- Rémy Cointreau released FY20 results last Thursday, with the new CEO announcing new 10-year profitability and margin targets.
- The new targets imply a 10%+ earnings CAGR, and management aim to raise margins to peer levels and manage the portfolio more actively.
- EPS fell 30% organically in FY20, due to the Hong Kong protests and COVID-19; management expects a "strong" recovery in H2 FY21.
- At €115.80, on unimpacted FY19 EPS, the P/E is 35.9x, a reasonable valuation given Rémy's unique brands and growth potential.
- Earnings growth alone lead to a 10%+ annualised return, and Rémy is a unique asset that may attract strategic interest to create further upside.
Rémy Cointreau (OTCPK:REMYY) (referred here as "RCO") has been a Buy-rated stock in our coverage universe since December 2019 - we like the structural growth in the global spirits sector, driven by both increasing premiumisation and rising emerging markets affluence (especially in China). RCO, while having a narrower portfolio than larger peers Diageo (DEO) and Pernod Ricard (PDRDY) (both Buy-rated), has a higher concentration of premium brands, which gives it faster though more cyclically volatile earnings growth.
RCO released its FY20 results last Thursday (4 June), and shares closed up 11% that day, though they have lost most of that gain since.
In this article, we review the results in more detail and show how they support our investment case.
New 10-Year Targets
The most important news within the FY20 results was the new 10-year targets announced by CEO Eric Vallat, who took up the role in December 2019.
RCO will now target an EBIT margin of 30% (compared to 21% in FY20) and a gross margin of 72% (66% in FY20) for 2030. The plan includes an EBITDA CAGR of 6-7% (with a volume CAGR of 2%) for RCO's House of Rémy Martin Cognac business and unspecified but faster EBITDA CAGR for its Liqueurs & Spirits business. While progression towards these targets will not be linear, together, these imply a net income CAGR of 10%+ in the next 10 years:
RCO New 2030 Targets
NB. Figures on organic basis and exclude currency.
Source: RCO results presentation (FY20).
The new EBIT margin target would put RCO more in line with peers, while the new gross margin target would put RCO even further ahead of peers:
RCO Margin Profile vs. Peers (Last 12 Months)
Source: Company filings.
RCO's concentration of premium and super-premium brands means that it already has a much higher gross margin than peers, but it has a higher operating expense margin (On reported figures, RCO is shown as having a higher sales & marketing expense margin and a lower administrative expense margin, but this may be due to different classifications.)
Achieving these targets will involve fundamental changes in how RCO manages its portfolio, directs its marketing, and drives growth, for example:
- RCO efforts will now be directed at managing its gross margin, not at increasing the percentage of sales from $50+ bottles as before
- RCO will try to "customize priorities by brand", which will involve growing volumes more aggressively in some brands, such as The Botanist
- Other RCO steps include more direct selling, more sales to tier-3 and tier-4 Chinese cities, making digital sales 20% of total sales, etc.
While plans remain at early stage and investors have little visibility over them, we believe management targets to be achievable. Our belief is based on the unique, historic quality of RCO's brands, and its strong growth track record - in prior years, RCO has achieved double-digit organic EBIT growth in most years, except those impacted by exceptional events (anti-corruption campaign in China in FY14 and COVID-19 in FY20; FY16 was a small miss due to "technical factors" such as the exit of a U.S. contract):
RCO Components of Organic EBIT Growth (FY15-20A)
NB. FY15 organic growth rates exclude loss of Edrington US distribution contract. FY ends on 31 Mar. Source: RCO company filings.
We also have confidence in CEO Eric Vallat, who has strong experience with both RCO and with the luxury sector in general. He was previously a senior executive at RCO in 2014-18, lastly as the head of their Cognac business, took up a role with luxury giant Richemont (OTCPK:CFRUY) as their Head of the Fashion & Accessories Maisons, before returning to RCO last year.
FY20 Results in Detail
The FY20 results gave more detail on RCO's performance, though headline sales and EBIT figures were previously announced in late April.
A breakdown of the sales performance of RCO's two businesses by region is below. During FY20, RCO suffered an organic net sales decline of 7.5% in its House of Rémy Martin Cognac business (on a volume decline of 10.1%) and 3.0% in its Liqueurs & Spirits business (on a volume decline of 3.4%):
RCO Net Sales & EBIT Growth by Segment (FY20)
NB. Organic change figures exclude technical factors.
Source: RCO results presentation (FY20).
Full-year sales growth rates showed a clear deceleration from H1 (which had organic sales growth of 2.1% for Cognac and 4.9% for Liqueurs & Spirits), the result of COVID-19.
APAC was the worst impacted, given COVID-19 started earlier in China, with Cognac sales falling 15.8% on a reported basis. It was already weak in H1 FY20, due to protests in Hong Kong disrupting the Travel Retail business there, with a reported sales growth of only 2.9%. (APAC reported Cognac sales growth was 29% in H1 FY19.) Excluding Hong Kong, mainland China sales have continued to grow at double-digits.
Americas sales were more resilient because COVID-19 only started to impact FY20 in its final 2 months and because 80% of U.S. sales were "off" premise and were, in fact, boosted by the lockdown.
Both Cognac and Liqueurs & Spirits sales fell less than volume, with the gap particularly wide (700 bps) in Cognac sales, thanks to the strong price/mix in that business (with price increases in April 2019). However, with COVID-19, U.S. price increases in 2020 have not been implemented.
For RCO's profit & loss, the combination of sales decline, cost increases, and a higher tax rate means recurring net income and EPS fell 30% organically:
RCO Profit & Loss (FY20)
NB. Organic change figures include technical factors.
Source: RCO results presentation (FY20).
The negative impact on FY20 earnings from COVID-19 and the Hong Kong protests was clearly exceptional and temporary in nature. There were also a number of other smaller, one-off factors that drove the earnings decline:
- RCO's exit from some partner brands contracts mean total sales fell 9.0% on a reported basis, more than the 4.0% decline in Group Brands sales
- Current EBIT fell by €49.0m, more than the €33.9m decline in gross profits, as costs continued to increase; costs were moderated in FY20Q4
- There was a €5m increase in holding company costs, "largely related to the reorganization of the Executive Committee", that also impacted EBIT
- There was an €18.8m impairment, for the Westland single-malt brand whisky business acquired in 2017, in "Other Operating Expenses"
- The effective tax rate rose from 29% to 36%, due to a shift in geographic mix to the higher-tax Chinese market; management believes tax rate will now be flat in the short term, though hard to predict long term
Free of these one-offs, we expect RCO's future profit trends to be far stronger.
Latest COVID-19 Update
FY20 results also contained some good news on COVID-19.
The Chinese market provides a hint of how quickly RCO's "on" trade can return after lockdowns end, with traffic now back to normal in the biggest cities:
We see good news in China and earlier than what we would have expected … 100% of the bars and restaurants and even clubs have reopened in Guangdong, which is a key region for us. People are not even wearing masks anymore. And the last weekend, they were very busy … And this applies to Shanghai … some regions are still 70%, 80% reopened ... Now business-wise, how does it translate? It's a bit too early to say … But clearly, this recovery is a bit earlier than expected."
Eric Vallat, RCO CEO (FY20 Earnings Call)
Management also disclosed that direct sales are now one-third of sales in China, and they have been much more resilient than indirect sales during the COVID-19 outbreak.
Outside China, the main news was that the U.S. "off" trade has done better than expected, enough for RCO to revise its Q1 FY21 sales forecast upwards, from an organic decline of 50-55% to one of "only" 45%. RCO now expects an organic EBIT decline of 45-50% for H1 FY20, and a "strong recovery" in H2:
RCO FY21 Outlook
Source: RCO results presentation (FY20).
At €115.70, relative to FY20 net income, RCO is on a 49.7x P/E:
RCO Earnings, Cashflows & Valuation (FY16-20A)
NB. "WCR" = Working Capital Required; "EdV" = Eaux de Vie. FY19 includes €46.3m move in trade payables, "mainly the result of a change in payment terms with eaux-de-vie suppliers". Source: RCO company filings.
However, as explained above, FY20 net income was 30% lower year-on-year organically due to the Hong Kong protests and COVID-19, both exceptional events (Hong Kong sales are now being shifted to China mainland). Using FY19 financials as an unimpacted year, we have a P/E of 35.9x. We believe this is a more meaningful measure given the one-off nature of FY20 problems. Also, with a "strong recovery" expected in H2 FY21, FY22 profits should return to at least FY19 levels.
Free cash flow yield is not a good valuation metric in the case of RCO. Since FY19, RCO has had large cash outflows to build up inventories ("Eaux de Vie" and "Spirits in Aging") for future growth.
The dividend yield is 0.9%, based on €1.00 dividend per share. This would cost €53m to pay in cash, which exceeds RCO's current FCF. However, it is manageable because the controlling shareholders (with 55% of the equity) has taken the option (available to all shareholders) to be paid in shares. In the past, larger dividends have been paid (e.g. €1.65 in FY19, including a special dividend), partly with borrowing (net debt/ EBITDA is still a solid 1.86x) and partly with shares (89% of shareholders took this option in FY18). Paying dividends will, of course, be easier when profits recover.
Management is also guiding to a slightly lower CapEx, at €50-60m each year in next the 2-3 years, compared to €64.8m in FY20.
Since our initial Buy rating in December 2019, RCO shares have been roughly flat, while Diageo and Pernod Ricard shares are down by mid-to-high single digits; Brown-Forman (BF.B), with its 80% developed market focus, is up by more than 10% (see our sector update last week for details):
Spirits Companies' Share Prices (Since 11-Dec-19)
NB. Share price performances in local currencies. Source: Yahoo Finance (09-Jun-20).
FY20 was an eventful year for RCO, with the Hong Kong protests and COVID-19, and earnings suffered an exceptional 30% hit that is one-off in our view.
With the new, explicit 10-year targets from the new CEO, we are more confident of RCO's ability to achieve a 10%+ EBIT CAGR, part of our original Buy case.
At €115.70, on unimpacted FY19 net income, RCO shares are on a 35.9x P/E, a reasonable valuation given RCO's high-quality brands and growth potential.
Investor returns will consist primarily of the share price growing in line with earnings, i.e. at a 10%+ CAGR; there is also a dividend yield of just under 1%, which together gives a 10%+ return.
As in our original Buy case, we believe there is potential additional upside in the case of RCO's unique brands attracting strategic interest, likely at a 20-40% premium to its current share price.
We continue to rate RCO a Buy and expect a double-digit annualised return over time, though we continue to prefer Diageo and Pernod Ricard for their more balanced portfolios and stronger downside protection.
Note: A track record of my past recommendations can be found here.
This article was written by
Analyst’s Disclosure: I am/we are long DEO, PDRDY. 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.
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