Pernod Ricard – Results update
Pernod Ricard is a French listed wines and spirits company. They produce wines, bitters, whiskies, liqueurs, cognacs and brandies, as well as white spirits and rums. The Group is present in all four major geographical regions of the world, with Asia being their number one market. They are the main player in both China and India.
Investment thesis
Pernod Ricard is the world’s second largest wine and spirits company with a strong portfolio of brands across the different key spirits categories. They are the market leader in the Asian premium spirits segment, with a strong footprint in China and India. India remains a growth driver for the Group, while China has slowed down since 2012 due to the anti-extravagance campaign. We believe there is room for operating margin improvement as the portfolio in China and India are being rebalanced towards higher margin international brands. We expect top line growth to recover as organic sales growth starts to stabilise in China and returns to positive growth over the next two years. Pricing is expected to remain under pressure but this will gradually improve as positive mix is driven by high growth in India and China sales recovering. With around 38% of revenues coming from emerging markets we believe there is scope for further sales growth of premium brands in this market. Pernod has been much criticized by the market for its high net debt/EBITDA versus its peers but foreign exchange has been a headwind to absolute debt reduction in the past. However this has come down from 4.8x in 2010 to 3.0x in 2017. The US Vodka sales and China’s Scotch and Cognac sales declines are some of the main issues affecting the company but we believe these concerns are overdone and already discounted in the price. At present, given the weak China backdrop and tough macro environment in other emerging spirit markets, the market is unwilling to give Pernod Ricard the benefit of the doubt. We believe this a quality company with a strong portfolio of brands that has the ability to grow both revenues and margins from this point forward.
Results update:
Pernod reported full year results which came broadly in line with expectations but the strong euro has weighed on the 2018 outlook with an averse FX impact expected of -€125m. Management guided for organic growth in Profit from Recurring Operations (PRO) of between +3% and +5% driven by continued growth of Jameson in the USA and Martell in China. The Strategic International brands (+4%) showed good growth with 11 out of the 13 brands growing. Gross margin was up 4% due to a positive mix mainly to Jameson and Martell as well as better cost management with operational efficiency initiatives. Free cash flow increased significantly (+22%) helping to decrease net debt and improve the net debt/EBITDA ratio to 3.0x from 3.4x in FY16, the lowest in a decade.
Highlights:

  • Pernod reported +3.6% Organic sales growth.
  • Strong growth driven by growth in USA (+5%) and Jameson (+15%) worldwide.
  • +3.3% Organic growth in Profit from Recurring Operations (PRO)
  • The Americas region posted +7% organic sales growth with Europe +3%.
  • Asia-RoW organic sales growth was up 1% with India showing resilience in a period of regulatory changes.
  • China posted +2% organic sales growth with a clear improvement from, FY16 (-9%) thus returning to growth for the first time since FY2013.
  • The Net debt / EBITDA ratio at average rates decreased to 3.0x from 3.4x in FY2016
  • Reported EPS increased 7% to €5.58.
  • Expects good sales growth to continue in USA, China and Europe
  • Pernod is an export orientated business with more than 70% of its brands generating revenue outside of the currency of production creating cross-currency exposure. Pernod’s largest exposure on currency is the US$ (~20% of sales) and with the weak US dollar coupled with a strong Euro in FY18, Pernod is expecting a negative FX impact of ~€125m. This guidance was based on a rate of $1.18 per € on 22 August and the euro has strengthened even further. The euro has already strengthened more than 5% since the start of the 2018 financial year.


Source. Bloomberg, SPW

Source. Bloomberg, SPW
 

  • Pernod Ricard has been able to bring down its net debt/EBITDA ratio significantly since 2009 as this has been one of the concerns the market has had with the stock.


Source. Bloomberg, SPW

  • According to Redburn; Absolut, Jameson and Martell combined accounted for ~30% of sales in FY2017. Indian whiskies (~9% of sales) are expected to grow in 2018 as the demonetization and highways ban start to moderate.


Thoughts:
We believe Pernod is well positioned to capture the growth opportunity within the emerging markets as China has returned to growth in FY17 and we expect this to continue based on positive cognac trends and the imported spirits penetration growing with purchasing power. The regulatory challenges within India is starting to moderate and we expect to see growth accelerate in FY18. We use a discounted cash flow valuation as our preferred methodology as it incorporates our long-term view about Pernod Ricard’s business model. Our DCF valuation is €121.0.