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Company

North America United States Consumer Beverages

28 March 2010

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

FITT Research Buy


Price at 26 Mar 2010 (USD) Price target 52-week range 57.29 64.00 58.01 - 38.32

Global Markets Research

Whiskey, neat; initiate at Buy


Marc Greenberg, CFA
Research Analyst (+1) 203 863-2355 marc.greenberg@db.com

Price/price relative
70

Andrew Kieley, CFA


Research Analyst (+1) 212 250-7817 andrew.kieley@db.com

60 50 40 30 20 3/07 9/07 3/08 9/08 3/09 9/09


Brown-Forman S&P 500 INDEX (Rebased)

Fundamental, Industry, Thematic, Thought-Leading Deutsche Bank Company Research's Product Committee has deemed this work F.I.T.T. for investors seeking differentiated ideas. Here our beverage analysts initiate coverage of Brown-Forman with a Buy rating, while assessing positive trends in US spirits category relative to beer.

Fundamental: Jack Daniels Alcohols strongest Americana brand Industry: Spirits leaders are focused on brand loyalty, beer on profits Thematic: BF can win the marathon, if not the sprint Though Leading: Treated like a shareholder? Yep

Performance (%) Absolute S&P 500 INDEX

1m 8.2 5.7

3m 7.5 3.5

12m 43.0 43.2

Thoughtful, consistent, long-term global investment behind the iconic whiskey it made famous underpins our constructive view of Brown-Forman. Amidst beer category decline (and in particular brand Budweiser), the old guy from Tennessee has maintained growth. High-single-digit EPS growth, compelling ROIC, consistent return of cash and attractive long-term growth support out Buy rating, $64 TP.

Stock & option liquidity data


Market Cap (USDm) Shares outstanding (m) Free float (%) Volume (26 Mar 2010) Option volume (und. shrs., 1M avg.) 8,466.2 147.8 100 81,600 3,750

Rational beer duopoly (ABI and MillerCoors) matters little to consumers choosing brands. Our research portrays spirits leaders as more innovative, promoting more, establishing loyalty with younger consumers. Our downgrade of TAP today factors in domestic margin erosion as investment re-accelerates, pricing erodes. Brown-Forman should continue to raise exposure to growth markets abroad and segments at home gradually, via new distribution, brand acquisition, innovation. This approach may not make every quarter clean, but sustains a strong franchise. Recent legacy of closely held or family controlled alcohol beverage companies gives pause regarding the benefit from strategic deals like MillerCoors, formation of ABI, and various iterations at Constellation over the years, owing to both share volatility and limited return of cash. In contrast, Brown-Forman treats investors like family: 10-year annualized dividend growth: 9.4% (40% payout ratio), 10-year share price appreciation: 228% (12.6% annualized).

Implied & Realized Volatility (3M)


80% 60% 40% 20% 0% Nov 08
Realized Vol

May 09
Implied Vol (ATM)

Forecasts and ratios


Year End Apr 30 1Q EPS 2Q EPS 3Q EPS 4Q EPS FY EPS (USD) P/E (x) Dividend yield (%) 2008A 0.61 0.83 0.75 0.62 2.81 19.9 4.2 2009A 0.69 0.94 0.68 0.58 2.90 17.6 2.2 2010E 0.81A 0.99A 0.80A 0.56 3.16 18.1 2.1 2011E 0.87 1.08 0.85 0.62 3.42 16.8 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 firm may 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

28 March 2010

Beverages Brown-Forman
Fiscal year end 30-Apr

Model updated:26 March 2010

2007
2.51 2.51 0.93 10.24 3.1 22.4 22.4 5.0 3.6 1.7 3.4 14.6 15.7

2008
2.81 2.81 2.36 11.27 2.6 19.9 19.9 4.8 5.7 4.2 2.9 12.8 13.8

2009
2.90 2.90 1.12 12.07 2.4 17.6 17.6 3.9 5.9 2.2 2.6 11.7 12.6

2010E
3.16 3.16 1.18 13.04 2.6 18.1 18.1 4.4 5.3 2.1 2.8 11.6 12.6

2011E
3.42 3.42 1.25 14.66 2.5 16.8 16.8 3.9 5.5 2.2 2.6 10.4 11.1

2012E
3.72 3.72 1.36 16.23 2.4 15.4 15.4 3.5 6.3 2.4 2.4 9.4 10.1

Running the numbers North America United States Beverages

Financial Summary
DB EPS (USD) Reported EPS (USD) DPS (USD) BVPS (USD)

Valuation Metrics

Brown-Forman
Reuters: BFb.N Bloomberg: BF/B US

Price/Sales (x) P/E (DB) (x) P/E (Reported) (x) P/BV (x) FCF yield (%) Dividend yield (%) EV/Sales EV/EBITDA EV/EBIT

Buy
Price (26 Mar 10) Target price 52-week Range Market Cap (m) Company Profile
Brown-Forman is an alcohol beverage company in the premium spirits and wine categories. Leading spirits brands are Jack Daniel's, Southern Comfort and Finlandia, and Fetzer and Korbel in wine. Brown-Forman biggest geographic market 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.

USD 57.29 USD 64.00 USD 38.32 - 58.01 USDm 8,466 EURm 6,319

Income Statement (USDm)


Sales EBITDA EBIT Pre-tax profit Net income 2,806 647 603 586 390 3,282 737 685 644 435 3,192 716 661 630 439 3,196 773 716 687 469 3,301 840 785 751 502 3,448 897 839 810 543

Cash Flow (USDm)


Cash flow from operations Net Capex Free cash flow Equity raised/(bought back) Dividends paid Net inc/(dec) in borrowings Other investing/financing cash flows Net cash flow Change in working capital 355 -41 314 27 -143 595 -1,059 -266 -80 534 -47 487 -212 -362 -172 9 -250 28 491 -37 454 -45 -169 -6 -13 221 -18 490 -45 445 -153 -174 -233 0 -115 -41 510 -53 457 -93 -182 0 0 182 -53 577 -58 519 -143 -196 0 0 180 -30

Price Performance
70 60 50 40 30 20
Mar 07 Sep 07 Mar 08 Sep 08 Mar 09 Sep 09
S&P 500 INDEX (Rebased)

Balance Sheet (USDm)


Cash and cash equivalents Property, plant & equipment Goodwill Other assets Total assets Debt Other liabilities Total liabilities Total shareholders' equity Net debt 369 506 670 2,006 3,551 1,177 801 1,978 1,573 808 119 501 688 2,097 3,405 1,006 674 1,680 1,725 887 340 483 675 1,977 3,475 999 660 1,659 1,816 659 225 471 675 1,974 3,345 766 652 1,418 1,927 540 407 469 675 2,005 3,556 766 650 1,416 2,140 358 587 469 675 2,044 3,775 766 667 1,432 2,343 178

Brown-Forman

Margin Trends
27 26 24 23 21 20
07 08 09 10E 11E
EBIT Margin

Key Company Metrics


12E
EBITDA Margin

Sales growth (%) DB EPS growth (%) Payout ratio (%)

14.8 8.1 36.6 23.0 21.5 24.9 51.4 37.0

17.0 11.9 83.2 22.5 20.9 26.3 51.4 16.5

-2.7 3.0 38.5 22.4 20.7 24.8 36.3 21.3

0.1 9.1 37.1 24.2 22.4 25.1 28.0 24.9

3.3 8.1 36.3 25.4 23.8 24.7 16.7 23.4

4.4 9.0 36.2 26.0 24.3 24.2 7.6 29.0

Growth & Profitability


20 15 10 5 0 -5 07 08 09 10E 11E 12E 27 27 26 26 25 25 24 24 23

EBITDA Margin (%) EBIT Margin (%) ROE (%) Net debt/equity (%) Net interest cover (x)

DuPont Analysis
EBIT margin (%) x Asset turnover (x) x Financial cost ratio (x) x Tax and other effects (x) = ROA (post tax) (%) x Financial leverage (x) = ROE (%) annual growth (%) x NTA/share (avg) (x) = Reported EPS annual growth (%) Source: Company data, Deutsche Bank estimates 21.5 0.9 1.0 0.7 12.4 2.0 24.9 -0.3 10.1 2.51 8.1 20.9 0.9 0.9 0.7 12.5 2.1 26.3 5.9 10.7 2.81 11.9 20.7 0.9 1.0 0.7 12.8 1.9 24.8 -6.0 11.7 2.90 3.0 22.4 0.9 1.0 0.7 13.8 1.8 25.1 1.1 12.6 3.16 9.1 23.8 1.0 1.0 0.7 14.5 1.7 24.7 -1.5 13.8 3.42 8.1 24.3 0.9 1.0 0.7 14.8 1.6 24.2 -1.9 15.4 3.72 9.0

Sales growth (LHS)

Solvency
60 50 40 30 20 10 0 07 08 09 10E 11E 12E 40 30 20 10 0

Net debt/equity (LHS)

Marc Greenberg, CFA


+1 203 863-2355 marc.greenberg@db.com

Deutsche Bank Securities Inc.

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28 March 2010

Beverages Brown-Forman

Investment thesis
Strong portfolio, growth, total return opportunity
We initiate coverage with a positive view of BFs brand portfolio, growth outlook, steady total shareholder 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, tradedown, 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-year EBITDA 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 11.5% (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.
Page 4 Deutsche Bank Securities Inc.

28 March 2010

Beverages Brown-Forman

Table of Contents

Executive summary ........................................................................... 6 US spirits overview ......................................................................... 12 Limited economic sensitivity, solid demographics ...................... 16 Vodka dominates category growth ............................................... 20 Brands come first within a fragmented market............................ 24 Alcohol innovation trends............................................................... 31 3-tier system & regulation .............................................................. 35 Brown-Forman overview ................................................................ 41 Company innovation ....................................................................... 51 Channel checks: JD strong amid trade down ............................... 54 The global story is bullish............................................................... 66 A great financial picture.................................................................. 76 Valuation: 14% upside potential, initiate at Buy........................... 85 Risks.................................................................................................. 88

Deutsche Bank Securities Inc.

Page 5

28 March 2010

Beverages Brown-Forman

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%. 10year 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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Deutsche Bank Securities Inc.

28 March 2010

Beverages Brown-Forman

Figure 1: Est. Brown Forman volume contribution by brand


Gent.Jack, 2% Finlandia,3% EarlyTimes, 6% JackDaniel's, 47% Southern Comfort,14% ElJimador, 2%

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

Canadian Mist, 17%

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. consensus expectations.

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 2009 survey 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 superpremium 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.

Deutsche Bank Securities Inc.

Page 7

28 March 2010

Beverages Brown-Forman

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

25% 20% 15% 10% 5% 0% 5% 10%

24%

9%

8% 3% 1%

4%

4%

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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Deutsche Bank Securities Inc.

28 March 2010

Beverages Brown-Forman

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)
10 9 8 7 6 5 4 3 2 1 0 JackDaniel's Finlandia Southern Comfort Canadian Mist

Figure 4: Volume CAGR, INTL vs. Total (2005-09E)


12% 10% 8% 6% 7.8% 5.6% 2.9% 3.4% 0.8%
International Total

10.1%

NonUS US

4% 2% 0%

Finlandia

JackDaniel's

Southern Comfort

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 see plenty 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 to buy 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.

Deutsche Bank Securities Inc.

Page 9

28 March 2010

Beverages Brown-Forman

Figure 5: Alcoholic Beverage Category innovation: 2008-2010


1,600 1,400 1,200 1,000 800 600 400 200 0 Spirits Wine Beer
Source: Mintel

New Product 215 398 233

New Packaging 49 71 83

Range Extension 94 68 152

Total 358 537 468

Three-year innovation data from Mintel suggests greater volume of innovation in wine and by smaller 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 going forward 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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Deutsche Bank Securities Inc.

28 March 2010

Beverages Brown-Forman

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-tohigh 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., 23% 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 posttax 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.

Deutsche Bank Securities Inc.

Page 11

28 March 2010

Beverages Brown-Forman

US spirits overview
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.

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. beer and 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)
4.0% 3.4% 2.9% 3.5% 3.0% 2.5% 2.0% 1.5% 0.8% 0.3% 1.0% 0.5% 0.0% Beer TotalAlcohol Spirits Wine

Wine, 10%

Spirits, 6%

RTD& Other, 2%

Beer, 82%
Source: Impact, Beer Institute, DISCUS, DB estimates

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

On-premise is a primary playing field for building brand equity and consumer recognition.

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 tradeup and demographic trends continue long after the current recession.

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Deutsche Bank Securities Inc.

28 March 2010

Beverages Brown-Forman

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 9: High-end & super-premium % US spirits vol.
30%

Figure 8: US spirits volume (mn cases)


220 200 180 160 140 120 100 80 60 40 20 0

146

150

153

159

165

171

177

184

187

189

195
25% 20% 15% 10% 5.7% 5% 3.5% 13.2% 19.2% 24.3% 22.3% 23.0%

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010E

0%

1970
Source: DISCUS

1980

1990

2000

2005

2008

2009

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

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 across male/female, showing broader and less compartmentalized appeal than we had expected. Figure 10: DB survey -- Which types of alcohol do you drink?
100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Yes No

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


100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0%

Beer 89.2% 10.8%

Wine 88.3% 11.7%

Spirits 88.6% 11.4%

2024 91.4% 8.6%

2530 87.7% 12.3%

Over30 80.4% 19.6%

Idrink Idonotdrink

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

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

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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.

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)

35 30 25 20 15 10 5 0 1990 Beer Wine Spirits 34.5 2.4 2.1 1995 31.0 2.4 1.7 2000 30.8 2.8 1.8 2005 29.6 3.2 1.9 2007 29.7 3.3 2.0 2008 29.6 3.3 2.0 2009 2010E 29.1 3.3 2.0 28.5 3.4 2.1
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.

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Figure 13: DB survey -- How frequently do you drink spirits per week?
70% 60% 50% 40% 30% 20% 10% 0%

Figure 14: DB survey -- Do you expect to drink spirits more or less frequently over the next year?
80% 70% 60% 50% 40% 30% 20% 10%

Not atall 2024 2530 Over 30 5.3% 13.9% 14.4%

Only occasionally 55.7% 66.4% 62.9%

Frequently 31.7% 16.4% 13.4%

Mostly Prefer to wine/beer 10.3% 3.3% 10.3%

0% More Less

2024 65.6% 35.2%

2530 29.6% 71.3%

Over30 31.3% 68.7%

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

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

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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


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.

Alcoholic beverages tend to be defensive in times of economic difficulty. People may stop spending 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 16: Real PCE % Beer vs. Real GDP
8% 6% 4% 2% 0% RealGDP % Spirits 2% 4% 6% 8% 10% RealGDP % Beer

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

Figure 15: Real PCE % Spirits vs. Real GDP


12% 10% 8% 6% 4% 2% 0% 2% 4% 6% 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008
Source: BEA

Rsquared =0.0003

Rsquared = 0.08

1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008
Source: BEA

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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 18: Spirits volume growth % by bottle price
12 10 8
Under$10 $10$15 $15$20 Over$20

Figure 17: US spirits volume by price category (2009)

Super6% HighEnd 16% Value 41%

6 4 2 0 (2) (4) (6)

Source: DISCUS

Premium 36%

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 highestpriced spirits tiers in 2009, and a decline in their share of US spirits. Figure 19: US spirits volume growth by price segment

8% 6% 4% 2% 0% 2% 4% 6% Value
Source: DISCUS

5.5% 3.7% 1.7% 0.6% 0.6%

2008
0.6% 3.5% 5.1%

2009

Premium

HighEnd

Super

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.

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Whiskey/Bourbon: Skews male, older Vodka, Rum, Tequila: Skews younger, female

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 a more 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


100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0%

Figure 21: US spirits drinkers by age


100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0%

33%

28%

24%

22%

Female Male

43%

42%

45%

47%

55+ 3554 2134

23%

30%

30%

30%

Bourbon

Vodka

Rum

Tequila

Bourbon

Vodka

Rum

Tequila

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 towards higher income levels, Caucasians, and the 21-24 age group.
Given bourbons strong acquired taste profile, expanding into new groups requires creativity around mixability - its harder to swallow for many vs. vodka or rum.

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.

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Figure 22: Jack Daniels share of US bourbon drinkers

50% 45% 40% 35% 30% 25% 20% 15% 10%

Source:Simmons Market Research, Impact 2007

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Vodka dominates category growth


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 goods consist primarily of vodka, tequila, and rum, which have driven the lions share of growth in spirits for the last several decades.

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 have out-performed the industry since 2000 while other categories, namely whiskey, have underperformed. 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 24: US alcohol consumption CAGR (2000-2010E)
6.0%
5.0%

Figure 23: US spirits consumption by volume (2010E)


Other,3.6% Gin,5.6% Tequila,6.2% Brandy,5.8% Domestic Whiskey, 10.6% Vodka, 31.4%

5.0% 4.0% 3.0% 2.0% 1.0% 0.0%

4.7% 4.3%

2.7% 1.9% 1.3% 0.4% 0.3%

Cordials, 11.1% Rum,13.0%


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

Imported Whiskey, 12.8%

0.2%

1.0% Vodka Tequila Rum Tot. Cordials Brandy Dom. Imp. Alcohol WhiskeyWhiskey Gin

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.

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2. A slow but stable US growth outlook


Against the broader US spirits industry, BFs chips are stacked hugely in the whisky category, and to a much lesser extent, vodka and tequila.

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 55.5%) 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 broader US 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. 2. Drinkability less distinct taste profile and milder vs. bourbon, scotch, etc. 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.

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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% 25%

20% 15% 10% 5% 0% 5% 10%


4% 4% 9% 8% 3% 1%

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

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

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 1996 respectively. 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.

Much of the growth in tequila falls into the super premium and luxury categories, in which BF is a major participant.

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 skew slightly 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 constantcurrency sales +6%.

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Figure 26: US tequila market (thous. cases)


14,000 12,000 10,000 8,000 6,000 4,000 2,000 0
2010E 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Figure 27: US tequila CAGR by price tier (2000-07)


50% 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% 5% 45%

4.2% 4.1% 4.0% 3.9% 3.8% 3.7% 3.6% 3.5% 3.4% 3.3%
Competitor brands BFbrands BFshare

10% 5% 2% 1%
Luxury(+$40) Super US Tequila premium ($25 Mkt 40) Premium ($1025) Sub premium (<$10)

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

Source: Impact

Tequila brands are underpenetrated.

We expect growth of BF brands to participate in long-term growth of the premium segment, and relatively low but growing penetration. Against an estimated 90-100% ACV penetration for Jack Daniels of US alcohol sales channels, El Jimador for example is estimated at only about 10-15%. Although these brands will likely never reach Jack Daniels penetration levels, it shows a huge distribution runway still ahead and opportunity to play BFs existing distribution capabilities around Jack Daniels.

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Beverages Brown-Forman

Brands come first within a fragmented 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


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 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 nature of the spirits industry creates intense competition relative to other beverage categories like soft drinks and beer. Figure 28: US spirits market share (2009E) Heaven STZ,3% Hill,5% BF,5%
Sazerac, 7% Pernod, 7% Fortune, 9% Bacardi, 9%
Source: Impact, NABCA, DISCUS,, IRI, Deutsche Bank estimates

Other, 32%

Diageo, 23%

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-building capabilities provide competitive advantage and long-term growth potential.
Brand leadership is essential to gaining leverage with distributors and retailers, commanding shelf/display space, and generating marketing buzz.

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.

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Figure 29: Top 10 US spirits brands & BF brands (2009E case volume)
R a nk 1 2 3 4 5 6 7 8 9 1 0 B ra nd Smirno ff (Diageo ) B acardi (B acardi) Cpt. M o rgan (Diageo ) A bso lut (P erno d) Jack Daniel's (B F) Cro wn Ro yal (Diageo ) Jo se Cuervo (Diageo ) E&J (E&J Gallo ) Grey Go o se (B acardi) Jagermeister (Sid. Frank) Canadian M ist (B F) So uthern Co mfo rt (B F) Early Times (B F) Finlandia (B F) Gentleman Jack (B F) El Jimado r (B F) P epe Lo pez (B F) Tuaca (B F)
Source: Impact, NABCA, IRI, DB estimates

2 0 0 9 E c a s e v o l. 1 0.1 8.6 6.1 4.7 4.6 4.2 3.8 3.7 3.3 3.1 1 .7 1 .4 0.6 0.3 0.2 0.2 0.1 0.1

Taste is critical to brand leadership not price -- is by far the most important category. Jack Daniels carries a certain differentiated taste profile appears most If you hitch your wagon to a few horses,

Our research indicates that taste not image, decision driver for consumers in the alcohol successful image among its drinkers, but its important to consumer loyalty, once they try it. youd better have good horses, and BF does.

Much of JDs success in our view is attributable to (1) consistency of marketing (driving premium equity and awareness), as well as (2) differentiated taste attributes.

Figure 30: DB survey -- Why do you prefer your favorite alcohol brand? 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Taste Price Drinkability Image Other

2024 2530 Over30

83.7% 86.7% 87.2%

30.7% 7.6% 11.6%

50.2% 45.7% 31.4%

11.2% 8.6% 5.8%

2.8% 1.9% 5.8%

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.
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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)

$40 $35 $30 $25 $20 $15 $10 $5 $0 Gent. Maker's Wild Jack Mark Turkey
Source: IRI

Jack Dan. Black

SoCo

Jim Evan Early Beam Williams Times

Old Crow

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 US spirits, and close to the top scoring equity brand like Grey Goose. Figure 32: DB survey What is your favorite alcohol brand?

40 35 30 25 20 15 10 5 0
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 MARKERS MARK 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


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.

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 the economy, as gains decelerated in 2009.

Figure 33: Avg. price/volume of BF brands (FY09)


$60 $50 $40 $30 $20 $10 $0

Figure 34: Retail pricing growth of BF spirits


8 7 6 5 4 3 2

Herradura

Chambord

Finlandia

SoCo

Spiritscategory

CanadianMist

Woodford

Gent.Jack

JDGreen

JDBlack

PepeLopez

ElJimador

EarlyTimes

1 0

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

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.

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


4.5% 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% USCPI% Spiritsprice % Spiritsvol.%

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

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)
Beer
0.0 (0.2) (0.4) (0.6) (0.8) (1.0) (1.2) (1.4) (1.6)

Figure 37: Price elasticity (Nelson study)


Beer
0.0 (0.1) (0.2) (0.3) (0.4) (0.5) (0.6) (0.7)
Source: J. P. Nelson 1997

2007

Wine

Spirits

Wine

Spirits

(0.3)

(0.2) (0.4) (0.6)

(1.0) (1.5)

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

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
12 10 8 6 4 2 0 (2) (4) (6) Under$10 $10$15 $15$20 Over$20

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

Source: IRI data for Food/Drug/Mass channel

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.

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 is insulated 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. 2. Jack Daniels is a must-have, based on high profitability and #1 position in bourbon Strong brand portfolio, with leading up-and-comers in attractive categories.

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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 of individual 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 other categories, (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
1,600 1,400 1,200 1,000 800 600 400 200 0 Spirits Wine Beer
Source: Mintel

The wine industry has introduced the highest number of new innovations compared to other categories, with beer coming in second, and spirits third.

New Product 215 398 233

New Packaging 49 71 83

Range Extension 94 68 152

Total 358 537 468

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.

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Figure 40: Wine Innovations by Company since 2007


50 40 30 20 10 0 Foster's Altria/UST Brown-Forman E & J Gallo The Wine Group Constellation Brands
Source: Mintel

New Product 1 2 3 15 11 13

New Packaging 8 0 1 6 1 17

Range Extension 1 2 1 3 7 4

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 with which 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
60 50 40 30 20 10 0 Boston Beer Diageo Constellation Brands Heineken Molson Coors Anheuser-Busch
Source: Mintel

New Product 1 0 2 1 3 15

New Packaging 0 0 6 5 24 16

Range Extension 10 2 0 1 19 19

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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
50 40 30 20 10 0 Bacardi Pernod Ricard Diageo Fortune Brands Constellation Brands Brown-Forman
Source: Mintel

New Product 3 11 12 5 1 4

New Packaging 8 7 1 3 1 7

Range Extension 2 10 11 10 2 6

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.

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, a function of more brands and companies chasing growth. Figure 43: Spirits innovation by type since 2007 400

350 300 250 200 150 100 50 0 Whisky Vodka Tequila Others
Source: Mintel

New Product 26 92 43 54

New Packaging 13 17 3 16

Range Extension 13 55 4 22

TOTAL 52 164 50 92

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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, for several 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
= p erm itted Wine Gro c ery C a lif o rnia Tex a s New Yo rk Flo rid a I llino is Penns y lv a nia Ohio Mic hig a n Geo rg ia No rth C a ro lina New J ers ey Virg inia Wa s hing to n Arizo na Ma s s a c hus etts I nd ia na Tennes s ee Mis s o uri Ma ry la nd Wis c o ns in Minnes o ta C o lo ra d o Ala b a m a So uth C a ro lina Lo uis ia na K entuc ky Oreg o n Okla ho m a C o nnec tic ut I o wa
Source: NABCA, state control boards

= p a rtia l B eer

= no t p erm itted Sp irits Liq uo r Gro c ery C - s to re Liq uo r

C - s to re

Liq uo r

Gro c ery

C - s to re

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1. Control vs. non-control states


NABCA estimates that control states cover 25% of US spirits consumption (the largest are MI, PA, OH, NC)

Alcohol distribution varies by state (and even within states), but the biggest differentiator is that 19 states are control territories in which state government controls retail and/or wholesale distribution of some or all alcohol beverages. According to NABCA, the control state structure was modeled after similar formats in Europe for health and tax control reasons, and benefit of owning distribution profits. In the US these systems emerged around the end of Prohibition. All 50 US states have an ABC agency charged with regulating wholesale distribution and retail sales. But the 19 control states (and two counties in MD) control spirits and sometimes wine sales through government agencies at the wholesale level. 14 states also control off-premise retail sales, through package stores or a retail agency relationship. NABCA estimates that control states cover 25% of US spirits consumption (the largest are MI, PA, OH, NC). Impact also estimates spirits consumption as lower on a per capita basis in control states vs. noncontrol states.
Figure 45: Control States in the United States

Source: National Alcohol Beverage Control Association NABCA

Fifteen states permit the sale of all alcoholic drinks in supermarkets, convenience stores, drug stores, and other outlets. Beer generally receives the most liberal treatment (i.e. with wine and spirits more often required to be sold in liquor stores), but the seven most restrictive states do not allow sales of alcohol on Sundays. Below we note specific distribution/retailing regulations for some of the largest states:

California: Not a control state. Alcohol sales from 6 AM through 2 AM. Local ordinances may limit hours of operations for both off and on-premise sale licenses beyond this. Florida: Not a control state. Prohibits on and off-premise sales between 3-7 AM, but local governments may change hours (Miami-Dade County has 24-hour liquor stores). Illinois: Not a control state. Alcohol sale hours vary by local ordinances, certain counties allow 24-hour sales on-premise. New York: Not a control state. On-premise sales between 8-4 AM, subject to local ordinance. Off-premise sales of spirits 9 AM to midnight (Mon-Sat), 12-9 PM Sundays.

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Pennsylvania: One of the strictest states -- Control state for spirits/wine (sold at stateoperated stores), but not beer. Texas: Not a control state. On-premise sales 7 AM to midnight, and in some cases until 2 AM. Off-premise sales of spirits 10 AM through 9 PM (Mon-Sat).

2. The three-tier distribution system


The various ordinances by state and municipality are in stark contrast to the generally uniform distribution availability for other beverage categories like soft drinks. Further, a closer look at such variety tends to betray the viability of frequently mentioned shared route-to-market for alcoholic and non-alcoholic beverages. To our minds such moves are potential at the regional, but not national level limiting scale potential. In fact, we believe these differences create a more important role for wholesale distributors (generally private local DSD operated businesses). Three-tier distribution for alcohol beverages was established after abolishment of Prohibition rules in 1933, and breaks down with goods flowing from (1) producers to (2) distributors to (3) retailers. The system is based on state/federal licenses for each tier, with differing state restrictions on licenses (i.e. selling days, times), and difference by beverage type and % ABV.

Beer generally operates in an open-state, three-tier system. Maryland (certain counties) and Utah (ABV > 4.0%) are the only states where beer distribution falls under a controlstate framework. There are various exceptions in some open states and locales (i.e. one is brewpubs, being simultaneously a producer and retailer, without a distributor required). Wine: Only a few states classify wine under control-state regulation, and wine is therefore mostly distributed under a normal three-tier system. Spirits: Regulated most strictly due to higher ABV, distributed under the three-tier system in open states and through state distribution in control states. 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.

Figure 46: Top 5 US spirits/wine distributors Company Territories

Southern Wine & Spirits of America Republic National Distributing Company Charmer Sunbelt Glazer's Wholesale Drug Company Young's Market Company
Source: Beverage World, Hoovers, DB estimates

28 states; 17 states; 14 states; 11 states; 10 states;

Quasi-national TX, Southeast, Atlantic, Midwest East Coast, Southwest TX, Midwest, South CA & Western US

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3. Federal and state excise taxes


Alcohol excises taxes are generally set according to alcohol content, with higher rates on spirits vs. wine/beer.

Alcohol excises taxes are generally set according to alcohol content, with higher rates on spirits vs. wine/beer.
Spirits pay much higher Federal Excise Taxes: There is a $13.50 federal excise tax on distilled spirits per proof gallon (a proof gallon is a gallon of liquid which is 100 proof or 50% alcohol). This is well above FET on beer ($18 per 31-gallon barrel, ~$0.58 per gallon, with a reduced rate of $7 for smaller brewers up to 60,000 barrels), and wine (ranges from $1.07 and $3.40 per gallon, subject to %ABV). On a volume equivalent basis, this works out to a $2.14 FET on each 750 ml bottle of distilled spirits at 80 proof, wines at $0.21-$0.67 per 750 ml bottle, and beer at $0.05 per 12 oz. can. At the state level, taxes are imposed as a dollar amount by volume, with tax on spirits ranging widely from $0.68 to $26.45/gallon (Washington has the highest tax rate, Vermont the lowest). Again, spirits bear the highest tax burden, and the wide variance in state rates and potential for individual state-level tax reform makes this a potential source of volatility in terms of consumer demand and volume growth for spirits companies.

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Figure 47: Alcohol excise tax by state (ranked by population)


California Texas New York Florida Illinois Pennsylvania Ohio Michigan Georgia North Carolina New Jersey Virginia Washington Arizona Massachusetts Indiana Tennessee Missouri Maryland Wisconsin Minnesota Colorado Alabama South Carolina Louisiana Kentucky Oregon Oklahoma Connecticut Iowa Mississippi Arkansas Kansas Utah Nevada New Mexico West Virginia Nebraska Idaho Maine New Hampshire Hawaii Rhode Island Montana Delaware South Dakota Alaska North Dakota Vermont District of Columbia Wyoming S pir it s Ta x (P er Ga llon) $3.30 $2.40 $6.44 $6.50 $8.55 $6.54 $9.04 $10.91 $3.79 $13.39 $5.50 $20.13 $26.45 $3.00 $4.05 $2.68 $4.46 $2.00 $1.50 $3.25 $5.08 $2.28 $18.78 $4.97 $2.50 $6.46 $24.63 $5.56 $4.50 $12.47 $6.75 $2.58 $2.50 $11.41 $3.60 $6.06 $1.85 $3.75 $10.96 $5.21 * $5.98 $3.75 $8.62 $3.75 $3.93 $12.80 $2.50 $0.68 $1.50 * T a ble Wine T a x (P er G a llon) $0.20 $0.20 $0.30 $2.25 $0.73 ** $0.32 $0.51 $1.51 $0.79 $0.88 $1.51 $0.87 $0.84 $0.55 $0.47 $1.21 $0.42 $0.40 $0.25 $0.30 $0.28 $1.70 $1.08 $0.11 $0.50 $0.67 $0.72 $0.60 $1.75 $0.43 $0.77 $0.30 ** $0.70 $1.70 $1.00 $0.95 $0.45 $0.60 ** $1.38 $0.60 $1.06 $0.97 $0.93 $2.50 $0.50 $0.55 $0.30 ** Beer T a x (P er Ga llon) $0.20 $0.20 $0.14 $0.48 $0.19 $0.08 $0.18 $0.20 $1.01 $0.53 $0.12 $0.26 $0.26 $0.16 $0.11 $0.12 $0.14 $0.06 $0.09 $0.06 $0.15 $0.08 $1.05 $0.77 $0.32 $0.08 $0.08 $0.40 $0.20 $0.19 $0.43 $0.21 $0.18 $0.41 $0.16 $0.41 $0.18 $0.31 $0.15 $0.35 $0.30 $0.93 $0.11 $0.14 $0.16 $0.27 $1.07 $0.16 $0.27 $0.09 $0.02

Source: American Petroleum Institute, state revenue departments, Distilled Spirits Council of the U.S., Commerce Clearing House, and Tax Foundation. * Control state where the implied excise tax rate as calculated by DISCUS is less then zero. ** All wine sales are through state-run stores. Revenue in these states is generated from various taxes, fees and net profits

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New taxes present a key risk The current environment presages ongoing risk for sin taxes in our view, based on the following:

State budget shortfalls. 100%+ increase in the FET on cigarettes in 2009. Rising state tobacco taxes as a source of revenue. State proposals to tax soft drinks. The last spirits FET hike was in 1991.

Beverage alcohol generated $9.5bn of excise tax revenue at the federal level in 2008 (bigger than cigarettes), with spirits comprising a little more than half, making it not a very sizable source of revenue. We therefore believe incremental federal tax increases and state-level actions are possible -- BFs home state of Kentucky for example imposed a new 6% sales tax on wine/spirits in April 2009. [This risk also extends to foreign markets BFs Australian business was adversely affected by a new 70% excise tax on RTD spirits in April 2008.]
Figure 48: Federal excise tax revenue on beverage alcohol

Beer, 40% Spirits, 51%

Source: TTB, Beer Institute, 2008 basis

Wine, 9%

While spirits may not be as politically easy to target as tobacco, many state shortfalls are severe. The Distilled Spirits Council also has recently had some success publicizing discrepancies between taxes on spirits vs. other alcohol, and in tying spirits tax increases to the impact on restaurants and the hospitality industry. DISCUS notes a fairly successful track record of defeating proposed state spirits tax increases, with 32 of 40 defeated in 2009, 33 of 33 in 2008, and 35 of 38 in 2007.
Figure 49: Historical FET on distilled spirits (per proof gallon) $16

$14 $12 $10 $8 $6 $4 $2 $0 1938 1940 1941 1942 1944 1951 1985
$2.25 $3.00 $4.00 $6.00 $10.50 $9.00

$13.50 $12.50

1991

Source: Alcohol and Tobacco Tax and Trade Bureau

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Brown-Forman overview
We provide a more detailed picture of Brown-Forman below, but broadly characterize this closely held business as concentrated and opportunistic regarding brand development and acquisitions. It appears willing to be firmly and ultimately independent. We note the Brown family has been reliable stewards of capital for shareholders posting an enviable track record over a long period. We are therefore disinclined to embrace any grand consolidation scenario. Its Jack Daniels brand may well be Americas finest at present, based on the strong loyalty and affinity of its consumers and successful platform initiatives to build premium brands, despite a less than ideal overlay for whiskey. Growth abroad with both Jack Daniels and Finlandia, as well as its recent Herradura acquisition in the attractive tequila segment suggest that good ol Jack may indeed have a few other stable-mates within a lean spirits portfolio.

1. Financial characteristics High ROIC, consistent, closely held


BF is a sterling financial asset worthy of premium valuation based on the following criteria.

Top line strength. Sales growth in the 7% range, well positioned (@45% of sales) globally. High EBIT growth and margins. Operating Profit growth of 8% on leading industry margins. Low double digit (12%) EPS. Also expect 2011 ROIC to crest at 16-17%, in-line with KO post bottler deal. Cash return focus. 9.4% 10-year dividend growth, consistent share repurchase special dividend activity over time. Pristine and very conservative balance sheet. Figure 51: Normalized EBITDA margin (2009E)*
900 800 700 600 500 400 300 200 100 0
EBIT (underlying) Margin

Figure 50: EBIT (normalized) ($mn)


30% 25% 20% 15% 10% 5% 0%
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009E 2010E 2011E 2012E

35% 30% 25% 20% 15% 10% 5% 0%

31.2%

30.6%

30.2% 26.0% 21.8%

BF

Diageo

Pernod

Campari

Remy

Source: Company data, Deutsche Bank estimates

Source: Company data, Deutsche Bank estimates. All calendarized for 2009 and margin of revenue ex-excise taxes

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Global growth Clearly, BF is an attractive player in the U.S. spirits business, but we also view BF as a significant long-term global growth opportunity. What is often overlooked is that an estimated 45-50% of operating profits now come from foreign markets, which are growing at a faster rate than the domestic market (key markets are UK, Australia, Mexico, Poland, Western Europe, China, Japan, Russia). A worthy beverage comparison here may be Coca-Cola. powerful brands, a strong legacy of brand-building, steady total return to shareholders, high ROIC, and a significant global growth opportunity ahead. Closely held by Brown family a forward thinking group BF is unusual as a controlled company, as the Brown family shareholder block controls the majority of Class A voting controls. While Class B shareholders have no voting rights, we believe family shareholders are aligned with investors in terms of growth objectives. While they may impart a more conservative approach, by taking a very long-term view of the business and total returns, they provide a strategic rudder to the business that most companies lack.

2. Brand portfolio
Based in Louisville, KY, Brown Forman is a leading producer of premium alcohol beverages in spirits and (secondarily) wine:

Flagship brand - Jack Daniels. Jack Daniels is the fifth-largest spirits brand in the world and best-selling American whisky. We estimate this account for roughly volumes and has supported premium efforts in Woodford Reserve, Gentleman Jack and Single Barrel brands. Premium running mates. Other key brands include Southern Comfort (third largest US liqueur brand), Canadian Mist (fourth largest Canadian whiskey brand globally), and Finlandia vodka, which has led global growth. These three represent @ 35% of spirits volumes. Tequila El Jimador leads growth. BF purchase of Herradura brands, (super-premium $45 /bottle) also brought the fast growing El Jimador ( @50% 10-year growth on volume base of @2% total spirits portfolio. Wine middling brands lead by mid-priced Fetzer and Korbel. BFs wine portfolio appears less strategic than spirits in the context of long-term growth assets. Neither represent fast growth or must-have brands in our view.

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Figure 52: BF brands


Sp irits Jack Daniel's Tennessee Whiskey Southern Comfort Finlandia Vodka Gentleman Jack Jack Daniel's Single Barrel Jack Daniel's Ready-to-Drink Antiguo Tequila Canadian Mist Blended Canadian Whisky Chambord Liqueur Don Eduardo Tequila Early Times Kentucky Whisky el Jimador Tequila Herradura Tequila New Mix Ready-to-Drink Old Forester Bourbon Pepe Lopez Tequilas Tuaca Liqueur Woodford Reserve Bourbon
Source: Company info

Wine Bel Arbor Wines Bonterra Vineyards Wines Fetzer Wines Five Rivers Wines Jekel Vineyards Wines Korbel California Champagnes Little Black Dress Wines Michel Picard Wines Sanctuary Wines Sonoma-Cutrer Wines Virgin Vines Wines

3. Narrow portfolio focus


BFs product portfolio is relatively concentrated compared to its principal competitors, with 1 monolithic brand and 3 overall driving approximately 80% of US volume.

BFs product portfolio is relatively concentrated compared to its principal competitors, with 1 monolithic brand and 3 overall driving approximately 80% of US volume. Although the US business approximates 50% of group revenue, the concentration factor is real -- the Jack Daniels label and to a lesser extent Canadian Mist and SoCo will largely determine BFs performance in its home market. While the luxury niche bourbons (Gentleman Jack, Woodford Reserve) are highly profitable and provide growth opportunities, they and BFs tequila brands remain very small in the overall volume context (less than 10% of US volume on our estimates).
Figure 53: BF US volume by brand (2010E)
Gent.Jack, 2% Finlandia,3% EarlyTimes, 6% JackDaniel's, 47% Southern Comfort,14% ElJimador, 2%

Canadian Mist,17%
Source: Impact, NABCA, IRI, DB estimates, NABCA

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Small portfolio asset or liability? BFs portfolio reach is one of the key drawbacks to BF as an investment (i.e. no rum, no gin, minor vodka presence, essentially the anti-Diageo), so how do we frame it? On one hand, the lace of exposure to high growth areas could limit BFs growth opportunities. On the other hand, Jack Daniels offers superior performance compared to the slow growth whiskey category, and niche brands provide some source of growth into key categories, vodka and tequila. Asset! In our view the positives will continue to outweigh the negatives, as long as BF continues to exhibit strong performance in managing each individual brand, which in the end is all that matters for investors:

A superior horse. Jack Daniels offers strong brand equity and proven growth power. Cash flow re-invested actively. Weak volume spots in the portfolio such as Canadian Mist can be viewed from a portfolio perspective i.e. weak volumes, monetized for profit, reinvested behind growth opportunities. Brand-builder credentials solid. Successful track record in developing smaller growth opportunities in product niches, such as Gentleman Jack and El Jimador tequila. Focus is in. In the CPG space, performance is often better in a product portfolio with fewer lead horses, than a big diversified portfolio, which lacks focus. The latter quite often leads to clutter, particularly in spirits where concentration on marketing brands is needed to generate consumer acceptance. ( Scale not an imperative. Scale in spirits is a topic for debate, but (we believe the strength of BFs brands and their importance to distributors matter more than sheer size.

4. Jack Daniels: Now alcohol segments strongest American brand?


For BF the JD label represents roughly half of the global revenue base, and 20% of revenue coming from the core Jack Daniels black label product in the US.

Brand equity is tricky. For Coke, many locals embrace the brand heritage as their own. Within beer Budweisers Classic Americana legacy has been unable to stem decline, (especially when excluding Bud Light) and almost certainly takes a hit from the fact that it is now foreign owned. Yet when we think of Jack Daniels or more proximately Jack, we think of a very distinct heritage as part of the brand. Yet the brands US based Jack Daniels sales account for just 20% of total company revenues. Its growth owes to planting the flag abroad and successfully line extending into premium at home. BF is not a one-product, one-market company as many believe. We estimate the Jack Daniels brand family (including the Green label, Gentleman Jack and Single Barrel extensions) is the largest bourbon brand in the US at 33% share in 2009. BF BFs share of US bourbon is about 38% when adding Old Forrester Early Times. Jack Daniels is estimated as the 5th largest spirits brand in the world and accounts for roughly half of the global revenue base,
Category outperformance in whiskey. The core Jack black product is central to BFs profitability, growth outlook and global ambitions, and (in the context of economic weakness) has maintained relatively robust performance. Although whisky overall is a flattish growth category in the US, higher-priced bourbon offers better growth characteristics, and Jack Daniels has consistently increased share and outgrown the category. In the last reported FY09, global depletions for the brand were up slightly less than 1%, but +2% in the US (and a 17th straight year of growth on a global basis). BF does not break out YTD performance in the US, but globally in FY10 the Jack Daniels whiskey family is running at an estimated 1%

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depletions growth, on our numbers, despite the economic downturn. IRI shows CY2009 black label volume at -2.6% and pricing +1.6%. As of its Q2, the company also reported that the high-end bourbon line extensions (Gentleman Jack, Single Barrel, and Woodford Reserve) were still growing in mid-single to low-double digits.
Figure 54: US bourbon market (thousand cases)
16,000 14,000 12,000 10,000 8,000 6,000 4,000 2,000 0 35% 34% 38% 37% 36% 40% 39%
Competitor brands OtherBF brands JackDaniel's black BFBshare

Figure 55: US bourbon market (2009E, thousand cases)


5,000 4,500 4,000 3,500 3,000 2,500 2,000 1,500 1,000 500 0

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

2010E

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

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

Figure 56: ACV weighted distribution in IRI measured channels 25.10


25.00 24.90 24.80 24.70 24.60 24.50 JDblacklabel
Source: IRI data for 13 weeks ended 12/27/2009

Bacardi

Smirnoff

Absolut

Cpt.Morgan

Jack also commands the best distribution in the portfolio, and among the highest in the US spirits industry. Here we note % penetration of ACV volume in IRI (which admittedly is limited in terms of coverage of key channels), for the most recent quarterly period shows Jack Daniels having the highest penetration among any of the top 5 volume brands in US spirits, and above its share of market.
IRI shows JD having the highest penetration among any of the top 5 volume brands in US spirits, and above its share of market.

High existing distribution limits future growth runway (Jack Daniels ACV has been at about the same level for the past five years) but the fact that Jack Daniels is one of the most ubiquitous alcohol products in the US is a testament to BFs brand and distribution-building as a core competency. We also believe it derives significant benefit from the US distribution alliance with Bacardi, within the four largest Jack Daniels states (CA, TX, NY, FL).
Retail data supports constructive view of the Jack Daniels brand. As a premium priced brand, JD black label has slowed in volume growth terms (IRI) during the economic downturn, after historically outpacing the spirits category. This indicates there is vulnerability to trade down given its premium price points. That said, the higher-priced Gentleman Jack products continued to handily outgrow category volume in 2009, even as its retail pricing also moved up.

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Beverages Brown-Forman

Figure 57: Jack Daniels IRI volume growth


12 10 8 6 4 2 0 2 4 6 8

Figure 58: Jack Daniels IRI pricing growth


5 4 3

USspirits JackDan. black

2 1 0 1 2

USspirits JackDan. black

Apr05

Apr06

Apr07

Apr08

Apr09

Aug05

Aug06

Aug07

Aug08

Aug09

Dec05

Dec06

Dec07

Dec08

Dec09

Apr05

Apr06

Apr07

Apr08

Aug05

Aug06

Aug07

Aug08

Apr09

Aug09

Dec05

Dec06

Dec07

Dec08

Source: Deutsche Bank

Source: Deutsche Ban k

5. Tequila - advantageous positioning at the high-end


BFs lead tequila brands are well positioned in higher price tiers, when excluding BF legacy brands in value, Pepe Lopez and recently-impaired Don Eduardo products.
Herradura: The Herradura carries the highest priced points (above $40), has generated rapid growth in CA, and is still expanding distribution. It also has heavier skew to the on-premise than Jimador, which BF is trying to spread more evenly to off-premise channels. In FY10, BF hopes to reaccelerate volume growth with new packaging (following a similar success with Jimador, Gentleman Jack), as well as expansion to off-premise retail outlets. Figure 59: Leading US tequila (2009E, thou. cases)
4,000 3,500 3,000 2,500 2,000 1,500 1,000 500 0

Figure 60: Leading tequila price points per bottle


$60 $50 $40 $30 $20 $10

ElJimador

Patron

1800

JoseCuervo

Montezuma

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

PepeLopez

Herradura

Sauza

$0

Juarez

Source: IRI for 4Q 2009

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El Jimador: BFs largest tequila brand and fastest grower is priced below Herradura but still at the higher end of the segment ($24-25) and at a premium to category leader Jose Cuervo. The 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. It has significant growth potential ahead as premium category expands, as it is a highly sought after brand among Hispanic Americans. El Jimador over-indexes among younger drinkers, lowerincome, males and Hispanics. This compares to a more balanced appeal for Herradura brand. According to Impact Database, Both Herradura and Jimador skew to poorer consumers (households under $25k). This speaks to their brand strength in our view, especially as Jimador has grown through the weak economy and held up its retail pricing. The 2009 migration to 100% agave validates el Jimador as a strong example of BF capabilities in re-positioning/re-packaging for greater consumer appeal.

6. Canadian Mist, other value whiskey brands remain weak


After Jack Daniels, BFs biggest US brands are other value whisky products, the lowestpriced brands in the spirits portfolio. Canadian Mist is BFs second largest brand in the US, and a top-three brand in the Canadian Whisky category. It has the lowest price points of any leading brand except Black Velvet. We estimate Early Times is the fifth or sixth largest bourbon brand in the US, and BFs fourth largest brand in the US. Growth trends here are weak. We see Mists positioning at the top of the value tier as quite vulnerable - value conscious consumers appear to be trading down to the cheapest available competitor brands. However we expect these can continue to be role players within a larger portfolio strategy. They can be continuously monetized. For example, Early Times has remained in heavy volume decline while taking pricing up. Profits have historically been used as a source of reinvestment behind BFs lead brands, which carry higher profits per case. Indeed Mist and Early Times have taken several rounds of pricing over the past few years, which has contributed to volume decline, while competitors have been more promotional. Such a tactical use of flanker brands is sensible in our view, as long as profitability remains intact and contributes to growth of priority brands.
Figure 61: Canadian whiskey category (thou. cases)
2,500 2,000 1,500 13% 1,000 12% 500 0 11% 10% 16% 15% 14%

Figure 62: Canadian Mist IRI data


10 5

Canadian Mist Share of category

0 5 10 15 20

Volume% Price%

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009E

Apr05

Apr06

Apr07

Apr08

Apr09

Aug05

Aug06

Aug07

Aug08

Aug09

Source: Deutsche Bank estimates, Impact, IRI , DISCUS

Source: IRI

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Figure 63: BF tequila brand CAGR (2000-2010E)


60% 50% 40% 30% 47.8%

Figure 64: IRI volume growth


100 80 60 40 20

Herradura PepeLopez ElJimador

20% 10% 0% 10%


ElJimador Don Eduardo

6.2%

4.8%

4.7%

4.7%

20 40

Apr05

Apr06

Apr07

Apr08

Apr09

Aug05

Aug06

Aug07

Aug08

Aug09

Herradura US Tequila Competitor PepeLopez Mkt brands

Source: Impact, DISCUS, IRI, Deutsche Bank estimates

Source: IRI

7. Southern Comfort and Finlandia


Finlandia BFs second largest brand globally (31% the size of Jack Daniels) is Finlandia - a small vodka player domestically, but attractive growth brand abroad. Volume growth globally for Finlandia has been consistently very strong (7% in FY09, 16% in FY08), simultaneous with pricing gains. However this is based on growing penetration in Eastern Europe/Russia.

Conversely, volume in the US has been weak. We attribute this partially to a very strong competitive set in premium vodka, (it is line-priced with Skyy/Absolut, but below luxury brands like Grey Goose), and second to a lack of established marketing identity. Finlandia has growth potential against strong vodka dynamics, but still does not appear to have settled on a brand strategy. BF has been in a process of repositioning the brand in the US in 2010, with aggressive reduction of price points starting in mid-2009 to put it more into the value tier.
Figure 65: Finlandia US case vol. (000)
400 350 300 250 200 150 100 50 0 1.0% 0.9% 0.8% 0.7% 0.6% 0.5% 0.4% 0.3% 0.2% 0.1% 0.0%

Figure 66: Finlandia IRI data


40 30 20

Finlandia

10 0

Dec05

Dec06

Dec07

Dec08

Dec09

6.2%

60

Shareof US vodka

10 20 30 40 50

Volume% Price%

Apr05

Apr06

Apr07

Apr08

Aug05

Aug06

Aug07

Aug08

Apr09

Aug09

Dec05

Dec06

Dec07

Dec08

Source: Impact, NABCA, DB estimates

2009E

2000

2001

2002

2003

2004

2005

2006

2007

2008

Source: IRI

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Southern Comfort: BFs third largest brand globally (and third in the US), has been a soft performer recently, FY09 depletions were down 5% and sales down 11% on a global basis. SoCo is a flavored bourbon, and the third largest liqueur brand in the US, based on strong brand recognition. It is premium-priced (although still well below Jack Daniels). We attribute much of the volume slowdown in recent years to its high relative exposure to the on-trade and weakness in travel destinations BF has been working on refining promotion/merchandising to return the brand to growth (although improvement of on-trade would obviously help), and this year launched two ready-to-pour products to stimulate growth. Figure 67: Southern Comfort US case vol. (000)
1,800 1,600 1,400 1,200 1,000 800 600 400 200 0
2009E 2000 2001 2002 2003 2004 2005 2006 2007 2008

Figure 68: Southern Comfort IRI data


10 8 6 4 2 0 2 4 6 8 10

Volume% Price%

Apr05

Apr06

Apr07

Apr08

Apr09

Aug05

Aug06

Aug07

Aug08

Aug09

Source: Impact, IRI, DB estimates

Source: Impact

8. Wine Is it a keeper?
The BF wine segment is almost completely US-based, plays in the middle price tiers and has much smaller scale than spirits. We believe EBIT is sub-standard vs. spirits and other likepriced wine portfolios, owing to limited growth and scale. Mid-priced Fetzer brand leads the portfolio, followed by the much smaller Bonterra organic and Sonoma Cutrer brands. BF has also been the distributor of Korbel Champagne since the 1960s it does not own the brand but makes a distributor margin and funds some marketing. Fetzer and Korbel comprise the vast majority of BF wine sales, and retail in the $6-11 range. We estimate volume figures for Fetzer and Korbel equate to 10% of BF case volume for FY09, and 11% of sales in 2009. We can ballpark EBIT margins at 15% (below BFs overall margins in the low 20s), or approximately 8% of group EBIT. This estimate might be a bit high given that Korbel only earns a distributor margin, but UST Wine is probably the most appropriate benchmark (small scale, premium portfolio) and its margins were in the mid to high teens.

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Key Risk: As in spirits, BF relies on strength of the individual brands and their importance to retailers, but theres nothing like Jack Daniels here in terms of retailer importance. Higher priced Bonterra and Sonoma Cutrer labels have enjoyed strong volume growth rates for the past few years, Fetzer is much larger. Fetzer retails at close $8, an extremely competitive segment in wine, and has grown 1% over the last 5 years, based on IRI scan data. Korbels growth has been better and at $11/bottle price point, creating better retail value proposition. Figure 69: Fetzer volume/price growth
10,200 10,000 9,800 9,600 9,400 9,200 9,000 1.5% 1.0% 0.5% 0.0% 0.5% 1.0% 1.5% 2.0% 2.5% 3.0% 3.5% Unitsales (thous.) Price%Chg

Figure 70: Korbel volume/price growth


5,800 5,700 5,600 5,500 5,400 5,300 5,200 5,100 5,000 4,900 0.5% 1.0% 1.5% 1.0% 0.5% 0.0% Unitsales (thous.) Price%Chg 2.5% 2.0%

2005 2006 2007 2008 2009


Source: IRI data for Food/Drug/Mass channel

2005 2006 2007 2008 2009


Source: IRI data for Food/Drug/Mass channel

Saleable asset? Although there is a favorable long-term tailwind here as US per capita wine consumption continues to grow, wine remains a highly competitive and fragmented field. It is also lower return, not a major growth objective for BF, and does not add much strategically to the core spirits business. We therefore believe that for the right price it could be a saleable asset. This business was built up through acquisition in the 1990s (Fetzer acquired 1992, Sonoma Cutrer in 1999), but BF sold off the Bolla business in Dec. 2008, and we believe that disposals of assets/brands are far more likely than any more acquisitions. Absent this, management discusses wine as contributing to long-term profit growth, so we would look for it to be managed more for profit maximization and improvement of ROIC, which the company acknowledges is not as structurally attractive as spirits.

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Beverages Brown-Forman

Company innovation
Jack Daniels has served as a rich global foundation for 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. Figure 71: US line extensions (IRI volume by quarter)

100,000 90,000 80,000 70,000 60,000 50,000 40,000 30,000 20,000 10,000 0
GENTLEMANJACK JACKDANIELSGREEN WOODFORDRESERVE JDCOUNTRYCOCKTAIL

04/01/04

09/01/04

02/01/05

07/01/05

12/01/05

05/01/06

10/01/06

03/01/07

08/01/07

01/01/08

06/01/08

11/01/08

04/01/09

Source: IRI volume data

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 (Country Cocktails has precipitously lost both pricing and distribution). For example, Gentleman Jack may have a limited audience, but is mix positive, even after factoring sales from RTD products. Importantly, line-extension initiatives carry a more limited risk, unless it moves the brand to a completely different equity.
Gentleman Jack for example carries even higher profits per bottle than Jack Daniels, while mix impact of RTD products is fairly low given low ingredient costs.

Line extensions win in economic downturn Therefore as long as BF follows a disciplined strategy, we believe line extensions can be a favorable part of the growth strategy, a series of singles vs. home runs, and can increase consumer relevance of the base brands. Line extensions taken on even more importance during the recent economic downturn (i.e. SoCo ready-to-pours), as a means for BF to increase brand awareness, relevance to consumers for key brands at new price points, and to increase off-premise drinking occasions as consumption has shifted that way. We believe these products may present an effective strategy to address ongoing consumer thrift, even once the economy improves. Packaging infuses freshness into the brand Packaging has come to represent a calling card of sorts for Brown Forman. The best example is the revamping of Gentleman Jack packaging to more contemporary and more premium design. Growth rates accelerated immediately after, and this has also improved growth of El Jimador in the US, and BF has also redesigned packaging on Jack Daniels Single Barrel, Herradura and New Mix to drive better growth.

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New product details Across alcohol categories, BFs pace of new products has been broadly consistent if we look back over the past 10 years. We note last years pick-up is a function of accounting, based on similar Finlandia flavors and Woodford Reserve product counted across a number of countries. Wine has played a decreasing role in innovation, whisky innovation has been a staple but not over-extended, and tequila taking on more of a role since 2007. New Jack Daniels branded products have been fairly low, with more attention to flavored/RTD cocktail line extensions, and a clear skew to higher-end whisky (i.e. Woodford). Figure 72: BFB global new products, by brand (1999-2009)
60 50 40 30 20 10 0
J.Daniel'sCtry Cocktails JackDaniel's Finlandia Fetzer OtherSpirits OtherWine Woodford SouthernComfort

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
Source: Mintel

Regional view

On a regional basis, activity is focused on BFs biggest markets -- US and UK with some recent broadening of activity in 2009 to emerging markets (Latam, Russia and Eastern Europe). We would expect to see the newer components growing, given the companys increasing orientation to a globally.
Figure 73: BFB global new products, by region (1999-2009) 50 45 40 35 30 25 20 15 10 5 0

AllOther US UK&Ireland Russia&E. Europe Mexico& Latam India Australia

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
Source: Mintel. W. Europe total is for Finland, Germany, Spain, France

US view

If we limit our search to the US market only for the past three years below, we note a minimal amount of activity by BF in wine, and a balance across type of innovation, without a huge amount of new products, which could indicate over-extension. Most notably it reflects the strategy of using repackaging to improve growth of existing brands, and judicious use of line extensions. Within this data for spirits, 7 new products were in whiskey, 6 in tequila, and 2 in vodka. Most of BFs new packaging are associated with the El Jimador brands. Finlandia , Jack Daniels, and Old Forester brands tended toward line extensions.
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Figure 74: Brown-Forman innovation in US, January 2007Present

25 20 15 10 5 0
Source: Mintel

BF Spirits

BF Wines

17

4 3

7 1

6 5 1

New Product

New Packaging

Range Extension

Total

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Beverages Brown-Forman

Channel checks: JD strong amid trade down


Over the past three months, we conducted 148 interviews with store managers in 11 states, covering liquor stores, large-format retailers, and ABC stores in control states. Although it does not give us insight into the on-premise channel, we spread this fairly evenly across all the key off-premise channels, spanning liquor stores and large-format retailers (club stores and supermarkets) in non-control states, and ABC stores in control states. We highlight key findings below, but summarize by saying BF tequila and Jack Daniels brands are best positioned as the economy weighs heavily on consumers.

Our survey delivers a mixed message regarding BF and the spirits category at present:
Pros. Spirits is an important category at retail, Jack Daniels is a must-have brand, inventories are stabilizing, premium tequila growth is picking up, and 2010 appears to be improving. Cons. Persistent consumer trade down is the #1 negative issue and not all channels are seeing improvements in overall trends. Figure 75: Interviews per state
30 25 20 15 10 5 0

Figure 76: Spirits sales by state (thousand cases)

25

25
23 17 15 15

20 15
12 10 10 10 9 2

10 5 0

CA

IL

NY MI* PA* TX

FL OH* MA VA* NC*

CA FL NY TX
Source: Impact 2007. * Control states

IL

NJ MI* PA* MA OH* NC* VA*

Source: Deutsche Bank survey. * Control states

Major takeaways from our channel checks:

Spirits a major revenue driver for retail: Across retail outlets, spirits comprise 30-50% of store sales, higher in control states and lower in large-format stores. Jack Daniels a critical brand: Across all channels, 70% of our sample ranked JD among top 10 spirits brands, and only 11% outside the top 20. Scores are best in TX and OH, and Illinois and California are also strong markets, with a lag in New York and MI.

Jack Daniels hanging tough, growing in-line with the category: 62% of sample indicates Jack Daniels sales performing in-line with spirits category, 19% outperforming, 19% underperforming. We conclude that weak consumer spending and trade-down are weighing on growth, but it is constructive the brand is holding up in the large majority of stores given the weak economy, which positions it well for potential economic upturn. Strongest responses in large format channel, in TX and PA, with MI and IL worst

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Consumer trade-down still challenging: Consumer trade-down to cheaper brands remains a headwind to growth, 71% of store managers seeing trade down, vs. 28% seeing none or improvement. Reponses significantly better at large format stores vs. liquor stores, better in NY, worst in IL. Retail inventories stabilized: 79% of store managers have adjusted spirits inventories to what they describe as normal levels. Again liquor stores weaker - 19% still see a need to cut inventory levels in spirits. but ABC & Large Format much stronger, with 86% and 93% indicating inventory at appropriate levels, and only 6-7% seeing a need to cut. Appear optimistic on 2010 sales growth: 54% of managers expect spirits category sales to grow in 2010, 30% expect flatness, only 16% expect declines, reflecting improved confidence. Again responses weakest in liquor stores (25% expecting decline), far more bullish from large format/ABC stores. By state, better TX, weaker IL/CA. Premium tequila outlook better: Managers outlook for premium tequila was slightly lower than spirits category, given higher pricing and the economic environment, but better vs. 2009 and an encouraging sign. 35% of respondents expect flat sales, 41% expect growth. Liquor stores gave the weakest response (with TX stronger but CA soft). Channel discrepancies: Liquor stores gave weaker responses in general vs. the large format and ABC stores. Although this is a challenge to industry growth, we believe it also reflects their smaller size, systems, adjustment to economic trends, and promotional activity with large distributors/suppliers.

Figure 77: Survey responses by store type 80


70 60 50 40 30 20 10 0 Liquor Stores
Source: Deutsche Bank

67 51

30

ABC

Large format

1. Spirits are a critical revenue driver for retailers


Spirits are a key revenue component for small liquor stores and large format retailers selling them, particularly in control state stores, which are limited in product range. Across retail outlets, we found that spirits generally comprise 30-50% of store sales, higher in control states, lower in large-format stores.
Liquor stores: Nationwide, 76% of stores in our sample have spirits comprising 20-50% of their store revenues. 12% of stores reported spirits at 75% of sales or more.

Spirits generally comprise 30-50% of store sales, higher in control states, lower in large-format stores.

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Figure 78: Liquor stores: What percentage of your store sales comes from spirits?
40% 35% 30% 25% 20% 15% 10% 5% 0%
0% 6% 2% 19% 15% 36%

4%

4%

4%

6% 2% 0%

Less than 20%


Source: Deutsche Bank

20 Pcnt

30 Pcnt

40 Pcnt

50 Pcnt

60 Pcnt

65 Pcnt

70 Pcnt

75 Pcnt

85 Pcnt

90 Pcnt

100 Pcnt

Across states, Texas showed highest reliance on spirits, as almost 90% of our sample had spirits comprising 50% or more of sales. This compares to 30% and 25% of liquor store managers in California and New York respectively with spirits at +50% of sales. About 45% of store managers in Illinois had spirits at 30% of sales.
ABC stores: Spirits sales are an even larger component in control state stores 40% or more of sales for 88% of stores. This is explained by limitations on type of alcoholic beverages sold 100% of sales in North Carolina, less in Pennsylvania where both wine and spirits are sold (53% of respondents have spirits sales as about half of total sales). Figure 79: ABC states: What percentage of your store sales comes from spirits? 40%

30% 20% 10%


2% 19%

30% 23%

6%

4%

4%

4%

2% 70 Pcnt

2% 75 Pcnt

0%
Less than 20%
Source: Deutsche Bank

0% 85 Pcnt

2% 90 Pcnt 100 Pcnt

20 Pcnt

30 Pcnt

40 Pcnt

50 Pcnt

60 Pcnt

65 Pcnt

Large-format retailers: Among club stores and supermarkets, spirits portion of revenue is obviously well below liquor store levels. About 80% of responses indicated spirits revenues below 5% of total sales.

2. Jack Daniels: Category leader


Despite macroeconomic headwinds for premium spirits Jack Daniels remains a leading brand across the retail channel, and a valued brand for store managers. Jack Daniels was ranked as a top 10 spirits sales brand by 70% of all stores: 57% of large format, 69% of liquor stores, and about 80% of ABC stores. Across all channels, 89%of our sample ranked JD among the top 20 spirits brands, and only 11% said it is outside the top 20.
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Figure 80: All stores: How do sales of Jack Daniel's rank among spirits brands?

60%
53%

50% 40% 30% 20% 10% 0% Top 3


Source: Deutsche Bank

17%

19% 11%

Top 10

Top 20

Not significant

Liquor stores: 25% of store managers rank Jack Daniels as a top three brand, and 69% within the Top 10, while only 8% put it outside the top 20. Scores are best in TX, with 55% of sample ranking it in top three. Illinois and California are also strong markets, since 39% and 29% of managers, put it in the top three. Figure 81: Liquor stores: How do sales of Jack Daniel's rank among spirits brands?

50%
44%

40% 30% 20% 10% 0% Top 3


Source: Deutsche Bank

25%

23%

8%

Top 10

Top 20

Not significant

Large format: We saw somewhat lower responses for JD but still very strong scores 57% scoring it a top 10 brand. We found no major differences across states, with somewhat greater strength in California (20% ranked it a top three performer and 60% in top 10). ABC stores: In this channel where we would expect strongest scores, JD ranks as a clearly critical brand, with 81% scoring it in the top 10. Ohio was strongest, with 40% of managers putting JD at a top three brand and the other 60% in the top 10, and Michigan weakest (53% distributed between the top 20 and not significant).

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Figure 82: Large-format retailers: How do sales of Jack Daniel's rank among spirits brands?
50% 40% 30%
23% 47%

Figure 83: ABC states: How do sales of Jack Daniel's rank among spirits brands?
80% 70% 60% 50% 40%

69%

20% 10% 0% Top 3 Top 10 Top 20


10%

20%

30% 20% 10% 0%

12%

10%

10%

Not significant

Top 3

Top 10

Top 20

Not significant

Source: Deutsche Bank

Source: Deutsche Bank

JD holding up fairly well in bad economy in-line with peers We questioned store managers about their sales of Jack Daniels relative to the overall spirits category during the winter months, including the holidays. While 62% of all respondents ranked it in-line with the category, 19% had it outperforming, and another 19% underperforming. We believe it is constructive that the brand is holding up or outperforming category in the large majority of stores, particularly given the weak economy and its premium price points. This likely explains many of the underperform responses we did receive, and we believe it positions well for a potential economic upturn. Figure 84: All stores: How have Jack Daniel's sales been tracking vs. overall spirits category through the winter?

70%
62%

60% 50% 40% 30% 20% 10% 0% Much faster Slightly faster
Source: Deutsche Bank

14% 5%

16%

3%

Same

Slower

Much slower

Liquor stores: Majority of stores seeing sales of JD performing in line with spirits category, with only 25% seeing it underperform. Illinois registers as the worse state, with 31% of stores seeing the brand underperform category, and the best scores in TX, with JD outgrowing category at 25% of stores. We also received good responses from NY, as about 24% of stores are seeing JD outperforming spirits (12% much faster).

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Beverages Brown-Forman

Figure 85: Liquor stores: How have Jack Daniel's sales been tracking vs. overall spirits category through the winter?

70%
62%

60% 50% 40% 30%


23%

20% 10%
3% 11% 2%

0% Much faster
Source: Deutsche Bank

Slightly faster

Same

Slower

Much slower

ABC stores: Stronger response, with 55% seeing JD in-line with category, 24% outperforming, and 22% underperforming. On a state basis, Pennsylvania scored best with 60% of managers seeing the brand outgrow category. Worst was Michigan, with 53% of stores seeing it underperform. Large format stores: Strongest response, with 73% seeing JD in-line with category, 23% outperforming, and just 3% underperforming. Figure 87: ABC states: How have Jack Daniel's sales been tracking vs. overall spirits category?
60% 50% 40% 30% 20%
20% 16% 6% 55%

Figure 86: Large-format stores: How have Jack Daniel's been tracking vs. overall spirits category?
80% 70% 60% 50% 40% 30% 20% 10% 0% Much faster Slightly faster
Source: Deutsche Bank

73%

10%

13% 3% 0%

10%
4%

0% Much faster Slightly faster


Source: Deutsche Bank

Same

Slower

Much slower

Same

Slower

Much slower

4. Trade-down: Still a headwind to growth


Survey responses indicate that consumer trade-down to cheaper brands remains a significant headwind. While this is restraining growth of higher-end brands like JD and remains a near-term obstacle. That said, it relative performance suggest things can improve with the economy. Respondents indicate that through the winter period, a majority of customers were still trading down and looking for value in cheaper brands. 71% of store managers are seeing trade down including 8% seeing a significant amount) and 28% seeing none or an improvement.
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Figure 88: All stores: Are you seeing consumers trade down to cheaper spirits or out of spirits altogether?

70% 60% 50% 40% 30% 20% 10% 0% 8%

63%

22%

6%

Lot of tradedown Some tradedown


Source: Deutsche Bank

No tradedown

Getting better/trading-up

74% of responses indicate consumers still trading down to cheaper spirits.

Liquor stores: 74% of responses indicate consumers still trading down to cheaper spirits. Again by state Illinois scores worst here, with 100% of store managers seeing trade-down. Best responses in New York, with 35% of managers seeing no trade down, and 53% and 6% respectively seeing some trade down and a lot of trade down. Figure 89: Liquor stores: Are you seeing consumers trade down to cheaper spirits or out of spirits altogether?

70% 60% 50% 40% 30% 20% 10% 0% Lot of tradedown Some tradedown
Source: Deutsche Bank

61%

21% 13% 4% No tradedown Getting better/trading-up

ABC & Large Format: Trade down most evident in ABC states, with 82% of store managers seeing substitution of more affordable brands, and just 2% seeing consumers trade back up. Large format stores exhibit by far the best response, with lower trade down responses and 54% seeing no trade down or an improvement. This could be due to more active promotion in this channel.
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Figure 90: Trade down at large-format retailers


50% 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% Lot of tradedown Some tradedown No tradedown Getting better/trading-up 3% 17% 43% 37%

Figure 91: Trade down at ABC states


90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Lot of tradedown Some tradedown
Source: Deutsche Bank

78%

16% 4% No tradedown 2% Getting better/trading-up

Source: Deutsche Bank

5. Trade inventories stabilizing


Overall, almost 80% of managers consider inventory levels appropriate.

Following significant impact on spirits-makers sales in 2H08 and 1H09 from reduction of trade inventories, checks indicate that at the retail level, the situation appears to have stabilized, with inventories at sustainable levels. Overall, almost 80% of managers consider inventory levels appropriate. We also note that among stores still seeing a need to cut inventory, JD is likely to be somewhat less impacted given its popularity. Figure 92: All stores: Does your store need to reduce inventory on spirits, or are inventory levels now OK?
100% 79% 75%

50%

25% 12% 0% N e e d to re duce


Source: Deutsche Bank

9%

L e v e ls a r e O K

NA

Liquor stores score weakest: It is unsurprising, given that liquor stores are the smallest stores, often independently owned, and will therefore be more challenged in terms of managing inventory and working capital. 19% still see a need to cut inventory levels in spirits. TX scored best, 83% of respondents with appropriate levels, vs. 77% in IL, 59% in NY, 53% in CA. Looking out, our earlier comments regarding the risk of excise taxes suggest collateral damage could be seen in lower inventories as was the case with cigarette in 2009.

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Figure 93: Liquor stores: Does your store need to reduce inventory on spirits, or are inventory levels now OK?
75% 67%

50%

25%

19% 13%

0% Need to reduce
Source: Deutsche Bank

Levels are OK

NA

ABC & Large Format present much better news, with 86% and 93% indicating inventory at appropriate levels, and only 6-7% seeing a need to reduce. We believe these larger stores would have adjusted earlier in the cycle and been quicker to adapt to changes in consumer demand, given more sophisticated systems management. Figure 95: ABC states inventories
100% 86%

Figure 94: Large-format inventories


100% 93%

75%

75%

50%

50%

25% 7% 0% Need to reduce


Source: Deutsche Bank

25% 6% 0% Need to reduce


Source: Deutsche Bank

8%

0% Levels are OK NA

Levels are OK

NA

While a significant 30% portion of our sample still expects sales to remain flattish versus 2009, the majority (54%) expects growth this year, and only 16% expect declines.

6. Spirits growth in 2010: More optimistic outlook


Store managers overall are modestly optimistic on the outlook for spirits sales growth. While a significant 30% portion of our sample still expects sales to remain flattish versus 2009, the majority (54%) expects growth this year, and only 16% expect declines. This reflects some improved confidence in the category, particularly in light of continued tradedown pressure.

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Figure 96: All stores: What is your expectation for total spirits sales growth in 2010?
40%
33%

30%

30%

21%

20%
15%

10%
1%

0% Up more than 5%
Source: Deutsche Bank

Up 0-5%

Flat

Down 0-5%

Down more than 5%

Significant channel differences: Responses were weakest among the liquor stores (38% expecting flat, 25% expecting declines), with far more bullish responses from the large format and ABC stores, which could respond more responsiveness in terms of promotion through the downturn. Figure 97: 2010 spirits sales outlook by store type
45% 40% 35% 30% 25% 20% 15% 10% 5% 0% Up more than 5% 11% 33% 26% Up 0-5% 27% 33% 40% Flat 38% 30% 20% Down 0-5% 23% 3% 12% Down more than 5% 2% 0% 2%

Liquor Stores Large Retailers ABC States


Source: Deutsche Bank

Among liquor stores, Texas had strongest responses, with 58% expecting spirits sales to grow between 0 and 5%, while the other 42% expects sales to be flat, and none expecting declines. We got weaker responses in IL (58% expecting declines), CA (86% expect sales flat of down), and NY (38% flat, 19% decline). Large-format retailers optimistic, with two-thirds expecting sales growth in 2010, and 33% expecting sales growth above 5%, and just 3% expecting declines. Similarly, ABC stores optimistic as 66% of managers are anticipating growth.

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7. Premium tequila may start to rebound in 2010


As a more expensive category exposed to trade-down, and a central plank of BFs US growth, we are encouraged by better outlook for premium tequila category. Although this is not surprising given the weak feedback we got on 2009, it appears sales are no longer falling, and are expected to stabilize in 2010, either flat or beginning to slowly resume growth. Overall 35% of respondents expect flat sales, with 41% expecting growth. Given higher price points, we find this an encouraging sign in terms of growth accelerating if and when consumer spending improves. Figure 98: 2010 premium tequila sales outlook
40%
35%

Figure 99: By store type


45% 40% 35%

30%
24%

30% 25%

20%

20% 17%

20% 15% 10%

10%
4%

5% 0% Up more than 5% 11% 24% 20% Up 0-5% 24% 21% 25% Flat 31% 48% 31% Down 0-5% 34% 7% 12% Down more than 5% 0% 0% 12%

0% Up more than 5%
Source: Deutsche Bank

Liquor Stores Large Retailers

Up 0-5%

Flat

Down 0-5%

Down more than 5%

ABC States
Source: Deutsche Bank

Liquor stores gave the weakest response (with TX stronger but CA weak, which will be a challenge for the industry). This channel discrepancy is consistent with the pattern in previous questions asked, and responses were slightly more bearish for liquor stores on tequila than for spirits category overall, given higher price points. 34% of respondents expect sales to drop, 31% forecast flat sales, and 35% looking for growth. Again TX responses were most optimistic, with 50% looking for growth, NY in a middle range (40% expect growth, 40% flat), and IL/CA most pessimistic (50% expecting declines, 25% flat in IL; 54% expecting declines, 31% flat in CA).

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Figure 100: Liquor Stores: 2010 premium tequila sales


60%

Texas California
42%

54%

50%

40% 31% 25% 15% 8% 0% Up more than 5%


Source: Deutsche Bank

30%

25%

20%

10%

0%

0% 0% Up 0-5% Flat Down 0-5% Down more than 5%

Again, large format stores gave more positive indications, with just 7% of respondents expecting sales declines in premium tequila in 2010, and 45% of respondents looking for growth. In the ABC channel, 24% of managers are expecting a decline, while 31% expect sales to be even and 45% growth.

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The global story is bullish


International sales are bigger than investors may realize at 45-50% of operating profit and growing. While BF accounts for only an estimated 1% of the global wine and spirits market, the company boasts strong brands in some of the most attractive categories. We are constructive on the global opportunity based on Jack Daniels and Finlandia platforms, increasing product awareness, and a burgeoning taste for tequila abroad. Figure 101: Brown Forman EBIT by region, FY09

Wine 8%

USSpirits 45% Intnl Spirits 47%


Source: Deutsche Bank estimate

1. An unrecognized international strength


Management initiated a strategy to expand globally in the mid 1990s non-US sales were less than 30% in FY03 and have since expanded to 47%.

Global diversification creates a diamond in the rough BF is far more geographically diversified than is understood in the investment community. We believe this is one of the most overlooked pieces of the story, particularly in terms of understanding the growth potential. 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.

Measured global expansion Although US remains the single biggest sales market (48% of revenue), the 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 growth steadily since that time. In FY08, non-US sales exceeded US for the first time (this flattened out in FY09 due to FX, but on a constantcurrency basis International continued to outgrow US, +2% to -1%). 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 46-47% 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 growth opportunities and as BF gains scale. We believe therefore that an overt domestic focus (or even more keenly Jack Daniels in the US) is an extremely short sighted perspective to take, overlooking the profit opportunity (and potential risks) from international expansion.
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Management expects International to outgrow US over time, particular through opportunities in BRIC economies, Eastern Europe, Asia, Latam, France and Australia.

The growth strategy: BF focuses on growing awareness and distribution of its brands in each key market, and in some cases, to increase awareness of the category itself (i.e. the tequila market 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. Management believes this process will over the long-term play out along the lines of US consumer over the past several decades. Given that consumer penetration of more expensive alcohol brands abroad is much lower than in the US, it does create a long-term growth tail for BF if it bears out. In our view this trend is also supported by the expanding global middle-class growth highlighted by KO, PEP and most other global CPG companies (although it is more challenging to capitalize on 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.

2. Key markets for Brown Forman


Absent a detailed global breakout in company disclosures, the Euromonitor case volume and share estimates are shown below. Although an imperfect indicator, it gives us a sense of relative importance of countries and BFs scale. Note that Euromonitor does not have data for some of the target emerging markets (namely the BRIC markets and Korea), which are among the biggest long term opportunities.
Figure 102: Top US export markets for spirits (2009, $mn)
160 140 120 100 80 60 40 20 0
Netherlands Australia Canada Germany Mexico France Japan Spain Italy UK

143.3 124.8 87.0 82.9

73.7

63.1 40.9 36.4 32.8 16.8

Source: Distilled Spirits Council, Dept. of Commerce. Data for Jan.-Nov. 2009

BF does disclose that Europe (including Eastern Europe) is its second largest region, at 28% of FY09 sales. Below we can also see that BFs biggest International presence/scale is in the UK, Mexico (tequila), Poland (1/3 of Finlandia sales), and Australia, but with a fairly broad presence across developed/G20 countries. This is consistent with company 10-k filings as main international markets; UK, Australia, Mexico, Poland, Germany, France, Spain, Italy, South Africa, China, Japan, Canada and Russia. Other priority growth markets discussed in recent presentations include India, Argentina, Romania, Ukraine and Brazil. And judging by current market share, opportunities still lie in markets like Canada, Germany, Czech, Spain, France, Japan, and South Africa.

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Figure 103: Estimated BF spirits cases by country 2009 (thousand 9-liter cases)
12,000 10,000 8,000 6,000 4,000 2,000 0

Figure 104: Estimated BF spirits share by country 2009


8% 7% 6% 5% 4% 3% 2% 1% 0%

Germany

Mexico

Canada

France

Source: Euromonitor

Argentina

Romania

US

Australia

Japan

Spain

Czech

Thailand

UK

Poland

S.Africa

Italy

Source: Euromonitor

3. BFs position in global spirits


We believe BF is well positioned to grow, despite smaller relative size. Globally BF lacks the scale of a behemoth like Diageo, but has a focused portfolio of excellent lead brands in attractive categories, and a track record of healthy growth. Strong foreign distribution partnerships and ongoing investment in local sales infrastructure should bolster brand awareness and growth potential. Data on the global spirits market below shows BFs core products in bourbon/tequila still compete in relatively small categories with room to expand, while growth of Finlandia is successfully expanding in the much larger vodka category market. Moreover, strength of the Jack Daniels brand provides a global growth anchor for BFs portfolio, as it ranks as the fifth-largest global spirits brand. Figure 105: Global spirits volume share (2010E)
Bourbon, 4.9% Gin, 5.0% Other Whisky, 8.7% Tequila, 3.7%

Figure 106: Global volume CAGR, 2000-2010E


8% 7% 6% 5% 4% 3% 2% 1% 0% 1% 7.6%

Liqueur/ Specialty, 22.6%

4.1% 2.5% 2.1% 1.6%

1.0%

0.5%

0.3% 0.4%

Rum,15.6%

Vodka, 20.1%

Scotch, 19.5%
Source: Impact, Euromonitor, DB estimates Source: Euromonitor

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Figure 107: Top 5 Global Spirits brands (mn cases)


30 25 20 15 10 5 0 Smirnoff
Source: Impact 2007

Bacardi

Johnnie Walker

Absolut

JackDaniel's

The volume estimates underscore the international opportunity, with the largest brand (JD) growing at twice the pace abroad - @6% over the last 5 years per Euromonitor. We estimate case sales of Jack Daniels are a 51/49% split between International/US at this point, Southern Comfort is 41% International, and Finlandia is a much larger brand outside the US (estimated 89% of volume).
Figure 108: BFB brand volume 2009E (mn cases)
10 9 8 7 6 5 4 3 2 1 0 JackDaniel's Finlandia Southern Comfort Canadian Mist

Figure 109: Volume CAGR, INTL vs. Total (2005-09E)


12% 10% 8% 6% 7.8% 5.6% 2.9% 3.4% 0.8%
International Total

10.1%

NonUS US

4% 2% 0%

Finlandia

JackDaniel's

Southern Comfort

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

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

JD depletions grew 8% in FY08 in International markets, but in FY09 depletions were essentially flat. Performance was weighed down by the recession and weakness of tourism channels.

International positioning of key brands

Jack Daniels JD is the 5th largest global spirit, and still generates consistent growth. Its biggest market abroad is the UK, followed by Western Europe, South Africa, Australia (also biggest market for the JD & Cola product), Canada, Mexico, and Japan.

With volume CAGR abroad of 5-6% in 2005-09 according to Impact and our estimates, we believe a continued good growth outlook is based on underlying category growth, rising consumer awareness of JD as an aspirational US lifestyle brand, and geographic expansion and marketing investment. JD depletions grew 8% in FY08 in International markets, but in FY09 depletions were essentially flat. Performance was weighed down by the recession and weakness of tourism channels (reflecting macro sensitivity around the brand), with declines in W. Europe offsetting growth in E. Europe, Australia (+30%), Asia, India, Latam (+20%).

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While emerging markets have fueled growth, the company expects more mature markets (like UK, a 1mn case market) to return to growth with an economic recovery and as trade inventory destocking fades. We note Jack Daniels has been in China for about 15 years but momentum has slowed of late.
Figure 110: Jack Daniels global depletions (thousand cases)
10,000 9,000 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0 2002 2003 2004 2005 2006 2007 2008 2009 2010E
0 5,000

Figure 111: Top global bourbon markets (case vol.)

20,000 15,000 10,000

Source: Company data, Deutsche Bank estimates

Source: Euromonitor estimates for 2009

Finlandia: Finlandia sources 89% of its volume outside the U.S., growing rapidly in Eastern Europe. after BF took full ownership in 2003. It now ranks as #1 vodka brand in several Eastern European markets, and a major strategic growth driver for BF internationally. It has grown successfully, although this is often overlooked by investors given its small share in the US. We estimate a 10% volume growth CAGR from 2005-09. In FY09 Finlandia was BFs fastest growing brand family, up 6.9%, with double digit depletions growth in Poland (biggest single market, 800k annual cases), Russia (100k cases), Georgia, Czech and Romania. This has weakened in FY10 based on the economic downturn and significant inventory destocking in Poland, but with a continued growth opportunity still ahead, particularly in Russia which has been barely penetrated. Management also believes that growth of Finlandia in Eastern Europe will contribute to growth of the JD brand, as it strengthens the presence with retailers/distributors, makes entre of JD easier, and creates profits for reinvestment. Figure 112: Finlandia global depletions (thousand cases)
3,500 3,000 2,500 2,000 1,500 1,000 500 0 2002 2003 2004 2005 2006 2007 2008 2009 2010E
Source: Impact

Figure 113: Top 5 non-US vodka brands (2007 cases)


16 14 12 10 8 6 4 2 0 Smirnoff Absolut Sobieski Finlandia Russian Standard 5.7 2.5 2.3 15.0

Source: Company data, DB estimates

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US Australia Germany UK Japan France S.Africa Spain China Canada Italy N.Zealand Hungary Austria Portugal Romania Czech Poland Turkey Greece Russia Mexico
1.9

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Southern Comfort SoCo is the most tourism-driven brand internationally -- leading markets are UK, Spain, Ireland and South Africa. Although we estimate 41% of volume comes from International, and growth has been respectable, we would not expect as good of a long-term growth opportunity outside the US, given the uniquely American profile and tourism channel limitations. Tequila: keep an eye on this one.. Tequila is a small, but fast growing category globally. Here we note the pull of all things Mexican, such as the strong global growth of Corona in recent years as a potential bull case to the outlook. Management notes that the UK is a rapidly-growing tequila market, and sees large potential in Russia as awareness is very low. BF is using the El Jimador trademark as its growth lever, to extend beyond its base in Mexico/US, and using existing distribution assets in areas of strength (UK, Australia, Germany, Poland). Figure 114: Top 10 global tequila markets

12,000 10,000 8,000 6,000 4,000 2,000 0

100 90 80 70 60 50 40 30 20 10 0 Casesper 000 people Cases(000)

Germany

Mexico

Canada

France

US

Russia

Japan

UK

Source: Euromonitor

The New Mix canned and pre-mixed tequila product (acquired with Casa Herradura) is a substantial business for BF in Mexico, where it is the largest RTD alcohol brand. New Mix grew depletions 7% in FY09, and BF hopes to build on this through flavored line extensions and expansion outside Mexico (including the US). Our concern here is regional/value orientation of the product -- suggesting limited potential beyond Mexico. Given that this is a highly regional and value-tier drink however, the potential outside Mexico seems limited.

4. Quantifying the growth potential


In an ideal scenario, we estimate 20-30% international growth potential vs. FY09 operating profit levels, or about $185m of EBIT.

Marking BF share abroad to home market levels suggest up to an incremental 27% EBIT boost or about $185 million in the intermediate term

We see several ways that one could frame the upside, but the most pragmatic is to assume that BF could get its market share abroad up to US levels. Such an approach is realistic in our view, as it requires no M&A, but is instead contingent on BFs execution. In an ideal scenario, we estimate 20-30% growth potential vs. FY09 operating profit levels, or about $185m of EBIT.

Deutsche Bank Securities Inc.

S.Africa

Italy

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We apply our estimates for existing US spirits volume vs. International, and afford 2% global share growth, (now at 3.2% per Euromonitor) to US levels (5.2% on our estimates). We then apply our estimate of BFs International EBIT per case ($18/case) at a 90% level (as a penalty for greater investment and D&A to achieve growth). On a dollar profit basis, this comes to 27% incremental EBIT, but by altering our estimates of volume and EBIT per case, we get to a 20-30% range. Of course this is a simplistic exercise, which does not delve into the fundamentals or investment needed in each market infrastructure abroad. It also assumes no issues with product image/affordability, etc. Nonetheless it helps frame the substantial growth opportunity if the company can execute, increase brand awareness and distribution.
Figure 115: BF market opportunities: share vs. per caps

8% 7% 6% 5% 4% 3% 2% 1%

1.2 1.0 0.8 0.6 0.4 0.2 BFshare (09) Spiritsper cap(cases)

Source: Euromonitor, company data, DB estimates

5. Distribution evolution
Reliance on outsourced marketing and distribution in some markets is a strategic weakness in our view, but the best possible approach to compensate for BFs smaller size and narrower portfolio abroad.

The marketing and distribution function is different abroad a hybrid of direct investment and partnerships with large international competitors. It is increasingly evolving towards the former, in order to harness growth potential. Reliance on outsourced marketing and distribution in some markets is a strategic weakness in our view, but the best possible approach to compensate for BFs smaller size and narrower portfolio abroad. Indeed it allows BF (at a cost) to leverage larger scale of partners, providing a good growth conduit for the brands without tying up capital. As BF gains critical mass in some of these markets, ownership of distribution will continue to increase. This requires greater upfront investment and fixed cost, but theoretically more control over destiny of the brands, distribution profits to reinvest, and better long-term cost leverage.
BFs international distribution has three basic formats:

Agency distribution partnerships, to leverage strength of a local partner. This is the primary structure in Western Europe where larger spirits competitors are more entrenched, and the dominant legacy structure for BFB. Bacardi is the partner in most markets (France, Portugal, Belgium, Netherlands, Denmark, Russia, Mexico), and Campari in Italy. Over time this has shrunk within the International mix as the company has shifted towards more integrated/owned distribution. In the agency format, BF pays a full distribution margin to its partner, but does not have to invest in asset. This
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Australia US Mexico UK Poland S.Africa Canada Romania Italy Czech Germa Spain France Japan Argenti Thailand

0%

0.0

28 March 2010

Beverages Brown-Forman

creates more favorable returns with a variable cost structure in small-scale markets. The downside is less control over the marketing/selling process, reliance on third parties and potential lack of focus, as well as lack of cost leverage as BF brands grow.

Direct distribution ownership is the second most prominent. BF selectively invests in distribution assets and sales force, and integrates the sales/marketing function. The decision here is control and captured distribution profits, vs. cost of investment. The company owns its distribution network in seven markets Australia, China, Czech, Korea, Mexico, Poland and Taiwan, and has announced it will transition Germany in Oct. 2010 upon expiration of a Bacardi partnership.

BF generally makes the commitment not only based on the upfront economics and distribution profits, but where more control makes sense against long-term growth potential of its brands, to drive consumer awareness (particularly on-premise promotion to drive trial). China is the best example of this, based on the long-term profit growth potential in the market. BF can also enhance profitability in these markets by distributing for third-parties (distributes for Bacardi/LMVH in Czech, Dekuyper in Poland) to add operating leverage.

The middle way of a JV, with a commission structure and cost-sharing between BF and a partner. BF typically pays a local distributor for only certain distribution services while handling other functions itself, or does pooling and cost-sharing with the partner. The key upside as opposed to a straight agency relationship is more control over the selling. A cost sharing structure is used in the UK with Bacardi, with sales costs allocated according to effectiveness targets. Figure 117: 2008 International distribution, % of business
Hybrid Ag./Owned

Figure 116: 1998 International distribution, % of business


Owned JV

Cost Sharing

Agency

Commissi onaire

JV

Agency
Source: Company data Source: Company data

Owned

Ownership will likely continue to grow Increasingly as BF evaluates distribution capabilities against what offers the best growth, we expect it to head towards more ownership vs. partnerships. As the brands gain scale abroad and can support more infra-structure, we expect BF to increase distribution control to harness the brands potential. 15 years ago for example, the company did not own any significant distribution networks, compared to 7-8 today. Since the companys goal is gaining as much control over the selling process as possible relative to cost of owing it, we do not expect a radical overhaul, but a gradual shift as partnerships come up for renewal. We note the recent announcement about converting Germany from agency to ownership later this year, and the company has highlighted plans in FY10 to review distribution in parts of Europe, Russia and Asia (as a matter of procedure, management fully reviews any expiring distribution contracts). Therefore we could see more announcements this year.

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Control may be costly in the short-run We observe BF management as thoughtful long-term operators, occasionally willing to accept short-term profitability impacts. Here, we see new distribution control as an areas that serves a greater long-term good, but would likely cap upside to local margins and ROIC, depending on speed and magnitude of investment. Although we do not have access to detailed case studies of financial impact of past transitions, it is not viewed as a major factor for group margins. One favorable factor is the narrower consumer geography in some of the key markets, since consumption in some markets is concentrated in tourist/expat areas, requiring only limited distribution coverage.

6. Currency creates profit volatility


BF prices its products on a local basis vs. local competitors, meaning investors bear a significant profit translation risk to US Dollar strengthening, as foreign profits are converted back.

BF prices its products on a local basis vs. local competitors, meaning investors bear a significant profit translation risk to US Dollar strengthening, as foreign profits are converted back. Although the company has broad currency exposure, most important are British Pound, Euro, Australian Dollar and Polish Zloty. It is a significant exposure the most recent 10-k highlighted exposure on an EBIT level was estimated at $435m (foreign-denominated revenue less foreign-denominated expense). The company does hedge, but not to a great degree as near as we can tell. some of this exposure (mostly reflected in the net sales line), but still has significant exposure to FX changes, and the profit impact of hedging programs lags spot rate changes in currency. Although management has not laid out any concrete hedging targets, general strategy is to hedge cash flow/profit exposure and smooth out year-to-year fluctuations (i.e. any significant hedge gains/losses will tend to reverse the following year).
Currency is never really neutral. Investors consider currency fluctuations in their estimates, which adds a significant layer of complexity to making forecasts, and which cannot be precisely mapped vs. spot rates. The other significant point of volatility is that many of the operating currencies are not hedge-able, specifically in BRIC markets and Eastern Europe. Growth of Finlandia for example is problematic here as it grows faster, volatility of Polish currency becomes more significant, and this is a currency BF does not hedge. Figure 118: Jack Daniels profit profile by region

%BrandProfit Growth

Russia Romania France UK US

China

Japan

BrandProfit
Source: Company data

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7. Margin impact appears containable


The lack of segment-level profits data for BF makes it difficult to trace the profit impact of International growth. But we can infer a few things:
Intnl mix has been positive. Operating margins have risen on a consolidated basis over the past decade as International has grown and distribution investment increased. This has included Finlandia/Eastern Europe outgrowing the overall business, and the 2007 acquisition of Casa Herradura, which increased exposure to Mexico and had a modest negative impact on group margins. Margins are highest in Japan and Europe, less so Latam, E Europe. BFs highest margin region is Asia-Pacific (specifically Japan), followed by Western Europe. Latam and Eastern Europe are the lowest margin regions. BFs margins tend to be more consistent across products on a global basis, with less consistency across regions.

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Beverages Brown-Forman

A great financial picture


Brown Forman manages its financial picture based on a long-term, total return philosophy, which generates steady shareholder value. Over a 10-year period, this has driven top-line at 7%, EBIT at 8% and EPS at 12% -- best in class among beverage companies. Continued strength in key brands, particularly JD, growth in International profits, and top-notch marketing should drive sales growth, while scale improvements and cost controls should push margins modestly higher. This makes for a stable growth outlook at all levels of the P&L.

1. Long-term earnings growthTotal return approach


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 going forward as its global exposure ramps 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. That said, BF quarterly EPS volatility vs. consensus estimates over the past 3 years has been significant.
Figure 119: Earnings growth CAGR, 35 & 10-year basis

14% 12% 10% 8% 6% 4% 2% 0%

35year 10year

Netsales
Source: Deutsche Bank estimates, company data

Operating income

EPS

DB forecast @5% revenue growth amidst greater volatility


Our assumptions may be conservative against the long-term track record and the International opportunity. However, the recent slowdown of growth based on economic conditions calls for conservatism, at least in the near-term.

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Figure 120: BF revenue growth ($mn)*

20% 15% 10% 5% 0% 5% 10% 15% 20%

3,000 2,500 2,000 Revenue 1,500 1,000 500 0 Growth

Source: Company data, DB estimates. *Revenue excluding excise tax

Balanced (2-3% each) from volume and price/mix; minimal currency impact We assume inflation based pricing, modest domestic volumes, better results abroad, flat CPI-type pricing growth in the US, very modest US volume growth, a few points of International volume growth per year with flat pricing as modest rev per case 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. Key revenue considerations: Inventory adjustments create quarterly volatility: This is a story that requires patience quarter-to-quarter. Slower retail turns mean spirits are a major working capital consideration for distributors/retailers (estimated avg. retailer carries three weeks of JD inventory). This can create volatility in quarterly shipments when trade inventories are adjusted (especially outside the US, where total volumes are lower and external distributors used). For FY09 on the JD brand for example, estimated impact of retail destocking was 200k cases and 80k more outside the US. Finally we note that sales growth expectations have to be tempered by the production process, given the years of aging required on JD (BF schedules production to meet demand 3-10 years in the future).

Slower retail turns mean spirits are a major working capital consideration for distributors/retailers. This can create volatility in quarterly shipments when trade inventories are adjusted, especially outside the US, where total volumes are lower and external distributors used.

Pricing/promotional fluctuations: This factor has been a source of pressure this year and limits our growth forecasts. We believe BF has good pricing power and is somewhat insulated by JDs leadership of the bourbon category. However premium spirits is an economically sensitive model in general (flat underlying revenue growth for BF in 2H09 as the economy weakened), and the larger global spirits companies can absorb the cost of promotion better than BF. Further spirits is much more fragmented than competing categories like beer, and the higher absolute unit prices can be more prone to promotion. Therefore price competition will always be a risk, as a temptation for competitors to drive growth. Outside the US, BF will also likely have some negative mix as it promotes to increase brand awareness, affordability, and entrance into developing markets.

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2000 2001 2002 2003 2004 2005 2006 2007 2008 2009E 2010E 2011E 2012E

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2. Expanding operating profits & margins


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. This is somewhat conservative vs. the longterm track record, but we base it on three factors:

International growth limits mix. If we assume International spirits margins are below US spirits but not dramatically so (i.e. 19-20% vs. mid-20s), growth should entail some margin pressure, and improve with greater scale over time. Perhaps the best way to look at margin mix on both a product and geographic basis is a portfolio approach, with a group of older products and markets (i.e. Jack Daniels, US/UK) funding growth of younger pieces (tequila, Eastern Europe/BRIC). These more mature areas will provide cash to reinvest on an ongoing basis, and we believe management will be mindful of the pace of growth investments to generate steady growth and avoid major margin volatility. The long-term growth opportunity is there, but we look for a stable approach to achieving it. Reinvestment for International growth and in distribution assets. Ongoing domestic category promotion.

We therefore model modest year-to-year operating margin improvement. This should support mid to high single digit EBIT growth. Again FX will be the major unknown factor yearto-year, although this should smooth out on a long-term basis. Key profit & margin considerations EBIT margins on a normalized basis have steadily increased over the past 10 years, from 16% to the low 20s, but have plateaued since 2006. With advertising/SG&A continuing to scale, this is based on gross margin slippage and appears mostly due to International mix (Mexico) and reinvestment (and in FY09, negative impact of FX and trade inventory destocking). Figure 121: EBIT (normalized) ($mn)
30% 25% 20% 15% 10% 5% 0%
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009E 2010E 2011E 2012E

Figure 122: Normalized EBITDA margin (2009E)*


900 800 700 600 500 400 300 200 100 0
EBIT (underlying) Margin

35% 30% 25% 20% 15% 10% 5% 0%

31.2%

30.6%

30.2% 26.0% 21.8%

BF

Diageo

Pernod

Campari

Remy

Source: Company data, Deutsche Bank estimates

Source: Company data, Deutsche Bank estimates. All calendarized for 2009 and margin of revenue ex-excise taxes

High gross margins. Despite gross margin pressure in FY09 and 1H10 (resulting from negative currency, trade inventory destocking, geographic mix, and some shift of ad spend to price cuts), gross margins remain structurally high (we project 65% for FY10 if we strip out excise tax from revenue). This is generally true in spirits, but for BF it is boosted by premium pricing and relatively small input costs. Key inputs include corn, grains (rye/barley), agave, sugar, glass/PET packaging, grapes (primarily externally grown), wood, and energy (for
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production/shipping/bottles). Input cost volatility is also smoother by hedging of some commodity exposure (specifically corn, but not 100%), and multi-year supply contracts (i.e. glass packaging, which has annual energy inflation adjustments and caps). The company does do not hedge gas/oil for shipping costs. Going forward, we expect slight gross margin expansion, with geographic/product mix offsetting scale gains and fixed cost leverage. There may also be incremental opportunities to improve margins by outsourcing more agriculture (i.e. owned agave/grape production).
As a total cost bucket, advertising and SG&A are slightly larger than COGS, but as gross margins have come under modest pressure since 2006, cost leverage in this area has improved.

Advertising and SG&A costs scalingBut need to keep up investment. As a total cost bucket, advertising and SG&A are slightly larger than COGS. As gross margins have come under modest pressure since 2006, cost leverage in this area has improved. It is a function of growing scale and recent cost-cutting, but we also attribute it partially to a shift of promotion from expensed advertising to price promotion and packaging investment (both captured in gross margin). While we believe leverage can continue to build, we do not expect a huge uplift because BF needs to maintain marketing/selling investments to grow, increase trial (i.e. on-premise sampling) and protect brand equity.

Indeed we would not want to see advertising expense cut back too much, given the demonstrated good returns. We also expect the relatively more expensive on-premise investment to ramp up once the economy revives (BF does not carry a large direct sales force, and on-premise marketing is largely outsourced and reported in advertising expense). As a side note, channel-shift from off to on-premise should not make a big difference to margins -- Off-premise is somewhat negative in terms of higher packaging costs (smaller average bottler sizes), but more favorable in terms of price discounts per ounce, and less intense marketing investment.
Figure 123: Gross profit ($mn)
55% 54% 53% 52% 51% 50% 49% 48% 47% 2,000 1,800 1,600 1,400 1,200 1,000 800 600 400 200 0 Gross profit Margin

Figure 124: Advertising expense ($mn)


30% 25% 20% 15% 10% 5% 0%
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009E 2010E 2011E 2012E

450 400 350 300 250 200 150 100 50 0


Advertising exp. % gross profit

Source: Company data, Deutsche Bank estimates

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009E 2010E 2011E 2012E

Source: Company data, Deutsche Bank estimates

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3. Spotlight question: Is the Ad Spend O.K.?


A&M is often investors short-hand for investment in the business. Using this approach one would tend to see BF as under-investing as spend has moderated. However, the number of new products and packages suggest otherwise. In particular, its success with high-end brand launches would support a view that marketing has not been cut but raised. Traditional media and promotion have increasingly come under the ROIC glare across CPG . Its efficacy for premium brands is hard to pin down. Trade spend to drive promotion is often not captured, but is also clearly an investment. In short, there are many things to consider besides advertising, but even within that, some leverage within digital and social media is clearly seen on a cost basis.

Ad and SG&A expenses have decreased on an absolute dollar basis in 2009 and YTD 2010, which is raised as a concern by bears. However, a number of factors are at work here. Specifically reallocation of promotional investment indeed underlying ad expense declined 2% in FY09, but this was more than offset by reallocation for $13mn more or repackaging expense and price promotion. It also does not consider the current benefit of media deflation (10-20% better ad rates, increased share of voice), investment in line extensions to drive consumer interest, and recent cost restructuring activities. Management does not look at advertising spend exclusively to gauge investment health, as it seeks a more nimble strategy, which is now manifesting in these reallocations of investment dollars, and since programs like new packaging have proven effective. As a final note, although restructuring is a common profit driver in the industry, we do not view it as a major strategy going forward. Employee reductions have historically been very rare, with the exception of voluntary retirement programs last year in light of the weak economy.

4. Strong FCF, conservative balance sheetRoom to raise payouts


One of the most attractive aspects of the investment case is high predictable FCF generation and a pristine balance sheet, as well as solid ROIC (we estimate 15-16%). In terms of cash distributions to shareholders, we envision consistent improvement. Dividends have grown consistently each year, at a stable 36-39% payout of normalized EPS. Share repurchases, while erratic, have supplemented this and increased in the past three years. Coupled with a solid earnings growth outlook, BF is compelling long-term total return opportunity, very much in the mold of a Coca-Cola. We would argue that it could stand to increase cash payouts, given the conservative balance sheet (0.7x net debt/EBITDA) and measured pace of expansion, however management is likely to save room for potential acquisitions.
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 over the past 10 years (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.

Barring big swings in currency/working capital, we expect FCF should grow along with earnings. Long-term capex is guided to remain in the $45-75m range, since BF has adequate production facilities (9 in the US, 1 Canada, 1 France, 1 Italy, 1 Mexico) and should mainly need to maintain plant, machinery, and barrels. The only variance we see is if higher growth requires new facilities built.

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Figure 125: Free cash flow ($mn)


$600 $500 $400 $300 $200 $100 $0

Figure 126: Combined dividend/repurchase, % of FCF


600% 500% 400% 300% 300 200% 100% 0% 200 100 0 700 600 500 400
Div.+ Repurch. % of FCF

2009E

2010E

2011E

2012E

2000

2001

2002

2003

2004

2005

2006

2007

2008

Source: Company data, Deutsche Bank estimates

Source: Company data, Deutsche Bank estimates

Leverage is conservative Despite undertaking bigger share repurchases the past two years ($262mn in FY08-09), paying a $204m special dividend in 2008, increasing dividends to maintain maintains a 3540% 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.

The company currently prioritizes uses of cash in the following order:


Investment for growth and distribution assets Debt pay down Dividends and share repurchase, M&A. Pension top-ups - although BF does not have a major hole to fill ($175mn deficit).

We therefore expectation cash to fall into three major categories:

Return to shareholders: We believe cash to shareholders could stand to increase, although the company appears unlikely to take a much more aggressive approach. Management emphasizes strength of credit profile, and views current cash payout policy as reasonable. Historically, higher leverage has been funneled into M&A. Therefore while our forecasts embed steady dividend increases with earnings, and more consistent share repurchases each year ($100-250m p.a.), leverage in our forecasts still steadily declines over time. Reinvestment: BF faces plenty of attractive growth and reinvestment opportunities, and this should be its primary focus. We also do not forecast much more aggressive cash payouts to shareholders because we expect the company will maintain flexibility for any M&A opportunities that arise. Given that BF has historically been disciplined here, and proved its mettle in terms of execution, this too could be a constructive growth opportunity. Debt reduction. Shareholders could argue with the prioritization of debt repayment over share repurchase or a higher dividend payout (the last share repurchase program was not fully used). There is some limitation on buybacks given the already low trading liquidity, and we would not expect a major change there (likely be opportunistic around any weakness of share price). But barring M&A activity or major International investments, leverage will continue to decline and, and a higher dividend payout is possible.
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5. Brown Forman has thoughtfully acquired new brands.


The spirits/wine industries offer more opportunities for consolidation vs. the wider Food/Beverage space, given the huge number of brands and fragmented market shares, and the list of wellcapitalized companies at the top.

Healthy cash flows and a higher degree of fragmentation suggests spirits and wine segments should continue to see consolidation activity in the coming years. We see BF as a potentially active but disciplined participant. In recent years activity has been consistent Casa Herradura (acquired Jan. 2007), Chambord (acquired June 2006), luggage business (sold May 2007), Lenox (Sept. 2005). Further its track record of development is sound and there are plenty of spirits segments where it has little or no presence. Figure 127: Brown Forman brand acquisitions/divestitures
D ate 2009 2007 2007 2007 2007 2007 2006 2006 2005 2004 2000-2002 2000-2002 2000 1 999
Source: Company data

B us ine s s Italian wine brands Casa Herradura B ro o ks & B entley Remaining Do n Eduardo stake P aso Ro bles winery Hartmann Chambo rd B o lla winery Leno x Glenmo rangie equity stake Finlandia Vo dka Tuo ni e Canepa Glenmo rangie equity stake So no ma-Cutrer Vineyards

A c t io n Divestiture A cquisitio n Divestiture A cquisitio n Divestiture Divestiture A cquisitio n Divestiture Divestiture Divestiture A cquisitio n A cquisitio n A cquisitio n A cquisitio n

B ra nds B o lla, Fo ntana Candida el Jimado r, Herradura, New M ix B ro o ks & B entley jewelry Do n Eduardo Vineyards - retain brand rights Hartmann luggage Chambo rd Winery - retain brand rights Leno x china, Dansk Glenmo rangie Finlandia Tuaca Glenmo rangie So no ma-Cutrer

We expect BF to remain a very disciplined buyer, and do not believe management has any strategic imperative to fill in other spirits categories for their own sake. Management shows particular concern that any acquisitions are attractive from a supply chain perspective (i.e. distribution fit, any asset investments like in the tequila business). We expect mid-sized rather than blockbuster deals, and growth-oriented. Strong high-end brands like Casa Herradura portfolio with clear growth potential appear most likely, so that BF can expand them globally, using existing portfolio for investment funding. This might also include investments in foreign distribution assets.

Very large-scale deals at a level that would require equity financing appear unlikely, especially since the family would not want to endanger company independence. Although it would be possible to line up JV alliances for big deals (as with the 2005 BF/STZ combination, which considered a bid for Allied Domecq in 2005), BF has been limited in its ability to participate in M&A cycles for this reason, and these structures can be cumbersome.

Wine appears unlikely, as it is not a growth priority. It is more likely BF would look to further reduce its wine business or sell production assets. Divestments probably would not occur near-term however, given that BF does not have any pressing need for cash and in the current market it could be hard to command multiples near BFs current 1011x EBITDA.

Could BF be a target? Highly unlikely, and we do not believe valuation should reflect much probability. This is not because it is not an attractive target, but because of shareholder structure and the legacy of independence. The trend in spirits is to consolidation and the big to get bigger. And all things equal, BF offers a stable of strong brands, good growth prospects, modest size and a clean balance sheet. Larger US spirits players also do not have much exposure to bourbon. Bacardi in particular would seem a good partner (although it already has significant leverage and probably would need equity issuance or a partner), given low product overlap, existing JV partnerships with BF, a global footprint, and potential for US cost saves/scale. That said, we do not believe the likelihood of an acquisition is significant, simply because of BFs voting structure.
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6. Ownership structure: Family matters


Brown Forman equity has two classes, Class A voting and Class B non-voting, both of which are publicly traded (despite low liquidity, Class As have historically traded at a slight premium). For investors, this makes it essentially an investment in a privately-owned company BF is classified under NYSE rules as a controlled company, as more than 50% voting is held by the designated Brown family shareholder group. This exempts BF from independent director requirements (although five of eleven directors are independent by NSYE standards). At last count Brown family members controlled 67% of Class A shares, and significant corporate actions and director elections require a majority of Class A votes.
The question then becomes, how has the family acted? And on any financial metric over time, the answer would be a positive one for shareholders. Strategies are given time to work. It is also a group which is likely to have a better understanding of the industry, and able to form a consensus on major decisions. For public investors, this may occasionally result in earnings misses for long-term objectives, or dissatisfaction with cash distributions. However the positive is a long-term rudder that many public companies lack. For example, BF management undertakes strategic planning sessions with a 10-20 year view (indeed the decision to divest the home goods business came out of these sessions), and the family takes a very long-term view of financial performance, focusing on ROIC and long-term compounding total returns (including providing ample liquidity through dividends).

To this end, BF documents indicate, members our of our controlling stockholder group participate directly on our BoardWe believe this governance structure confers a distinct competitive advantagedue largely to the long-term ownership perspective of the Brown family. Secondly (and highlighting the importance of company independence), we believe that a strong relationship with the Brown family is essential to our growth, independence, and long-term value creation. To this end, the company also holds regular meetings with the Brown Family Shareholders Committee.
On the basis of the track record, we are disinclined to view the closely held nature of this company as a disadvantage. While Class B holders have no vote, the family tends to make good decisions.

Our 2010-11 estimates Light at end of the tunnel


Our estimates for Q4 2010 and 2011 are generally conservative. We consider soft near-term consumer spending, trade-down, competitor promotion, and weak on-premise channel (indeed the companys outlook remains fairly cautious on these points, as well as competitors). Our bias would shift with economic and/or category pickup. We expect a modest improvement in top-line growth in 2H11, based on easier laps and assumption that the spending environment improves modestly. Overall we look for 8.1% EPS growth in FY11 and high single digits annually in future years.
Overall we look for 6% EPS growth in FY11 and high single digits annually in future years.

The biggest variables against our estimates are: (1) Any reacceleration of consumer spending against premium spirits brands, both in the US and globally, as management has indicated it expect JD depletions to re-accelerate once this occurs, (2) any improvement in the pricing/promotion environment, (3) volatility of trade inventories, which appear to have been through the worst at this point and could rebuild at some point, (4) FX. We emphasize that our estimates do not factor in a meaningful positive impact from any of these factors at this point, so they are a potential of upside.

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Q4, $0.56 underlying EPS: Revenue +2.9% against easier laps, including 1.5% underlying growth, +2% currency, -0.5% impact from trade inventory adjustments. We model adjusted EBIT +-.9% to $129.7m (margin -110bps to 18.4%), and adjusted EPS of $0.56 (excludes $0.03 expected charges for routing changes), against guidance of $0.480.58. We believe this might prove conservative, however margin deterioration reflects the guidance for weaker FX impact (Q3 benefit reversing), and difficult expense laps against significant cut-backs a year ago. FY11 EPS $3.42, 8% growth: We model 8% EPS growth to $3.42, essentially in line with long-term targets for high single digits growth. This embeds an acceleration of revenue growth (+2.2% volume, +2.2% price/mix, -0.5% FX, 0% trade inventory impact) and modest EBIT margin improvement (margin +90bps to 23.8%, EBIT $785mn) from revenue growth and scaling of ad/SG&A costs. Volume-wise, we are hearing signs of stabilization in on-premise but no acceleration yet, and Diageo/Fortune recently indicated full-year US industry volume growth in the 0-1% range. One of the key questions will be if price/mix can meaningfully improve, based on need for industry promotion. We also embed modest decrease in tax rate (33.2% as International grows, and share repurchase of $100mn (adds 1% to EPS growth). Beyond FY11, 9-10% EPS growth: We model a pick-up in EPS growth in 2011 and beyond, to a 9-10% annual rate (i.e. 9.0% growth in FY12 to $3.72). We model revenue growth of 5-6%, evenly split between volume and price/mix and assuming flat FX impact. We model 7% annual EBIT growth, with annual margin expansion of 50-60bps, gradually lower tax rate, and assume annual share repurchase of $150-250m. Figure 129: DB vs. consensus estimates
A ct ual 0.65 0.80 0.79 0.55 0.71 0.93 0.77 0.49 0.62 0.84 0.80

Figure 128: Historical quarterly EPS


1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10
Source: Company data, DB estimates, CapIQ

St reet 0.62 0.83 0.74 0.65 0.69 0.94 0.68 0.58 0.81 0.99 0.70

Q 4 10 F Y 11 F Y 12

D B est. $ 0.56 $ 3.42 $ 3.72

S t re e t $ 0.53 $ 3.30 $ 3.61

Source: Deutsche Bank estimates, CapIQ

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Valuation: 14% upside potential, initiate at Buy


Fundamentally, BF offers a sound future outlook with an attractive growth profile. Long-term, we expect total shareholder returns to rank among the highest in the industry, not to mention the entire CPG sector. Our target price of $64 yields a total return of 14% including a 2.2% dividend yield. We therefore initiate coverage at a Buy recommendation, with the belief that superior total returns justify a relatively high valuation multiple.

Valuation: $64 target price


Our target price of $64 yields a total return of 14% including a 2.2% dividend yield.

DCF value of $64: We value BFB shares on a DCF-basis, and arrive at a valuation of $64/share. Key assumptions within this 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 assume a perpetuity growth rate of 1-1.5% (below long-term expected GDP growth given relative maturity of spirits industry). $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, vis--vis the upside for premium brandowners.

Figure 130: Historical forward P/E


30 25 20 15 10 5 0
09/01/98 03/01/99 09/01/99 03/01/00 09/01/00 03/01/01 09/01/01 03/01/02 09/01/02 03/01/03 09/01/03 03/01/04 09/01/04 03/01/05 09/01/05 03/01/06 09/01/06 03/01/07 09/01/07 03/01/08 09/01/08 03/01/09 09/01/09

Figure 131: Historical relative P/E


2.0 1.8 1.6 1.4 1.2 1.0 0.8 0.6 0.4 0.2 0.0
09/01/98 03/01/99 09/01/99 03/01/00 09/01/00 03/01/01 09/01/01 03/01/02 09/01/02 03/01/03 09/01/03 03/01/04 09/01/04 03/01/05 09/01/05 03/01/06 09/01/06 03/01/07 09/01/07 03/01/08 09/01/08 03/01/09 09/01/09

Source: Company estimates, CapIQ

Source: Company estimates, CapIQ

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Figure 132: Historical EV/EBITDA

18 16 14 12 10 8 6 4
09/01/98 03/01/99 09/01/99 03/01/00 09/01/00 03/01/01 09/01/01 03/01/02 09/01/02 03/01/03 09/01/03 03/01/04 09/01/04 03/01/05 09/01/05 03/01/06 09/01/06 03/01/07 09/01/07 03/01/08 09/01/08 03/01/09 09/01/09

Source: Company estimates, CapIQ

Figure 133: Trading multiples (2010E, calendarized) C a le nda rize d 2 0 10 E E V / E B IT D A F C F yie ld P erno d 1 3.4 6.6% Campari 1 0.1 6.7% Diageo 1 1 .3 7.0% Remy 1 2.8 4.7% STZ 7.5 9.9% FO 1 1 .3 NA BF 1 1 .1 5.4% BF 1 0-yr avg. 1 1 .7 4.6%
Source: Deutsche Bank estimates, company data, CapIQ

P /E 1 5.2 1 4.0 1 5.4 1 8.3 9.1 1 8.0 1 7.2 1 8.9

While BFs multiples appear somewhat high vs. US beverage averages, and against our growth projections, we believe higher EBITDA multiples are warranted based on: (1) High returns on capital and barriers to entry, (2) High FCF generation, (3) Higher than average security of growth projections, given the stable/defensive nature of spirits, (4) Underappreciated global growth opportunity. Similarly on an earnings basis, we see support not only from the outlook for high single digit growth, but the relatively high stability around those estimates, the global growth opportunity, and an attractive total earnings return profile for investors, based on steadily compounding earnings and high dividend payout ratio. We believe these more than offset the negatives of low financial leverage, low trading liquidity, and the non-voting shareholder structure.
Key factors for the multiple:

Slow and steady wins the race. We note that despite risk to profitability from tradedown and competitor promotion, BFs long-term compounding of operating profit has been extremely steady over very long-term periods, and even in the most recent downturn years of FY09-10, is on track have EBITDA of -1% and +8% respectively. And although international expansion adds some potential macro/currency volatility vs. the US business, it also supplements growth and adds an element of geographic diversification for growth.
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Voting control & M&A are two final considerations for investors. The question is if the Class B shares should carry a significant discount given the lack of voting rights. This should only be the case if we believe that lack of voting power is obstructing value creation, however we have no reason to take this view. Rather, the company operates under the stewardship of patient family shareowners interesting in steady long-term total return growth, and pursuing global growth of the brands. However we also do not believe BFB shares should embed any kind of M&A premium, despite the fact that it would otherwise make an attractive target. Given the family blocs ability to prevent an acquisition, and their interest in keeping the company independent, we think it is highly unlikely they would be willing sellers.

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Risks
Key risks to our recommendation:

Slower volume growth than expected in key products. This includes potential decline in popularity of BF brands, consumer trade-down to cheaper spirits brands, ineffective marketing or innovation, or temporary disruption from trade inventory adjustments. Price competition. Given the high number of competitors in spirits, there is potential for pressure on pricing and promotional investment, and BF could be disadvantaged keeping pace against larger competitors. Failure of International strategies. Against the US as a more mature market for its major brands, growth in foreign markets is key to achieving long-term growth targets. Ineffective marketing, distribution (including reliance on third-party distributors), or macroeconomic weakness abroad could damage the growth outlook. Scale. As a smaller scale player on a global basis, BF is potentially more vulnerable to of industry pricing weakens, if it needs to increase marketing spending, or of losing focus of distributors/retailers. Currency volatility, given exposure to non-US markets, and faster growth some of the more volatile developing economies (i.e. Eastern Europe). Regulation, including higher excise taxes on alcohol, changes laws on alcohol consumption, as well as US tax deductions for foreign income and taxes paid. M&A: As a historically active buyer and seller of assets, there is a risk BF could overpay for acquisitions, pursue large transactions, or sell assets at low prices. Shareholder voting structure: Class B shareholders do not have voting rights, and are subjected to the majority Class A voting bloc of Brown family shareholders.

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28 March 2010

Figure 134: BFB income statement ($mn)


Net Sales Excise Taxes Cost of Sales Gross Income Advertising Expenses SG&A Expenses Other (Income), net Special Charges Operat ing Income Oper. Inc. Excl. C harges Interest Expense Interest Income Interest Expense, net Pret ax Income Taxes Income f rom C ont . Operat ions Income from Discontinued Operations Net income Net Income Excl. charges Shares Outstanding - Basic Basic EPS Dilution Avg. Shares Outstanding - Diluted D ilut ed EPS D ilut ed EPS (Excl. C harges) Dividend Payout Margin St ruct ure Gross Margin Advertising Expenses SG&A Expenses Operating Margin EBITDA Margin Tax Rate Net Margin Growt h Leverage Net Sales Excise Taxes Sales ex-tax Cost of Sales Advertising Expenses SG&A Expenses Operating Income EBITDA Net Income Diluted EPS
Source: Deutsche Bank estimates, company data

2009 3 ,1 9 2 .1 711.0 882.0 1 ,5 9 9 .1 382.9 540.6 0.6 14.0 6 6 1 .0 6 7 5 .0 (37.0) 6.0 (31.0) 6 3 0 .0 (195.4) 4 3 4 .6 4 3 4 .6 4 3 8 .8 150.5 $2.89 1.1 151.5 $ 2 .8 7 $ 2 .9 0 $1.12 2009 50.1% 12.0% 16.9% 21.1% 22.9% 31.0% 13.7% 2009 -2.7% 1.6% -3.9% -0.6% -7.8% -9.4% -1.5% -0.9% 1.0% 3.0%

1 Q1 0 7 3 7 .9 167.1 190.7 3 8 0 .1 76.0 118.5 (6.4) 1 9 2 .0 1 9 2 .0 (8.1) 1.0 (7.1) 1 8 4 .9 (63.5) 1 2 1 .4 1 2 1 .4 1 2 1 .4 149.6 $0.81 0.7 150.3 $ 0 .8 1 $ 0 .8 1 $0.29 1 Q1 0 51.5% 10.3% 16.1% 26.0% 28.0% 34.3% 16.5% 1 Q1 0 -6.6% -5.2% -7.0% -9.4% -21.6% -18.6% 17.8% 17.1% 16.5% 17.8%

2 Q1 0 8 9 2 .9 194.1 255.8 4 4 3 .0 92.1 126.4 (1.1) 2 2 5 .6 2 2 5 .6 (7.8) 0.4 (7.4) 2 1 8 .2 (70.9) 1 4 7 .3 1 4 7 .3 1 4 7 .3 148.0 $1.00 0.7 148.7 $ 0 .9 9 $ 0 .9 9 $0.29 2 Q1 0 49.6% 10.3% 14.2% 25.3% 26.9% 32.5% 16.5% 2 Q1 0 -4.5% -1.4% -5.3% -5.7% -16.3% -10.5% 1.8% 2.0% 2.8% 5.0%

3 Q1 0 8 6 1 .7 224.3 226.5 4 1 0 .9 92.0 132.8 0.6 11.6 1 7 3 .9 1 8 5 .5 (7.5) 0.4 (7.1) 1 6 6 .8 (58.9) 1 0 7 .9 1 0 7 .9 1 1 8 .3 146.8 $0.74 0.8 147.5 $ 0 .7 3 $ 0 .8 0 $0.30 3 Q1 0 47.7% 10.7% 15.4% 21.5% 23.2% 35.3% 13.7% 3 Q1 0 9.9% 17.0% 7.6% 2.1% 5.7% 16.1% 18.3% 17.1% 14.4% 17.5%

4 Q1 0 E 7 0 3 .1 150.0 183.3 3 6 9 .8 91.4 149.8 (1.0) 5.0 1 2 4 .7 1 2 9 .7 (7.5) 0.3 (7.2) 1 1 7 .5 (38.8) 7 8 .7 7 8 .7 8 2 .1 146.8 $0.54 0.8 147.5 $ 0 .5 3 $ 0 .5 6 $0.30 4 Q1 0 E 52.6% 13.0% 21.3% 18.4% 20.5% 33.0% 11.7% 4 Q1 0 E 2.9% 2.5% 3.0% 2.7% 2.8% 7.4% -2.9% -2.9% -6.7% -4.6%

2010E 3 ,1 9 5 .6 735.5 856.3 1 ,6 0 3 .8 351.5 527.5 (7.9) 16.6 7 1 6 .2 7 3 2 .8 (30.9) 2.1 (28.8) 6 8 7 .4 (232.1) 4 5 5 .3 4 5 5 .3 4 6 9 .1 147.8 $3.08 0.7 148.5 $ 3 .0 6 $ 3 .1 6 $1.18 2010E 50.2% 11.0% 16.5% 22.9% 24.7% 33.8% 14.7% 2010E 0.1% 3.4% -0.8% -2.9% -8.2% -2.4% 8.6% 8.2% 6.9% 9.1%

1 Q1 1 E 7 6 9 .4 172.9 194.8 4 0 1 .6 78.5 120.8 (0.5) 2 0 2 .9 2 0 2 .9 (9.6) 0.9 (8.7) 1 9 4 .2 (66.0) 1 2 8 .1 1 2 8 .1 1 2 8 .1 146.5 $0.87 0.9 147.4 $ 0 .8 7 $ 0 .8 7 $0.30 1 Q1 1 E 52.2% 10.2% 15.7% 26.4% 28.2% 34.0% 16.7% 1 Q1 1 E 4.3% 3.5% 4.5% 2.2% 3.3% 1.9% 5.7% 5.1% 5.6% 7.6%

2 Q1 1 E 9 2 7 .5 198.0 264.9 4 6 4 .7 94.6 128.0 (0.5) 2 4 2 .6 2 4 2 .6 (9.6) 1.1 (8.5) 2 3 4 .1 (74.9) 1 5 9 .2 1 5 9 .2 1 5 9 .2 146.2 $1.09 0.9 147.1 $ 1 .0 8 $ 1 .0 8 $0.30 2 Q1 1 E 50.1% 10.2% 13.8% 26.2% 27.7% 32.0% 17.2% 2 Q1 1 E 3.9% 2.0% 4.4% 3.5% 2.7% 1.3% 7.5% 7.0% 8.1% 9.3%

3 Q1 1 E 8 7 1 .8 223.0 227.8 4 2 1 .1 92.4 132.5 (0.5) 1 9 6 .7 1 9 6 .7 (9.6) 1.2 (8.4) 1 8 8 .3 (64.0) 1 2 4 .3 1 2 4 .3 1 2 4 .3 145.8 $0.85 1.0 146.8 $ 0 .8 5 $ 0 .8 5 $0.32 3 Q1 1 E 48.3% 10.6% 15.2% 22.6% 24.2% 34.0% 14.3% 3 Q1 1 E 1.2% -0.6% 1.8% 0.6% 0.4% -0.2% 6.0% 5.6% 5.0% 5.5%

4 Q1 1 E 7 3 2 .6 153.0 189.2 3 9 0 .5 94.5 153.8 (0.5) 1 4 2 .6 1 4 2 .6 (9.5) 1.5 (7.9) 1 3 4 .7 (44.4) 9 0 .2 9 0 .2 9 0 .2 145.5 $0.62 1.0 146.5 $ 0 .6 2 $ 0 .6 2 $0.32 4 Q1 1 E 53.3% 12.9% 21.0% 19.5% 21.2% 33.0% 12.3% 4 Q1 1 E 4.2% 2.0% 4.8% 3.2% 3.4% 2.7% 10.0% 8.0% 9.9% 10.7%

2011E 3 ,3 0 1 .4 746.8 876.7 1 ,6 7 7 .9 360.0 535.2 (2.0) 7 8 4 .7 7 8 4 .7 (38.3) 4.7 (33.5) 7 5 1 .2 (249.4) 5 0 1 .8 5 0 1 .8 5 0 1 .8 146.0 $3.44 1.0 146.9 $ 3 .4 1 $ 3 .4 2 $1.25 2011E 50.8% 10.9% 16.2% 23.8% 25.4% 33.2% 15.2% 2011E 3.3% 1.5% 3.8% 2.4% 2.4% 1.5% 7.1% 6.3% 7.0% 8.1%

1 Q1 2 E 8 0 6 .1 177.4 206.3 4 2 2 .4 80.6 125.0 (0.7) 2 1 7 .6 2 1 7 .6 (9.9) 2.1 (7.8) 2 0 9 .8 (70.9) 1 3 8 .9 1 3 8 .9 1 3 8 .9 145.1 $0.96 1.2 146.3 $ 0 .9 5 $ 0 .9 5 $0.32 1 Q1 2 E 52.4% 10.0% 15.5% 27.0% 28.7% 33.8% 17.2% 1 Q1 2 E 4.8% 2.6% 5.4% 5.9% 2.7% 3.4% 7.2% 6.8% 8.4% 9.2%

2 Q1 2 E 9 6 9 .2 203.1 278.5 4 8 7 .5 96.9 131.8 (0.7) 2 5 9 .5 2 5 9 .5 (10.2) 2.8 (7.4) 2 5 2 .1 (80.7) 1 7 1 .4 1 7 1 .4 1 7 1 .4 144.6 $1.19 1.4 146.0 $ 1 .1 7 $ 1 .1 7 $0.32 2 Q1 2 E 50.3% 10.0% 13.6% 26.8% 28.3% 32.0% 17.7% 2 Q1 2 E 4.5% 2.6% 5.0% 5.2% 2.4% 3.0% 7.0% 6.8% 7.7% 8.5%

3 Q1 3 E 9 0 8 .3 228.3 239.3 4 4 0 .7 95.4 136.2 (0.8) 2 0 9 .9 2 0 9 .9 (10.5) 3.4 (7.1) 2 0 2 .8 (67.9) 1 3 4 .9 1 3 4 .9 1 3 4 .9 144.1 $0.94 1.5 145.6 $ 0 .9 3 $ 0 .9 3 $0.36 3 Q1 3 E 48.5% 10.5% 15.0% 23.1% 24.7% 33.5% 14.8% 3 Q1 3 E 4.2% 2.4% 4.8% 5.1% 3.2% 2.8% 6.7% 6.5% 8.5% 9.5%

4 Q1 3 E 7 6 4 .1 156.6 199.8 4 0 7 .7 97.7 158.6 (0.8) 1 5 2 .2 1 5 2 .2 (10.7) 4.1 (6.6) 1 4 5 .6 (48.0) 9 7 .5 9 7 .5 9 7 .5 143.6 $0.68 1.7 145.3 $ 0 .6 7 $ 0 .6 7 $0.36 4 Q1 3 E 53.4% 12.8% 20.8% 19.9% 21.9% 33.0% 12.8% 4 Q1 3 E 4.3% 2.4% 4.8% 5.6% 3.4% 3.1% 6.7% 7.4% 8.1% 9.0%

2012E 3 ,4 4 7 .7 765.5 923.9 1 ,7 5 8 .3 370.6 551.6 (3.0) 8 3 9 .1 8 3 9 .1 (41.3) 12.4 (28.9) 8 1 0 .2 (267.5) 5 4 2 .6 5 4 2 .6 5 4 2 .6 144.3 $3.76 1.5 145.8 $ 3 .7 2 $ 3 .7 2 $1.36 2012E 51.0% 10.8% 16.0% 24.3% 26.0% 33.0% 15.7% 2012E 4.4% 2.5% 5.0% 5.4% 2.9% 3.1% 6.9% 6.8% 8.1% 9.0%

2013E 3 ,6 0 8 .6 786.9 974.1 1 ,8 4 7 .6 382.5 570.2 (3.0) 8 9 7 .9 8 9 7 .9 (42.1) 19.1 (23.0) 8 7 4 .9 (287.8) 5 8 7 .1 5 8 7 .1 5 8 7 .1 141.5 $4.15 2.0 143.5 $ 4 .0 9 $ 4 .0 9 $1.50 2013E 51.2% 10.6% 15.8% 24.9% 26.6% 32.9% 16.3% 2013E 4.7% 2.8% 5.2% 5.4% 3.2% 3.4% 7.0% 6.9% 8.2% 9.9%

2014E 3 ,7 8 7 .4 810.5 1,030.1 1 ,9 4 6 .7 395.8 590.8 (3.0) 9 6 3 .1 9 6 3 .1 (45.9) 22.3 (23.7) 9 3 9 .5 (308.1) 6 3 1 .3 6 3 1 .3 6 3 1 .3 138.7 $4.55 2.0 140.7 $ 4 .4 9 $ 4 .4 9 $1.66 2014E 51.4% 10.5% 15.6% 25.4% 27.1% 32.8% 16.7% 2014E 5.0% 3.0% 5.5% 5.8% 3.5% 3.6% 7.3% 7.0% 7.5% 9.7%

Beverages Brown-Forman

Page 90 Deutsche Bank Securities Inc.

28 March 2010

Figure 135: BFB cash flow statement ($mn)


Net income Depreciation and amortization Stock-based compensation Deferred tax Working capital Other Operat ing C ash Flow Acquisition of businesses Acquisition of distribution rights/brand Asset disposals ST investments Capex Other Invest ing C ash Flows Debt issuance Equity issuance Equity repurchase Dividends paid Other Net Financing C ash Flows Cash and equivelents beginning of yea Cash and equivelents end of year
Source: Deutsche Bank estimates, company data

2000 218.0 62.0 (51.0) 11.0 1.0 2 4 1 .0 (27.0) 5.0 (78.0) (19.0) (1 1 9 .0 ) (30.0) (83.4) 0.4 (1 1 3 .0 ) 171.0 180.0

2001 233.0 64.0 (40.0) (30.0) 4.0 2 3 1 .0 (114.0) (99.0) 1.0 (2 1 2 .0 ) (23.0) 1.0 (3.0) (87.0) (1.0) (1 1 3 .0 ) 180.0 86.0

2002 228.0 55.0 (43.0) (11.0) 21.0 2 5 0 .0 (79.0) 3.0 (7 6 .0 ) (37.0) 4.0 (13.0) (93.5) (4.5) (1 4 4 .0 ) 86.0 116.0

2003 245.0 55.0 (15.0) (70.0) 28.0 2 4 3 .0 (99.0) 1.0 (127.0) (1.0) (2 2 6 .0 ) 592.0 7.0 (561.0) (98.5) (0.5) (6 1 .0 ) 116.0 72.0

2004 257.7 56.0 (1.0) (41.0) 34.3 3 0 6 .0 (41.0) (22.0) (6 3 .0 ) (162.0) 12.0 (97.0) (2 4 7 .0 ) 72.0 68.0

2005 309.9 58.0 7.0 (5.0) 33.0 (6.9) 3 9 6 .0 (64.0) 93.0 (48.0) 3.0 (1 6 .0 ) (50.0) 9.0 (3.0) (111.0) 2.0 (1 5 3 .0 ) 68.0 295.0

2006 320.2 44.0 9.0 (33.0) 32.0 (28.2) 3 4 4 .0

2007 389.7 44.0 8.0 (7.0) (43.0) (36.7) 3 5 5 .0

2008 439.4 52.0 10.0 5.0 (268.0) 295.6 5 3 4 .0 2.0 (13.0) 6.0 86.0 (53.0) 2 8 .0 (172.0) 11.0 (223.0) (361.7) (66.3) (8 1 2 .0 ) 369.0 119.0

2009 434.6 55.0 7.0 12.0 54.1 (71.7) 4 9 1 .0 17.0 (54.0) (3 7 .0 ) (6.0) (6.0) (39.0) (169.0) (13.0) (2 3 3 .0 ) 119.0 340.0

2010E 455.3 57.0 6.8 11.3 (20.8) (20.0) 4 8 9 .6 (45.0) (4 5 .0 ) (233.0) 5.0 (157.5) (173.8) (5 5 9 .3 ) 340.0 225.3

2011E 501.8 55.0 6.9 (23.5) (30.0) 5 1 0 .3 (53.0) (5 3 .0 ) 6.8 (100.0) (182.2) (2 7 5 .4 ) 225.3 407.2

2012E 542.6 58.0 7.1 (20.3) (10.0) 5 7 7 .4 (58.0) (5 8 .0 ) 6.9 (150.0) (196.4) (3 3 9 .4 ) 407.2 587.2

2013E 587.1 61.0 7.4 (31.4) (10.0) 6 1 4 .0 (62.0) (6 2 .0 ) 7.1 (250.0) (211.8) (4 5 4 .6 ) 587.2 684.6

2014E 631.3 63.0 7.7 (38.9) (10.0) 6 5 3 .0 (64.0) (6 4 .0 ) 7.4 (250.0) (230.5) (4 7 3 .1 ) 684.6 800.5

Beverages Brown-Forman

(1,045.0) (25.0) 212.0 26.0 (160.0) 74.0 (52.0) (67.0) (4.0) (1.0) (4 .0 ) (1 ,0 3 8 .0 ) (55.0) 19.0 (3.0) (128.0) 167.0 295.0 635.0 595.0 27.0 (143.0) (62.0) 4 1 7 .0 635.0 369.0

Deutsche Bank Securities Inc. Page 91

28 March 2010

Figure 136: BFB DCF valuation ($mn)


EBIT D&A Non-cash compensation Tax Working capital Capex Other FC F 2011E 785 55 7 (259) (23) (53) 511 2012E 839 58 7 (277) (20) (58) 549 2013E 898 61 7 (296) (31) (62) 577 2014E 963 63 8 (318) (39) (64) 613 2015E 1,021 67 8 (337) (40) (67) 652 2016E 1,082 71 9 (357) (40) (71) 694 2017E 1,136 73 9 (375) (40) (73) 730 2018E 1,193 75 9 (394) (40) (76) 768 2019E 1,253 77 10 (413) (40) (79) 808 2020E 1,315 80 10 (434) (40) (81) 850

Beverages Brown-Forman

D iscount Rat e PV of FCF PV of Terminal Value C orporat e V alue Net debt Net pension/PRBO liability Equit y V alue Shares (Millions) Equit y V alue
Source: Deutsche Bank estimates, company data

8 .0 % $4,372 $6,052 $ 1 0 ,4 2 4 ($540) ($175) $ 9 ,7 0 9 147 $64

Terminal

$ 6 ,0 5 2

9 .4 Terminal EBITDA multip

Page 92 Deutsche Bank Securities Inc.

28 March 2010

Figure 137: EVA analysis ($mn)


B ro wn F o rm a n ( $ m n) EB IT Increase in bad debt reserve Operating lease expense Equity inco me P ensio n/P RB O benefit expense (inco me) Increase in LIFO Reserve A dvertising adjustment Restructuring adjustment Impairment/dispo sal adjustment A djus t e d E B IT Operating taxes N O P LA T Co mmo n Equity P referred sto ck M ino rity interest Deferred tax liabilities B ad debt reserve Debt P V o f No n-Cap. Leases LIFO Reserve Capitalized A dvertising Capitalized restructuring P ensio n/P RB O o bligatio ns T o t a l C a pit a l R O IC Required Rate o f Return P o st-tax co st o f Debt Relative P /E % Debt % Equity Weighted Co st o f Debt Weighted Co st o f Equity M a rk e t A dj C o s t o f C a pit a l ROIC M A CC S pre a d
Source: Deutsche Bank estimates, company data

2005 492.3 (0.4) 1 .1 7.0 (5.0) (3.7) 0.0 (35.0) 4 5 6 .3 (1 59.8) 2 9 6 .5 1 ,31 0.0 61 .0 5.1 631 .0 53.0 1 41 .0 (3.7) 0.0 (71 .0) 2 ,12 6 .3 13 .9 % 9.0% 2.1 % 1 .4 32.2% 67.8% 0.7% 4.4% 5 .0 % 1 3.9% 5.0% 8 .9 %

2006 563.2 0.1 1 .1 1 6.0 (20.0) (26.5) 0.0 (42.9) 4 9 1.0 (1 70.7) 3 2 0 .3 1 ,563.0 52.0 5.3 576.0 52.9 1 21 .0 (30.3) 0.0 (76.0) 2 ,2 6 3 .9 14 .1% 9.0% 2.1 % 1 .5 27.8% 72.2% 0.6% 4.3% 4 .9 % 1 4.1 % 4.9% 9 .2 %

2007 602.6 1 6.7 1 .1 22.0 4.0 8.7 0.0 (1 1 .1 ) 6 4 4 .0 (272.7) 3 7 1.3 1 ,573.0 (20.0) 22.0 1 ,1 77.0 42.2 1 25.0 (21 .6) 0.0 1 04.0 3 ,0 0 1.5 12 .4 % 9.0% 2.7% 1 .0 40.6% 59.4% 1 .1 % 5.3% 6 .4 % 1 2.4% 6.4% 5 .9 %

2008 685.0 (3.2) 1 .2 25.0 25.0 48.1 0.0 7 8 1.2 (220.6) 5 6 0 .6 1 ,725.0 (1 3.0) 1 8.8 1 ,006.0 39.8 1 50.0 26.5 0.0 1 05.0 3 ,0 5 8 .1 18 .3 % 9.0% 3.1 % 1 .0 34.2% 65.8% 1 .1 % 5.9% 7 .0 % 1 8.3% 7.0% 11.3 %

2009 661 .0 (3.9) 1 .3 20.0 39.0 (3.5) 8.0 2.0 7 2 4 .0 (226.9) 4 9 7 .0 1 ,81 6.4 (22.1 ) 1 4.9 998.5 52.4 1 89.0 23.1 8.0 1 75.0 3 ,2 5 5 .1 15 .3 % 9.0% 2.5% 1 .0 32.3% 67.7% 0.8% 6.1 % 6 .9 % 1 5.3% 6.9% 8 .4 %

2 0 10 E 71 6.2 3.0 1 .1 1 9.5 (0.4) (31 .7) (4.0) 1 6.6 7 2 0 .3 (258.1 ) 4 6 2 .2 1 ,926.9 (25.1 ) 1 7.9 765.5 45.3 1 88.6 (8.6) 4.0 1 80.3 3 ,0 9 4 .8 14 .9 % 9.0% 2.3% 1 .0 26.2% 73.8% 0.6% 6.6% 7 .2 % 1 4.9% 7.2% 7 .7 %

2 0 11E 784.7 3.0 1 .5 1 9.8 4.5 (4.8) (4.0) 0.0 8 0 4 .7 (269.2) 5 3 5 .6 2,1 40.3 (25.1 ) 20.9 765.5 44.9 1 93.1 (1 3.4) 0.0 1 70.3 3 ,2 9 6 .4 16 .2 % 9.0% 3.3% 1 .0 24.6% 75.4% 0.8% 6.8% 7 .6 % 1 6.2% 7.6% 8 .6 %

2 0 12 E 839.1 3.0 1 .7 20.4 7.7 9.9 0.0 0.0 8 8 1.8 (288.5) 5 9 3 .3 2,342.8 (25.1 ) 23.9 765.5 45.9 200.9 (3.5) 0.0 1 68.2 3 ,5 18 .5 16 .9 % 9.0% 3.6% 1 .0 23.1 % 76.9% 0.8% 6.9% 7 .8 % 1 6.9% 7.8% 9 .1%

2 0 13 E 897.9 3.0 1 .7 21 .1 1 0.9 1 1 .5 0.0 0.0 9 4 6 .2 (309.2) 6 3 6 .9 2,474.7 (25.1 ) 26.9 765.5 47.4 21 1 .8 8.0 0.0 1 66.0 3 ,6 7 5 .2 17 .3 % 9.0% 3.7% 1 .0 22.1 % 77.9% 0.8% 7.0% 7 .8 % 1 7.3% 7.8% 9 .5 %

2 0 14 E 963.1 3.0 2.0 21 .9 1 2.2 1 2.8 0.0 0.0 1,0 14 .9 (331 .0) 6 8 3 .9 2,632.9 (25.1 ) 29.9 765.5 48.7 224.0 20.8 0.0 1 63.8 3 ,8 6 0 .4 17 .7 % 9.0% 4.0% 1 .0 21 .1 % 78.9% 0.9% 7.1 % 8 .0 % 1 7.7% 8.0% 9 .8 %

Beverages Brown-Forman

28 March 2010

Beverages Brown-Forman

Appendix 1
Important Disclosures Additional information available upon request
Disclosure checklist Company Brown-Forman Ticker BFb.N Recent price* 57.44 (USD) 25 Mar 10 Disclosure 2,8

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

Important Disclosures Required by U.S. Regulators


Disclosures marked with an asterisk may also be required by at least one jurisdiction in addition to the United States. See Important Disclosures Required by Non-US Regulators and Explanatory Notes. 2. Deutsche Bank and/or its affiliate(s) makes a market in securities issued by this company. 8. Deutsche Bank and/or its affiliate(s) expects to receive, or intends to seek, compensation for investment banking services from this company in the next three months.

Important Disclosures Required by Non-U.S. Regulators


Please also refer to disclosures in the Important Disclosures Required by US Regulators and the Explanatory Notes. 2. Deutsche Bank and/or its affiliate(s) makes a market in securities issued by this company.
For disclosures pertaining to recommendations or estimates made on securities other than the primary subject of this research, please see the most recently published company report or visit our global disclosure look-up page on our website at http://gm.db.com/ger/disclosure/Disclosure.eqsr?ricCode=BFb.N.

Analyst Certification
The views expressed in this report accurately reflect the personal views of the undersigned lead analyst(s) about the subject issuer and the securities of the issuer. In addition, the undersigned lead analyst(s) has not and will not receive any compensation for providing a specific recommendation or view in this report. Marc Greenberg

Deutsche Bank Securities Inc.

Page 93

28 March 2010

Beverages Brown-Forman

Historical recommendations and target price: Brown-Forman (BFb.N)


(as of 3/25/2010)
90.00 80.00 70.00 60.00
Previous Recommendations Strong Buy Buy Market Perform Underperform Not Rated Suspended Rating Current Recommendations Buy Hold Sell Not Rated Suspended Rating *New Recommendation Structure as of September 9, 2002

S ecurity Price

50.00 40.00 30.00 20.00 10.00 0.00 Mar 07 Jun 07 Sep 07 Dec 07 Mar 08 Jun 08 Sep 08 Dec 08 Mar 09 Jun 09 Sep 09 Dec 09

Da te

Equity rating key


Buy: Based on a current 12- month view of total share-holder return (TSR = percentage change in share price from current price to projected target price plus pro-jected dividend yield ) , we recommend that investors buy the stock. Sell: Based on a current 12-month view of total share-holder return, we recommend that investors sell the stock Hold: We take a neutral view on the stock 12-months out and, based on this time horizon, do not recommend either a Buy or Sell. Notes: 1. Newly issued research recommendations and target prices always supersede previously published research. 2. Ratings definitions prior to 27 January, 2007 were: Buy: Expected total return (including dividends) of 10% or more over a 12-month period Hold: Expected total return (including dividends) between -10% and 10% over a 12-month period Sell: Expected total return (including dividends) of -10% or worse over a 12-month period

Equity rating dispersion and banking relationships

450 400 350 300 250 200 150 100 50 0

46% 37%

50%

31% 3% 32%

Buy
Companies Covered

Hold

Sell

Cos. w/ Banking Relationship

North American Universe

Page 94

Deutsche Bank Securities Inc.

28 March 2010

Beverages Brown-Forman

Regulatory Disclosures 1. Important Additional Conflict Disclosures


Aside from within this report, important conflict disclosures can also be found at https://gm.db.com/equities under the "Disclosures Lookup" and "Legal" tabs. Investors are strongly encouraged to review this information before investing.

2. Short-Term Trade Ideas


Deutsche Bank equity research analysts sometimes have shorter-term trade ideas (known as SOLAR ideas) that are consistent or inconsistent with Deutsche Bank's existing longer term ratings. These trade ideas can be found at the SOLAR link at http://gm.db.com.

3. Country-Specific Disclosures
Australia: This research, and any access to it, is intended only for "wholesale clients" within the meaning of the Australian Corporations Act. EU countries: Disclosures relating to our obligations under MiFiD can be found at http://globalmarkets.db.com/riskdisclosures. Japan: Disclosures under the Financial Instruments and Exchange Law: Company name - Deutsche Securities Inc. Registration number - Registered as a financial instruments dealer by the Head of the Kanto Local Finance Bureau (Kinsho) No. 117. Member of associations: JSDA, The Financial Futures Association of Japan. Commissions and risks involved in stock transactions - for stock transactions, we charge stock commissions and consumption tax by multiplying the transaction amount by the commission rate agreed with each customer. Stock transactions can lead to losses as a result of share price fluctuations and other factors. Transactions in foreign stocks can lead to additional losses stemming from foreign exchange fluctuations. New Zealand: This research is not intended for, and should not be given to, "members of the public" within the meaning of the New Zealand Securities Market Act 1988. Russia: This information, interpretation and opinions submitted herein are not in the context of, and do not constitute, any appraisal or evaluation activity requiring a license in the Russian Federation.

Deutsche Bank Securities Inc.

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Deutsche Bank Securities Inc. North American locations


Deutsche Bank Securities Inc. 60 Wall Street New York, NY 10005 Tel: (212) 250 2500 Deutsche Bank Securities Inc. 225 Franklin Street 25th Floor Boston, MA 02110 Tel: (617) 988 6100 Deutsche Bank Securities Inc. 101 California Street 46th Floor San Francisco, CA 94111 Tel: (415) 617 2800 Deutsche Bank Securities Inc. 222 South Riverside Plaza 30th Floor Chicago, IL 60606 Tel: (312) 537-3758 Deutsche Bank Securities Inc. 700 Louisiana Street Houston, TX 77002 Tel: (832) 239-4600 Deutsche Bank Securities Inc. 3033 East First Avenue Suite 303, Third Floor Denver, CO 80206 Tel: (303) 394 6800

Deutsche Bank Securities Inc. 1735 Market Street 24th Floor Philadelphia, PA 19103 Tel: (215) 854 1546

International locations
Deutsche Bank Securities Inc. 60 Wall Street New York, NY 10005 United States of America Tel: (1) 212 250 2500 Deutsche Bank AG London 1 Great Winchester Street London EC2N 2EQ United Kingdom Tel: (44) 20 7545 8000 Deutsche Bank AG Groe Gallusstrae 10-14 60272 Frankfurt am Main Germany Tel: (49) 69 910 00 Deutsche Bank AG Deutsche Bank Place Level 16 Corner of Hunter & Phillip Streets Sydney, NSW 2000 Australia Tel: (61) 2 8258 1234

Deutsche Bank AG Level 55 Cheung Kong Center 2 Queen's Road Central Hong Kong Tel: (852) 2203 8888

Deutsche Securities Inc. 2-11-1 Nagatacho Sanno Park Tower Chiyoda-ku, Tokyo 100-6171 Japan Tel: (81) 3 5156 6701

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The information and opinions in this report were prepared by Deutsche Bank AG or one of its affiliates (collectively "Deutsche Bank"). The information herein is believed to be reliable and has been obtained from public sources believed to be reliable. Deutsche Bank makes no representation as to the accuracy or completeness of such information. Deutsche Bank may (1) engage in securities transactions in a manner inconsistent with this research report, (2) with respect to securities covered by this report, sell to or buy from customers on a principal basis, and (3) consider this report in deciding to trade on a proprietary basis. Opinions, estimates and projections in this report constitute the current judgement of the author as of the date of this report. They do not necessarily reflect the opinions of Deutsche Bank and are subject to change without notice. Deutsche Bank has no obligation to update, modify or amend this report or to otherwise notify a recipient thereof in the event that any opinion, forecast or estimate set forth herein, changes or subsequently becomes inaccurate. Prices and availability of financial instruments are subject to change without notice. This report is provided for informational purposes only. It is not an offer or a solicitation of an offer to buy or sell any financial instruments or to participate in any particular trading strategy. Target prices are inherently imprecise and a product of the analyst judgement. As a result of Deutsche Bank's recent acquisition of Sal. Oppenheim and BHF-Bank AG, a security may be covered by more than one analyst within the Deutsche Bank group. Each of these analysts may use differing methodologies to value the security; as a result, the recommendations may differ and the price targets and estimates of each may vary widely. Disclosures made by Deutsche Bank AG and Sal. Oppenheim jr. & Cie. KGaA / Bank Sal. Oppenheim jr. & Cie (Switzerland) Ltd. ("Sal. Oppenheim") will remain separate through the closing of the acquisition of Sal. Oppenheim's Cash Equities Research business by Macquarie, which is expected to be completed in Q2 2010. For further information regarding the disclosures of potential conflicts of interests of Sal. Oppenheim please refer to the homepage of Sal. Oppenheim: http://www.oppenheim.de/disclaimer/Disclosure?site=dede. Deutsche Bank has instituted a new policy whereby analysts may choose not to set or maintain a target price of certain issuers under coverage with a Hold rating. In particular, this will typically occur for "Hold" rated stocks having a market cap smaller than most other companies in its sector or region. We believe that such policy will allow us to make best use of our resources. Please visit our website at http://gm.db.com to determine the target price of any stock. The financial instruments discussed in this report may not be suitable for all investors and investors must make their own informed investment decisions. Stock transactions can lead to losses as a result of price fluctuations and other factors. If a financial instrument is denominated in a currency other than an investor's currency, a change in exchange rates may adversely affect the investment. Past performance is not necessarily indicative of future results. Unless governing law provides otherwise, all transactions should be executed through the Deutsche Bank entity in the investor's home jurisdiction. In the U.S. this report is approved and/or distributed by Deutsche Bank Securities Inc., a member of the NYSE, the NASD, NFA and SIPC. In Germany this report is approved and/or communicated by Deutsche Bank AG Frankfurt authorized by the BaFin. In the United Kingdom this report is approved and/or communicated by Deutsche Bank AG London, a member of the London Stock Exchange and regulated by the Financial Services Authority for the conduct of investment business in the UK and authorized by the BaFin. This report is distributed in Hong Kong by Deutsche Bank AG, Hong Kong Branch, in Korea by Deutsche Securities Korea Co. This report is distributed in Singapore by Deutsche Bank AG, Singapore Branch, and recipients in Singapore of this report are to contact Deutsche Bank AG, Singapore Branch in respect of any matters arising from, or in connection with, this report. Where this report is issued or promulgated in Singapore to a person who is not an accredited investor, expert investor or institutional investor (as defined in the applicable Singapore laws and regulations), Deutsche Bank AG, Singapore Branch accepts legal responsibility to such person for the contents of this report. 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