CFA Institute Research Challenge Hosted by CFA Society France Team L PERNOD RICARD S.A Valuation Date: 01/19/2018 Stock Exchange: Euronext Paris Current Price: EUR 130 Sector: Consumer Staples TP: EUR 152 Ticker: RI Industry: Alcoholic Beverages Upside: 17% BUY MARKETING, POSITIONING AND CASH GENERATION: Chart 1: Key stock informations THE PREMIUM COCKTAIL TO CRUSH A DISCOUNT Stock Informations 7, 0 0 0 , 0 0 0 190 52w price range 106.7-133.6 5,610,000 158 3-m Average 398,880 4,220,000 Daily Volume 125 Volume 2,830,000 1-year 20.8 % 93 Share Price in EUR performance 1,440,000 Market 34,504 50,000 60 capitalisation 11/2014 01/2015 04/2015 06/2015 09/2015 11/2015 01/2016 04/2016 06/2016 08/2016 11/2016 01/2017 03/2017 06/2017 08/2017 10/2017 12/2017 02/2018 03/2018 05/2018 07/2018 08/2018 10/2018 12/2018 (EURm) HIGHLIGHTS Free float 45.8 % We initiate coverage of Pernod Ricard (PR) with a BUY recommendation and a one-year target price of EUR 152 per share pointing to 17% upside potential from its 19th January, 2018 closing price of EUR 130. More than on a 1-year horizon, we consider Pernod Ricard as a long FY18 Dividend 1.6 % Yield term investment opportunity to fully seize the group’s growth potential. Source: Bloomberg SMART MARKETING POLICY SUPPORTING A POWERFUL BRANDS PORTFOLIO We believe that Pernod Ricard’s powerful “Top-13” brands supported by a strong 19% ad-spend to sales ratio added to an extensive product Chart 2: Key valuation metrics innovation policy provide a solid basis for organic growth. PR’s portfolio - composed of flagship brands such as Absolut and Jameson - covers the whole products spectrum and enables them to capture the most promising consumption trends going forward. PR has a unique Valuation Weight Target organisation spread between Brand* and Market* companies, which provides brands with heavy marketing power, giving them wide Price exposure and fostering organic growth potential. We see such an ability being all the more important as the market is increasingly consolidated. Overall, we consider this strategy as the main tool to reach our 5.1% 2017-22 organic sales CAGR estimates. DCF 40% 152.6 WELL-OILED PREMIUMISATION PROCESS Relative SOTP 40% 157.5 Pernod Ricard is the global leader in the premium sector where it generates 66% of its revenues. This high-end segment exhibits the most dynamic growth potential reaching up to 9% 2012-16 CAGR in the above-$42/Litres category. PR’s positioning is expected to bring stronger P/E Regression 20% 140.6 pricing power which we consider as a key advantage to develop sales and a main driver to secure the 62.8% gross margin that we estimate for FY22E. We believe that PR’s value growth strategy is the best path to overcome volume pressure from regulatory constraints. 1-Year Target Price 152 PREFERENTIAL POSITION IN EMERGING MARKETS PR dominates the premium international styles spirits segment in emerging markets, which generate 38% of its revenues. We expect high Source: Team estimates single digit growth in Asia RoW mainly driven by India - where PR enjoys a 42% market share in the premium segment- and China where PR ranks #1 in international spirits with the Chivas and Martell brands. We consider that strong fundamentals coupled with low penetration rates of international spirits (1% in Asia Pacific) offer even more momentum for PR’s activity in this region. Chart 3: PR 1-Y Performance ACCELERATING CASH GENERATION TO BOOST DELEVERAGING & FINANCIAL FLEXIBILITY DJ EUROSTOXX Food & Bev PR focuses on generating stronger cash-flow performance through “Operational Efficiency”, ie tighter cost management and organisational 40% Pernod Ricard restructuring. We estimate this should accelerate the deleveraging process to FY20 (2019/20) with net debt/EBITDA moving from 3x in FY17 to 1.5x in FY20E. Additional cash generation after this date should bring flexibility to develop the existing brands organically, increase the 30% return of cash to shareholders or perform strategic premium brand acquisitions. 20% DRIVERS TO SHRINK VALUATION DISCOUNT PR has historically been trading at a 23.6% discount compared to its peers based on EV/EBITDA, which we believe is unjustified given the 10% company’s strong sector positioning and the expected cash-flow momentum. Our valuation leads to a 1-year target price of EUR 152 (%) Performance representing 17% upside potential and reflecting a lower discount to peers. We derive this target price from a combination of three valuation 0% methods: DCF (40%), Sum-Of-The-Parts (SOTP) relative valuation (40%) and multiple linear regression of PR’s P/E valuation (20%). We -10% conclude that PR is undervalued by the market which offers a good entry point for investors. In the longer term, we could expect PR to gradually trade a premium to the sector, leading for additional outperformance potential. 12.2016 02.2017 04.2017 06.2017 08.2017 10.2017 12.2017 Source: Bloomberg Chart 4: Key Financial Metrics Source: Pernod Ricard / Team estimates FY13 FY14 FY15 FY16 FY17 FY18E FY19F FY20F 2021F 2022F REVENUES (in EURm) 8,575 7, 9 4 5 8,558 8,682 9,010 9,021 9,425 9,984 10,527 10,942 GROSS MARGIN 62.4 % 62.8 % 61.9 % 61.9 % 62.2 % 62.5 % 62.7 % 63% 62.8 % 62.8 % EBIT MARGIN 26% 25.9 % 26.2 % 26.2 % 26.6 % 27.1 % 27.4 % 27.5 % 27.5 % 27.5 % EPS 4.46 3.86 3.26 4.68 5.27 5.74 6.25 6.84 7. 2 5 7. 5 8 CASH POSITION (in EURm) 597 477 545 569 677 766 873 1,505 2,541 3,647 NET DEBT-TO-CAPITAL 44% 42% 40% 39% 36% 30% 25% 20% 15% 10% EV/EBITDA 13.8x 13.2x 16.3x 14.2x 15.5x 15.4x 14.2x 13.1x 12.1x 11.2x Chart 5: Revenue Breakdown INVESTMENT SUMMARY We initiate coverage of PR with a BUY recommendation and a one-year target price of EUR 152 pointing to 17% upside potential. Our investment case is backed by four levers: (1) A powerful brand portfolio with dedicated marketing resources USA OTHERS 19% 21% (18.8% ad spend to sales ratio, 350bps above peers average); (2) A leading position in the premium spirits market; (3) A deep-rooted presence in emerging countries’ high-growth markets (See Chart 5, Appendix 8: PR’s top-line ASIA RoW geographical breakdown); (4) An increasing cash generation capacity (FCF yield increased by 100bps to 4.6% in FY17 and AMERICAS MEXICO 40% 31% 5% expected to reach 5.8% in FY22E) allowing for balance sheet deleveraging to FY20E. INDIA OTHERS 10% 6% PERNOD RICARD is the #2 global player in the spirits market, one of the fastest growing sector (3.2% 2010-16 CAGR) in the alcoholic beverages industry ahead of beers, wine and cider. The group benefits from a unique corporate organisation divided into six EUROPEEUROPE France Brand companies and eighty-five Market companies (See Chart 6). We believe that this structure is the pillar for CHINA 30% 29 % 9% 9% driving an efficient group strategy which is well-adapted to local specificities. While market companies offer a highly extensive UK distribution network, brand companies design PR’s strategy to promote the brands. One of the most efficient tools is bringing consumers OTHERS 5% 16% together during so-called « moments de convivialité » (« moments of friendship »)*, while mitigating the regulatory and reputation risks surrounding alcohol consumption. Such a strategy is part of a larger initiative to adopt a best-in class ESG policy rated 70/100 by Sustainalytics - an ESG rating provider - and ranking among the sector’s « out-performers ». We consider that this Source: Pernod Ricard / Euromonitor approach is one of PR’s strengths and should help reducing the stock’s valuation discount (see below). This strategy is a long-term process made possible by a stable shareholder structure and the family owned nature of the company. Chart 6: Corporate Organisation EFFICIENTLY SEIZING MARKET OPPORTUNITIES - PR is the international leader of premium spirits in two of the fastest BRAND COMPANIES MARKET COMPANIES growing markets: China and India (+17% CAGR over 2016-21 for international style spirits). These two markets weigh 20% of PR’s sales The Absolut Pernod Ricard Asia and 25% of its operating profit. We estimate that PR’s comprehensive emerging markets penetration strategy in these regions is a key Company advantage to trigger sustainably higher growth compared to its peers. While having one of the widest industry portfolios, PR maintains a proactive acquisition policy to stick to changing consumer trends, and to keep premiumising its Chivas Brothers Pernod Ricard North America product mix. Additionally, the group capitalises on its brand recognition to deepen its portfolio with flavoured and cocktail spirits obtained through an extensive product innovation policy (33% of organic growth derives from innovation). Martell / Mumm Pernod Ricard EMEA / Perrier-Jouet LATAM INCREASINGLY SOUND FINANCIAL POSITION - We expect PR to generate a EUR 9bn revenue next year with a 4.9% organic growth rate mitigated by a 4.7% negative forex impact. The group should outperform its 4-5% mid-term sales Irish Distillers Pernod Ricard Global growth guidance in FY19E with a 5.5% organic growth rate driven mainly by Asia (+8.7%) with China and India both reaching Travel Retail high single-digit growth by FY19E. On the one hand PR is tightening its cost management through the operational efficiency Pernod Ricard Société Pernod roadmap with EUR 400m targeted savings, while maintaining a high ad spend to sales ratio to ensure brand development.