Brown-Forman: A Value Investor's Assessment of Moat, Margin of Safety, and the Fundsmith Exit

Terry Smith's Fundsmith Equity fund has completely sold its stake in Brown-Forman, marking the end of a position that represented 1.29% of its £20bn portfolio. The move follows a period of declining stocks for the spirits maker, with the stock down 22.8% year-to-date and having struggled with weaker demand amid rising prices and macroeconomic uncertainty. The disposal comes after disappointing quarterly results in May, a clear signal of a portfolio shift.

This exit raises the core investment question: does it reflect a deterioration in Brown-Forman's intrinsic value, or a strategic rotation toward different growth and risk profiles? The contrast with Fundsmith's recent purchases is telling. While selling Brown-Forman, the fund has been building new positions in companies like Intuit and Waters, which are in more dynamic, higher-growth sectors. This suggests a rotation away from a mature, value-oriented consumer staples business toward companies with different margin profiles and expansion trajectories.

Fundsmith's own recent performance adds another layer. The fund has faced investor frustration after several years of lagging returns, and its top detractors in June included Brown-Forman alongside other large-cap names. The exit, therefore, could be part of a broader portfolio realignment driven by relative performance and a search for new growth catalysts, rather than a definitive verdict on Brown-Forman's long-term economic moat.

The Business: Analyzing the Moat and Financial Headwinds

Brown-Forman's core strength remains its formidable brand moat. The company's portfolio, anchored by Jack Daniel's and Woodford Reserve, commands a wide competitive advantage, with intangible assets scoring a robust 45% of its economic moat. This century-plus of brand equity, built on heritage and premium positioning, sustains pricing power and shelf access globally. Yet, this moat is not impervious. The analysis notes a moderation in the moat rating due to potential erosion from shifting consumer preferences, regulatory overhang, and the persistent threat of tariffs. The durability of this advantage is now a key question for investors.

The financial results for the first half of fiscal 2026 reveal the pressures testing that moat. The company reported a 4% decrease in net sales and a 4% decrease in gross profit. CEO Lawson Whiting directly attributed this to lower discretionary spending in the U.S. and in many developed international markets, a clear sign of macroeconomic headwinds. While the company saw resilience in emerging markets and a 5% growth in ready-to-drink products, its entire whiskey portfolio was essentially flat, and other categories like tequila and the rest of the portfolio saw significant declines. This is the reality of compounding: even a strong brand faces top-line pressure when consumer confidence wanes.

In this environment, the company's capital allocation discipline stands out. Despite the earnings per share decline of 13% year-over-year, Brown-Forman executed a ~2% share buyback for roughly $266 million. This move signals a commitment to returning capital to shareholders when the stock appears undervalued, a hallmark of a disciplined management team. It also provides a tangible floor for the share price, as the company is effectively buying its own shares at a discount. The challenge now is whether this discipline can be maintained through a longer period of consumer retrenchment, or if further cost cuts and portfolio adjustments will be required to protect margins and free cash flow.

Valuation and the Margin of Safety: What Price Represents a True Discount?

The numbers tell a clear story of a reset. Brown-Forman's stock trades at a trailing price-to-earnings ratio of 16.4, a significant discount to its own historical average and to the broader market. This multiple reflects the market's recalibration of growth expectations, driven by the 4% decline in net sales and 13% drop in earnings per share seen in the first half of fiscal 2026. For a value investor, this is the core of the opportunity: a price that appears to be pricing in a permanent impairment of the business, not just a cyclical downturn.

Yet the recent price action adds a layer of complexity. The stock has shown notable near-term momentum, gaining 10.4% over 30 days and 12.6% over 90 days. This re-rating suggests some investors see a floor or a path to stabilization. However, that optimism is sharply contrasted by the longer-term view. The one-year total return remains deeply negative at -27.5%, a stark reminder that the fundamental pressures-weak discretionary spending, tariff costs, and a potential shift in consumer preference-are still very much in play. The recent bounce may be a technical relief rally, not a fundamental reversal.

The key question for a margin of safety is whether the current price adequately compensates for these risks. The company's capital allocation discipline provides a tangible support. Its ~2% share buyback for roughly $266 million is a powerful signal. Management is effectively saying the stock is worth more than it is trading for, using cash to retire shares at a discount. This creates a direct, if modest, floor under the price.

For the intrinsic value to be realized, two conditions must hold. First, the cyclical pressures must ease, allowing the company's formidable brand moat to reassert itself. Second, management must successfully navigate the threats to that moat-regulatory scrutiny, trade policy, and the potential for premium pricing to erode volume. The current valuation offers a wide margin of safety only if one believes the business can weather this period of consumer retrenchment and emerge with its competitive position intact. If the erosion proves structural, the discount may not be deep enough. The stock's price today is a bet on the durability of Brown-Forman's century-old brand in a more uncertain world.

The Value Investor's Checklist: Applying Classic Principles

For the value investor, the situation with Brown-Forman is a classic test of principles. The core tenets of margin of safety, business quality, and management discipline must be applied with a clear-eyed view of the current risks.

First, the Margin of Safety is paramount. The current price of roughly $30.76 offers a discount, but it must account for the specific risks at hand. The primary threat is prolonged weak consumer spending in developed markets, which the company itself cites as a key headwind. This isn't a one-quarter blip; management expects the behavior of the consumer and trade inventories to remain under pressure through the fiscal year. A true margin of safety requires a price that discounts the possibility of this pressure persisting longer than expected. Furthermore, the potential for tariff impacts to linger adds another layer of uncertainty. The safety margin is only adequate if the intrinsic value calculation assumes these headwinds could be more severe or longer-lasting than the market currently prices in.

Second, Business Quality is a study in a wide moat under stress. The evidence confirms a formidable economic moat, with intangible assets scoring 45% and a century of brand equity behind Jack Daniel's and Woodford Reserve. This is a durable competitive advantage. Yet, the company's resilience is being tested. The 4% decline in net sales and gross profit for the first half of fiscal 2026 shows that even a powerful brand faces top-line pressure when consumer confidence wanes. The moat provides a floor, but it does not guarantee immunity. The real question is whether the company's pricing power can hold against both economic retrenchment and the cost of trade barriers. The moderation in the moat rating due to regulatory and tariff overhang is a direct signal that the business environment has become more challenging.

Finally, Management & Capital Allocation is where the discipline of the owner is revealed. The recent ~2% share buyback for roughly $266 million is a powerful signal. It is a tangible act of capital allocation that aligns management's interests with shareholders, effectively buying shares at a discount. This is a hallmark of a disciplined team. However, for long-term value creation, this discipline must be consistent. The company has already taken significant cost actions, including closing a cooperage and laying off 12% of its global staff. The path forward likely requires more of the same-careful cost management and strategic portfolio adjustments-while the buyback program provides a floor. The key is that management must continue to return capital prudently, whether through buybacks or dividends, as long as the stock remains undervalued. This consistency, not a one-time gesture, is what compounds value over the long cycle.

In essence, Brown-Forman presents a value opportunity only if one believes the business can navigate its current headwinds and that management will continue to act as a prudent steward of capital. The margin of safety is there, but it is thin if the macroeconomic and trade pressures prove more persistent than hoped.

Catalysts, Risks, and What to Watch

For the value investor, the path forward hinges on a few clear catalysts and risks. The primary catalyst is a sustained recovery in the company's core financial engine: gross profit margins and organic sales growth. The recent quarterly report showed a gross margin expanded 20 basis points to 59.3%, a positive sign from cost management and portfolio shifts. However, this was on a decline in gross profit of 5% year-over-year. The real test is whether this margin expansion can be maintained or even improved as the company navigates higher input costs and tariff pressures, while simultaneously driving top-line growth.

Organic sales growth is the other critical metric. The company has already taken decisive actions, including closing a cooperage and laying off 12% of its global staff, to protect profitability. The next step is to see if these cost savings can be leveraged to fund marketing and innovation that drives volume, particularly in the areas showing resilience. The evidence points to resilient consumers in a number of emerging international markets, where the company saw 10% growth last quarter. Sustained expansion in these regions, where the company's premium brands can command a price, would be a powerful validation of the moat and a key driver for the stock.

The primary risk remains a prolonged period of weak consumer spending in key developed markets. CEO Lawson Whiting has directly cited lower discretionary spending in the U.S. and in many developed international markets as a core headwind. If this consumer retrenchment persists, it could pressure the company's pricing power and distribution, making it harder to offset cost increases. The potential for tariffs to linger adds another layer of uncertainty to the trade environment, which the company has repeatedly noted as a factor.

Finally, monitor the company's capital allocation for consistency. The recent ~2% share buyback for roughly $266 million is a positive signal of management's belief in the stock's value. Any shift away from buybacks or dividends, especially if earnings remain under pressure, would be a negative signal for shareholder returns and could undermine the margin of safety. The discipline shown in the buyback is a tangible floor; maintaining it through the cycle is what will compound value.