Four Factors that Will Hold Back Pernod Ricard's Growth Momentum

Pernod Ricard (PDRDF.PK) Stock price: €56.1($84.2)
Conclusion: The stock further re-rated since September (up 9%), reaching our valuation range of €55-58 ($82.6-87.1). We expect it to consolidate around this level. Although we expect like for like growth to accelerate in H2, we think that EPS growth will be held back by negative forex and higher marketing spending.

Q1 sales down 6% reported, down 4% like for like. Guidance will be given at the AGM on November 2.

Q1 sales could have been worse considering the tough comparison base (sales up 7% in Q109), and the timing of US distributors orders for Christmas and the New Year. Diageo (DEO) sales declined by 6% during the corresponding period.
We think that Pernod Ricard could end the year with net positive organic growth between +1-2%, thanks to: return to positive growth for Absolut in the US ( +1% in consumer off take in Q1), the end of destocking from wholesalers, continuing positive price and mix impact, strong momentum in emerging markets (+15% sales in emerging Asia in Q1, Martell gaining share), and higher marketing support.

EPS growth momentum will be held back by four factors:

• Weak organic growth in H1 which accounts for more than 2/3 of the full year earnings. Although we expect Q2 to improve, this should not be enough to compensate for the slow start in Q1. The second half of the year should benefit from positive operating leverage, but the contribution is smaller.
• Higher marketing expenses. We understood already in September that management would raise expenses; that has been confirmed last week. We expect spending to amount to 18% of sales against 17.2% last year (-€50m [$75m] impact).
• We estimate the negative impact of the dollar on operating earnings at around €85m, only partly offset by reduced financial expenses (€21m).
• Higher number of shares.

As a result, profit from recurring operations could be down 5%, while adjusted earnings could remain flat helped by lower financial expenses. EPS could fall by 8.4% to €3.91.

The stock trades at a moderate 13.7x and 13.5x P/E based on our calendared estimates for 2009 and 2010 vs. 15 and 14x respectively for Diageo. Based on EV/EBITDA, Pernod Ricard looks more expensive than Diageo (12.5x 2010 vs. 10.6x for Diageo).
The stock price reached the middle of our valuation range, which suggests that it is fairly priced for the coming months.