Casablanca SE by students competing in the Italian CFA Society Investment Research Challenge.

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1 Casablanca SE by students competing in the Italian CFA Society Investment Research Challenge. Consumer Goods Campari Group Date 28/02/2010 Ticker: CPRI.MI / CPR IM Recommendation: Buy Price: 7.57 Price Target: 9.0 Mln Sales EBITDA EBIT Net Income EPS P/E Ratio (x) 2007A A E E E Discipline pays off! Attractive industry for premium players: The spirits industry will continue to grow and consolidate in the coming years. The global growth rates are forecast to slightly increase from 2.1% ( ) to 2.3% ( ). In the Asia Pacific region growth is forecast at 5% for the period spanning Campari is planning a JV with Remy Cointreau and other partners to enter the Indian market and exploit this growth opportunity. Deserving a premium: Campari holds a portfolio of more than 40 premium and super-premium products sold in over 190 countries. Capitalizing on this resource, the company aims to exploit the recent premiumisation trend emerged in the industry. Anticipating market trends: the company has always picked the right moment for making value creating acquisitions without overpaying for the target companies. The acquisitions of Wild Turkey, SKYY Vodka, and Aperol show the ability of the company in selecting and exploiting fastgrowing markets. Looking at Eastern Europe, Latin America, Asia Pacific, Campari aims to follow its successful tradition in deal selection and execution. Sound financial structure: Lower than average Debt/Ebitda at 2.41 is a peculiarity of Campari s financial structure due to the pursuit of a selective acquisition growth, while maintaining moderate debt levels. Target price : We believe that the price of 9 correctly reflects the value of Campari. Market profile 52 week price range Average Daily Volume 851k shares Shares Outstanding mln Market Capitalization 2,198 mln Institutional holdings 30% Insider Holdings 51% Book value per share 09E 3.67 Dividend yield 09E 1.5% Return on Equity 09E 14.1% Debt to total capital 09E 38% Beta 0.85 Important disclosures appear at the back of this report 9,00 8,00 7,00 6,00 5,00 4,00 3,00 2,00 1,00 lug-01 gen-02 Campari Stoxx 600 Food&Bev. Share price performance lug-02 gen-03 lug-03 gen-04 lug-04 gen-05 lug-05 gen-06 lug-06 gen-07 lug-07 gen-08 lug-08 gen-09 lug-09 gen-10

2 Investment Summary BUY rating and target price at 9. Gruppo Campari is the sixth largest player in the spirits industry worldwide and is one of the leading global producers and distributors of branded spirits, wines and soft drinks. We consider this stock as an interesting investment opportunity thanks to: Campari s very strong brand portfolio. The company s portfolio consists of over 40 premium and super premium brands, merchandized and sold in over 190 countries around the globe. A market-leading position in Italy and increasing market shares in Germany, Switzerland and the USA. The company has the opportunity to further strengthen its competitive positioning in Continental Europe and gain critical mass in the USA, Australia, and emerging markets such as Brazil, India and Eastern Europe. The Group s growth strategy that delivered an average EBIT/Price paid ratio of 10% 1Y after the acquisition while maintaining a solid financial structure of Debt/EBITDA below 2.5x (vs.3.5x of industry average). DCF-based target price of 9, with a potential upside of 18.8%. We valued Campari through a DCF model (6.68% WACC and 1% perpetual growth) and obtained a target price of 9, which reflects the capability of the company to generate cash flows in the long run through strong competitive position and sound financial strategy. Multiples: in line with vs. peers, discount vs. top two players. The peer analysis based on EV/EBITDA and on EV/Sales suggest that Campari trades at multiples broadly in line relative to its group of multi-brand peers. We believe that a premium would be justified by the value creation coming from the recent Wild Turkey acquisition that allows Campari to improve positioning with respect to the group. In comparison with Diageo and Pernod Ricard, the top two players of the multi-brand beverage industry, Campari stands at a 10% discount based on EV/EBITDA. Nonetheless, a more solid financial structure and slightly higher forecasted sales growth rates distinguish it from the leaders. The upside remains based on a multiples forecast. The average EV/EBITDA, EV/Sales and EV/EBIT imply a price range of 8.15 to 8.51, but applying the maximum multiples would further enhance the upside potential of Campari s stock to between and Investment Incentives Trades at a discount with respect to top-competitors Potential gain in value through the successful integration of Wild Turkey Higher sales growth prospects than major competitors Strong focus on high-growth emerging markets Investment Disincentives Relatively low dividend yield Large exposure to low-growth Italian beverage market External growth-driven expansion strategy leads to uncertain levels of investment Potential sensitivity to an unexpected rise in raw material prices (sugar, glass and alcohol)

3 Company overview Reaching new heights Gruppo Campari chose a route of international growth by means of acquisition from the 1990s. A series of strategic acquisitions enabled Campari to enter new markets and product segments allowing it to boost growth and compete with the top players of the beverage industry. Increasing value from 1995 onwards. The acquisition of the Italian business of the Dutch Group BolsWessanen has increased the portfolio of Campari with well-known brands (Crodino, Cynar, Lemonsoda, Oransoda, Biancosarti and Crodo). In 1996, Campari acquired leading Scotch whisky brands Glenfiddich and Grant's and received a license to produce and distribute Jägermeister in Italy and later in Brazil. The company further extended its operations in Brazil with distribution rights for Clan McGregor, Scotch whisky. The acquisition of minority holding in Skyy Spirits and world distribution rights (except for US) allowed Campari to expand its presence in the spirits segment of the beverage industry. Whereas, the acquisition of Cinzano improved Campari s positions in wines segment. Capturing opportunities in new markets. Campari's strategy has been focused on selection of segments with diverse levels of profitability in both mature and emerging markets. Campari was searching for new opportunities to increase geographical spread and product variety. For example, in 2001 the Group concentrated on markets with excellent growth potential, such as Brazil and Uruguay and acquired leading brands like the Dreher aguardente, the Old Eight, Drury's, Gregson's and Gold Cup whiskies and the Liebfraumilch wine. Aperol as perpetuum catalyst of sales growth. In 2003 Campari made the strategic acquisition of Barbero 1891 S.p.A., owner of a wide portfolio of brands including Aperol, Aperol Soda and Barbieri liqueurs in the spirit segment, Mondoro and Enrico Serafino in the wine segment. Aperol have since been growing a double digit growth for Campari s revenue. Entry to Scotch Whiskey Segment. Thanks to Campari s acquisition of Glen Grant, Old Smuggler and Braemar whiskies from Pernod Ricard in 2006, the group has strengthened its presence in the growing spirits segment. Adding Tequila to Campari s portfolio. In 2007, in order to grasp opportunities of premiumisation in the spirits industry, the group acquired Cabo Wabo tequila (80% stake), one of the fastest growing tequila in the luxury and super premium category. 3

4 Focus on Emerging Markets. The year of 2008 was characterized by a number of acquisitions in strategic emerging markets: India, Mexico, Argentina and Ukraine. In India, the Group has made an effort to become a player in the Indian spirits and wines business. Likewise, Campari announced deals in Argentina, Mexico and Ukraine with the aim to increase its presence in these attractive markets through a well-established production and distribution platform. More whiskey within Campari s portfolio. The largest deal in Campari s history occurred in 2009 with acquisition of the world's premium bourbon whiskey, Wild Turkey. This deal has changed the outlook of company dramatically, creating a significant value for the company, bolstering its presence mainly in the US premium spirits market. We believe that this series of well focused and reasonably paid acquisitions has finally made Campari a real top-class competitor in the spirits industry, with a full range of products enabling it to capture opportunities from growing markets globally. Operating overview Campari is a leading global producer and distributor of branded spirits, wine and soft drinks, with total sales of around 1 billion. The spirits segment, driven by category leaders Aperol, Campari Glenn Grant and Skyy Vodka, is the most relevant one, accounting for 70.5% of total sales in 2008 and 73.2% in the first three quarters of The Wines segment that comprehends brands like Cinzano and Mondoro accounted for 16.7% in 2008 and 13.8% in the first 3Q of Finally, the Soft Drinks segment, which includes non-alcoholic aperitif Crodino and Lemon Soda, represented 10.9% of total sales in 2008 and 11.6% in the first 3Q of Chart 1. Revenues 9M 2009: segmentation by product Chart 2. Revenues 2008: segmentation by product The company has a clear strategy, focused on financial discipline and actively seeks growth through continuous brand strengthening, strategic acquisitions and distribution agreements. Recently, it has succeeded in acquiring Wild Turkey, the number one premium Kentucky bourbon whiskey, thus completing its largest acquisition up to date ( 433 mln). This deal allows the company to widen its critical mass and portfolio appeal in the highly profitable US market and to establish a distribution platform in the attractive Australian market. 4

5 Geographic diversification Campari group reaches with its over 40 premium and super premium brands more than 190 countries. The main market is still Italy accounting for 41.1% of total sales in 2008 and 39.3% in the first 3Q of Americas accounted for 31.5% in 2008 and 30.9% in the first three quarters of In this area, the main markets are represented by US and Brazil which contributed to respectively, 21.9% and 5.8%, of total sales in the first 3 Q of Europe (ex Italy) was responsible for 22.6% of total sales in 2008 and 22.7% in the first 3Q of The remaining sales are located in other countries, mainly Australia and Japan, and duty free. The company aims to further diversify its global presence strengthening its position in emerging markets like Eastern Europe and Argentina. Moreover, it is currently seeking to widen its global presence with a joint venture with Remy Cointreau to enter the Indian market. Chart 3. Revenues 2008: segmentation by product Chart 4. Revenues 9M 2009: segmentation by region Industry Overview The spirits market consists of the sale of alcoholic beverages such as brandy, gin & genever, liqueurs, rum, specialty spirits, tequila & mezcal, vodka and whisky. On a global level, the most relevant products are Whiskey, Vodka, specialty spirits, and Liqueurs; however, on a regional basis, huge differences in terms of market segmentation by product are experienced, because of different preferences and culture of consumers. Geographically, the consumption of spirits is mainly concentrated in Europe, even if the forecast growth rates for the forthcoming years may hugely change the relative importance of the Old Continent. Chart 1. Segmentation by product Chart 2. Segmentation by geography 5

6 As far as the growth rates are concerned, the following table summarizes the historical and forecasted growth rates of the principal market for the spirits, wine and soft drinks. Table 1. Market forecasts 1 Market Value CAGR Billion $ Products Regions 2004A A 2009E E E Spirits Italy (1.2%) (0.7%) Europe 2 1% 1.4% United States 2.8% 2.1% Brazil 0.2% 1.4% Asia-Pacific 3 4.8% 5% WorldWide 2.1% 2.3% Wine Italy 1.6% 0.6% Europe 2% 1.5% United States 3.1% 2.8% Brazil 3.2% 3.1% WorldWide 2.3% 1.9% Soft Drinks Italy 0.9% 0.9% Europe 3.4% 3.4% United States 2.1% 2.4% Brazil 2.1% 2.8% Worldwide 3.1% 3.4% The global sprit market reached an overall value of $205.3 billion in 2008, experiencing a compound growth rate of 2.1% from 2004; the performance of the market is forecasted to slightly improve during the following five years, reaching an overall value $229.9 billion in 2013, equivalent to a CAGR of 2.3%. Most of this additional growth will be driven by the Asia-Pacific countries, where almost double digit growth rates are foreseeable. As a matter of fact, India, which is the most important Asian country in terms of spirits revenues, has a forecasted CAGR of 9.1% for the period spanning Five-Forces Analysis A fragmented market is a free-lunch for the existing players The global spirits market is fairly fragmented, and large multinationals, such as Diageo, Pernod Ricard, Jinro account for just 15.3% of the global market share, leaving room for the growth and the establishment of new worldwide premium competitors, such as Campari. Most of the companies operating in such an industry is also involved in the production of alternative products, such as beer or wine, weakening further the rivalry among competitors. Brand awareness keeps new entrants away from the market On a global level, these major players make huge investment to build up and maintain their brand awareness, which represents the most important successful key factor because spirits consumers will rarely prefer the unknown alternative, even if it is cheaper, to the branded product. Indeed, the spirits consumption is more related to a lifestyle rather than to a need. Thus, new entrants might successfully compete with them just by making huge advertisement investment on a global level, or by offering niche products to a very wealthy target market. Moreover, accelerating growth rates may constitute an incentive for new firms to enter this industry. 1 Datamonitor s Data. 2 Europe comprises Belgium, the Czech Republic, Denmark, France, Germany,Hungary, Italy, Netherlands, Norway, Poland, Romania, Russia, Spain, Sweden, theukraine and the United Kingdom. 3 Asia-Pacific comprises Australia, China, Japan, India, Singapore, South Korea and Taiwan. 6

7 Chart 3. Market Shares Source: Casablanca SE Diversification lowers the threat of substitute products Most of the companies operating in the spirits market directly offer some of the substitute products, such as beer and wine, so that, the threat of substitute products is overall reduced. However, as consumers are becoming more health conscious, a switch over the healthier drinks may negatively affect the spirits demand. Weak bargaining power of suppliers and buyers Even if the raw materials necessary for the spirits production vary according to the specific product, they are commonly available. Moreover, some manufacturers, such as Pernod Ricard, are vertical integrated, weakening even further the overall power of suppliers. Typical buyers of spirits manufacturers are retailers, alcoholic beverage wholesaler, on-license sales, and companies in the hospitality industry such as bars, restaurants and clubs. Given the huge investments made by spirits companies to strengthen their brand awareness, the power of buyers is by far weakened. Campari s competitive positioning Strengths Expansion into new geographical areas Strong financial structure Solid track record of acquisitions Own distribution network in major markets Opportunities Facilitated access to new markets through JVs Expanding the Italian Aperitivo culture in markets with similar consumer habits Product innovation Source: Casablanca SE Weaknesses Still high dependence on its local market Poor dividend policy Financial conservatism Threats Possible decrease in alcoholic consumption Impact of regulative decisions (e.g. penalizing taxes) High dependence on raw material prices 7

8 Strengths With a strong position on the Italian market and increasing market share in the Americas, most recently driven by the acquisition of Wild Turkey, Campari is expanding its strong brand portfolio into new geographical areas. The planned Joint Venture with Remy Cointreau is an example of such strategy. A strong net cash position in comparison to its peers enables the company to be a quick mover towards attractive new acquisition targets and continue a path of external growth and strategic investments. Campari s large product portfolio is crucial for the company to be responsive to the different consumer habits across the countries in which it operates. Being a key player in the rum and whiskey segments, both Wild Turkey and other of its trademarks, such as Old Smuggler, open Campari the opportunity to obtain a critical mass in the whiskey segment in India, for example, being the single largest sub-market in the Asian-Pacific spirits marketplace. A further point of strength is Campari s well-organized distribution network, of which the company owns an increasingly larger share in markets of key importance. Both in Italy with distributors exclusively owned by the company, and on an international level there is a strong tendency to internalize the distribution network as critical mass in these countries increases, as is foreseen for example on the Australian market in the years to come. Weaknesses Despite its increasing presence on international markets, Campari is still strongly rooted in Italy where in % of its revenues were generated. This considerable dependence on the local market might prove as a disadvantage in particular as the growth rate for the Italian spirits market is forecasted to be lower than in the rest of the world with a negative forecasted compound annual growth rate until However this dependence is expected to decrease from 2010 onwards, thanks to the impact of Wild Turkey s acquisition. Taking a look at the company s dividend payout policy over the last five years, Campari s dividend payout ratio should continue to be modest at around 20% in the following two to three years. This is mainly due to the huge amount of acquisitions made around 650m and their target leverage ratio, which we expect to remain conservative net debt/equity at 0.28X. Campari s traditionally conservative constraints regarding new acquisitions may impede the company to pursue interesting M&A opportunities and leave these to the competition. Opportunities The key driver for Campari s efforts to continue a path of sustained growth can be identified as external growth through acquisitions. Especially in entering emerging markets such as India, Campari s ability to enter joint venture agreements will be of crucial importance to gain market share and obtain both better tacit knowledge of local consumer habits and gain visibility in order to pave the way for potential acquisitions eventually. Furthermore, an expansive strategy to integrate the Italian aperitivo culture into markets across Europe and other markets with similar consumer habits as in Italy such as Brazil and Argentina is an important opportunity for Campari to sustainably establish its product portfolio in the local cultures for spirits. As the successful introduction of SKYInfusions in March 2008 in the USA has demonstrated, product innovation remains an opportunity to attract both new and existing consumers of Campari s products, yet we note that this will be only possible in markets in which the company has substantial knowledge of the local beverage market and will therefore be a more likely opportunity in marketplaces in which the company has already developed local expertise over time. Threats Having a strong product and brand portfolio around the world, Campari is well-diversified to move accordingly in case of distribution difficulties in single markets, yet a possible decrease in alcohol consumption due to either new regulations or behavioral changes in consumption remain a threat both to Campari and the industry in general. 8

9 Raw materials accounting for more than 40% of Campari s total cost base, the company is highly dependent on the price of predominantly alcohol, sugar and glass and therefore major fluctuations in these have a direct, yet impact on Campari s profitability given the company does not adopt a hedging strategy. Financial Analysis Thanks to our analysis we have been able to individuate the strengths of Campari. A satisfactory gross profit margin has been kept constant at outstanding levels throughout the years thanks to a policy of timely acquisitions, joint with a prudent financial policy, which are the basis of the company s success. When building our business plan as far as Campari s operative activity is concerned, we have accurately modelled sales, raw materials and Advertising and Promotion. Revenue Forecast The revenue forecast was developed by analyzing the growth perspectives of the company in the regions where it operates. For Italy the analysis was further specified to take into account different product categories. Indeed, in the Italian market the company sells not only spirits but also wine and soft drinks. In our estimates we started from the growth forecasts for the geographical markets provided by Datamonitor and adjusted them to take into account the competitive position of Campari and its strategy for the next few years. Table 2. Revenues growth rates Revenues Forecast Italy 0.80% 2.25% 2.45% 2.55% 2.75% Western Europe 6.20% 5.30% 5.40% 5.40% 5.50% Easten Europe -0.70% 7.80% 7.80% 7.80% 7.80% United States 12.10% 5.10% 5.10% 5.10% 5.20% Brazil and South America -1.10% 6.20% 6.40% 6.60% 6.70% Asia-Pacifi Pacific c and Duty Free 40.00% 13.00% 13.00% 13.00% 13.00% Total 7.41% 4.57% 4.73% 4.88% 5.07% Source: Casablanca SE 9

10 In the following analysis, further insights are provided for the growth drivers in each region. Italy The Italian market is the primary source of revenues for the company representing 39% (2009) of its net sales. In this region the company offers spirits, wine and soft drinks. While in the spirit segment, the company is likely to outperform the market thanks to its strong brands and the positive momentum of the aperitif consumption, the same does not hold for the other product categories. Indeed, as far as wines and soft drinks are considered, Campari does not have a competitive advantage with respect to the other players. Based on these considerations we recognized a premium in terms of additional growth with respect to the market only in the spirit segment. In order to quantify this premium we relied on the results of the first three quarters for 2009 and looked at the historical performance for the following years. The CAGR we forecasted is 2.15% for the period Western Europe Net sales in Western Europe account for 20.6% (2008) of the total turnover of the company. In this region, the market is expected to experience a growth in value of roughly 1.4% a year from 2009 to The company has the opportunity to grow faster thanks to the diffusion of the Aperitif culture and to the ongoing premiumisation trend. For these reasons we added to the growth of the market a premium of 4% a year for the period from 2009 to 2013 to take into account the gradual expansion of the market share. Eastern Europe Eastern Europe accounts for about 2% of the total net sales of the company. The region represents a huge growth opportunity because it shows consumption patterns that are really similar to that of the Italian market. These peculiar conditions will facilitate the success of the company s brands and provide an ideal environment for its expansion. The management stated clearly that this will be one of the key regions for the future development of the revenue base of the company, so we recognized this opportunity in a 6% additional growth rate with respect to that of the market from 2010 to 2013 the year 2009 will be characterized by a shrinking in revenues due to currency and de-stocking. The CAGR will be 6.1% in the period spanning United States The United States account for 21.6% (2008) of the total net sales of the company. The market will grow at a pace of roughly 2% a year for the next five years. Campari has completed in 2009 the biggest acquisition in its history adding Wild Turkey to its product portfolio. Moreover, the company is really well positioned because it has products in all the fastest growing segments of the spirits market. Having said that, we expect the company to experience really fast growth in 2009 (12%) due to the external growth and to outperform the market growth by 3% from 2010 to Brazil and South America Brazil and South America account for about 9.6% of total sales. Campari is one of the leading companies in Brazil and is seeking to expand its operations in Argentina, that represents a really attractive market because of the consumers taste - really close to that in the Italian market. Growth in 2009 will be affected by the intense de-stocking that took place in Brazil in past months. This will result in a contraction of sales of 1.1%. We then expect the market to recover and the company to grow at a fast pace benefiting from the expansion of its operations in Argentina and the increase in its market share in Brazil. For the period we forecast a CAGR of 4.9%. Asia-Pacific and Duty Free Asia-Pacific and Duty Free account for 6.6% of total sales (2008). The Asian region represents a market in rapid expansion with a forecast CAGR of 5% for the period from The company has the opportunity to outperform the market, increasing its presence in the Australian and Japanese markets thanks to the development of new distribution networks and to the entrance in the Indian market. The growth will be really high in 2009 because of the change in the perimeter due to the acquisition of Wild Turkey (40%). We expect the company to continue to grow fast in the period from at a pace of 13% per year. 10

11 Raw Materials Purchases As far as raw materials purchases are concerned, we decided to model separately the two main drivers: oil price (affecting glass and packaging) and sugar price. Following the Industry s reports on commodities, we assumed an increase of 5% per year in oil price, and a peak of sugar price in 2011, followed by a growth at the inflation rate. However, noticing that Campari has always been able to keep its Gross Profit margin stable, we assumed it is going to pass on the increase in price of raw materials to customers. The remainder was linked to sales growth. Advertising and promotion For A&P, we estimated as 17.5% of sales, as stated by Campari s management for 2009, given the optimization of A&P investments due to reduction in competitive advertising pressure. After that year, we fixed the A&P/Sales ratio to 18%, in accordance with the majority or analysts forecasts, and the company s trend in 2007 and Financial items As far as the financial operations of the company are concerned, financial income has been built by using the average market rate of cash investments, while the interest charges have been estimated using short term interest rates for all debt excluding lines used for Wild Turkey acquisition (long term bank debt). Finally, the interest applied to bonds is the same the last issued bond is yielding, since it represents the majority of Campari s bond invoice. Ebitda Margin We expect the Ebitda margin of the company to increase over the forecasting period from the current level of 25.3% to 28.6% in The company should be able to increase ist operating profitability thanks to its ability to exploit premium brands. Net Income The Net Income of the company will grow at a CAGR of 12.79% in the period reaching 200M in Our forecasts are slightly above consensus estimates only from 2012 onwards and reflect the expansion of the spirits market and the competitive positioning of Campari. Balance Sheet Working Capital We expect working capital to increase in 2009 due to an increase in inventory and trade receivables level. The former is related to de-stocking in Brazil and Eastern Europe, the latter is attributable to the increase in turnover of the group and to the specific payment condition associated. Starting from 2011, working capital will grow in conformity with the increase in the turnover of the company. 11

12 Capex In order to estimate Capital Expenditures we relied on the management disclosure. The company will invest 58 million in 2009, 36 million in 2010 and then 21 million in the following three years. Dividend policy Campari has a dividend policy that is poorer with respect to its competitors. This is because Campari plans to reward its shareholders mainly with the increase in the share price, due to the reinvestment of the majority of its earnings. In our estimates we assumed a flat dividend at 0.11 per share. Valuation DCF Campari s recipe for acquisitions: never overpay, and grow thanks to your cash flows In a mature market such as Spirits&Drinks, where external growth is the main way to gain market shares, it is surprising to see a company which has an acquisition policy as chary as Campari. According to the management, Campari never pays its targets more than 10x EBITDA, and expects an average EBIT/Price paid ratio of 10% already one year after the acquisition. Moreover, the firm has an agreement with its financing banks to never stress its Debt/EBITDA ratio beyond 3.5x, and as best practice tries not to exceed the 2.5x threshold. Such strict requirements have paid off: not only has the company built itself a reputation for its skills in the M&A activity and the post-merger integration process, but also it was also able to make a relevant acquisition every two years or so, even in adverse market conditions. It is to be noted that in 2009, in a market growing by 2.3%, Campari experienced an increase in sales of 7.22% (first 3Q 2009), and was able to conclude the profitable acquisition of Wild Turkey. It is to be noted that in our business plan, Campari will repay the debt generated by the acquisition of Wild Turkey within If this fact on one hand is a good example of the ability of the firm to generate cash flows, on the other hand is an unrealistic hypothesis: given the historical trend, Campari will perform another acquisition by If we want to make an estimate based on the debt capacity (maximum Debt/EBITDA), we could say that they will be able to buy a target whose size goes up to 658,7 million Euros. Finally, we can comment on the ability of the management in performing acquisitions by looking at historical (and therefore not hindered by our hypotheses) ROIC: from 2007 to 2009 Campari managed to maintain ROIC stable to values close to 11%. The price range suggested by our DCF analysis is with central point given by 9.02 and implies 20% premium over the current price. Terminal Growth Price Range WACC In 5.93% 6.18% 6.43% 6.68% 6.93% 7.18% 7.43% 0.50% % % % % Campari vs. peers To analyze Campari s performance with respect to a peer group, we have chosen its closest competitors within the industry. The peer group was made of beverage companies with similar characteristics. The selected peers are multi-brand companies that are diversified across different geographical regions (US, Europe, Pacific Rim) The product portfolio of these global players is diversified in several brands and spreads over spirits, wines and soft drinks 12

13 2010E Diageo Pernod Ricard Remy Cointreau Constellation Fortune Brown- Forman Average Campari Mkt cap ( m) 30,201 14,962 1,722 2,155 4,805 3,512 2,198 Sales 10,776 6, ,485 4,943 2,321 1,058 ROIC 33.4% 9.1% 2.2% 8.5% 5.7% 16.5% 12.6% 15.1% EBITDA 3, % EBITDA 31.7% 27.9% 21.3% 28.1% 15.8% 24.3% 24.8% 25.2% EBIT % EBIT 28.6% 25.1% 19.0% 19.8% 11.7% 22.7% 21.1% 22.7% Wines x x x x X Spririts x x x x x x x Soft drinks x x x x Source: Bloomberg Campari and its main rivals (Diageo, Pernod Ricard, Constellation, Forune, Brown-Forman) showed similar patterns in financial indicators. All companies have shown increasing EBITDA margins due to the premiumisation trend of spirits industry. Campari outperforms its peers by EBIT margins with 22.7%, also due to the relatively lower D&A expenses (depreciation/sales of 2.35% vs. 3% of peer group average). Multiples now in line with average of peers. Campari is trading at a very small premium with respect to its peers (see table below). We believe that Campari s modest premium does not fully reflect the company s competitive positioning characterized by strong financial structure and synergies expected from the recent acquisition of Wild Turkey. In comparison with the top players of the multi-brand beverage industry Diageo and Pernod Ricard, Campari stands at a ca. 10% discount implied by EV/EBITDA and EV/EBIT multiples. EV/Sales EV/EBITDA EV/EBIT 2010E 2011E 2012E 2010E 2011E 2012E 2010E 2011E 2012E Diageo 3.6x 3.5x 3.3x 11.4x 10.8x 10.1x 12.7x 11.8x 11.0x Remy Cointreau 3.7x 3.5x 3.4x 13.2x 12.3x 11.5x 14.7x 13.5x 12.6x Pernod Ricard 3.0x 2.9x 2.7x 14.2x 12.6x 11.6x 15.9x 14.0x 12.7x Constellation 2.2x 2.1x 2.1x 7.8x 7.4x 7.3x 11.0x 9.8x 9.2x Fortune 1.6x 1.5x 1.4x 10.0x 9.1x 8.1x 13.6x 11.8x n.a. Brown-Forman 1.7x 1.8x 1.8x 7.0x 6.8x 6.5x 7.5x 7.1x 6.8x Average 2.6x 2.5x 2.4x 10.6x 9.8x 9.2.2x x 11.3x x Campari 2.7x 2.6x 2.5x x x 9.7x x 2x x 10.6x Premium/(discount) 5% 2% 2% 4% 4% 6% (3%) (1%) 2% Source: Bloomberg Consensus (incl. Campari) 13

14 10,00 9,00 8,00 7,00 Campari Diageo Pernod-R. Remy-Cointreau Constellation Fortune Brown-F. 6,00 5,00 4,00 3,00 2,00 1,00 lug-01 ott-01 gen-02 apr-02 lug-02 ott-02 gen-03 apr-03 lug-03 ott-03 gen-04 apr-04 lug-04 ott-04 gen-05 apr-05 lug-05 ott-05 gen-06 apr-06 lug-06 ott-06 gen-07 apr-07 lug-07 ott-07 gen-08 apr-08 lug-08 ott-08 gen-09 apr-09 lug-09 ott-09 gen-10 Source: Bloomberg P/E multiple confirms no current premium to peers. The stock is currently trading at 13.6 times 2011E P/E, in contrast with its historical level of 15x. Overall the P/E indicators are rising from the 1Q09 low with Campari showing an impressive performance. In comparison with the top players of the multi-brand beverage industry, using 1Y forward P/E, Campari is trading in line with the average. P/E 2011E Diageo 13.5 Fortune 13.1 Pernod Ricard 13.1 Brown-Forman 16.2 Remy Cointreau 16.7 Average 13.5 Premium/(discount) Constellation 8.3 Campari % The table below shows the average multiples we obtained for our peer group. The price range for the stock suggested by these figures is EV/sales EV/EBITDA EV/EBIT Price 8,51 8,25 8,15 However, if we used the maximum 2011E PE in the peer group (16.7x) we would obtain a fair price of 10,15 ; if we used the maximum EV/EBITDA (12.6x) we would obtain a fair price of 10,31. The range achievable using multiples lies perfectly within the range we found in our DCF analysis. Therefore we identify a target price of 9, because we believe that Campari does not deserve the large discount it is trading at with respect to the top two players in the market (if we took their multiples we would have a price in the mid 10 ). Our choice is based on the following reasons: Campari has been gaining critical mass by successfully identifying and undertaking acquisition opportunities. The transforming deal of SKYY, Glen Grant, Cabo Wabo and recent Wild Turkey 14

15 acquisitions were effectively integrated to add value and size to Campari s operations. This decreased the gap between Campari and competitors during the last 7 years. Campari s success in brand building supported by cutting edge marketing skills bringing greater product recognition and value appreciation, which are crucial for consumer choice of Campari over competitors. Soundness of financial structure and clearly stated and implemented competitive strategy, are key blocks for Campari s reputation. Campari has slightly better growth perspectives with respect to the top players in the market Investment Risks The main driver of our DCF model is revenues estimate and so we are vulnerable to mistakes in the construction of our estimates. Raw material purchase may follow a path different than the one forecasted. However, Campari s strong bargaining power should enable them to transfer to customer at least part of any excessive increase in price. Moreover, the main growth factor in these costs, through past years, was the increase in volumes due to the increase in sales, rather than an increase in price. It should be noticed that Campari doesn t employ derivatives to hedge against exchange rate risk: the company prefers to base its costs and revenues structures on the same currency, thus generating a natural hedge. As an example, we looked at US (21% of sales), Campari s largest exposure to a single currency. A shift of 10% in the exchange rate /$ would produce - all else being equal - a 2% impact on the EBITDA margin. We have thus decided not to model the effect that a currency shock would have on the company s profitability. In our forecasts for the geographical areas in which Campari operates, we do not consider potential unforeseen regulatory changes with drastic impact on Campari s profitability. 15

16 Figure 1: Income Statement Income Statement, A 2008A 2009E 2010E 2011E 2012E 2013E Net Sales 957, ,329 1,012,114 1,058,335 1,108,411 1,162,465 1,221,418 Raw materials purchases 349, , , , , , ,166 Personnel costs 30,374 28,355 30,455 31,846 33,352 34,979 36,753 Utilities 6,958 6,531 7,015 7,335 7,682 8,057 8,465 External production and 11,762 11,913 12,795 13,380 14,013 14,696 15,441 maintenance costs Variable Transport cost 25,268 26,291 28,238 29,528 30,925 32,433 34,078 Other costs 2,283 7,081 7,605 7,953 8,329 8,735 9,178 Cost of Goods Sold 426, , , , , , ,082 Gross Profit 531, , , , , , ,337 Gross Margin 56% 56% 58% 58% 59% 60% 61% Advertising and 174, , , , , , ,855 Promotional Costs G&A expenses/personnel 95,346 96, , , , , ,254 Utilities/Services 3,568 3,669 3,941 4,121 4,316 4,526 4,756 Other costs 35,055 37,320 40,084 41,914 43,898 46,038 48,373 Non-recurring charge 2,835 3,649 3, (One-offs) Structure Costs 136, , , , , , ,383 EBITDA 220, , , , , , ,099 Tangible Fixed Asset 17,523 16,608 24,721 25,177 25,431 25,577 25,650 Depreciation Intangible Fixed Asset 2,016 2,693 1,613 1, Amortization Total Depreciation and 19,539 19,301 26,334 26,280 26,186 26,094 26,003 Amortization EBIT 200, , , , , , ,096 Bank Interest 9,337 8,548 8,306 8,306 14,004 21,203 29,659 Other Financial income 2,175 2,002 2,002 2,002 2,002 2,002 2,002 Total Financial Income 11,512 10,550 10,308 10,308 16,006 23,205 31,661 Net charges on bonds and 19,091 19,279 27,353 27,353 27,353 27,353 27,353 private placements Bank Interest charges 5,976 5,160 7,336 2,793 2,566 2,566 2,566 Other financial charges 3,349 3,354 4,500 4,500 4,500 4,500 4,500 Total Financial charges 28,416 27,793 39,189 34,647 34,419 34,419 34,419 Exchange rate difference 80 1,652-4, loss One-off charges 0 3,308 5, Net financial Income (16,984) (22,203) (29,881) (24,339) (18,413) (11,214) (2,758) Result from participations Put option charges EBT 183, , , , , , ,338 Taxes 58,097 45,608 56,092 60,517 68,783 78,803 89,975 Net Profit 125, , , , , , ,363 Minority interest Group Profit 125, , , , , , ,063 Source: Company reports, Casablanca SE Estimates 16

17 Figure 2: Balance Sheet Assets, A 2008A 2009E 2010E 2011E 2012E 2013E Trade receivables 279, , , , , , ,211 Other receivables 37,140 32,447 35,424 37,042 38,794 40,686 42,750 Inventories 166, , , , , , ,001 Current Assets 484, , , , , , ,962 Payables to suppliers 156, , , , , , ,971 Other current liabilities 39,437 40,727 42,600 44,423 45,170 45,585 46,005 Total current liabilities 195, , , , , , ,975 Operating working capital 288, , , , , , ,987 Net fixed assets 155, , , , , , ,930 Biological assets 15,899 18,018 18,018 18,018 18,018 18,018 18,018 Investment property 4, Goodwill and Trademarks 812, ,315 1,196,453 1,196,453 1,196,453 1,196,453 1,196,453 Intangible assets with a finite life 5,089 5,105 3,492 2,389 1,634 1, Financial fixed assets 608 1,101 1,101 1,101 1,101 1,101 1,101 Other non-current assets 10,009 7,473 7,473 7,473 7,473 7,473 7,473 Non-current assets held for sale 2,473 12,670 12, Total fixed assets 1,005,702 1,141,834 1,449,638 1,446,688 1,441,502 1,436,408 1,431,405 Defined benefit plan( TFR) 11,657 10,663 11,929 12,474 13,064 13,701 14,396 Reserve for risks and future liabilities 11,038 9,013 9,013 9,013 9,013 9,013 9,013 Net operating capital employed 1,271,081 1,399,546 1,841,514 1,779,160 1,796,436 1,817,405 1,840,983 Deferred tax assets 15,875 14,362 14,362 14,362 14,362 14,362 14,362 Payables to tax authorities 54,592 59,273 59,273 59,273 59,273 59,273 59,273 Deferred tax liabilities 60,696 69,486 69,486 69,486 69,486 69,486 69,486 Total net operating capital employed 1,171,668 1,285,149 1,727,117 1,664,763 1,682,039 1,703,008 1,726,586 Long term bonds 287, , , , , , ,900 Other non-current financial 70,820 55,767 55,767 liabilities 55,767 55,767 55,767 55,767 Long term bank payables 1, ,957 9, Long term debt 360, , , , , , ,667 Other financial payables 21,168 25,843 25,843 25,843 25,843 25,843 25,843 Short-term financial receivables 2,878 4,093 4,093 4,093 4,093 4,093 4,093 Cash and Equivalents 199, , , , , , ,175 Bank Payables 114, ,454 51,178 51,178 51,178 51,178 51,178 Short term debt (67,140) (43,354) (99,630) (99,630) (218,014) (367,572) (543,246) NFP 293, , , , , ,095 21,421 Share capital 29,040 29,040 29,040 29,040 29,040 29,040 29,040 Reserves 847, ,821 1,035,948 1,159,452 1,304,211 1,474,737 1,673,989 Group Shareholder's equity 876, ,861 1,064,988 1,188,492 1,333,251 1,503,777 1,703,029 Minority interest 1,928 2,136 2,136 2,136 2,136 2,136 2,136 Total Shareholder's equity 878, ,997 1,067,124 1,190,628 1,335,387 1,505,913 1,705,165 Total sources 1,171,668 1,285,149 1,727,117 1,664,763 1,682,039 1,703,008 1,726,586 Source: Company Reports, Casablanca SE Estimates 17

18 Figure 3: Statement of Cash Flows Cash Flow Statement, E 2010E 2011E 2012E EBIT 229, , , , ,096 D&A 26,334 26,280 26,186 26,094 26,003 Total internal sources 256, , , , ,099 Taxes 64,347 67,332 73,938 81,943 90,747 Capex 58,000 36,000 21,000 21,000 21,000 Acqusitions/Disinvestures 276, Change in working capital 135,431 (58,859) 23,053 26,699 29,276 Change in Non current assets for sale 0 (12,670) Total operating uses 533,916 31, , , ,022 Operating Free Cash Flow (277,771) 234, , , ,076 Net financial income/charges (29,881) (24,339) (18,413) (11,214) (2,758) Interest tax shield 8,255 6,815 5,156 3, Change in Long term bonds 192, Change in Short Term Bank payables (56,276) Change in Defined Benefit Plan 1, Put option charges (100) Profit from participation Dividend (31,811) (31,811) (31,811) (31,811) (31,811) minority interest (300) (300) (300) (300) (300) Total financial uses/sources 83,701-49,090-44,778-39,548-33,402 FCFE (194,070) 185, , , ,674 Change in NFP 194, , , , , E Source: Company Reports,Casablance SE Estimates 18

19 Disclosures: Ownership and material conflicts of interest: The authors, or a member of their household, of this report holds a financial interest in the securities of this company. The authors, or a member of their household, of this report does not know of the existence of any conflicts of interest that might bias the content or publication of this report. Receipt of compensation: Compensation of the authors of this report is not based on investment banking revenue. Position as a officer or director: The authors, or a member of their household, does not serves as an officer, director or advisory board member of the subject company. Market making: The authors does not act as a market maker in the subject company s securities. Ratings guide: Banks rate companies as either a BUY, HOLD or SELL. A BUY rating is given when the security is expected to deliver absolute returns of 15% or greater over the next twelve month period, and recommends that investors take a position above the security s weight in the S&P 500, or any other relevant index. A SELL rating is given when the security is expected to deliver negative returns over the next twelve months, while a HOLD rating implies flat returns over the next twelve months. Investment Research Challenge and Global Investment Research Challenge Acknowledgement: Italian CFA Society Investment Research Challenge as part of the CFA Institute Global Investment Research Challenge is based on the Investment Research Challenge originally developed by the New York Society of Security Analysts. Disclaimer: The information set forth herein has been obtained or derived from sources generally available to the public and believed by the authors to be reliable, but the authors does not make any representation or warranty, express or implied, as to its accuracy or completeness. The information is not intended to be used as the basis of any investment decisions by any person or entity. This information does not constitute investment advice, nor is it an offer or a solicitation of an offer to buy or sell any security. This report should not be considered to be a recommendation by any individual affiliated with the Italian CFA Society, CFA Institute or the Global Investment Research Challenge with regard to this company s stock. 19