Alexis Bernet & Paul Guérin
alexis.bernet@hec.edu
04-Sept-2020
Pernod Ricard’s recent updates
· Q4 results: Pernod Ricard FY20 results showed more resilience than expected, beating Visible Alpha consensus by 2% on EBIT and 4% on EPS. Organic revenues declined by -9.5%, negatively impacted by Covid-19 crisis especially in Asia (-48% in Q4) and in the Americas (-31% in Q4). Sales in Europe demonstrated resilience (-6% in FY20).
· Partnership signed with Ojo de Tigre, a traditional Mexican producer of mescal which has a strong growth potential in North America.
Business description
· Activity
Pernod Ricard is the world's second largest producer and marketer of luxury wines and spirits, headed by Alexandre Ricard. The Group's business is centred on a portfolio of 13 international brands, which generate nearly 2/3 of revenues, and a portfolio of local brands. Revenues for the year 2020 amounted to €8.448 billion with a margin rate of 28.1%, broken down as follows:
- Spirits and champagnes (63.3% of revenue, or €5.811 billion) : Absolut brand (11 million cases sold between 2018 and 2019), Ballantine's (7.6 million), Jameson (7.3 million), Havana Club (4.6 million), Chivas Regal (4.5 million), Ricard (4.4 million), Malibu (3.7 million), Beefeater (3.2 million), Martell (2.6 million) and others (2.9 million)
- Spirits of strategic local brands (19.1% of revenue, or €1.754 billion): Imperial Blue, Wyborowa Wodka, Kalhúa, Pastis 51, 100 Pipers, Olmeca, Clampbell, etc.
- Strategic Wines (4.9%, or €451 million): Jacob's Creek, Kenwood Vineyards,Brancott Estate and Campo Viejo. - Other (12.7% or €1.166 billion)
· Geographic
Pernod Ricard generates most of its sales outside France, particularly in Asia and the rest of the world. In recent years, the Group has significantly expanded its presence in emerging countries, which have strong growth potential given their economic and demographic dynamism and the rise of a middle class that consumes luxury products. The geographical breakdown of revenue is as follows Europe (29.1%), the Americas (27.7%) and Asia & Rest of the World (43.2%).
· Competitive landscape
-DIAGEO (UK): £11.752 billion revenues in FY20; 29.7% of EBIT margin.
-HEINEKEN (NE): $23.894 billion revenues in FY19; 16.8% of EBIT margin
-LVMH (FRA): €5.528 billion revenues from wines & spirits segment in FY19; of 21.4% of EBIT margin.
-BROWN-FORMAN (US): $3.363 billion in FY20; 32.4% of EBIT margin.
-CAMPARI (ITA): 1.843 billion euros in FY18; 22.1% of EBIT margin.
· Competitive positioning
The PERNOD-RICARD Group has the advantage of a portfolio of brands with strong worldwide recognition, accessible in geographical regions where the purchasing power of local consumers allows high margins (28.1%) thanks to its high-end positioning. The price elasticity of demand for the products sold by PERNOD-RICARD is therefore low enough to fuel a price increase over the last fifteen years, particularly due to the entry into force of the Egalim law. The group has also pursued a differentiating communication policy for many years, in particular by marketing limited editions and working with container designers. This communication strategy aims to position the group in the high-end segment, with, for example, an increased presence in the "luxury spirits" duty-free segment. The growth in international air traffic should thus act as a driver of the group's revenue.
Nevertheless, the group's production remains concentrated in Europe. The export activities of PERNOD-RICARD liqueurs are therefore largely subject to exchange rate risk. It should also be noted that the internal consumption (understand here, French) of aniseed-flavoured drinks is declining considerably, whereas Ricard and Pastis 51 have long been brand images for the group. Thus, weakened sales growth in Western Europe combined with rapidly growing competition in the global market for luxury spirits should adversely affect the Group's pace of growth.
Industry outlook
- The alcoholic beverage market worldwide amounts to $1,579bn in 2020 and is expected to reach $1,751bn by 2024. This is mainly due to a constant rise in the volume of global spirit consumption from 3,086 million 9 litre cases in 2014 to 3,180 million 9 litre cases in 2018.
- The biggest revenue of the spirits market worldwide first comes from China with $134bn, followed by the United States with $84bn and India with $34bn. Leading exporters of spirits worldwide in 2018 are the UK with $8bn, followed by France with $5.3bn and the United States with $2.3bn. Leading importers are the United States with $8.7bn dollars, followed by Germany with $1.8bn and Singapore with $1.7bn.
- Gin, Whiskey, Agave-based spirits and mixed drinks are the four alcohols with positive growth in consumption worldwide, respectively 8%, 7% and 5%. Liqueurs, wine, beer and vodka present negative growth rate in consumption, in average -2%. Overall, the consumer market of alcoholic beverages is down 1.8% in 2018.
- The most important markets in terms of turnover is that of Rum ($70bn), followed by Whiskey ($65bn), Vodka ($48bn) and Gin ($9.5bn).
Financial analysis and estimates
· Covid-19 has affected Pernod-Ricard’s sales fin FY20, down 8%. However, its business remains quite resilient to economic downturn and shows stable growth over the long term. Its wide and diversified portfolio of famous alcoholic beverages provides a sustainable competitive advantage in the industry. We estimate that sales will grow annually by 5% on average.
· The group has a strong and stable operating cash-flow generation (€1,182mn in FY20), due to growing sales and operating costs containment. We estimate that the group’s cash-flow generation will continue this trend, with limited growth of FCF, due to the maturity of the business and growing working capital.
· Pernod-Ricard maintains its Capex level at around 350 million dollars. The group has adopted a multiscale capex allocation strategy: constant investments for “Stars” brands to perpetuate their reputation, variable investments on “Relais de croissance” brands, targeting growth opportunities, and sustained investments on “Bastion” already mature brands in order to strengthen their market shares. We think capex level will remain at 4.2% of sales, as an average of 4 past years’ capex.
· Pernod-Ricards’s capital structure is very healthy, providing strong guarantees for liquidity and solvency. Net debt to EBITDA ratio for FY20 is worth 3.23, on the rise this year because of FCF decrease, but should be back at average historic levels in FY21 (around 2.8); The French group’s capital structure is composed of 55% debt and 45% equity. The Ricard family has a significant power in the company, owning 15.5% of the group. Other traditional investment funds have shares in Pernod Ricard (Groupe Bruxelles Lambert (7.49%), Capital Research & Management (3.29%), The Vanguard Group (2.34%)…), as this business is considered as very stable and not too risky by portfolio strategists. The firm has also sharply increased its amount of cash & cash equivalents (€1.947bn in FY20 vs €0.923bn in FY19), traducing a culture of prudence and a proven ability to react in context of crisis.
Valuation
· Our 12-month €153.53 price target is based on a 50:50 DCF:Comps. €145.4/shr (DCF based on discount rate 6%, terminal growth 1.5%). €161.6/shr from Comps.
· We adopted a conservative approach for DCF valuation, betting on stable growth and margins. Our capex and change in WCR projections for Walmart are based on the evolution of its revenues, taking constant ratios. The WACC calculation was quite challenging due to COVID-19 crisis that has lowered discount rates for retailers at very low levels (~4%). Based on 10-Y historical data, we note that Walmart’s WACC tends to converge towards 6.5%, a percentage that we weighted down to 6% to reflect the actual situation for our 12-month valuation.
· Comparable companies analysis shows that Pernod Ricard’s peers are trading high (average PER in FY19 of 27.1 on the list chosen), Pernod Ricard ratios being in line with those of its competitors. We tried to select peers from different regions as the French group has worldwide activities. Heineken, the famous dutch brewing company, remains a reference in the industry. Diageo, Remy Cointreau, Campari are traditional European actors for centuries. We consider this pool as very representative of spirits and wines industry. Using EV/EBITDA LTM ratio to value Pernod Ricard, we see potential upside of 12.6% compared to current share price.
Investment thesis
· We set an overweight recommendation for Pernod Ricard stock, with a 12-month target price of €153.5 vs $143.55 currently.
· We think the group will keep recovering slowly, alcohol consumption going back gradually to pre-crisis level with relaxation of measures in public points of consumption. Pernod Ricard’s strategic positioning, competitive advantage through its diversified portfolio of famous brands and worldwide implantation are trusted by investors, who should support the stock over the long term.
· Main investment risks include worse-than-expected impact of Covid-19, travel retail slowdown and possible US tariff escalation.