer-term risks (as with all other beverage categories)

to consumption, which could reverse the trend. Some potential limiting factors, and our take:

Figure 12: US alcohol consumption per capita (gallons)

1990 1995 2000 2005 2007 2008 2009 2010E

Beer 34.5 31.0 30.8 29.6 29.7 29.6 29.1 28.5

Wine 2.4 2.4 2.8 3.2 3.3 3.3 3.3 3.4

Spirits 2.1 1.7 1.8 1.9 2.0 2.0 2.0 2.1

0

5

10

15

20

25

30

35

Beer

Wine

Spirits

Source: Impact, Beer Institute, DISCUS, IRI, Euromonitor, DB estimates, NABCA

Cyclicality. Spirits consumption has over the very long-term been somewhat cyclical total

and per capita consumption declined in the 1980s and early 1990s for example, and based

on higher price points per bottle in premium spirits, consumption is somewhat exposed to

economic cycles. Our research also shows that spirits are still more of an occasion drink

than beer/wine. Frequency is significantly higher among the younger groups, which bodes

well for growth in our view, but also exposes it to volatility were it to fall out of favor (i.e

fashion risk).

Demographics. Boomer growth implies lower per capita as older consumers drink less.

Historically spirits consumption in US tends to correlate with growth of younger populations

in the 21-24 group, which could mean headwinds (see Figure 9 below).

Wellness trends. General shift to healthier lifestyles in the US might pressure spirits

consumption. Indeed this may have been a factor behind BFs decisions in earlier periods to

attempt diversification (i.e. wine/luggage). Relative to beer and spirits, wine appears best

positioned here, (i.e. moderation, French paradox). However we see this as becoming less of

a factor over time, as companies have done a good job marketing the spirits occasion in

moderation as an acceptable part of a balanced lifestyle just like wine/beer.

Our research shows that

spirits are still more of an

occasion drink than

beer/wine. Frequency is

significantly higher among

the younger groups, which

bodes well for growth.


15/96



Figure 13: DB survey -- How frequently do you drink

spirits per week?

Figure 14: DB survey -- Do you expect to drink spirits

more or less frequently over the next year?

NotatallOnly

occasionallyFrequently

MostlyPrefer

to wine/beer

2024 5.3% 55.7% 31.7% 10.3%

2530 13.9% 66.4% 16.4% 3.3%

Over30 14.4% 62.9% 13.4% 10.3%

0%

10%

20%

30%

40%

50%

60%

70%

2024 2530 Over30

More 65.6% 29.6% 31.3%

Less 35.2% 71.3% 68.7%

0%

10%

20%

30%

40%

50%

60%

70%

80%

Source: Deutsche Bank November 2009 survey of 1,010 US consumers Source: Deutsche Bank November 2009 survey of 1,010 US consumers


16/96



Limited economic sensitivity,solid demographics

We highlight research below portraying spirits limited volatility as function of

economic weakness. While evidence of trade-down is clear, trade-out is not

happening as industry leaders position well to hold on to consumers in tough times.

This is especially critical for the Jack Daniels brand , a somewhat older, male crowd.

The industry also benefits from millenials a group of active tryers that appear

destined to follow the recent trend of growth in white spirits: rum, vodka and the

fastest growing tequila segment. On the latter, broadly Hispanic and Mexican cultural

influences in particular are seen underpinning growth.

1. Alcohol is a relatively defensive group

Alcoholic beverages tend to be defensive in times of economic difficulty. People may stopspending on expensive dinners out, vacations, shopping trips, and the like, but the vices are

often the last to go. That said, trade-down to more value is a fact of life across CPG, and the

best companies will adapt to what may be a more permanent state of thrift.

Short-term cyclicality:

Sensitivity to macroeconomic factors has taken on more importance in recent slowdown, and

requires more attention than we might otherwise devote to a category like spirits. Trade

down from high priced products to more affordable brands and alternatives is a realism in the

industry today, illustrated by our findings during recent channel checks (see section, Whats

Happening at Retail?).

Long-term defensive:

Constructively, longer-term data suggests spirits remains defensive broadly. We ran

correlations on 20 years of real US GDP growth data vs. consumer spending growth on

spirits and beer. Although visually we see more of a connection in the past 10 years, over the

entire period consumer spending on alcohol products shows no correlation to GDP growth.

Here we note that good or bad branding likely plays a greater role than just the economy.

Figure 15: Real PCE % Spirits vs. Real GDP Figure 16: Real PCE % Beer vs. Real GDP

6%

4%

2%

0%

2%

4%

6%

8%

10%

12%

1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008

RealGDP%

Spirits

Rsquared=0.0003

10%

8%

6%

4%

2%

0%

2%

4%

6%

8%

1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008

RealGDP%

Beer

Rsquared=0.08

Source: BEA Source: BEA

Trade down from high

priced products to more

affordable brands and

alternatives owes to

economic weakness as

illustrated by our findings

during recent channel

checks.

Over the entire periodconsumer spending on

alcohol products shows no

correlation to GDP growth.


17/96



Trade-down focus. High-end players have greater exposure to economic weakness.

The below charts portray these trends during the recent downturn, with growth in higher

priced spirits stalling while value tiers accelerated. Indeed on a state level, higher levels

of spirits consumption correlate with higher disposable income (DC has highest spirits

per capita consumption in the US according to Impact, and CA has highest per cap

consumption within the bourbon market), so there is economic sensitivity in play.

Figure 17: US spirits volume by price category (2009) Figure 18: Spirits volume growth % by bottle price

Value

41%

Premium

36%

HighEnd

16%

Super6%

(6)

(4)

(2)

0

2

4

6

8

10

12 Under$10

$10$15

$15$20

Over$20

Source: DISCUS Source: IRI data for Food/Drug/Mass channel, all US spirits brands by average bottle price

Another look at this from DISCUS data shows much more profound weakness in the highest-

priced spirits tiers in 2009, and a decline in their share of US spirits.

Figure 19: US spirits volume growth by price segment

0.6%

3.7%

0.6%

1.7%

5.5%

0.6%

3.5%

5.1%6%

4%

2%

0%

2%

4%

6%

8%

Value Premium HighEnd Super

2008

2009

Source: DISCUS

2. Demographics favor continued growth

Premium spirits and bourbon in particular face solid demographic trends in the coming years.

White male boomers represent a dominant population segment and they like their whiskey.

For marketers, the challenge is recruiting new old guys to the category, something

Diageos Johnny Walker brand has done quite successfully. At the same time millenials or

echo boomers provide a favorable backdrop for long-term, stable growth in the top white

spirits categories, vodka, rum, and tequila.


18/96



BFs largest driver, the bourbon category skews largely male and significantly older than

other categories like vodka, rum, and tequila. BFs core demographic market centers on the

Jack Daniels brand, which skews even more male (estimated at 82% in terms of brand

preference) than the bourbon category, somewhat younger, and heavily Caucasian (estimated

84% of drinkers).

This creates a far more concentrated core user group for BF. Marketing is therefore amore narrowly focused endeavor compared to most CPG companies, leading to more easily

identifiable demographic target markets. The key risk is the somewhat younger skew may

help Jack Daniels outpace competitors and take share thus the importance of its recent

tequila acquisition Herradura and the El Jimador brand specifically as it captures both young

and Hispanic consumer trends.

Figure 20: US spirits drinkers by sex Figure 21: US spirits drinkers by age

0%

10%

20%

30%

40%

50%

60%70%

80%

90%

100%

Bourbon Vodka Rum Tequila

Female

Male

23%30% 30% 30%

43%42% 45% 47%

33% 28%24% 22%

0%

10%

20%

30%

40%

50%

60%70%

80%

90%

100%

Bourbon Vodka Rum Tequila

55+

3554

2134

Source: Simmons Market Research, Impact 2007 Source: Simmons Market Research, Impact 2007

The data below outlines general demographics of Jack Daniels buyers specifically, showing

its share of US bourbon drinkers by characteristic. Most noticeable here is the skew towardshigher income levels, Caucasians, and the 21-24 age group.

More Jack and Coke over here! This means some clear opportunities to increase

penetration in non-core groups namely female consumers, African Americans and

Hispanics. However, given bourbons strong taste profile, expanding into new groups may

require renewed emphasis on mixability as it does not blend as smoothly as vodka or rum.

Unlike these however, the co-branding: Jack and Coke, Jack and Ginger is legendary and

offers an alternative to those eschewing whiskey , rocks or neat. As the chart below

highlights, 45% share of 21-24 year olds favoring Jack Daniels brand over-indexes overall

share.

Whiskey/Bourbon: Skews male,

older

Vodka, Rum, Tequila: Skews

younger, female

Given bourbons strong

acquired taste profile,

expanding into new groups

requires creativity around

mixability - its harder to

swallow for many vs. vodka

or rum.


19/96



Figure 22: Jack Daniels share of US bourbon drinkers

10%

15%

20%

25%

30%

35%

40%

45%

50%

Source:Simmons Market Research, Impact 2007


20/96



Vodka dominates categorygrowth

The last 10-years have been much kinder to spirits than the 90s. Ability to advertise

more freely, new distribution channels and importantly the rise of RTD brands

(Smirnoff Ice, Jack and Cola) all played a role. Remarkably Jack Daniels has grown

despite not being a vodka the dominant driver of spirits in the last 30 years. Brands

do matter. That said, migration of the portfolio into tequila was not only timely, but

quite vital to long-term growth in our view.

1. White spirits driving 3-4% annual category growth

White spirits growing 4-5%: White goods consist primarily of vodka, tequila, and rum,

which have driven the lions share of growth in spirits for the last several decades. The charts

below illustrate these trends since 2000, showing that the top white goods categories haveout-performed the industry since 2000 while other categories, namely whiskey, have under-

performed.

Whiskey & other specialties flat to +2%: Whiskey in particular has experienced a long-term

maturation process and stabilized into a modest volume growth category. However, the

growth in white spirits has driven this category down from more than 50% share of U.S.

spirits before 1970 to less than 25% for 2010E. White spirits have taken over the category at

over 50% share.

Figure 23: US spirits consumption by volume (2010E) Figure 24: US alcohol consumption CAGR (2000-2010E)

Vodka,

31.4%

Imported

Whiskey,

12.8%Rum,13.0%

Cordials,

11.1%

Domestic

Whiskey,

10.6%

Brandy,5.8%

Tequila,6.2%

Gin,5.6%Other,

3.6%

5.0%4.7%

4.3%

2.7%

1.9%

1.3%

0.4% 0.3%

0.2%

1.0%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

Vodka Tequila Rum Tot.

Alcohol

Cordials Brandy Dom.

Whiskey

Imp.

Whiskey

Gin

Source: Impact, DISCUS, Euromonitor, DB estimates, NABCA Source: Impact, DISCUS, DB estimates

Niche growth opportunities for 2010 and beyond: DB expects niche areas to offer some

of the most significant growth opportunities over the next few years. These would include

luxury bourbon and vodka, tequila, new and exotic flavors across a variety of categories. This

should add incremental fuel to volume growth for heavy whiskey players like Brown-Forman.

As noted earlier, the demographic convergence appears to set up quite well for tequila.

White goods consist

primarily of vodka, tequila,

and rum, which have driven

the lions share of growth in

spirits for the last several

decades.


21/96



2. A slow but stable US growth outlook

Low single digit growth: BF does not maintain specific company-level volume targets, but

in terms of the LT outlook, management expects the US spirits market to sustain modest

volume growth. The company stresses BFs low overall share of US spirits (we estimate 5-

5.5%) leaving room for continued upside, and the long-term premiumization trend in spirits,

which would benefit its higher priced lead brands vs. the overall category.

Niche markets are most compelling: In addition to driving uptake of the lead Jack Daniels

franchise, we also think some of the most significant growth opportunities will come in the

smaller niche growth categories (i.e. luxury bourbon and tequila) and further line extensions.

This should add incremental fuel to volume growth, but the fact is that BF is tied to the

relatively low-growth whiskey category and Jack Daniels already has high penetration. In our

minds this suggests that a low single digit volume growth outlook in the US is

reasonable for our estimates. This assumes per capita consumption in trends remain

stable, BFs brands and marketing relevant and effective, and of course depending on pricing.

Consistency is the critical factor: BF offers entry into stable growth categories and has

some higher-growth niches, but it is important to temper expectations. Against the broaderUS spirits industry, BFs chips are stacked hugely in the whisky category, and to a much

lesser extent, vodka and tequila. Faster growth in the smaller luxury whiskey and tequila

categories are a good supplement, but Finlandia has struggled to top growth of vodka

category, and most of BFs growth is tied to the slower whiskey segment. Therefore while

no reasonable investor will expect high volume growth rates in the US market, in our view

the most important criteria investors will be delivering modest but consistent volumes with

consistent profit growth.

3. Whiskey, leave the bottle

The broad whisky category (including domestic whisky, bourbon and imports like

Scotch/Canadian) is the second largest in the US as a category, behind vodka. If we drill

down further, domestic whiskey including the bourbon category is fourth largest (behind

imported whiskey and rum). It has performed at an essentially flat volume CAGR from 2000

through our 2010 estimate (+0.4%), which is at the low end of the spectrum (i.e. vodka and

tequila +5%).

Losing share to white spirits:

Although volume CAGR has been slightly positive this decade, domestic whiskey has

therefore lost share within spirits over the past decade. In our view long-term favorability of

white spirits like vodka owes to:

1. Drinkability less distinct taste profile and milder vs. bourbon, scotch, etc.

2. Mixability, which easily lends itself to marketing flavored line extensions and

combinations with various mixers.

Forging long-term, sticky connections with consumers:

In contrast whisky and bourbon are a harder initial sell given a much more acquired taste

profile. On the downside this makes initial consumer acceptance more difficult, but on the

upside creates more category/brand loyalty once the initial connection is established.

We believe it also means that bourbons, like Jack Daniels, with a more unique taste and

brand message will be stickier with consumer and can outperform the category.

Against the broader US

spirits industry, BFs chips

are stacked hugely in the

whisky category, and to amuch lesser extent, vodka

and tequila.


22/96



This also means the bourbon category can do a better job at marketing. For instance, the

larger Canadian whisky segment has been able to outgrow bourbon in the US. BF

management specifically sees opportunities to improve marketing around Jack Daniels

mixability, as an alternative to the scotch occasion, and as a shot alternative to tequila.

Figure 25: BF bourbon volume CAGR (2000-2010E)

24%

9% 8%

3%1%

4% 4%

10%

5%

0%

5%

10%

15%

20%

25%

Source: Impact, DISCUS, IRI, DB estimates, NABCA

High end = growth:

Some of the best growth in whisky has been in higher-end bourbons, which BF has

capitalized on, and which have gained share in the category. It is another indication of the

ability to adapt and market successfully. Consider the fact that the core Jack Daniels brand

tracked behind Jim Beam as the #1 US bourbon until 1995, when it overtook the #1 spot. BF

has also enjoyed great success with the high-end brands Gentleman Jack (FY09

volume +20%, nearing 300k cases) and Woodford Reserve, launched in 1987 and 1996respectively. These brands still comprise a small share of the category (luxury brands are a

relatively new category within the past 10-15 years) but provide a source of growth for BF.

Tequila A growth category, expensive is better

Attractive growth characteristics:

In the US, tequila growth is underpinned by expanding awareness, particularly of smoother

high-end products, and growth of the Hispanic population (although estimated 80% of tequila

drinkers are Caucasian). Tequila is also more geographically concentrated than other spirits --

CA comprises 20-25% of tequila sales, with TX the second largest state (highest per capita

consumption in NV, DC, CA). Aside from its attractive leverage to growth of the US Hispanic

population, tequila is also one of the highest priced spirits categories, and drinkers skewslightly higher income than spirits overall, and slightly younger (54% of drinkers are under age

45). This helps explain the category ability to sustain high growth rates at higher price points.

Compelling BF opportunity:

Much of the growth in tequila falls into the super premium and luxury categories, in which BF

is a major participant. BF is the fourth-largest global tequila producer (Euromonitor) based on

its presence in the US/Mexico market, and is positioned well against a growth tailwind in

these markets. BFs acquisition of the Casa Herradura high-end tequila brands in FY07

added a long-term growth outlet to complement the slower growth bourbon category

and Jack Daniels. BF tequila depletions came in at +6% globally in FY09, with constant-

currency sales +6%.

Jack Daniels brand tracked

behind Jim Beam as the #1

US bourbon until 1995,

when it overtook the #1

spot.

Much of the growth in

tequila falls into the super

premium and luxury

categories, in which BF is a

major participant.


23/96



Figure 26: US tequila market (thous. cases) Figure 27: US tequila CAGR by price tier (2000-07)

3.3%

3.4%

3.5%

3.6%

3.7%

3.8%

3.9%

4.0%

4.1%

4.2%

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010E

Competitorbrands

BFbrands

BFshare

45%

10%

5%2%

1%5%

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

Luxury( +$40) S upe r

premium($25

40)

US Tequila

Mkt

Premium

($1025)

Subpremium

(


24/96



Brands come first within afragmented market

Sprits consumers try a lot, but more than other categories are drawn to badge and

image. Premium brands dominate, but the Top 10 brands represent just 28% share or

just a bit more than Bud and Bud Light total in beer. The Top 100 represent 75-80%

share, but within brand houses more than 50% of share rests within the Top 5, (BF is #6

with a 5% share.) In short, even the giants are not insurmountable, and consumers are

more willing to try new things. This creates opportunity to innovate, but challenges in

rising above the din.

1. Brand equity is the key to success

Brand equity is king in the spirits industry, and the most significant driving factor in brand

equity is taste profile, according to our extensive proprietary research. The fragmented natureof the spirits industry creates intense competition relative to other beverage categories like

soft drinks and beer.

Figure 28: US spirits market share (2009E)

Other,

32%

Diageo,

23%

Bacardi,

9%

Fortune,

9%

Pernod,

7%

Sazerac,

7%

BF,5%

Heaven

Hill,5%STZ,3%

Source: Impact, NABCA, DISCUS,, IRI, Deutsche Bank estimates

Brand leadership is critical to competitive edge

Given the high profitability of successful spirits, it makes for a relatively tough playing field

against a large number of entrants, and highlights the central importance of brand equity.

Despite BFs smaller scale vis--vis the Diageo, Fortune and Pernod, and lack of presence in

some categories, we believe that strong brands in its chosen categories and brand-buildingcapabilities provide competitive advantage and long-term growth potential.

Must-Have, Must-Stock - Jack. Lets be honest, can it really be a fully stocked bar without

Jack Daniels? And can you really say that as readily about any other brand? Brand leadership

is essential to gaining leverage with distributors and retailers, commanding shelf/display

space, and generating marketing buzz. Despite limited portfolio breadth, we believe BF is

well positioned by owning the #1 bourbon brand, Jack Daniels, which has among the

highest channel penetration of any spirits brand, the #3 Canadian whiskey brand in the US,

significant niche brands in Southern Comfort, Finlandia, and a strong tequila growth portfolio.

The fragmented nature of

the spirits industry creates a

competitive environment,

with only about 28% market

share held by the 10 largest

US brands.

Brand leadership is essential

to gaining leverage with

distributors and retailers,

commanding shelf/display

space, and generating

marketing buzz.


25/96



Figure 29: Top 10 US spirits brands & BF brands (2009E case volume)R ank B rand 2009E case vo l.

1 Smirnoff (Diageo) 10.1

2 Bacardi (Bacardi) 8.6

3 Cpt. M organ (Diageo) 6.1

4 Absolut (Pernod) 4.7

5 Jack Daniel's (BF) 4.6

6 Crown Royal (Diageo) 4.27 Jose Cuervo (Diageo) 3.8

8 E&J (E&J Gallo) 3.7

9 Grey Goose (Bacardi) 3.3

10 Jagermeister (Sid. Frank) 3.1

Canadian M ist (BF) 1.7

Southern Comfort (BF) 1.4

Early Times (BF) 0.6

Finlandia (BF) 0.3

Gentleman Jack (BF) 0.2

El Jimador (BF) 0.2

Pepe Lopez (BF) 0.1

Tuaca (BF) 0.1 Source: Impact, NABCA, IRI, DB estimates

Taste is critical to brand leadership

Our research indicates that taste not image, not price -- is by far the most important

decision driver for consumers in the alcohol category. Jack Daniels carries a certain

successful image among its drinkers, but its differentiated taste profile appears most

important to consumer loyalty, once they try it. If you hitch your wagon to a few horses,

youd better have good horses, and BF does.

Figure 30: DB survey -- Why do you prefer your favorite alcohol brand?

Taste Price Drinkability Image Other

2024 83.7% 30.7% 50.2% 11.2% 2.8%

2530 86.7% 7.6% 45.7% 8.6% 1.9%

Over3087.2% 11.6% 31.4% 5.8% 5.8%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Source: Deutsche Bank November 2009 survey of 1,010 US consumers

Strong brand with great taste = pricing power & competitive barriers

While the spirits category operates at a higher price point and therefore can be more price

competitive than other categories, brand equity and taste profile can create a competitive

barrier at the brand level.

Much of Jack Daniels success in our view is attributable to (1) consistency of marketing

(driving premium equity and awareness), as well as (2) differentiated taste attributes. Given

that bourbon is an acquired taste (and differs across products to a far greater extent than in

vodka for example), we believe there is a greater propensity for bourbon drinkers to stick to

their brand.

Much of JDs success in our

view is attributable to (1)

consistency of marketing

(driving premium equity and

awareness), as well as (2)

differentiated tasteattributes.


26/96



This also makes the marketing investment and effectiveness critical, and BF has proven

successful at doing so. Marketing the Jack Daniels brand remains the overwhelming focus

of BF management, and by reinforcing it over time, has created high levels of consumer

loyalty, which in turn allows the brand to sustain high price points and profits per case. It also

lends itself to an ability to grow Jack Daniels -brand line extensions (more below). Finally, we

note that this (plus long production times) enhances high barriers to entry.

Figure 31: Leading bourbon brands, price per bottle (4Q09)

$0

$5

$10

$15

$20

$25

$30

$35

$40

Gent.

Jack

Maker's

Mark

Wild

Turkey

Jack

Dan.

Black

SoCo Jim

Beam

Evan

Williams

Early

Times

Old

Crow

Source: IRI

Our prior consumer research indicates taste is by far the dominant decision driver for alcohol

brands, and that cost ranks much lower. Both are favorable factors for JD, which scores high

on taste and among the most popular of any brand. In our 2009 survey of alcohol brand

preference, JD ranked in the top 3 for spirits brands mentions, above its overall #5 spot in USspirits, and close to the top scoring equity brand like Grey Goose.

Figure 32: DB survey What is your favorite alcohol brand?

05

10

15

20

25

30

35

40

GREYGOOSE

COORS/LIGHT

SMIRNOFF

BUD

BUDLIGHT/LIME

JACKDANIELS

ABSOLUT

KETTLEONE

CAPTAINMORGAN

SKYY

CORONA

SAMADAMS

BLUEMOON

HEINEKEN/LIGHT

BACARDI

GUINNESS

MALIBU

MILLER/LITE

JAMESON

JOHNNIEWALKER

JIMBEAM

BELVEDERE

KEYSTONE/LIGHT

MAGICHAT

NEWCASTLE

SVEDKA

MARKERSMARK

NATURALLIGHT

PATRON

SIERRANEVADA

STELLA

YUENGLING

BAREFOOT

BOMBAY

JAGERMEISTER

JOSECUERVO

STOLICHNYA

Source: Deutsche Bank November 2009 survey of 1,010 US consumers


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2. Category price elasticity in detail

A higher margin business

Spirits offers higher profit margins given higher average unit price points. For instance, BFs

leading position in the premium spirits and above-category pricing strategy drives high

margins/profits per case, supported by a narrower portfolio of strong lead brands, and brand

stickiness/loyalty in bourbon. Our research indicates that price points rank relatively low as a

decision driver for spirits drinkers, allowing BF to thrive and grow with some of the highest

priced brands in the industry.

with greater vulnerability to price competition

Higher prices foster vulnerability to consumer trade down in times of economic difficulty,

illustrated by the promotional skirmishes prevalent throughout the 2009 downturn. This trend

has had a clear negative impact on BFs price/mix gains, even as global volume growth

remained stable through the downturn. Since BF provides no sales decomposition in terms

of price/mix vs. volume, the best proxy we have is IRI retail pricing data. Below we have

broken out retail pricing growth for BFs spirits portfolio in IRI it is an imperfect indicator

since it also captures changes in distributor/retail pricing, but gives us a gauge nonetheless. It

confirms is that pricing power has stayed resilient, but there has been a clear impact from theeconomy, as gains decelerated in 2009.

Figure 33: Avg. price/volume of BF brands (FY09) Figure 34: Retail pricing growth of BF spirits

$0

$10

$20

$30

$40

$50

$60

Herradura

Chambord

Woodford

Gent.Jack

ElJimador

JDBlack

JDGreen

SoCo

Finlandia

PepeLopez

Spiritscategory

CanadianMist

EarlyTimes

0

1

2

3

4

5

6

7

8

04/01/05

07/01/05

10/01/05

01/01/06

04/01/06

07/01/06

10/01/06

01/01/07

04/01/07

07/01/07

10/01/07

01/01/08

04/01/08

07/01/08

10/01/08

01/01/09

04/01/09

07/01/09

10/01/09

01/01/10

Source: IRI Source: IRI

Given the intense competitive field, this makes the longer-term direction of US

pricing/promotion a key issue for investors. While we believe BF boasts excellent pricing

power overall (especially around Jack Daniels), we remain cautious on price/mix forecasts,

for three reasons:

Increased promotion to sustain share. High degree of competition and promotion in

spirits, which has intensified in 2009 as consumer spending slowed and does not appear

to be improving yet.

Industry pricing below CPI historically. It has been mix, not front line pricing that has

improved rev per over the past two decades, as spirits category pricing has had trouble

keeping up with CPI inflation. This in our view is a function of brand fragmentation and

slow consumption growth in the industry.

Our research indicates that

price points rank relatively

low as a decision driver for

spirits drinkers, allowing BFto thrive and grow with

some of the highest priced

brands in the industry.

Spirits is generally

estimated to be at the

higher end of the alcohol

beverage scale in price

elasticity.


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Figure 35: US spirits price/volume growth vs. CPI

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

USCPI%

Spiritsprice%

Spiritsvol.%

Source: Impact, BLS

Price elasticity greater than beer:

Although estimates vary, spirits is generally estimated to be at the higher end of the alcohol

beverage scale in price elasticity. While elasticity it is not as high as in soft drinks for example

(less-easily substitutable product), there still is significant responsiveness to price changes.

This is aggravated by the large number of brands/competitors in the space in our view there

is no rational duopoly here like in beer. Below we show two of the most widely cited price

elasticity estimates from academic research.

Figure 36: Price elasticity (Leung/Phelps

study)

Figure 37: Price elasticity (Nelson study)

(0.3)

(1.0)

(1.5)(1.6)

(1.4)

(1.2)

(1.0)

(0.8)

(0.6)

(0.4)

(0.2)0.0

Beer Wine Spirits

(0.2)

(0.6)

(0.4)

(0.7)

(0.6)

(0.5)

(0.4)

(0.3)

(0.2)

(0.1)0.0

Beer Wine Spirits

Source: S.F. Leung and C.E. Phelps, My Kingdom for a Drink, 1993 Source: J. P. Nelson 1997

BF recently deployed tactical pricing to hold share

The risk of trade down makes price promotion a key tactic to increase brand popularity and

relevance, especially in periods of economic weakness. In 2008 amid the teeth of the

downturn, BF management laid out a strategy for incremental promotion on Jack Daniels(which is promoted frequently off-premise) on a market-by-market basis to address

affordability issues, while avoiding a race to the bottom in pricing.

Short-term: BF will use price promotion as a strategic lever, as we have seen this year, with

global price/mix up only about +0.5% YTD, US retail pricing growth flattening out and

Finlandia repositioned.

Long-term: We are not seeing a change to long-term pricing strategy (with the exception of

Finlandia), and as long as we do not see significant negative pricing, this helps keep the

brands relevant and well positioned for an eventual economic upturn. Management also will

not reposition the lead brands on a price basis simply to generate volume growth

this is crucial in our view to guard against damaging brand equity.


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Alternative tactics: bundling: Alternatives include couponing on Jack Daniels brand family

(i.e. to offer value but also trade consumers up to Gentleman Jack), and non-price based

tactics like line extensions and repackaging to offer value in other ways.

Figure 38: US spirits volume growth by price tier

(6)

(4)

(2)

0

2

4

6

8

10

12

03/01/05

05/01/05

07/01/05

09/01/05

11/01/05

01/01/06

03/01/06

05/01/06

07/01/06

09/01/06

11/01/06

01/01/07

03/01/07

05/01/07

07/01/07

09/01/07

11/01/07

01/01/08

03/01/08

05/01/08

07/01/08

09/01/08

11/01/08

01/01/09

03/01/09

05/01/09

07/01/09

09/01/09

11/01/09

Under

$10$10$15

$15$20

Over$20

Source: IRI data for Food/Drug/Mass channel

In 2009 category price promotion was a source of pressure, as competitors and distributors

have been more aggressive, particularly around the holiday season. We view it as one of the

key risks to monitor, not only for the impact on profitability but also because it registers as

one of the biggest factors for investor perception of the company. BF management has

spoken plainly about a more aggressive promotional environment this year, and although this

is factored into our estimates, we would like to see some abatement. Although BF isinsulated somewhat by its leading position in bourbon and global growth opportunities,

promotion is a key risk to the extent that the larger players would be willing to use it as a

blunt competitive instrument. In 2009, more promotional pressure derived from size leaders

Diageo/Pernod, and less from smaller competitors. As a smaller player, irrational pricing

would exert proportionately more pressure on BF, although one wonders if cheap vodka or

gin can truly effect whiskey as consumers tend to have varied tastes by occasion.

3. Scale: bigger is not always better

Scale is important to growth, given the need to command attention from US distributors,

retailers, and on-premise bartenders. Scale also leverages the cost of direct sales and

advertising/marketing spend across the portfolio more dollars to put behind the brands.However, bigger does not always mean better.

Small stable, with strong lead horses. Although there are clear advantages to scale, we

believe a small stable of good lead horses can provide a solid backdrop for superior sales and

profit growth. Despite its smaller size vs. global spirits competitors (#6 in the U.S.), BF

appears well positioned based on the following factors:

1. Jack Daniels is a must-have, based on high profitability and #1 position in bourbon

2. Strong brand portfolio, with leading up-and-comers in attractive categories.

Although there are clear

advantages to scale, we

believe a small stable of lead

horses can provide a solid

backdrop for superior sales

and profit growth.


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Structural limitations on scale: The three-tier US distribution system is also something of a

leveling factor for successful brands. Unlike in beer, where a distributor is majority aligned

with a given brand house and puts most of its resources against those brands, the large

spirits distributors typically carry a full product portfolio across categories/brands, and interact

with a wider array of suppliers. These distributors live or die by leveraging sales and margins

against a fixed cost base, which also makes profitability at a brand-level crucial to them.

Therefore a spirits companys sheer size can add leverage to the relationship, but strength ofindividual brands (popularity, growth prospects, profit per case) is most important. This is a

key positive for BF, since a brand like Jack Daniels is must-have in terms of popularity and

profitability.

Alliances & Partnerships: A secondary tactic utilized by BF to improve leverage in the trade

is the sales alliance. In 2008, BF launched alliances with Bacardi and Remy Cointreau in

certain US markets, with a committed sales force across the three brand portfolios, to

increase clout with retailers and on-premise channels. New York was the first alliance

market launched, and in 2009 this partnership was stepped up to include more states. This is

a similar strategy to that deployed by STZ in wines this year: consolidating distributors in an

effort to gain more committed sales representation in the field.

Outside the US (which we discuss further in the International section of this report), BF

employs a mix of owned distribution and partnerships. Partnerships with other spirits

companies allow it to capitalize on their strength and distribution in each local market (i.e.

Campari in Italy). BF management also believes that distribution scale is less of an issue in

many of the overseas markets, given a higher concentration of drinkers in certain of these

geographies (meaning not as much geographic coverage is needed through an owned

distribution system). The downside is obviously reliance on partners and less control over the

selling process (as well as less cost leverage), but we expect increasing investment in

distribution to improve control in key overseas markets as BF gains scale.


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Alcohol innovation trends

We believe spirits have a fundamental share of stomach opportunity with consumers

as the leaders in beer domestically have seen new product pipelines dry up,

suggesting a dangerous risk to any beer investor or management seeking to primarily

cost-cut ones way to prosperity. Consumers need a reason to use ones product or

else they may just go away. As wines constant product flow is to some degree

systemic (new grapes, varietals, regions, etc), the break-through potential squarely lay

in the hands of spirits and smaller craft beer at present.

Three-year innovation data from Mintel suggests a greater volume of innovation in wine and

among smaller brewers beer compared to a more concentrated and focused innovation

strategy in spirits. Much of the spirits industry innovation has focused on the growth

categories, primarily in white spirits, while whiskey has seen innovation activity in high-end

brands where growth still exists for this category.

The wine industry has introduced the highest number of new innovations compared to othercategories, (538) with beer coming second at 468 and spirits third with 358. Wine also leads

in new product introductions versus packaging or line extensions, while beer has relied more

on packaging and range extensions. Spirits ranks in the middle in terms of proportionate use

of new products, which comprised 60% of all innovation. Here we note the highly

fragmented nature of wine, regular shift in varietals and regions explains some of this.

Figure 39: Alcoholic beverage new products in US since 2007

New Product New Packaging Range Extension TotalSpirits 215 49 94 358Wine 398 71 68 537Beer 233 83 152 468

0200400600800

1,0001,2001,4001,600

Source: Mintel

1. Wine category: Loading up on new brands

Wine has been the most innovative category in the industry over the past three years in

terms of quantity of new product, mostly in the form of new brands. Constellation Brands,

Wine Group, and Gallo lead, each with about a 5% share of new products. Overall, six major

wine companies account for about 20% of all innovation, showing the extreme fragmentation

in the industry. Brown-Formans wine businesses created 1% of industry innovation during

this period, suggesting spirits is rightly the focus.

The wine industry has

introduced the highest

number of new innovations

compared to other

categories, with beer

coming in second, and

spirits third.


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Figure 40: Wine Innovations by Company since 2007

New Product New Packaging Range ExtensionFoster's 1 8 1Altria/UST 2 0 2Brown-Forman 3 1 1E & J Gallo 15 6 3The Wine Group 11 1 7Constellation Brands 13 17 4

01020304050

Source: Mintel

2. Beer: Can you really cost-cut your way to prosperity?

Beer under indexes against its share of the alcohol market in terms of innovation. This

owes in part to high new brand launches in wine, however beer also has innovated

proportionately less than wine/spirits in new product, and been more reliant on repackaging

and line extensions. More ominously, the leading 4 brand houses ABI. MC, Heineken

and Crown delivered just 23% of product innovations despite controlling 80% of

market share. While some of this is due to rapid innovation in craft segment, ABI and Miller

Coors number of new products is far below their share of the beer market. MC in particular

has been heavily reliant on new packaging formats as opposed to new products, while we

see smaller players strongly outpacing in terms of line extensions, such as SAMs successful

line of seasonals. These data highlight spirits clearest opportunity in our view. The zeal withwhich ABI in particular cuts cost has a risky downside: its consumer base will look

elsewhere for new drinks.

Figure 41: Beer innovation by company since 2007

New Product New Packaging Range ExtensionBoston Beer 1 0 10Diageo 0 0 2Constellation Brands 2 6 0Heineken 1 5 1Molson Coors 3 24 19Anheuser-Busch 15 16 19

0102030405060

Source: Mintel


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3. Spirits - white spirits lead growth

US spirit industry has released an estimated 358 innovations over the past three years. Six

major companies with operations in the US account for just over 50% of volume and about

30% of innovation. Brown-Forman ranks fourth, tied with Fortune Brands, with about 5% of

all innovations in this period. Diageo and Pernod lead, with 7% and 8% respectively, and

have been most active with new products versus repackaging and line extensions.

Figure 42: Spirits innovation by company since 2007

New Product New Packaging Range ExtensionBacardi 3 8 2Pernod R icard 11 7 10Diageo 12 1 11Fortune Brands 5 3 10Constellation Brands 1 1 2Brown-Forman 4 7 6

01020304050

Source: Mintel

The chart below reveals that the vodka category has introduced the largest number of new

products (particularly reformulations, line extensions), reflecting its leading size position in

spirits and consumption growth. Whiskey ranks a distant second, and perhaps most

surprising is the large amount of new tequila products vs. its small share of the category, afunction of more brands and companies chasing growth.

Figure 43: Spirits innovation by type since 2007

New Product New Packaging Range Extension TOTALWhisky 26 13 13 52Vodka 92 17 55 164Tequila 43 3 4 50Others 54 16 22 92

050100150200250300350400

Source: Mintel

The vodka category has

introduced the largest

number of new products

(particularly reformulations,line extensions), reflecting

its leading size position in

spirits and consumption

growth.


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BF Innovation Strategy: Line extensions are BFs innovation brand of choice, and have had

relatively good success based on existing equity of the Jack Daniels brand and bona fides in

bourbon. Increasingly the company is also having success with revamped packaging for

priority brands.

Although this strategy creates some controversy in terms of potential for over-extension or

risk to brand equity, as long as it is disciplined, we regard it as a viable support for growth, forseveral reasons. (1) Strong brand equity and consumer awareness of the lead brands

provides a good platform. (2) Raises awareness of the base brands and creates more

consumer impressions. (3) Success of previous line extensions such as Gentleman Jack and

RTD Jack Daniels cocktails. (4) BF has a track record of introducing new product in limited

form and avoiding over-extension. (5) This strategy avoids the cost of completely new

product launches or M&A to exploit growth opportunities.


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3-tier system & regulation

Spirits regulation is a significant factor for the industry. We highlight the regulations

governing the distribution and retailing of alcoholic drinks below. In 19 control states,

state government has a total or partial monopoly on distribution of alcohol, while 31

open states operate in the three-tier system, which regulates production, distribution,

and retailing of alcohol under three independent groups. Federal taxes, and then

varying taxes at the state level can present a significant impediment to growth.

Broadly, taxation and distribution limits present greater challenges for spirits than beer

or wine.

Figure 44: Alcohol Segment availability by channel in 30 most populous states

=permitted =partia l = not permitted

Grocery C-store Liquor Grocery C-store Liquor Grocery C-store LiquorCal iforniaTexasNew YorkFloridaI l l inoisPennsylvaniaOhioMichiganGeorgiaNorth CarolinaNew JerseyVirgini

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