Top Pick For 2017: Andrew Peller Has 24% Upside

| About: Andrew Peller (ADWPF)

Summary

Andrew Peller's stock is up 7% after reporting double-digit profit growth.

The expansion of the supply chain for the whisky launch is in the works.

Forecasting revenue of $348.3 million and EBITDA of $45.3 million for fiscal 2017.

Reiterating a Buy rating with a $13.70 target price based on a DCF and EBITDA multiple valuation.

(Source: Andrew Peller)

Andrew Peller (OTC:ADWPF) released earnings for the third quarter that included new sales of the Wayne Gretzky No. 99 Red Cask Canadian Whisky, the first spirits beverage launched by the winemaker. The stock price has been in correction mode since hitting a high of $13.00 in mid-October, but shares seem to have bottomed, and are now moving higher after reporting strong earnings.

I have a Buy rating and a $13.70 target price based on a mixed valuation of DCF and comparables. At current levels, my target price implies 24% upside. Andrew Peller's strong brand portfolio, extensive supply chain and distribution network, market leadership, and improving fundamentals, give me confidence to rate Andrew Peller's stock a Buy.

Fiscal Year

2015A

2016A

2017E

Valuation Summary

EV/Sales

1.8x

1.4x

1.6x

EV/EBITDA

16.1x

13.8x

12.5x

EV/EBIT

21.8x

18.1x

15.7x

Financial Summary (C$ mln)

Revenue

315.7

334.3

348.3

Gross Profit

114.9

123.0

130.6

EBIT

25.9

31.2

35.9

EBITDA

35.2

40.9

45.3

Adj. Net Profit

15.4

20.3

25.3

Growth Summary (Y-O-Y% Change)

Revenue

6.0%

5.9%

4.2%

EBITDA

8.9%

16.3%

10.7%

EBIT

7.8%

20.5%

15.0%

Adj. Net Profit

5.5%

31.7%

24.6%

Ratio Summary (% of Revenue)

COGS

63.6%

63.2%

62.5%

Gross Profit

36.4%

36.8%

37.5%

SG&A

25.2%

24.5%

24.5%

EBIT

8.2%

9.3%

10.3%

EBITDA

11.1%

12.2%

13.0%

Adj. Net Profit

4.9%

6.1%

7.3%

Overview of Andrew Peller

Andrew Peller is the second largest wine producer and marketer of red and white wines in Canada, with 14.4% share of the total wine market. It owns wineries in Ontario, British Columbia, and Nova Scotia, and sells wine products across many pricing segments in Canada. This includes value-priced blended and varietal table wines, sparkling wines, fortified wines (less than $8 to $12 per bottle), and premium to ultra-premium priced VQA wines ($10 to over $20 per bottle).

Andrew Peller owns 100 independent retail locations in Ontario under The Wine Shop (97), Wine Country Vintners (2), and Wine Country Merchants (1) store names. You can find many of The Wine Shop stores inside grocery store chains, such as Sobey's, Metro, Longo's, and Loblaws. Andrew Peller's distribution network expands into provincial liquor control boards (e.g. LCBO, BC Liquor Stores), estate wineries, and restaurants.

In the past fiscal year, Andrew Peller generated $334.3 million in revenue, with a large chunk of sales (>95%) coming from Canada. Less than 5% of sales arise from selling icewine and wine-making products to the U.S., China, New Zealand, Australia, and the U.K. I believe Andrew Peller will eventually make the necessary investments to expand its supply chain and distribution channel to access new markets and customer bases, particularly in the U.S.

Fiscal Year

2012A

2013A

2014A

2015A

2016A

Liquidity and Profitability Ratios

Current Ratio

1.3x

1.4x

1.4x

1.9x

1.9x

Quick Ratio

0.2x

0.2x

0.2x

0.3x

0.4x

Debt-to-Equity

0.9x

0.8x

0.7x

0.6x

0.5x

Net debt-to-EBITDA

3.2x

3.2x

3.0x

2.5x

2.1x

ROE

11.1%

11.6%

10.5%

10.6%

12.6%

ROA

4.7%

5.0%

4.7%

5.0%

6.3%

ROCE

11.5%

11.1%

10.8%

11.0%

13.2%

Investing in whisky

Andrew Peller's attractive portfolio of brands has been successful in taking market share from small and large Canadian and international wineries. But the winemaker is now looking to gain traction in the spirits market, with the third quarter launch of the new Wayne Gretzky No. 99 Red Cask Canadian whisky. Andrew Peller set up a strategic partnership with the Wayne Gretzky Estate Winery in 2011 and sells Wayne Gretzky No. 99 red and white wines in Canada and select U.S. markets.

The Wayne Gretzky No. 99 brand has become one of Andrew Peller's fastest-growing VQA brands, with sales rising 16% in fiscal 2016. It is the tenth largest VQA wine brand in Canada in both volume and sales. The company is using the brand's equity and familiarity to bring whisky to market. The Wayne Gretzky No. 99 Red Cask Canadian whisky is only available in certain Canadian provinces.

I expect the whisky launch to fully roll out across Canada in fiscal 2018. Andrew Peller plans to first expand the distribution network in the remaining provinces, and then will consider taking the whisky launch to the U.S. and other international markets. The latest earnings report highlights that there will be new product launches from the Wayne Gretzky Estate Winery and Craft Distillery in the coming year. It is unclear if the new Wayne Gretzky beverages will fall under the wine or whisky category.

To date, Andrew Peller has spent $16.4 million in capital expenditures. This capex spend is mostly for the development of the new Wayne Gretzky Winery and Craft Distillery in Niagara-on-the-Lake, Ontario. The 15,000-square-foot facility will include a winery, craft distillery, tasting rooms, barrel aging cellars, and three to four acres of vineyards for Gretzky wines. Andrew Peller expects the facility to open to the public this spring.

I expect capital expenditures to run up to $19.2 million (5.5% of revenue) for fiscal 2017, as Andrew Peller completes the construction of the new winery and distillery. Therefore, there is expectation of a large decrease in capital spend in fiscal 2018 and 2019, giving way to an attractive free cash flow growth profile. At a recent $11, shares are trading at a 2017 unlevered free cash flow yield of 1.9%.

In fiscal 2018, I estimate Andrew Peller to generate $21.8 million in unlevered free cash flow, assuming 5% revenue and EBITDA growth, capex at 3% of revenue and a tax rate of 23%. This derives an unlevered free cash flow yield of 4.6% (rising to 5.1% in fiscal 2020). As earnings growth drives shareholder returns and dividend increases, it would not surprise me to see a dividend increase at some point in fiscal 2018.

Unlevered Free Cash Flow and Yield (C$000s)

2016A

2017E

2018E

2019E

2020E

2021E

17,781

8,746

21,794

22,880

24,021

25,218

3.8%

1.9%

4.6%

4.8%

5.1%

5.3%

Earnings review

Revenue and earnings are historically the strongest in the third quarter because of increased consumer spending during the holiday season. I expected the whisky launch to drive 8% quarter-on-quarter sales growth for the third quarter, but the actual number was closer to 6.4%. I overestimated the size of the whisky launch considering Andrew Peller was still in the early stages of the roll out and widening of the supply chain. Revenue increased to $94 million, up 2.5% from the prior year.

Gross margin improved by 100 bps year over year to 37.3%. Margins are seeing the benefits from Andrew Peller's cost control program intended to increase productivity and raw material cost savings. There is a long-term risk to margin growth if you account for the devaluation of the loonie. Andrew Peller imports bulk wine, grapes, and juice from international markets, mostly from the U.S., and including Chile, Spain, Australia, and South Africa.

A weaker loonie will raise the cost of such raw materials. Andrew Peller uses effective economic hedges such as foreign exchange forward contracts to mitigate short-term foreign currency (U.S., euro, and Australian-dollar) volatility. Net earnings were $8.2 million or $0.20 per Class A share, compared to $7.1 million or $0.17 per Class A share. Strong sales and margins contributed to double-digit net profit growth.

FISCAL 2015

FISCAL 2016

FISCAL 2017

(in C$000s, except per share amounts)

Q1

Q2

Q3

Q4

Q1

Q2

Q3

Q4

Q1

Q2

Q3

Revenue

$79,517

$82,759

$84,630

$68,791

$83,118

$85,200

$91,775

$74,170

$87,906

$88,357

$94,048

Gross Profit

$29,298

$29,990

$31,267

$24,648

$31,811

$32,716

$33,277

$25,160

$34,143

$33,644

$35,042

Gross Margin

36.8%

36.2%

36.9%

35.8%

38.3%

38.4%

36.3%

33.9%

38.8%

38.1%

37.3%

EBITDA

$10,018

$9,507

$11,024

$4,635

$12,846

$12,011

$12,445

$3,614

$14,803

$12,583

$11,886

EBITDA Margin

12.6%

11.5%

13.0%

6.7%

15.5%

14.1%

13.6%

4.9%

16.8%

14.2%

12.6%

Net earnings

$3,994

$5,038

$5,682

$511

$6,689

$7,023

$7,146

($1,659)

$8,573

$7,630

$8,137

EPS - Class A

$0.10

$0.12

$0.14

$0.01

$0.16

$0.17

$0.17

($0.04)

$0.21

$0.18

$0.20

EPS - Class B

$0.08

$0.11

$0.12

$0.01

$0.14

$0.15

$0.15

($0.04)

$0.18

$0.16

$0.17

There were two one-time expenses recorded in the second and third quarter under SG&A that have slowed EBIT, EBITDA, and EPS growth. In the first nine months of fiscal 2017, SG&A margin increased by 20 bps year over year to 23.5%. However, Andrew Peller reported a total of $2.4 million in one-time expenses related to professional service fees ($1.1 million) and post-retirement benefits ($1.3 million). After removing one-time items, SG&A margin improves to 22.6% of sales for the first nine months of fiscal 2017.

The $1.1 million spent on professional services fees ($0.8 million in Q2 and $0.3 million in Q3) relates to a strategic acquisition that Andrew Peller did not complete. I assume Andrew Peller tried to acquire Canadian wine brands from Constellation Brands (NYSE:STZ), but the private equity arm of the Ontario Teachers' Pension Plan (OTTP) outbid them. The OTTP acquired the Canadian wine business from Constellation Brands for $1.03 billion (12x EV/EBITDA) in October 2016.

Andrew Peller is very much capable of making small bolt-on acquisitions to either expand in Canada or internationally. Solid annual cash flow streams plus a $55.4 million operating loan facility is available to support M&A. Growth through acquisition can be risky, but Andrew Peller has a long history of successfully integrating business and growing them. It has made 14 wine-related acquisitions (Sandhill, Thirty Bench, Red Rooster, Trius) over the last 20 years with a total investment value of $114 million.

To date, fiscal revenue has increased 3.9% to $270.3 million. Net profit has jumped 16.9% to $24.4 million or $0.59 per Class A share. Andrew Peller's EBITDA has increased 5.3% to $39.3 million (margin of 14.5%). After accounting for one-time items, adjusted EBITDA for the first nine months rises to $41.7 million (margin of 15.4%). I expect EBITDA and net profits to gradually grow over the next two fiscal years, helped by cost control initiatives and incremental sales from new wine and whisky launches.

Valuation

The fourth quarter is historically the weakest. I am expecting sales growth of 3% to 5% year over year from $76 million to $78 million, driven by wine sales and the whisky launch in certain provincial markets. This brings my revenue estimates to $348.3 million and EBITDA of $45.3 million (margins of 13%) for fiscal 2017. I have gross margins expanding by 70 bps to 37.5% because of higher revenues and better cost controls.

Revenue (C$ mln)

EBITDA (C$ mln)

EPS (Class A)

2016A

$334.26

$40.92

$0.46

2017E

$348.31

$45.28

$0.61

2018E

$365.73

$47.54

$0.64

2019E

$384.01

$49.92

$0.67

I have a Buy rating and a $13.70 target price based on a DCF and EBITDA multiple valuation model. At current levels, my target price implies 24% upside. Andrew Peller's strong brand portfolio, extensive supply chain and distribution network, market leadership, and improving fundamentals, give me confidence to rate Andrew Peller's stock a Buy. I believe the stock could re-rate on the back of rising sales momentum from the whisky launch.

1. DCF method ($14.75/share)

My DCF model assumes a cost of equity of 6.2% based on the 10-year Canadian government bond for a risk-free rate of 1.70%, an equity beta of 0.75 and an equity risk premium of 6%, and an after-tax cost of debt of 2%, for an implied WACC of 5.5%. We assume a conservative 1.5% terminal growth rate, which is 60 bps below Canada's expected GDP growth for 2017 and 2018 (BOC, January 18, 2017 - MPR).

(in C$000s)

2016A

2017E

2018E

2019E

2020E

2021E

NOPAT

22,943

27,630

28,871

30,326

31,853

33,457

Add: Depreciation and amortization

9,708

9,397

10,050

10,538

11,050

11,588

Less: Increase in working capital

(4,469)

(9,124)

(6,155)

(6,463)

(6,786)

(7,126)

Less: Capital expenditure

(10,401)

(19,157)

(10,972)

(11,520)

(12,096)

(12,701)

Free cash flow to the firm

17,781

8,746

21,794

22,880

24,021

25,218

2. EV/EBITDA method ($12.60/share)

I apply a target EV/EBITDA multiple of 14x to my 2017 EBITDA estimate of $45.3 million. This EV/EBITDA multiple is a discount to the large-cap wine and spirits peer group average of 16.3x 1-year forward EBITDA. Andrew Peller merits a discounted multiple because the wine and spirits peer group i) generates on average 1.6x more gross margin and 2.7x more EBITDA margin, ii) has strong links to international supply chain and distribution networks, and iii) enjoys scale and size that gives them bargaining power and financial flexibility.

LTM

LTM Margins

EV/LTM

EV/1-year forward

($ in millions)

Ticker

Price

Market Cap

EV

Revenue

EBITDA

Gross

EBITDA

Revenue

EBITDA

Revenue

EBITDA

Andrew Peller

ADW

11.00

472

565

344

43

37.2%

12.4%

1.6x

13.2x

1.6x

12.5x

Constellation Brands

STZ

147.31

29,225

37,639

7,246

2,443

49.6%

33.7%

5.2x

15.4x

5.2x

15.6x

Brown-Forman Corporation (NYSE:BF.B)

BF.B

43.89

17,318

19,361

2,979

1,101

66.1%

36.9%

6.5x

17.6x

6.3x

17.7x

Diageo plc (NYSE:DEO)

DGE-GB

26.70

66,016

79,968

15,532

4,862

59.8%

31.3%

5.2x

16.4x

5.8x

17.3x

Pernod Ricard SA (OTCPK:PDRDF)

RI-FR

110.93

29,119

39,067

9,631

2,891

61.6%

30.0%

4.1x

13.5x

4.2x

14.5x

Group Average

59.3%

33.0%

5.2x

15.7x

5.4x

16.3x

I arrive at my $13.70 target price by taking the average of the DCF and EV/EBITDA methods.

DCF

Relative

Average

$14.75

$12.60

$13.68

Target price

Current Market Price

Upside

$13.7

$11.00

24.3%

Catalysts

There is a long list of short-term catalysts, including: i) the whisky launch and the supply chain expansion into remaining Canadian provinces, and then the U.S. and other international markets, ii) the launch of new wine, cider, and whisky products in fiscal 2018, iii) the opening of the Wayne Gretzky Estate Winery and Craft Distillery in two to three months, iv) consumers trading up to premium and ultra-premium wines (margin enhancement), v) strong wine industry fundamentals, and vi) the retail expansion of wine sales into Ontario grocery stores (in effect since October 2016).

The Ontario government plans to issue 150 new wine-selling licenses that will allow stores, such as Loblaws, Metro, Longo's, and Wal-Mart, to sell wine on store shelves. The plan is to have 300 of the provinces' 1,500 grocers to sell wine by 2025. There are 70 retail stores already selling wine. Andrew Peller will be moving 14 out of 100 independent retail locations to the main aisles of grocery stores in May 2017. This will create more points of sale for Andrew Peller's wine brands. The Ontario government has said they would consider issuing more wine-selling licenses if there is an uptick in consumer demand.

Risks

The downside risks to our valuation include, i) losses on derivative financial instruments (foreign exchange forward contracts and interest rate swaps), ii) increased competition from low-priced import wines and whisky brands, iii) changes to provincial liquor laws, regulations, and taxes, iv) the devaluation of the Canadian dollar (versus U.S., Australia, and euro currencies), and v) macro-economic and consumer spending weakness in Canada.

Appendix

1. Wayne Gretzky Estate Winery and Craft Distillery (August 2016)

(Source: Google Maps)

2. Wayne Gretzky Estate Winery and Craft Distillery (August 2016)

(Source: Google Maps)

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

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