2024-01-21 23:38:02 ET
Summary
- Pernod Ricard is a luxury goods company with a high potential for investment and returns.
- The company has a strong portfolio of premium spirits brands and a solid financial performance.
- Despite some risks, such as cyclicality and regulatory intervention, Pernod Ricard is undervalued and offers significant upside potential.
Dear subscribers,
You should be aware, if you follow my work, that I'm a fairly prolific investor in luxury goods companies in Europe, specifically something like LVMH ( OTCPK:LVMUY ). Another example of a luxury goods company that I'm looking at and now am investing more heavily into (0.3% of portfolio so far, expanding), is Pernod Ricard ( PRNDY) .
Pernod has made it to my top-10 "BUY" list of companies that are both qualitative and with a high upside on the investing and potential return side. In this article, I'm going to show you why that is and what makes this such a solid potential investment.
Otherwise, I wouldn't be investing in it, after all.
This is my first article on Pernod Ricard. I haven't properly covered it on SA before, and that's something I mean to change at this time.
Let's see what we, at this time, have going for us.
Pernod Ricard - Plenty to like at this valuation with an over 20% annualized upside in luxury spirits
Pernod, like most luxury companies and most French luxury companies especially, is rarely undervalued. I would say this company became an attractive buy over 3 years ago - and I didn't buy at that time, unfortunately.
The company was formed back in the mid-1970s through the then-merger of two aniseed liqueur makers with the respective names of Pernod and Ricard, and since then, it's made a name for itself by becoming a serial acquirer of luxury and qualitative spirit brands. That means it has a history that's actually in some ways "richer" or at least older than LVMH as a business.
This is a sector where we have a fairly heavy concentration overall, and outside the major players like Pernod, there aren't many businesses that have an overly significant market position, with plenty of fragmentation outside those major players - which for spirits also includes LVMH.
Pernod Ricard manages annual sales of over €12B, and for the latest full-year fiscals, the company increased this 13%, with an organic 10% YoY growth. On that net sales, which is about a sixth of the sales level managed by LVMH, the company manages a net profit of about €2.2B, with €3.3B of operational profit, also an 11-13% YoY growth.
The company does this while managing a conservative net debt/EBITDA of sub-3x, currently at 2.7x and while generating between €1.4-€2B worth of free cash flow.
Here are the company's various segments and how they performed during that last fiscal.
Pernod Ricard IR (Pernod Ricard IR)
In short, the company saw sales growth in every single segment and every single geography. Like much of the luxury market, the company is heaviest in weight in terms of Asia/to Asia. The company has a 42% sales weight to the geography at this time, with 29% in both NA and Europe. Asia is also growing faster than Europe, and much faster than the Americas, at least for this last fiscal.
Pernod Ricard IR (Pernod Ricard IR)
The company's portfolio contains more than 240 premium spirits brands, and it's the worldwide #1 player in the premium spirits category, with 17 brands of the company's current selection found in the global top 100.
There are, at least according to the market, reasons why this company is currently trading down. I just don't happen to agree with them. The company manages a gross margin level of over 59%, with an operating margin of over 27% and a net margin above 18%. That puts it on par with LVMH in how "good" it is, and while it's not as solid as LVMH in terms of lack of high debt, it's still very impressive up there.
A selection of the brands that the company owns include:
- Ricard
- Pernod
- Lillet
- Beefeater
- Havana Club
- Absolut Vodka
- Ballantine's
- Jameson
- Aberlour
- Glenlivet
- Perrier Jouet
...and many others.
Looking at the company from a purely business perspective, it's easy to see, as I find it, that this is a quality business model with a lot of things going for it. Any business model that manages to squeeze a consistent 15% net margin from its revenues is what I would consider one of the better ones out there.
Pernod Ricard Business Model (GuruFocus)
This is a company that's consistently ROIC/WACC positive, and while its record of growing revenues after the GFC and until 2019-2020 was lackluster, it has started picking up its growth over the past few years.
Pernod Ricard Revenue/net income (GuruFocus)
So what I want to showcase here is the company's quality and safety. Pernod also comes with a BBB+ credit rating, and unlike LVMH does not trade at a material sort of premium - as we'll see later on, it trades at what could be considered a material discount to both historical and fair value estimates.
The company also gives you a well-covered 3%+ yield, which isn't the highest out there for sure, but it's what I would consider to certainly be good enough here.
Like most global distillers and vintners, including LVMH, RI is putting faith in the premiumization of parts (large parts) of its overall portfolio. What we've been seeing in the industry is products like spirits taking market shares from Beers and wines as consumers purchase the former instead of the two latter, and we've seen an average organic growth of 20 bps from one to the other in terms of segments for the past decade. If this trend continues, which I don't see there any reason beyond maybe pricing to not continue, then this would provide a very solid backdrop for a tailwind for Pernod Ricard here.
This includes the activity in new markets like China, where Pernod remains heavily invested, and where it has a very strong presence. Pernod has labeled both the Indian and the Chinese markets as markets where the company "Must" win.
RI is a very M&A-capable company, and the history proves this.
Pernod Ricard IR (Pernod Ricard IR)
Meanwhile, Pernod is also adding innovations to its portfolio, including things like non-alcoholic gin alternatives - a so-called 0.0 (Seagram), cocktails, twist & mix spirits (an innovation which I have yet to try out), and other things.
So, as I see it, there are plenty of things to get excited about here. The company is continuing to push a heavy capital flow towards investing.
RI IR (RI IR)
And while the dividend doesn't showcase a perfect growth trajectory, it nonetheless has delivered solid growth over time, starting at €1.88 for the 2016 year, and ending in 2023E at a €4.7/share which would bring the current yield to a total of 3.15%, approved at the company AGM.
The company, even with the latest crash, has also significantly outperformed most of the comparative and comparable indices, if not my own portfolio or many other portfolios out there. As always, it comes down to buying it at the right sort of valuation.
Overall, I see the following risks and upsides for Pernod Ricard as a fundamental investment.
Risks & Upsides for Pernod Ricard
The greatest risk to the company is cyclicality, and this is a more cyclical luxury business than LVMH. The spirits specialization is more cyclical than other staple categories and does suffer a historically proven drawdown during downturns - and this also translates to some higher share price volatility. The company, as you can read in the news, has also seen some heavy-handed regulatory intervention in key areas like China and India, even Russia, and this is a secondary risk - because governments tend to have strong opinions about alcohol in their nations, something that's not necessarily true in other luxury segments or sub-segments.
Some analysts will argue that the company's exposure to wine also gives it more cyclicality because it's a mostly fragmented market. There's some truth to that, but overall I view it as overstated, because Pernod operates in very attractive "Niche" categories and sub-categories of spirits and products, which I argue insulates them from some of these ups and downs.
On the further upside, I would clearly state that Pernod Ricard has some of the best moats out there in the industry. The company's portfolio creates some of the most comprehensive entry barriers out there, supported by mature product categories with clear company cost advantages. While it can never be said that any brand or category is immune, I feel that the spirits industry is not somewhere that anyone can easily "get into".
As a final advantage, I would point to Pernod's incredible pricing power for its established products, proven by its net margins. It has ample room to drive growth, both organic and inorganic, and dislodging this company from anywhere is not an easy thing.
Let's look at why I'm so excited here - the valuation.
Pernod Ricard - The upside
If you've been following my posts and the chat, you'll know that I have been pushing money to work for a few weeks now and that my pace of pushing money to work, far from slowing down, has been increasing.
Pernod Ricard Valuation (Pernod Ricard FAST Graphs)
That, dear readers, is the reason. Pernod is now down to 16.9x, and below 17x for this company is quite rare. It's hard to say whether we'll see further material downside - I'm investing slowly here - but if we do, I'll buy even more.
When it comes to Pernod, I would be comfortable with a 2.5-3% portfolio position, easily. Even if the company were to underperform here and manage only the 20-year average, which essentially dilutes much of the recent upside the company has been achieving, we still have a market-beating 15% annualized upside here of very close to 15% per year.
Pernod Ricard Upside (FAST Graphs)
And I'm far from the only one that sees this. S&P Global analysts for the company give us an average price target of over €180/share, from 22 analysts between €137 as a low and €250/share as a high with an average of €183. I still view that as too low based on the company's growth potential and overall safety.
I would say forecasting Pernod at the 10-year average is a more fair estimate, and at 22x P/E, this company manages to give investors, under current forecasts, a 20% annualized, or almost 60% until the 2026E.
So, while I've already established a small and growing position in Pernod, I hope we see further short-term downside as a result of the ongoing probes but also as a result of the ongoing uncertainty for the 2024E results. It will enable me to lower my cost basis further and prepare very nicely for an eventual upside here, where I have an actual very high conviction that it is in fact coming.
Out of 22 analysts, 12 have the company at a "BUY" here, with most others at "HOLD". There is clearly some waiting for a further downside here. That might come, and I'll be ready for it. But as things stand now, I believe that RI is in an even better position than LVMH to see an upside from luxury, because you're able to buy it cheaper. Granted, not the same sort of quality - no argument from me there - but not much less, as the price would otherwise suggest here.
Even if you check services like Morningstar, you'll find that they have, for the past few weeks, been bumping this company up, and give it a fair-value estimate of €185/share.
Let me run through the upsides I see here.
- The operating margin is in expansion
- The P/B ratio is at a 3-year low
- The P/E ratio is at a 10-year low
- The Rev/share is showing consistent overall growth.
- The P/S ratio is at a 5-year low
- The dividend yield is at a 10-year high.
This is, as I see it, a low-risk high-fundamental play, and those are fairly rare. Even just a median of the company's P/S implies a €200+ share price here.
I say "BUY" here, and I give you my introductory thesis for Pernod Ricard.
Thesis
- Pernod Ricard is one of the more interesting luxury vintners and distillers out there. The company owns a portfolio of one of the most market-beating companies and brands out there, giving it a great moat and making it very investable at the "right" sort of overall price. The company has been overvalued or at least fully valued for some time.
- However, at below €175/share, it no longer is overvalued, and I've started adding shares to my portfolio.
- I believe Pernod Ricard, based on a growth estimate of 7-11% for the next few years, has the potential to outperform the market at 13-20% per year, and this means that it qualifies as a conservatively-adjusted market-outperforming company as far as my approach is concerned. I rate it a "BUY" with a €190/share long-term share price, at minimum.
Remember, I'm all about:
1. Buying undervalued - even if that undervaluation is slight, and not mind-numbingly massive - companies at a discount, allowing them to normalize over time and harvesting capital gains and dividends in the meantime.
2. If the company goes well beyond normalization and goes into overvaluation, I harvest gains and rotate my position into other undervalued stocks, repeating #1.
3. If the company doesn't go into overvaluation, but hovers within a fair value, or goes back down to undervaluation, I buy more as time allows.
4. I reinvest proceeds from dividends, savings from work, or other cash inflows as specified in #1.
Here are my criteria and how the company fulfills them (italicized).
- This company is overall qualitative.
- This company is fundamentally safe/conservative & well-run.
- This company pays a well-covered dividend.
- This company is currently cheap.
- This company has a realistic upside based on earnings growth or multiple expansion/reversion.
I went back and forth on calling this company "cheap" here, but I do in fact believe that it is "cheap" at sub-€150/share. This means that the company fulfills every single one of my criteria, making it relatively clear why I view it as a "BUY" here.
Thank you for reading.
For further details see:
Why I'm Buying And Adding To Pernod Ricard