INDEPENDENT RESEARCH Pernod 19th December 2017 Asia accelerating strongly Food & Beverages Fair Value EUR145 vs. EUR130 (price EUR129.10) BUY

Bloomberg RI FP We see a strong step-up in the group’s performance this year as both Reuters PERP.PA 12-month High / Low (EUR) 132.4 / 102.1 China and India are expected to return to high-single-digit sales Market capitalisation (EURm) 34,266 growth. Buy recommendation reiterated, Fair Value upgraded to Enterprise Value (BG estimates EURm) 41,020 EUR145. Avg. 6m daily volume ('000 shares) 394.1 Free Float 79.4%  We forecast organic sales growth of 9% in India (9% of total sales) 3y EPS CAGR 8.1% (vs +1% last year) as the effects of the highway ban should Gearing (06/17) 57% in 2017/18 Dividend yields (06/18e) 1.60% have completely disappeared in H2, enabling the group to tap into the

country’s true potential. GST should finally turn out to be beneficial as YE June 06/17 06/18e 06/19e 06/20e the taxation of molasses and not grain neutral spirit is expected to Revenue (EURm) 9,010 9,123 9,681 10,316 EBIT(EURm) 2,394 2,401 2,582 2,802 accelerate the premiumisation of the market. China (8% of total Basic EPS (EUR) 5.61 5.73 6.42 7.09 sales) should also show a material improvement this year, driven by Diluted EPS (EUR) 5.58 5.71 6.39 7.06 a very dynamic market and a resumption of the group’s EV/Sales 4.67x 4.50x 4.14x 3.79x investments in high-end scotch. Our estimate calls for 8% growth in EV/EBITDA 16.1x 15.6x 14.2x 12.8x EV/EBIT 17.6x 17.1x 15.5x 14.0x the country in 2017/18, after +2% in 2016/17. P/E 23.1x 22.6x 20.2x 18.3x ROCE 7.0 6.5 6.7 7.1  We now expect the group to deliver organic sales growth of 5.6% in Share price as at close of 15th December 2017/18, implying a significant improvement vs last year (+3.6%). This should accelerate to 6.2% in 2018/19 and 6.6% in 2019/20. Our previous 133.9 estimates for the next three years were, respectively, +5.1%, +5.4% and

123.9 +5.8%. We think the market is under-estimating the extent of the recovery in Asia. We have revised upward our EPS by 5% on average 113.9 over the next five years and our 2019/20 EPS forecast now stands 103.9 5.5% above the market consensus.

93.9  In our view, will announce a return of cash to 83.9 15/06/16 15/09/16 15/12/16 15/03/17 15/06/17 15/09/17 15/12/17 shareholders at the end of 2017/18. A buyback of EUR1.4bn should PERNOD-RICARD SXX EUROPE 600 have a 4% accretive impact on 2018/19 EPS. If the company prefers a special dividend, we calculate that this could reach 5.3EUR per share, pointing to a total dividend of EUR7.3 (payout ratio of 129% and dividend yield of 5.7%).

 In 2018e, the stock is trading at a discount of 18% in terms of EV/EBIT and 21% in terms of P/E. This is significantly above the average discount over the last 10 years which was 6% on EV/EBIT and 14% on P/E. Our DCF points to a Fair Value of EUR145, implying 12% upside potential. Our Buy recommendation is reiterated.

Analyst: Sector Analyst Team: Virginie Roumage, CFA Nikolaas Faes 33(0) 1.56.68.75.22 Clément Genelot [email protected] Loic Morvan Cédric Rossi

r r Pernod Ricard

Simplified Profit & Loss Account (EURm) 30/06/15 30/06/16 30/06/17 30/06/18e 30/06/19e 30/06/20e Sales geographical breakdown, 2016/17 Revenues 8,558 8,682 9,010 9,123 9,681 10,316 Change (%) 7.7% 1.4% 3.8% 1.3% 6.1% 6.6% Asia-ROW Europe 40% Gross Profit 5,296 5,339 5,602 5,638 6,022 6,458 31% Contribution after A&P 3,453 3,473 3,912 3,905 4,182 4,498 Adjusted EBITDA 2,456 2,494 2,619 2,629 2,824 3,060 Recurring EBIT 2,238 2,277 2,394 2,401 2,582 2,802 Change (%) 8.9% 1.7% 5.1% 0.3% 7.5% 8.5% Financial results (489) (432) (373) (315) (280) (260) Pre-Tax profits 1,100 1,663 1,858 2,086 2,302 2,542 Tax (221) (409) (438) (492) (526) (585) Minority interests / Discontinued operations (18.0) (20.0) (27.0) (29.0) (31.0) (33.0) Net profit group share 861 1,234 1,393 1,565 1,746 1,923 Americas Restated net profit group share 1,329 1,380 1,482 1,515 1,696 1,873 29% Change (%) 12.2% 3.8% 7.4% 2.2% 11.9% 10.5% EBIT geographical breakdown, 2016/17 Cash Flow Statement (EURm)

Europe Operating cash flows 2,466 2,529 2,635 2,641 2,840 3,082 25% Asia-ROW Change in working capital 192 211 65.0 172 226 263 42% Capex, net 313 337 357 319 339 361 Financial investments / tax paid 807 781 742 807 806 845 Dividends 461 497 511 536 548 613 Other(s) (913) (260) 49.0 290 1.0 0.0 Net debt 9,020 8,715 7,851 6,754 5,830 4,831 Free Cash flow 1,154 1,200 1,471 1,343 1,470 1,613 Balance Sheet (EURm) Tangible fixed assets 2,933 3,233 3,028 3,103 3,171 3,230 Intangibles assets 17,706 17,572 17,152 17,495 17,845 18,202 Americas 33% Cash & equivalents 595 577 700 1,890 2,814 2,963 current assets 7,419 7,282 7,520 8,799 10,129 10,740 Other assets 2,339 2,511 2,387 2,353 2,330 2,306 Company description Total assets 30,397 30,598 30,088 31,750 33,475 34,478 L & ST Debt 9,510 9,362 8,545 8,661 8,661 7,811 Pernod Ricard was formed in 1975 Others liabilities 7,600 7,730 7,656 7,681 7,974 8,286 from the merger of two French anis Shareholders' funds 13,288 13,506 13,886 15,407 16,840 18,382 groups (Pernod and Ricard). Through Total Liabilities 17,110 17,092 16,201 16,342 16,634 16,097 organic development and various Capital employed 26,041 26,056 25,493 27,273 28,840 29,668 acquisitions ( in 2001, Allied Ratios Domecq in 2005, V&S in 2008), Gross profit margin 62.5 61.1 61.9 62.1 60.7 61.5 A&P as % of sales 19.0 19.0 18.8 19.0 19.0 19.0 Pernod Ricard has now become the Contribution after A&P as % of sales 42.9 42.5 43.4 42.8 43.2 43.6 second largest and spirits group Recurring operating margin 26.2 26.2 26.6 26.3 26.7 27.2 worldwide. The company commands a Effective tax rate 20.1 24.6 23.6 23.6 22.8 23.0 global 18% share behind Underlying tax rate 24.4 24.5 25.2 26.0 25.0 25.0 Net margin group share 10.1 14.2 15.5 17.2 18.0 18.6 (28%). The group’s strategy is based ROE (after tax) 6.6 9.3 10.2 10.3 10.6 10.6 on three pillars: decentralization, ROCE (after tax) 6.5 6.6 7.0 6.5 6.7 7.1 premiumisation and innovation. Gearing 67.9 64.5 56.5 43.8 34.6 26.3 Pay out ratio 36.1 36.2 36.2 36.0 36.0 36.0 Number of shares, diluted 266,230 265,633 265,478 265,478 265,478 265,478 Data per Share (EUr) Restated basic EPS 5.03 5.20 5.61 5.73 6.42 7.09 Restated diluted EPS 4.99 5.20 5.58 5.71 6.39 7.06 % change 11.9% 4.1% 7.5% 2.2% 11.9% 10.5% BVPS 49.91 50.84 52.31 58.04 63.43 69.24 Operating cash flows 9.26 9.52 9.93 9.95 10.70 11.61 FCF 4.33 4.52 5.54 5.06 5.54 6.07 Net dividend 1.80 1.88 2.02 2.06 2.31 2.55

Source: Company Data; Bryan, Garnier & Co ests.

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Pernod Ricard

Table of contents

1. Investment Case ...... 4

2. India recovering strongly in 2017/18… ...... 5

3. …as well as China...... 9

4. The US and Europe proving highly satisfactory ...... 12

4.1. US: closing the gap with the market ...... 12 4.2. Europe: the East driving the growth ...... 15

5. A bright outlook for 2017/18 ...... 16

5.1. A strong acceleration in the top line driven by Asia-ROW ...... 16 5.2. An EBIT margin flat in organic this year but improving from 2018/19 ...... 17 5.3. Potential upwards revisions in consensus estimates ...... 18

6. A very healthy financial situation leaving room for cash return to shareholders ...... 19

7. Buy reiterated ...... 20

7.1. The stock has not been amongst the best performers in the spirits sector and … ...... 20 7.2. …is trading at a discount vs peers which is higher than its average over the past ten years .. 20 7.3. Our DCF points to a Fair Value of EUR145 ...... 21

Price Chart and Rating History ...... 23

Bryan Garnier stock rating system...... 27

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Pernod Ricard

1. Investment Case

The reason for writing now After a very challenging year, both China and India should return to high-single-digit sales growth in 2017/18 and, as a result, the group’s organic sales growth should show a material acceleration to up 5.6% this year post +3.6% in 2016/17. The strong deleveraging over the past year also leaves room for cash return to shareholders.

Valuation DCF puts the value per share at EUR145, implying 12% upside potential. In 2018e, the stock is trading at a discount of 18% in terms of EV/EBIT and 21% in terms of P/E. This is significantly above the average discount over the last 10 years which was 6% for EV/EBIT and 14% for P/E.

Catalysts We do not expect the upcoming H1 results (released on February 8th) to constitute a positive catalyst due to the later timing of the Chinese New Year. Q2 sales should only grow by 3.9% (after +5.7% in Q1) while the EBIT margin is anticipated to drop by 10bps, both on an organic basis.

Difference from consensus We anticipate upwards revisions to the consensus estimates. Our EPS forecast is roughly in line with market expectation in 2017/18 but 3.5% and 5.5% above in 2018/19 and 2019/20, respectively.

Risks to our investment case Changes in regulations in China and India might negatively impact our estimates.

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2. India recovering strongly in 2017/18…

India is the third largest liquor market in the world, amounting to USD35bn. The market remains dominated by whiskeys which represented 61% of volumes in 2016, even if liquor companies have tried to develop other categories. India is the number two market for Pernod Ricard, The country is the second market for Pernod Ricard after the United States, accounting for 9% accounting for 9% of total of total sales. The portfolio is 90% comprised of Indian whiskeys (as a % of Indian sales), the remaining sales. 10% coming half from and half from international brands. The group’s Indian whiskeys are Imperial Blue (approx. USD6 a bottle), (approx. USD8), and (approx. USD14).

The past twelve months have been particularly difficult for the Indian spirits market, with the The demonetization in demonetization in November 2016 and the ban on highway liquor stores in April 2017. In late November 2016 and the August, the Supreme Court clarified the highway ban and said it did not apply within the city limits. ban on highway liquor Outlets have thus started to re-open since September, especially in the on-trade (bars, restaurants), and stores in April 2017 impacted spirits this is proving particularly beneficial for the premium segment. 20% of outlets (60,000 are left) will consumption over the past remain permanently closed as they cannot relocate to a distance beyond 500 meters from a highway. twelve months Spirits consumption already started to rebound in calendar Q3 and this improving trend should continue in Q4. The situation is expected to have completely normalized by the end of 2017.

India is probably one of the toughest booze markets in the world due to its changing regulations. But its growth potential is highly significant due to its:

 Young population. The median age is expected to be 28 years in 2020 and should only increase to 37 years in 2050 (Statista). There are between 15 and 20 million new adults entitled to consume alcohol each year.

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Fig. 1: A median age of only 37 years in 2050

37.5 34.5 31.4 28.2 25.1 22.7 21.3 20.2

1950 1980 2000 2010 2020 2030 2040 2050

Source: Statista

The growth potential of  Urbanisation process. According to the Indian authorities, 60% of the country’s population India is highly significant due to its young will live in cities by 2050 vs 31% as per the 2011 census. This should increase the social population, urbanisation acceptance of alcohol consumption. process and strong  Strong economic growth. The IMF forecasts an increase in real GDP of 6.7% in 2017 and economic growth 7.4% in 2018 vs 4.6% and 4.9% for emerging countries as a whole, respectively.

Fig. 2: Real GDP growth

8.1% 7.8% 7.9% 7.4% 6.7%

4.9% 5.0% 5.0% 5.1% 4.6%

2017 2018 2019 2020 2021

India Emerging countries

Source: IMF

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Pernod Ricard

The group generates Pernod Ricard is well positioned in India. It generates 100% of its sales on premium while this 100% of its sales on the segment only represents 60% of the sales of its main competitor United Spirits. Premium is premium segment which expected to post a 13% sales CAGR between 2016 and 2021 vs +3% for the popular segment and +8% is growing well ahead of for the market as a whole. the market Fig. 3: Indian spirits market: sales CAGR by segment between 2016 and 2021

13%

8%

3%

Popular Market Premium

Source: IWSR; Bryan, Garnier

Grain neutral spirits are The Goods & Services Tax (GST) reform should accelerate the premiumisation of the market not taxed by GST, contrary to molasses. This and gives Pernod Ricard a competitive advantage. Grain neutral spirits (the basic component of should accelerate the premium whiskeys) are not taxed by GST, contrary to molasses which have been classified in the highest premiumisation of the tax bracket of 28% and are used to produce lower-end whiskeys. As a result, the prices of low end Indian spirits market. whiskeys are expected to increase and consumption to switch towards more premium products.

Pernod Ricard only posted 1% organic sales growth in 2016/17 (end-June), a slowdown vs the previous year (+12%). Q1 2017/18 was a positive surprise, with sales up by 2% organically despite the continued impact of the highway ban and a tough comparison base (+8% in Q1 2016/17). The effects of the highway ban should have completely disappeared in H2, enabling the group’s to tap into the country’s true potential. We expect the company’s sales in India to increase by 9% this year (vs +6% previously). We have also upgraded our organic sales growth estimate for 2018/19 from 8% to 13% and for 2019/20 from +10% to +13%. Organic sales in Q2 2017/18 should be up by 6% organically as the earlier timing of Diwali should be largely offset by easy comps (negative impact from demonetization in Q2 2016/17) and the alleviation of the highway ban impact.

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Fig. 4: Company returning to 13% organic sales growth in India in 2018/19

19.0% 18.0% 17%

13.0% 13.0% 12.0%

9.0%

1.0% 2012/13 2013/14 2014/15 2015/16 2016/17 2017/18e 2018/19e 2019/20e

Source: Company Data; Bryan, Garnier

The GST hit on margin should be limited. Pernod Ricard said it only expects a negative impact of EUR15m on EBIT this year. Grain neutral spirit is not taxed but tax on glass bottles has been increased from 15-16% to 18%, on transport freight from 4.5% to 5% and on service from 15% to 18%. The group has secured most of the price hikes that were necessary to offset the negative effect and a few of them are still under discussion.

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Pernod Ricard

3. …as well as China

China is Pernod Ricard’s number three market, accounting for 8% of total sales. Sales were up 2016/17 was the first year 2% in 2016/17. This was the first year the country had returned to growth since 2012/13 and China returned to growth represented a significant improvement compared to the 9% decline in 2015/16. It was driven and this represented a by cognac, with up 6% over the year across all price segments (Cordon Bleu returned to significant improvement positive territory). But Chivas dropped by 30% as the group concentrated its investments on cognac compared to the 9% which is its profit pool in the country. Note that Martell, high-end scotch (Chivas, and decline in 2015/16. Ballantine’s 30 Years) and premium brands (Absolut, Jameson, Ballantine’s Finest, and the champagnes) respectively account for 80%, 10% and 10% of the group’s sales in China.

Fig. 5: Sales breakdown in China by category, 2016/17

Premium brands 10%

High-end scotch 10%

Cognac 80%

Source: Company Data; Bryan, Garnier & Co

Q1 2017/18 showed a further improvement, with 15% organic sales growth. Martell continued to accelerate, up by 15%. But Chivas was also slightly positive. There was obviously a pipeline effect as Pernod Ricard launched Chivas 12 Extra (a bottle only sold in China) but CFO said that the trend would have been better even excluding this effect. We expect sales in China to be up 8% organically We expect the country to see growth of 8% this year, compared with our previous forecast of this year, with +9% for cognac, -10% for high- 5%. This is expected be driven by +9% for cognac, -10% for high-end scotch and +15% for end scotch and +15% for premium brands. In 2018/19 and 2019/20, we see growth in China reaching 9%, vs +7% premium. previously. Note, however, that the Q2 2017/18 should be weak given the timing of the Chinese New Year that will take place on February 16th in 2018 vs January 28th in 2017. We estimate China will only be up 5% in H1 after +15% in Q2.

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Pernod Ricard

Fig. 6: China back to 8% organic sales growth in 2017/18

9% 8% 9% 9%

2%

-2%

-9%

-23% FY12/13 FY13/14 FY14/15 FY15/16 FY16/17 FY17/18e FY18/19e FY19/20e

Source: Company Data; Bryan, Garnier  The on trade, which was still very The Mid-Autumn festival The rebound of the Chinese spirits market is very supportive. was excellent, which is a difficult last year, has started to improve led by the modern on trade. Players reported that the Mid- very good sign for the Autumn festival which is the second most important event for spirits consumption in China upcoming Chinese New (accounting for an estimated 15% of annual consumption) was excellent. This is a very good sign Year. for the upcoming Chinese New Year.  Pernod Ricard is also expected to benefit from better trends on Chivas as it is increasing its commercial and marketing expenses on the brand after concentrating them over the past few years on Martell.  Furthermore, the group is well positioned to seize the premium opportunity. International spirits consumption currently accounts for only 1% of alcohol volumes consumed in China (2% of alcohol sales

Fig. 7: International spirits still representing only 1% of alcohol volumes in China

International spirits Wine 1% 11%

Beer Baijiu 31% 57%

Source: IWSR

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Pernod Ricard

A growing part of international spirits consumption should come from premium brands as a result of the growing middle class. The consumption by the Chinese middle class represented 13% of global middle class consumption in 2015 but this should rise to 16% in 2020 and 22% in 2030.

Fig. 8: 22% of the middle class consumption in the world will come from China in 2030

in PPP USDbn 16 India 14

12 The Chinese spirits China market will normalize 10 with a higher proportion 8 of premium and a lower China proportion of super 6 U.S. U.S. U.S. premium and prestige China India 4

Japan 2

0 2015 2020e 2030e

Source: Company Data; Bryan, Garnier & Co

Pernod Ricard is well positioned to seize the middle class opportunity due to its premium portfolio. This currently represents 10% of its sales in China with brands such as Absolut, Jameson, Ballantine’s Finest, Havana Club and the champagnes. The company has created a salesforce dedicated to premium and, in Q1 2017/18, its sales were reported to be seeing strong double- digit growth. Martell is clearly helping to finance the growth in the segment.

Note that the cut in import duties on scotch and cognac from 10% to 5% which will be effective in December 2017 should be positive, especially in 2018/19. We consider this is a bit early to factor it into our estimates.

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Pernod Ricard

4. The US and Europe proving highly satisfactory

In 2017/18, the performances in the Americas and Europe should remain broadly similar to the previous year but this should not obscure the strong progress in the US, where the group will grow in line with the market for the first time ever (4.1), and the double-digit growth in Eastern Europe (4.2).

4.1. US: closing the gap with the market Pernod Ricard generates 19% of sales and 25% of EBIT in the US. This is its number one market, even though the group is under-exposed vs its peers (Diageo: 32% of sales; Rémy Cointreau: 35%; Campari: 28%). The US is the most dynamic developed market for spirits as the segment continues to gain share over beer (see graph below). The US spirits market has historically grown by 4% on average and we consider this to be its underlying growth potential. These days it is running slightly below this trend at 3-4%.

Fig. 9: US alcoholic beverages market by segment (in value)

30% 32% 32% 35% 36% Between 2000 and 2016, spirit increased their share 15% 15% 15% of the US alcoholic 15% 16% beverages market by 600bps, to the detriment 55% of beer 53% 53% 50% 48%

2000 2004 2008 2012 2016

Beer Wine Spirits

Source: Beverage information Group

2017/18 should be the first year during which the group enjoys growth in line with that of the 2017/18 will be the first market. The latest Nielsen data show that it has already closed the gap with the market (see figure 9). year when Pernod Ricard does not lose market This is really a turning point in the company’s history as it has always lost market share in the shares in the US country. Pernod Ricard should be able to deliver stronger-than-market growth in 2018/19.

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Pernod Ricard

Fig. 10: Value growth of Pernod Ricard vs the market (in percentage and at 04/11/17)

0.3

-0.2

-0.4

-0.8

52W YA 52W 26W 13W

Source: Nielsen

Pernod Ricard posted a very solid performance over the past two years in the US. After a flat 2014/15, the group’s organic sales increased by 4% in 2015/16 and by 5% in 2016/17. This year we expect the In 2017/18 we have a group to post 3.5% organic sales growth, in line with the market, before improving to 4% in cautious estimate of 3.5% 2018/19 (+50bp vs market growth assuming market is not recovering and still running at 3.5%). organic sales growth in In 2019/20, we expect the US to grow by 5% in a market up 4%. The company has a mid-term the US, in line with the guidance of mid-single digit growth. Note that Q2 2017/18 should be slightly lower than Q1 (+4%) market due to 1/ tough comps as the group launched Absolut Lime in Q2 2016/17 and 2/ the negative impact of fires in California and the terror attack in Las Vegas.

Fig. 11: The US up 3.5% organically next year, according to our estimates

8.0%

5.0% 5.0% 4.0% 4.0% 3.5%

1.0% 0.0% FY12/13 FY13/14 FY14/15 FY15/16 FY16/17 FY17/18e 2018/19e 2019/20e

Source: Company Data; Bryan, Garnier

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Pernod Ricard

The US is starting to benefit from recent organisational changes. North America has been separated from Latin America which is now integrated into Europe/Middle East/Africa. A significant part of the US management has also been changed and the structure has been decentralised.

Absolut (20% of US sales) should show a better trend in 2017/18. In 2016/17, the brand was down by 5% according to Nielsen and 3% according to NABCA. Consumers continued to exhibit preference Absolut should show a for brown spirits and, on top of that, the prices of many super premium were cut, increasing better trend in 2017/18 vs competition for premium vodkas (Absolut is priced at around USD18). We think this year’s last year improvement should be due to increased investment in the on-trade and a change in marketing which is now much more in line with the tastes of the millennial generation. The group still aims to stabilize the brand in the medium term but we do not think this will be achieved in the next three years. The stabilization of Absolut is not a precondition for mid-single-digit growth in the US. Note that Absolut Elyx in the super premium range is growing double-digit but the base is small (2% of Absolut sales).

Growth in the US continues to be fueled by Jameson which is the group’s leading brand in the US (25% of sales). In 2016/17 its sell-out remained very strong at +15%. Distribution gains are still possible in some States and, in States where the distribution rate is already very high, the group is improving the mix through innovations such as Jameson Caskmate or Jameson IPA which are sold at a 20% premium. Price increases have already been implemented in 2016/17 and we should see more in the years to come. The company is concentrating its investments on Martell cognac and Altos/Avion so that they could replace Jameson as growth drivers when the brand reaches maturity. Martell and the tequilas currently account for only 5% of the group’s sales in the US.

Fig. 12: Growth of Jameson’s sell-out in the US

23%

18%

15% 15%

2013/14 2014/15 2015/16 2016/17

Source: Company Data

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Pernod Ricard

4.2. Europe: the East driving the growth Sales in Europe (31% of total sales) increased by 3.3% organically last year and we expect roughly the same performance in 2017/18. Our estimate calls for 3.2% organic sales growth. This should continue to be driven by the East while the trend in the West should obviously be much more moderate.

Fig. 13: Europe expected to grow by 3.2% organically this year

3.5% 3.5% 3.3% 3.2%

1.7%

1.1%

0.3% 0.0% 2012/13 2013/14 2014/15 2015/16 2016/17 2017/18e 2018/19e 2019/20e Source: Company Data; Bryan, Garnier

Sales in Eastern Europe increased by 11% in 2016/17 (+5% in 2015/16) and we expect 13% growth next year. Russia has enormous potential in the medium term due to the rising penetration of imported Pernod Ricard is growing at three times the rate of alcoholic beverages, partly thanks to an increase in the middle class. This market has recovered in the market in Russia 2016/17 and is currently running at +4%. Pernod Ricard is growing at three times the rate of the market driven by its international brands, especially Jameson. Note that the increase in rouble is obviously beneficial for the profitability in the country. Western Europe posted a significant improvement in 2016/17, with 2% organic sales growth vs a flat performance in 2015/16. The UK and Spain were the growth drivers. We expect Western Europe to grow by only 0.7% organically in 2017/18. This should reflect deteriorating trends in 1/ France (7% of the group’s sales), which is expected to move into negative territory as a result of the weak pricing environment and the company’s exposure to (30% of French sales) and 2/ Spain (4% of total sales) which should normalize to low-single-digit growth after two very strong years (+8% in 2015/16 and +5% in 2016/17). The UK should continue to perform strongly in the year to come.

Fig. 14: The East expected to be up 13% in 2017/18 Organic sales growth in Western Europe Organic sales growth in Eastern Europe

13% 13% 13% 2% 11% 11% 1% 1% 0.7% 0% 0% 0% 8%

5%

1% -3% 2012/13 2013/14 2014/15 2015/16 2016/17 2012/13 2013/14 2014/15 2015/16 2016/17 2017/18e 2018/19e 2019/20e 2017/18e 2018/19e 2019/20e Source: Company Data; Bryan, Garnier

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Pernod Ricard

5. A bright outlook for 2017/18

The outlook of the company is very bright. The organic sales growth should show a significant acceleration in 2017/18 driven by the recovery of Asia-ROW with a return to strong growth for India and China. The performances in the Americas and Europe should remain broadly similar to those of the previous year but this should not obscure the double-digit growth in Eastern Europe and the strong progress in the US where the group will grow in line with the market this year for the first time ever (5.1). The EBIT margin is expected to be flat in organic in 2017/18, which is a satisfying performance given the implementation of GST in India. It should start to improve from 2018/19 helped by the dynamism in the top line (5.2). We see potential upward revisions to consensus estimates (5.3).

5.1. A strong acceleration in the top line driven by Asia-ROW We now expect organic sales growth of 5.6% in 2017/18, in line with the group’s mid-term guidance for a mid-single-digit growth and implying a significant improvement vs last year (+3.6%). This should accelerate to 6.2% in 2018/19 and 6.6% in 2019/20. Our previous estimates were +5.1%, +5.4% and +5.8% respectively over the next three years. FX should have a negative impact of 4.3% on sales over the year (representing -EUR387m) but, in 2018/19, the effect should be broadly neutral.

Fig. 15: Sales assumptions

EURm 2015/16 2016/17 2017/18e 2018/19e 2019/20e

GROUP

Sales 8,682 9,010 9,123 9,681 10,316

Reported variation 1.4% 3.8% 1.3% 6.1% 6.6%

Organic variation 1.8% 3.6% 5.6% 6.2% 6.6%

External variation -0.6% 0.0% -0.1% 0.0% 0.0%

FX variation 0.3% 0.2% -4.3% -0.1% 0.0%

ASIA-ROW The group’s organic sales growth expected to be Sales 3,496 3,568 3,663 3,967 4,305 5.6% in 2017/18 after Reported variation 1.5% 2.1% 2.7% 8.3% 8.5% +3.6% in 2016/17 Organic variation 0.8% 1.4% 7.2% 8.2% 8.5%

AMERICAS

Sales 2,475 2,661 2,623 2,781 2,976

Reported variation 3.9% 7.5% -1.4% 6.0% 7.0%

Organic variation 4.0% 6.9% 6.0% 6.5% 7.0%

EUROPE

Sales 2,710 2,781 2,837 2,933 3,035

Reported variation -0.8% 2.6% 2.0% 3.4% 3.5%

Organic variation 1.1% 3.3% 3.2% 3.5% 3.5%

Source: Company Data; Bryan, Garnier

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5.2. An EBIT margin flat in organic this year but improving from 2018/19 The EBIT margin is expected to be flat in organic in 2017/18, which is satisfactory within the context of GST in India. The group has said that this tax reform should have a EUR15m negative The EBIT margin should impact on the EBIT over the full year. In 2018/19 and 2019/20, the organic margin improvement rise by 35bps in 2018/19 should reach a respective 35bps and 50bps, benefitting from the accelerating top line. In terms of after remaining flat this FX, the company’s guidance is for a EUR125m negative impact on EBIT this year, based on a year EUR/USD of 1.18, and our forecast is bang in line with this. The FX impact on 2018/19 is broadly neutral (-0.1% estimated). Our EPS over the next five years are revised up by 5% on average.

Fig. 16: EBIT assumptions

EURm 2015/16 2016/17 2017/18e 2018/19e 2019/20e

GROUP

EBIT 2,277 23,94 2,401 2,582 2,802

Reported variation 1.7% 5.2% 0.3% 7.5% 8.5%

Organic variation 2.1% 3.3% 5.6% 7.7% 8.5%

External variation -0.6% -0.2% 0.0% 0.0% 0.0%

FX variation 0.3% 2.1% -5.3% -0.1% 0.0%

Margin 26.2% 26.6% 26.3% 26.7% 27.2%

Variation in bps 7 34 -25 35 49

Organic variation in bps 7 -6 0 35 50

ASIA-ROW

EBIT 983 1,001 1,006 1,106 1,225

Reported variation -1.6% 1.8% 0.5% 10.0% 10.7%

Margin 28.1% 28.1% 27.5% 27.9% 28.5%

Variation in bps -87 -6 -60 43 57

AMERICAS

EBIT 706 790 779 834 909

Reported variation 11.7% 11.9% -1.4% 7.0% 9.0%

Margin 28.5% 29.7% 29.7% 30.0% 30.5%

Variation in bps 198 116 1 28 56

EUROPE

EBIT 588 604 617 643 670

Reported variation -3.1% 2.7% 2.2% 4.1% 4.2%

Margin 21.7% 21.7% 21.8% 21.9% 22.1%

Variation in bps -53 2 4 15 15

Source: Company Data; Bryan, Garnier

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5.3. Potential upwards revisions in consensus estimates We anticipate upwards revisions to consensus estimates. Over the next three years, our forecasts are 1.2%, 2.9% and 4.5% above market expectations in terms of sales. Our EPS estimate is roughly in line with consensus in 2017/18 but 3.5% and 5.5% above in 2018/19 and 2019/20, respectively.

2017/18 2018/19 2019/20

BG estimate Consensus BG estimate Consensus BG estimate Consensus

Sales 9,123 9,013 9,682 9,410 10,316 9,874

Difference 1.2% 2.9% 4.5%

EBIT 2,401 2,406 2,582 2,534 2,802 2,695

Difference -0.2% 1.9% 4.0%

EPS 5.71 5.71 6.39 6.17 7.06 6.69

Difference -0.1% 3.5% 5.5%

Source: Company Data; Bryan, Garnier

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6. A very healthy financial situation leaving room for cash return to shareholders Pernod Ricard was able to increase its FCF by 22% in 2016/17 thanks to tight management of operating working capital, and lower growth in strategic inventory build. Consequently, its net debt/EBITDA ratio fell to 3x in 2016/17 vs 3.4x in 2015/16. Between 2012/13 and 2015/16, this ratio remained broadly unchanged at around 3.5x. We estimate it will continue to decrease to 2.6x in 2017/18 and 2.1x in 2018/19.

Fig. 17: Net debt to EBITDA ratio

10000 4.0 8727 9020 8716 9000 8353 3.5 7851 3.6 8000 3.5 3.5 3.4 3.0 7000 6754 3.0 5830 6000 2.5 2.6 4831 A net debt to EBITDA 5000 2.0 2.1 ratio of only 2.6x in 4000 1.5 2017/18 3000 1.6 1.0 2000 1000 0.5 0 0.0 2012/13 2013/14 2014/15 2015/16 2016/17 2017/18e 2018/19e 2019/20e

Net debt Net debt/EBITDA

Source: Company Data; Bryan, Garnier

Pernod Ricard is always looking for attractive acquisition targets. It wants to remain investment grade, A buyback of EUR1.4bn i.e. a potential net debt/EBITDA ratio of up to 4.4x. This gives the Group firepower of EUR4.7bn in should have a 4% 2017/18 and EUR6.6bn in 2018/19. However we expect it to favour bolt-on deals as 1/ it is looking accretive impact on to improve its growth profile, not to increase critical mass and 2/ a lot of craft brands have 2018/19 EPS emerged over the past few years, offering attractive growth opportunities. Acquisitions in the US are likely to be preferred.

Our view is that Pernod Ricard will return cash to shareholders either in the form of a special A special dividend could dividend or buy-backs. This will probably be announced at the end of 2017/18. Our scenario is that reach EUR5.3 per share the group will want to maintain its net debt to EBITDA ratio at around 2.6x, which means it will have which will imply a around EUR1.4bn available. dividend yield of 5.7% (vs A buyback of EUR1.4bn should have a 4% accretive impact on 1.6% currently) 2018/19 EPS. If the company prefers to use a special dividend, we calculate it could reach EUR5.3 per share, pointing to a total dividend in 2017/18 of EUR7.3 which would imply a payout ratio of 129% and a dividend yield of 5.7% (vs 1.6% currently).

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7. Buy reiterated

The stock has not been amongst the best performers in the spirits sector (7.1) and is trading at a discount vs peers (7.2). Our DCF-derived valuation points to a Fair Value of EUR145, implying 12% upside potential (7.3). Our Buy recommendation is reiterated.

7.1. The stock has not been amongst the best performers in the spirits sector and … On a relative basis, the share price has risen by 16.5% year-to-date and by 6.0% over the past six months. This performance is fairly average vs the sector.

Fig. 18: Share performances vs DJ Stoxx Year-to-date Over the last six months

MBWS -37.5% MBWS -24.2%

Campari 5.7% Diageo 15.9%

Pernod Ricard 6.0% Pernod Ricard 16.5%

Diageo 12.5% Campari 28.7% Rémy Cointreau 12.6% Rémy Cointreau 33.2% -30 -20 -10 0 10 20 -50 -40 -30 -20 -10 0 10 20 30 40

Source: Thomson Reuters

7.2. …is trading at a discount vs peers which is higher than its average over the past ten years In 2018e, the stock is trading at a discount of 18% in terms of EV/EBIT and 22% in terms of P/E. This is significantly above the average discount over the last 10 years which was 6% for EV/EBIT and 14% for P/E.

Fig. 19: EV/EBIT

2018e EV/EBIT (x) 2019e EV/EBIT (x) 2018e premium/discount 2019e premium/discount

Campari 20.3 17.3 -2% -7%

Diageo 18.7 17.1 -10% -8%

Pernod Ricard 17.1 15.5 -18% -16%

Rémy Cointreau 27.3 24.2 31% 30%

Average 20.8 18.5

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Fig. 20: P/E

2018e P/E (x) 2019e P/E (x) 2018e premium/discount 2019e premium/discount

Campari 29.3 24.3 2% -3%

Diageo 22.9 21.0 -20% -17%

Pernod Ricard 22.6 20.2 -21% -20%

Rémy Cointreau 40.1 35.2 40% 40%

Average 28.7 25.1

Source: Company Data; Bryan, Garnier

7.3. Our DCF points to a Fair Value of EUR145 Discounting cash flows puts the value per share at EUR145, implying 12% upside potential. We have the following assumptions:

 WACC of 6.9% stemming from a cost of equity of 7.9% with:

• A risk-free rate of 1.6%

• A market risk premium of 7.0%

• An adjusted three-year beta vs. DJ Stoxx of 0.9

 A growth rate to infinity of 2% as of 2027;

 An average recurring tax rate of 26% aligned with the company's guidance;

 A growth rate of 7.2% in 2022, which then decelerates gradually to 2% in 2027, and an EBIT margin rising by an annual 10bps between 2023 and 2027.

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Fig. 21: DCF (1/1)

EURm 2017/18e 2018/19e 2019/20e 2020/21e 2021/22e 2022/23e 2023/24e 2024/25e 2025/26e 2026/27e

Sales 9,123 9,681 10,316 11,023 11,812 12,535 13,174 13,709 14,125 14,408

% reported 1.3% 6.1% 6.6% 6.9% 7.2% 6.1% 5.1% 4.1% 3.0% 2.0%

EBIT 2,401 2,582 2,802 3,049 3,326 3,542 3,736 3,902 4,034 4,129

EBIT margin 26.3% 26.7% 27.2% 27.7% 28.2% 28.3% 28.4% 28.5% 28.6% 28.7%

-Income taxes -492 -526 -585 -628 -685 -730 -770 -804 -831 -851

+Depreciation 228 242 258 291 328 366 403 439 472 501

+Change in WC -172 -226 -263 -281 -301 -319 -335 -349 -360 -367

as % of sales -1.9% -2.3% -2.5% -2.5% -2.5% -2.5% -2.5% -2.5% -2.5% -2.5%

Operating cash flows 1,965 2,073 2,212 2,431 2,669 2,859 3,034 3,187 3,315 3,413

-Capex -319 -339 -361 -386 -413 -439 -461 -480 -494 -504

as % of sales -3.5% -3.5% -3.5% -3.5% -3.5% -3.5% -3.5% -3.5% -3.5% -3.5%

Free cash flows 1,646 1,734 1,850 2,045 2,255 2,421 2,573 2,708 2,821 2,909

Discount coefficient 0.94 0.87 0.82 0.77 0.72 0.67 0.63 0.59 0.55 0.51

Discounted FCF 1,539 1,517 1,514 1,565 1,614 1,620 1,610 1,585 1,544 1,489

Fig. 22: DCF (2/2)

Sum of discounted cash flows 15,597

+Terminal Value 30,860

+Financial assets 650

-Net debt -7,851

-Provisions -612

-Minorities -180

Equity Value 38,464

Number of shares (m) 265

Fair Value 145

Source of all tabs: Company Data; Bryan, Garnier

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Price Chart and Rating History

Pernod Ricard

140.0

130.0

120.0

110.0

100.0

90.0

80.0 15/06/16 15/09/16 15/12/16 15/03/17 15/06/17 15/09/17 15/12/17

PERNOD-RICARD Fair Value Achat Neutre Vente

Ratings

Date Ratings Price 18/11/16 BUY EUR102.75

18/05/16 NEUTRAL EUR94.95

Target Price Date Target price 20/10/17 EUR130 01/09/17 EUR123 06/07/17 EUR120 21/04/17 EUR123 10/02/17 EUR117 18/11/16 EUR115 21/10/16 EUR114 02/09/16 EUR112 22/04/16 EUR107 31/03/16 EUR113 12/02/16 EUR117 11/12/15 EUR122

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Intentionally left blank

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Intentionally left blank

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Bryan Garnier stock rating system For the purposes of this Report, the Bryan Garnier stock rating system is defined as follows: Stock rating Positive opinion for a stock where we expect a favourable performance in absolute terms over a period of 6 months from the publication of a BUY recommendation. This opinion is based not only on the FV (the potential upside based on valuation), but also takes into account a number of elements that could include a SWOT analysis, momentum, technical aspects or the sector backdrop. Every subsequent published update on the stock will feature an introduction outlining the key reasons behind the opinion. Opinion recommending not to trade in a stock short-term, neither as a BUYER or a SELLER, due to a specific set of factors. This view is intended to NEUTRAL be temporary. It may reflect different situations, but in particular those where a fair value shows no significant potential or where an upcoming binary event constitutes a high-risk that is difficult to quantify. Every subsequent published update on the stock will feature an introduction outlining the key reasons behind the opinion. Negative opinion for a stock where we expect an unfavourable performance in absolute terms over a period of 6 months from the publication of a SELL recommendation. This opinion is based not only on the FV (the potential downside based on valuation), but also takes into account a number of elements that could include a SWOT analysis, momentum, technical aspects or the sector backdrop. Every subsequent published update on the stock will feature an introduction outlining the key reasons behind the opinion. Distribution of stock ratings

BUY ratings 00% NEUTRAL ratings 0% SELL ratings 00%

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