Corby Spirit And Wine: An Investment Thesis

Summary

• Corby Spirit and Wine has a straightforward investment thesis.
• Its business model is simple, the corporation is consistently well managed, and it carries strong brands via its relationship with Pernod Ricard.
• Though its been on our watch list for years, we only recently took a position because we were waiting for the appropriate valuations.
• Risks include – ironically – aspectsof its relationship with Pernod Ricard, defined pension liabilities, and lowinsider ownership.
• Going forward investors can anticipate respectable quarterly dividends and possible capital gains.

Introduction

Corby Spirit and Wine Limited (OTCPK:CBYDF) and (OTC:CRBBF) manufactures, markets, and imports spirits and wines. The company is based in Canada but is 51.6% owned by the French-headquartered Pernod Ricard (OTCPK:PDRDF) and (OTCPK:PDRDY). Corby Spirit’s brands include J.P. Wiser's Canadian Whisky, Lot No.40, Pike Creek and Gooderham, Lamb’s Rum, and Polar Ice Vodka, among others. Though most of its sales are in Canada, approximately 9.3% comes from international markets.

Corby is listed on the Toronto Stock Exchange under the symbols (CSW.A) and (CSW.B). The stock first caught my attention in the aftermath of the 2008-2009 Financial Crisis. It has been on my radar for years, but it was not until March of this year that we finally took a position in it here at Contra the Heard Investment Newsletter. The purchase price was CAD$14.25 for the A listed shares.

Investment Thesis

Corby’s investment thesis is straightforward. The balance sheet is consistently clean with high cash, no debt, and ample working capital. Shares outstanding have tallied 28 million for the past decade which means owners have avoided dilution and expensive buybacks. Though this isn’t a growth company, the top line has been stable for the past 10 years and net profit margins are generally in the 17% to 18% range. This means returns on asset and returns on equity have averaged in the low double digits. Instead of growth, the enterprise is focused on paying out quarterly distributions. The dividend policy calls for a quarterly dividend at the greater of 90% of trailing-twelve-month net income or CAD$0.60 per share annually.

The business plan is simple too: increase market share and brand awareness in Canada while focusing on growth abroad, strong cashflows, and high margins. Over time, management has been able to do this successfully due to its strong brands and its distribution agreements with Pernod Ricard. In September, for example, Corby and Pernod renewed their representation agreement, which was set to expire in June 2021. The new contract lasts through September 2026 thereby building upon a mutually beneficial relationship dating back to 2006.

The thesis could be summarized as: consistent and simple.

Why Invest Now?

We did not originally take a position in Corby because it looked fairly priced. Over the last decade the yield of roughly 4% looked likely to continue and dividend growth appeared possible, but capital gains seemed unlikely. Each time I reviewed the name I was interested in what they were doing and admired how they operated, but wasn’t enticed enough to buy based on a 4% distribution alone.

The past year changed that. The stock has fallen and the valuations have declined. The data below by Morningstar details how the price to sales, earnings, cashflow, and book value have contracted versus 5-year averages. We anticipate these valuations to revert back to their mean. As such, investors can now achieve a yield of over 5% and capital appreciation is more likely moving forward too.

Source: Morningstar’s Valuation Table for Corby’s A Shares.

It is unclear whether investors can expect dividend increases though. Eventually a dividend increase is likely, but that will depend on revenue growth or higher margins. In the meantime, the possibility of a 5% yield and capital gains was enough to justify taking a position.

Another factor which influenced the timing of this purchase was COVID-19. The assumption in March was that Corby’s business would do well through the pandemic. The thinking was that if bars closed, people would still buy alcohol. So far, that assumption has panned out. The latest quarterly revenues declined only 3% and net income fell 8%. While management has implemented a cost reduction program and cautions that the pandemic’s outlook is uncertain, it appears that Corby is primed to continue serving customers regardless of if they are cooped up at home or out socializing.

Risks

Corby’s investment thesis carries certain risks investors should be aware of. Perhaps the biggest one, somewhat ironically, is its relationship with Pernod Ricard. While Corby’s relationship with its parent company has clear benefits, two small notes of caution stand out.

First, Corby’s excess cash is deposited to a cash management pool under a “Mirror Netting Service Agreement” as discussed in its latest annual report and MD&A. This structure is a little odd as it means that Corby’s credit risk associated with its cash is dependent on Pernod’s credit rating. Fortunately, Pernod has investment grade credit and is a large company, meaning it generally has easy access to capital markets. Corby can also withdraw these funds as needed and Pernod pays Corby interest, based on the 30-day Canadian Dealer Offered rate plus 0.40%.

The second wrinkle is the parent company’s implied bargaining power in their representation agreements. So far representation agreements (including the one signed in September) have benefitted both parties. We expect mutually beneficial agreements to continue long into the future but there is always the possibility that the parent undercuts its subsidiary. If that happened Corby’s business model would be significantly impacted and remedies would be hard to implement.

Source: 2020 Annual Report and MD&A.

Corby has a net defined benefit liability too. As many firms with defined benefit plans can attest, the dollar value of the pension obligations can exceed the assets held in the pension. In Corby’s case, the present value of their defined benefit obligations is $70.34 million while the value of pension’s assets is $59.78 million. This leaves a gap of $10.56 million. This gap is narrowing however, as in 2016 this liability was $24.64 million and in 2019 it was $11.93 million.

Source: INK Research

Pernod Ricard may have a majority stake in the organization but direct insiders (i.e. the board of directors and executive officers) have low ownership. According to INK Research, direct insiders own 0.88%. This means the people pulling the levers have little skin in the game.

Some prospective investors may also be uncomfortable with its relatively high dividend payout policy at 90% of earnings, the fact the distribution is lower now than it was in 2018 and 2019, or that Corby has a dual class share structure. All these points are valid, but as with the other risks mentioned here, they are not – at least for Contra the Heard – showstoppers.

Conclusion

The investment thesis for Corby Spirit and Wine is straightforward. The business model is simple, the corporation is consistently well managed as demonstrated by its financials, and it represents many strong alcohol brands thanks to its relationship with Pernod Ricard. Though this organization has been on our watch list for years, we only took a position this year because we were waiting for the appropriate valuations. As with all investments, Corby has its risks, including aspects of its relationship with Pernod Ricard, defined pension liabilities, and low insider ownership. Going forward we anticipate respectable quarterly dividends with a yield over 5% and possible capital gains.

Disclaimer

The opinions expressed – imperfect and often subject to change – are not intended nor should be taken as advice or guidance. Contra the Heard Investment Newsletter is not an investment advisor or financial advisor. Contra the Heard Investment Newsletter provides research, it does not advise. The information enclosed in this article is deemed to be accurate and reliable, but is not guaranteed by the author.

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.

Analyst’s Disclosure: I am/we are long CBYDF. 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.