2023-11-02 11:40:11 ET
Summary
- Pernod Ricard's organic sales growth declined by 2% in Q1 2024 due to challenging market conditions in the US and China.
- The company expects to see true earnings growth in FY24 as it overcomes tough comparable issues.
- The US and China performance data is positive, leading to a revised rating of buy for Pernod Ricard.
Summary
Readers may find my previous coverage via this link . My previous rating was a hold rating for Pernod Ricard (PRNDY), as I wanted to have more information related to China and US performance before turning bullish. I am revising my rating to buy as I now have more confidence in the US and China's performance. Looking ahead, for FY24, I expect PRNDY to showcase its true earnings growth power as it finally gets rid of the tough comparable issues faced in FY23.
Financials/Valuation
The primary emphasis during the first quarter of 2024 was on organic growth. The organic sales growth [OSG] of PRNDY experienced a decline of 2% in the first quarter of 2024, primarily attributed to challenging market conditions in both the United States and China. The OSG performance was bolstered by a notable 7% contribution from pricing and product mix, primarily driven by the advantageous impact of the previous year's price hike. This also means that PRNDY saw a steep decline in volume of 9% (7% OSG - 9% price/mix). From a geographical perspective, the Americas OSG experienced a decline of 9%. This decrease can be primarily attributed to tough comp last year and a reduction in inventory levels, particularly at the retail level. The performance of the Asia and rest of world OSG remained stagnant, however, it can be argued that the region would have exhibited strong growth had China been excluded from the analysis. The China region experienced an 8% decline, primarily attributed to weakened consumer demand and a challenging comparison to previous performance, similar to the situation in the United States. In contrast, the India OSG experienced a 1% increase, despite facing challenging comparisons. This growth can be attributed to favorable pricing growth and product mix for Seagram's whiskies, as well as the robust development of Strategic International Brands. Lastly for Europe, OSG was up 1% with growth mainly driven by Germany, France and Poland. The sales growth in Germany was primarily influenced by the performance of Jameson and Absolut, whereas in France, Ricard experienced notable growth, particularly within the on-trade sector. Poland experienced significant double-digit growth, surpassing the low comparison basis. The performance of the United Kingdom market remained stagnant, although there were notable increases in market share within the on-trade sector. Conversely, the market in Spain experienced a decline, primarily due to the high basis of comparison within the on-trade sector.
Based on my updated view of the business, I am now expecting PRNDY to grow at a slightly faster pace in FY24, ~1% above consensus estimates, as I gained more confidence regarding US and China performance as well as the partnership with Coca-Cola. With faster growth, I expect margin to start expanding from here as well, following its historical path of margin expansion. The main driver of my upside is that I now expect PRNDY to trade back to its historical average as the market realizes that PRNDY is poised for growth in FY24. From a historical perspective, PRNDY is now trading at the -1st of its historical trading range, 17.7x forward PE, which I think is a function of the market pessimistic near-term view, which I had previously. As the market recognizes FY24 is going to be a strong year, the re-rating of multiples should crystallize.
Comments
Finally, the data that I have been waiting for-US and China performance data-seems to be going the way I wanted.
Beginning with the United States, while the first quarter of 2024 has revealed a decline in the US OSG, which has been influenced by an unfavorable tough comp last year, it is reassuring to know that the market is gradually returning to its usual state and is performing at an approximate annual growth rate of 2%. Depletions in Q1 were comparable in magnitude to shipments, and 1Q24 performance was similarly impacted, as anticipated, by unfavorable shipment phasing comparisons resulting from price increases implemented in October of last year. In the first quarter, retailers made modifications to their inventories in response to the market's normalization and the presence of higher interest rates. Conversely, the impact of wholesalers' inventory adjustments was comparatively less significant. It seems to me that these are transitional periods, so the pressure will lessen in the long run, and the responses from management have borne this out. Management believed that the aforementioned inventory adjustments predominantly affected 1Q24. I believe the key takeaway is that management is optimistic about the United States' performance in FY24 thanks to favorable H2 comps, brand activations, and exciting plans for the busiest shopping season of the year. This is literally the message and positive sentiment that I was looking for previously.
As we mentioned before, we believe the market is normalizing and we believe that it's currently at plus 2% in term of growth, including FTD. As far as Pernod Ricard brands are concerned, we are cycling high comp and technical effects. 1Q24 earnings
In regards to China, it is evident that the current perspective is more lucid and significantly more optimistic compared to the preceding quarter. During the latter part of the third quarter of 2023, consumer demand experienced a decrease in volume in the on-trade sector and a more significant decrease in the off-trade sector. However, there have been positive developments in September and October, indicating a return to a relatively stable value basis in both channels. This argument is substantiated by an increase in demand for clubs, as well as a resurgence in weddings and banquets, which also contributed to a relatively stable performance for Martell in the month of September. Regarding inventories, management pointed out that while there are timing discrepancies around festivals, wholesalers' generally cautious approach to inventories has improved since September. With more manageable comparison periods coming up in Q2 and Q3, I am optimistic about FY24 as a whole.
And moving now to the -- your first question of China. So obviously, this is a very early days, but Mid Autumn Festival that happened only a few days ago. But that's fair to say that we see some signs of improvement in September. That by the way are confirmed in this first half of October. So maybe let me just come back quickly on the summer. So, what we were sharing at the end of August, early September was the soft consumer demand that happened in July and August where our volumes were declining. Modest decline in Indian trade and stronger decline in the off-trade in July and August. And this has improved in September, where we see both on and off-trade moving towards stability in September. And I'm talking about value performance. So, stability in the on trade which is improving. By the way, clubs are doing better, especially in the south, improvement as well in the off trades are moving to stability. And on that channel for instance, we see a very clear pickup in weddings and banquets. So, that means by the way that Martell is being flattish in September, which is we believe a good performance in the current environment. Again, cycling a very high record Mid Autumn Festival last year. So this is boding[ph] well for our Chinese New Year, and that's why well we are clarifying this positive outlook for the year in China. Source: 1Q24 earnings
Other aspects of the results that deserve attention are India's performance and product innovations.
India continues to exhibit robust fundamentals, as evidenced by its favorable OSR despite facing challenging comparisons to the previous year. The consumer fundamentals that underpin PRNDY's efforts to enhance the quality and value of its product remain robust. As per the management's statement, they are experiencing an increase in market share within the Indian whisky sector and witnessing significant growth in their international brand portfolio. The management team additionally anticipate significant expansion in the Indian market in fiscal year 2024. They emphasize the robust consumer fundamentals, favorable comparison basis, and well-developed activation strategies leading up to the second quarter. In light of India's progress in overcoming challenges, I anticipate that FY24 will mark the onset of its genuine performance, particularly if successful in reclaiming the Delhi license.
Management has recently made an announcement regarding product innovations, revealing a forthcoming global partnership with the Coca-Cola Company. This collaboration aims to introduce a ready-to-drink pre-mixed cocktail, specifically Absolut Vodka & Sprite, to the market in early 2024. I am highly enthusiastic about this collaboration, as I perceive it as a merger of two esteemed brands, presenting a captivating recruitment instrument for prospective customers. The inaugural release is scheduled to take place in specific European markets, namely the United Kingdom, the Netherlands, Spain, and Germany. Although it is challenging to precisely quantify the extent of the growth uplift, I anticipate that this initiative will contribute to enhanced brand recognition and undoubtedly stimulate growth in the fiscal year 2024.
Risk & Conclusion
The company is exposed to the risk of experiencing weaker-than-expected organic sales growth in the United States. Factors such as changing consumer preferences, competitive pressures, or economic uncertainties could lead to a reduction in sales growth. A slowdown in the US market could negatively affect financial results and potentially lead to a revision of earnings estimates.
In light of the recent developments and the data now available on the performance in the United States and China, I am revising my rating on PRNDY from a hold to a buy. While the first quarter of 2024 saw a decline in organic sales growth, there are reasons for optimism regarding the company's prospects in FY24. The United States is gradually returning to growth, with a promising annual growth rate of approximately 2%, despite facing tough comparisons. This optimism is reinforced by management's positive sentiment for the fiscal year, including favorable comps, brand activations, and promising plans for the upcoming holiday season. In China, the perspective has become clearer and more optimistic, with positive developments in September and October. The return to stable performance in both on-trade and off-trade sectors bodes well for the future. India continues to exhibit strong fundamentals, while a global partnership with the Coca-Cola Company for a ready-to-drink cocktail presents an exciting growth opportunity.
For further details see:
Pernod Ricard: Rating Upgrade As The Business Is Set To Grow In FY24