CFA Institute Research Challenge Hosted in France Team N

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1 Hosted in France Team N

2 PERNOD RICARD SA Consumer Goods Food, Beverage & Tobacco Distillers & Vintners BUY January Figure 1: 12m s Stock Price Performance and Trade Volume March May Market Profile Stock exchange: Ticker: ISIN: July September November Euronext Paris RI FP FR No. of Shares: 265,421,592 Performance 1m 3m 12m Ratings Long-term Short-term Outlook Price 15/01/ Pernod 0.69% 12.73% 28.17% Fitch F3 BBB POS 12m Target Price CAC % -0.32% 9.26% Moody's P-2 Baa2 STABLE Upside 14.86% SBF % -0.17% 11.02% Standard & Poor's BBB A-2 POS, Bloomberg 1,200, , , ,000 -, Bloomberg SUMMARY As the 2 nd largest manufacturer in the alcoholic beverage industry with focus on premium spirits and wine, Pernod Ricard operates with its unique brand portfolio of 86 market companies worldwide. HIGHLIGHTS We issue a BUY recommendation with a 12-months target price of per share, which represents a 14.86% upside based on the 15 th January 2018 closing price of We used 70:30 DCF method and multiple valuation. Our valuation is based on the industry and GDP growth analysis, taking into account Pernod Ricard s specific strategy and growth drivers. We identified the following key drivers to support our recommendation: Strong branding contributes strong business strategy The strong portfolio mix, based on local and international brands over a premium to prestigerange grants the company access to different markets. The high brand awareness attracts potential customers and helps to distinguish from competitors. Positive economic development in emerging markets boosts growth The strong engagement in Asia, which is characterized by dynamic demographics, continuing globalization and travel activity, and an increasing wealth of the population is a key advantage and is expected to provide a compound annual growth rate (CAGR) of 7.60% until 2022, while overall CAGR expected to reach 5.72%. Social changes offer possibilities to attract new customers Pernod Ricard s decentralized organization accelerates the adaption of digitalization and social trends. Social trends are seen to decrease overall alcoholic beverage consumption but might also shift demand towards premium sector. Adversely impacts of the liberalization of Marijuana are expected to be minor. Par Value of Shares: 1.55 Market cap: 34,664 m 52-weeks: low high Volatility: 12.78%, Bloomberg Efficiency program strengthening operational excellence Pernod Ricard s target to save 200 m in Operating Working Capital. Further, digitalization in operations, marketing, and sales ease pressure on costs. Correspondingly, profitability is likely to increase. Adequate financial structure with room for improvement Successful deleveraging reduced Debt to Equity from 0.69 in 2016 to 0.62 in Improvement in the cash conversion cycle and liquidity sharpens Pernod Ricard s financial profile. The main risks remain the high sensitivity to unforeseeable changes in the regulatory environment, substitution due to increasing rivalry and lower product differentiation along with decreasing margins, a downturn in the economic development, especially in emerging markets. Key Financials 2016/ /2018e 2018/2019e 2019/2020e 2020/2021e 2021/2022e Revenues (m ) 9,010 9,465 10,118 10,775 11,366 11,897 Rev. growth yoy 3.8% 5.1% 6.9% 6.5% 5.5% 4.7% EBIT (m ) 2,380 2,461 2,681 2,855 2,955 3,093 EBIT-margin 26.4% 26.0% 26.5% 26.5% 26.0% 26.0% ROA 4.6% 5.0% 5.4% 5.6% 5.6% 5.6% ROE 10.2% 10.7% 11.0% 11.3% 11.1% 11.0% Debt/Equity EPS ( ) DPS ( ) DPS growth yoy 2.3% 23.4% 9.5% 9.1% 5.4% 4.7% 1, S&P Capital IQ

3 Figure 2: Pernod Ricard s Geographical Sales 40% 29% 31% Europe Americas Asia, Rest of the World, Bloomberg BUSINESS DESCRIPTION Pernod Ricard SA (RI.PA), incorporated 1975, is an alcoholic beverages producer, one of the leading worldwide international groups: 2 nd in wine and spirit and 1 st in premium/ultra-premium and prestige spirit. (1) With a decentralization strategy and a geographically segmented business, the entity has a headquarter for each region: Europe, the Middle East and Africa/Latin America (EMEA/LATAM) in Paris, France, North America in New-York, US, and Asia in Hong-Kong, China. Pernod Ricard is structured with six brands companies in charge of the strategic brand development, the production and management of industrial facilities and 86 market companies tasked with market strategies. On the 30 th June 2017, the group counted 96 industrials production site, 18,442 employees. Products: Pernod Ricard owns 38 premium brands that are classified under five categories: international strategic brands (13), strategic wine brands (4), innovation (3), luxury (3) and domestic strategic brands (15). The product range is wide: Whiskey, Liqueurs, Cognac, Brandy, Bitters, Anise, Gin, Vodka, Champagne, Tequila and Wine. Two third of the sales (in term of volume) come from 2 categories of alcohol: white spirits and rums and whiskeys, for which the group ranked respectively 3 rd and 2 nd position among international groups. The creation of value is completed from the harvest of the raw material to the customer s delivery throughout production infrastructure modernization and capacity upgrade. Geographic location: The group has expanded into 86 regions. Its decentralized organizational structure enables flexibility and agility to meet customers and consumers needs and market s expectations. Sales are originated for 29% in the Americas, 40% in Asia and the rest of the world and 31% in Europe (see Figure 2). The 96 industrial sites are located worldwide. This geographic scattering enables the group to locally embed its activities, is sometimes necessary to respect appellation of origin requirements and creates a network enhancing the synergies between sites: Wine production: France (Champagne), Spain, Australia, New Zealand, Argentina, California and China; Production of distilled alcohols: Sweden and Poland (vodka), UK and Germany (gin), Cuba (rum), Scotland, Ireland, India, Canada and Brazil (whiskey), France and Armenia (cognac), Mexico (tequila); Production of liqueurs and various spirits: Europe (France, Spain, Italy, Finland, Czech Republic and Greece), Asia (India) and Americas (USA, Brazil and Argentina). COMPANY S STRATEGIES Adaptation to new consumption ways and new markets EMEA/LATAM: winning strategy, market share gains. In Europe, Pernod Ricard aims to consolidate its position and wine market share (leader with 30% of market share in France) through two key growth drivers: prestige and innovation. In Latin America, the international brand s penetration should be done through a portfolio of local brands. North America: rebound in world s largest market, Pernod Ricard restructured sales and marketing organization around consumption occasions. In addition to the new decentralized-market approach, marketing and sales teams are working more closely, intermediate elimination, to have a better and faster understanding of consumer needs and decision-making process. Pernod Ricard s top brands of this market are Jameson and Absolute, followed by Malibu, Martell and Altos. Innovation plays a key role in the sales growth for all these brands. Asia: ideally positioned in a high-potential market. Pernod Ricard aspires to take advantage to the intense economic and demographic dynamic of the region in order to develop its global market and sales. Inspired by the increasing purchasing power, they decided to implement a premium/super-premium strategy and to develop their portfolio in this specific sector. They have developed an excellent knowledge of the local routes to market, which is essential for their market penetration. Accounting for 74.4% of the Asia- Pacific wine market value, 59.4% of the spirit-market and reflecting a high growth potential, China is a targeted market for the group. (12) Despite of the GST, India recorded and is expected strong wine and spirit industry growths which confirms Pernod Ricard s aim to maintaining its leading position in India: 45% market share in term of value, by attracting the growing upper middle class to the existing premium international brands through the construction of a strong local brands portfolio. Innovations: Pernod Ricard is paying a big attention to the development and implementation of both Core Business (incremental innovation) and New Business innovations (breakthrough innovation) in order to increase its future growth. Therefore, the Group creates new beverages such as Jameson Caskmates, Chivas Regal Extra and Absolut Lime, in order to introduce new flavors and, thus, satisfy more costumers. In addition, Pernod Ricard focuses on the premiumization by creating attractive designs and services for their consumers, positioning itself as a premium company. Moreover, they have a BIG (Breakthrough Innovation Group), devoted to establish the future group s conviviality. Organic growth: Pernod Ricard s medium-term objective consists of reaching the organic growth of between +4% and +5% from its recurring operations. To achieve that, the group focuses on operatio- 2

4 Figure 3: Shareholder Structure 14.20% 9.82% 7.50% 66.24% 1.50% 0.74% Societe Paul Ricard Massachusetts Financial Services Groupe Bruxelles Lambert Caisse des Depots et Consignations Other stagnant shares Free float, Bloomberg Figure 4: Executive Board nal excellence: a more efficient and simplified organization leading to a better expense management. Concretely, they operate through three headquarters. Moreover, they consider talent development either by improving their employees or by attracting and acquiring new ones. In 2017, Pernod Ricard has built a campus to ensure a qualitative training for its employees (700 per years). Another important strategic decision regards the route-to-market/consumer. Pernod Ricard s objective is to improve the distribution channel targeting, and also select the best among the traditional distribution channels (large retailers, bars, restaurants), travel retail (ecommerce) and the home trade. Travel retail represents a key challenge for the group. Finally, the group promotes sustainability and responsibility for their performance on the long run. They set themselves medium term goals to be achieved by 2020 focusing on four main pillars such as governance, supply chain, brand and consumers, and resource stewardship. Thus, Pernod Ricard aims to achieve 100% of certified vineyards, 100% of recyclable packaging, 0% of waste at production sites, as well as 20% and 30% of reduction of energy consumption and CO2 emission. External growth - A targeted M&A strategy : Pernod Ricard targets to enhance its portfolio management and a premiumization to position itself as a luxury brand and to attract wealthy consumer. In addition of constant development and innovation, Pernod Ricard acquired the majority stake of four promising brands: Monkey 47 ( ), Domaines Pinnacle ( ), Smooth Ambler ( ) and Del Maguey ( ). This enables the company to provide additional high-quality products. In the same time, the group decided to divest of four non-core assets (brands). Today, the company s portfolio, consisting with the most popular and luxury brands, shows how well the company is diversified with high quality products. Alexandre Ricard Chairman & Chief Executive Officer Executive Director Conor McQuaid Global Business Development Director Cédric Ramat Human Resources and Sustainability & Responsibility Director Ian FitzSimons General Counsel Gilles Bogaert Managing Director, Finance & Operations, Pernod Ricard Figure 5: Members of the Board of Directors (in blue the independent directors) 01. Anne Lange 02. Manousos Charkoftakis Employee Director 03. Wolfgang Colberg Chairman of the audit committee 04. Kory Sorenson 05. Gilles Samyn 06. Veronica Vargas 07. Pierre Pringuet Vice-Chairman of the Board of Directors 08. Nicole Bouton Chairman of the nomination CSR & compensation committee 09. César Giron 10. Sylvain Carré Employee Director 11. Martina Gonzalez-Gallarza 12. Paul-Charles Ricard Permanent Representative of Société Paul Ricard 13. Ian Gallienne 14. Alexandre Ricard Chairman & Chief Executive Officer + Chairman of the strategic committee, Pernod Ricard CORPORATE GOVERNANCE Shareholders structure: Pernod Ricard s capital stock consists of around 265 millions of common stocks that are listed on numerous market indices, including: CAC 40, London Stock exchange, the SBF 120 and the SBF 250 French indices; Euronext 100 and DJ EuroStoxx. Pernod Ricard has implemented only one stock split, the two-for-one split of The share capital is broken down as follows: 38.9% of the share capital is hold by various US institutional investors, 15% by the société Paul Ricard, 11.2% by UK institutional investors, 10.6% by French institutional investors, the remaining capital is shared by other institutional investors, individuals, boars-management-employees, and Groupe Bruxelles Lambert (see Figure 3). Moreover, Pernod Ricard Family own 21% of voting rights. Corporate management: The management structure consists of the General Management, represented by Alexandre Ricard (Chairman & CEO), the Executive Board and the Executive Committee. As the third generation, Mr. Ricard got back the control of Pernod Ricard after the retirement of the CEO in 2015, Mr. Pringuet, the only non-family member having enrolled the executive role. At that time, he also became chairman, succeeding his mother. The executive board gathers four directors (see Figure 4) and the CEO; it assists the CEO in his responsibilities. All of them have been working for Pernod Ricard or an affiliate for at least more than 15 years and have also developed a comprehensive understanding of the company and its industry. The executive committee is comprised of 15 members: the executive board and the managing directors of the affiliates. Five of them started they career at Pernod Ricard as (internal) auditors and a great majority have been working for the group for at least 15 years as well. They meet every month to enhance the coordination between headquarters and affiliates. In addition, they work to improve Pernod Ricard s business activities performance, to set financial and operational objectives and to ensure Pernod Ricard s policies maintenance. Corporate governance: The board of directors is made of 15 members, including the chairman and CEO Mr. Alexandre Ricard, Vice Chairman, four Directors, six Independent Directors, two Directors representing employees and one Director representing employees (see Figure 5). With 35.7% of women on the board of directors, the company s gender disposition is in accordance with the AFEP- MEDEF code. The remuneration of the CEO is displayed in the annual report. Pernod Ricard makes great emphasis on business transparency, organizing general shareholders meetings, investors conferences, and on ethic, preventing of corruption and anti-competitive practices, in order to ensure a positive relationship among stakeholders: employees, shareholders, customers, consumers, suppliers. SOCIAL RESPONSIBILITY: SUSTAINABILITY AND RESPONSIBILITY Being included in major CSR indexes such as the Ethibel Sustainability (ESI) Excellence Europe and Global and the FTSE4Good or Euronext Vigeo Eiris World 120 / France 20, Pernod Ricard demonstrates its high social responsibility involvement. The Group responsibilities are based on four main areas of engagement, which include promoting responsible drinking, protecting the planet, empowering employees, developing communities and engaging partners. Thus, to promote the best practices and to be responsible toward the alcohol consumption, the Group created an event Responsib All Day. In addition, Pernod Ricard founded the Fondation pour la Recherche en Alcoologie (FRA), an organization that finances and publishes studies on alcohol consumption and its 3

5 in bn Figure 6: Global Alcohol Market - Product Segmentation % Beer Spirits Wine 50% 40% 30% 20% 10% 0%, Frent, M. (2016) Figure 7: Historic yoy-gdp growth (%) France US China India Source: World Bank impact on consumer s health. Finally, they participate to educational programs and awarenessraising campaigns targeting young people and pregnant women. The company is also proud to observe that 86% of affiliates carried out at least one responsible drinking initiative ( ). Moreover, the company makes a lot of partnerships with different countries financing, for example, the Paul Ricard Oceanographic Institute that protect aquatic biodiversity and marine ecosystems in France or helping the World Wide Fund on Nature (WWF) to protect snow leopard in Russia. Pernod Ricard also takes actions to reduce CO2 emissions by installing 5,000 m 2 of solar panels in India and to protect the planet s water resources by saving, reusing and recycling it. In addition, the Group is caring about their employees by highly respecting human and working rights and by training talents in Pernod Ricard University developed in INDUSTRY OVERVIEW AND COMPETITIVE POSITIONING In 2015, wine and spirits contributed only 21.1% to the global alcohol consumption in volume terms, while in value terms these two segments accounted for 47.4% for the overall value of the alcoholic beverage industry, which in total accounted for about 760 bn (see Figure 6). (13) Thereby, demand dynamics and drinking habits are very diverse and cultural influenced. Meanwhile, the trend towards premiumization and regional diversification with a focus on emerging markets appears to become the new priority for international brand companies. Macroeconomics The key determinant of the consumption of wine and spirits, especially in the premium segment, is the increasing disposable income of potential customers, which in turn correlates positively with the economic growth. The World Bank expects the global real GDP to grow moderately by 3.1% in 2018 with significant distinctions between mature and developing markets. (14) High growth rates, in combination with favorable demographic development, higher personal wealth and continuing globalization are interpreted to drive the increasing demand for premium alcohols in emerging markets. In connection with this, the historically strong population growth in developing countries represents an assisting factor to increase the consumer base. (15) In contrast, the premiumization and digitalization in mature markets such as North America and Europe might be one of the solutions to face modest growth and new drinking habits. In combination with the positive economic situation and outlook this translates into overall strong expectations towards growth for the alcohol market (see Appendix 7). France: Economic revival of the Grand Nation takes time The main ambition of the French President Macron is the reduction of the unemployment (9.5% in the third quarter of 2017), the achievement of a sustainable level of public debt, and the stop of the eroding competitiveness. The labor market reforms are interpreted to support the GDP growth, even though they may partly contradict the traditionally strong private consumptions and investments as real wages tend to decrease. In addition, the appreciation of +15% of the Euro towards the US-Dollar within the last twelve months shortens the possibilities for the export sector. Nevertheless, the progressive reduction in corporate taxation should help the inflation rate to slowly muscle up to 1.30 % and GDP to grow by 1.80% in 2018, respectively, underlining the positive overall outlook for France. (16) The tax adjustment in France is not expected to have any significant impact, as Pernod Ricard s business is globally diversified. US: FED s dilemma of strong labor market but low inflation - The real GDP growth of 3.2% in the third quarter of 2017 confirmed the good shape the US economy is currently in. (17) The strong labor market with an unemployment rate close to full employment and positive consumer spending favor the business friendly environment. Confronted with such a good development, the FED may see itself forced to increase interest rates gradually to prevent an overheating of the labor market even though inflation is clearly below its target. (18) But inflationary pressure is likely to be generated when the foreign demand for US exports accelerates due to the global economic growth and relatively advantageous USD weakness. Uncertainty arises from the replacement of FED chairwoman Yellen and the foreign affairs, especially with regard to protectionist measures conducted by President Trump. The tax reform however will have a positive on the US economy in general in China: Structural transformation dethrones two-digital growth China is simultaneously characterized by stability and a deceleration of growth. The inflation rate, CPI +1.9% in December 2017, (19) is in line with the target area. In spite of a mining and steelproducing industry that lost its momentum and does not stimulate excessive foreign investments anymore and a weakening export sector as increasing wages reduce the competitiveness, the outlook for China is very positive. (20) (21) China s Premier Li Keqiang announced a robust GDP growth of 6.9% for 2017, which is above the targeted an annual real GDP growth of 6.5%. (22) That rate would imply a doubling of the country s economy between 2010 and The accessibility of this ambitious target depends significantly on the success of the initiated transformation process. It includes an increase in innovation in the form of higher qualitative competitiveness, focusing on the tertiary sector, and a growing domestic consumption, which complementary underpins the potential for the premium beverage sector in China. In the long run, the implementation of a social insurance system would fur- 4

6 Figure 8: Pernod Ricard s Historical Sales Growth in China 30% 10% -10% -30% Bargaining power of customers Food, Beverages and Tobacco Gross Margin EBIT- Margin 2011/2012, Pernod Ricard Figure 9: Porter s Five Forces Bargaining power of suppliers 2012/ /2014 Entrance Barriers Beverages 2014/2015, Frent, M. (2016) Figure 10: Global industry attractiveness by margin 2015/2016 Rivalry Substitution risk Avg. Competitor Premium Segment 27.60% 40.30% 52.60% 12.40% 16.30% 20.90%, S&P Capital IQ ther contribute to the domestic demand as gross savings remain at 46.1% of GDP. (23) India: Challenges in demonetization and GST will be rewarded in the long-term The demonetization as well as the standardization of the tax system and the harmonization of the domestic market by introducing a national Goods-and-Service Tax (GST) in 2017 led to massive disruptions in India. GDP growth decreased from 9.1% in the first quarter of 2016 to 5.7% in the second quarter of (24) In the long-run, both lays the foundation for sustainable growth. Given the robust domestic demand and the possible stimulus for investments and increasing exports as transportation shell benefit from the GST, negatives effect will be temporary and the Indian economy is likely to recover with a GDP growth of 7.30% in Industry Regulative situation plays a key role for success of the industry The alcoholic beverage industry is highly sensitive to regulatory measures and legally binding restrictions. Country-specific regulations regarding minimum drinking age, sale days and times and the prohibition of public drinking, reduce the availability of alcohol while restrictions or bans on advertising and promotion of alcoholic products limit the product awareness through marketing channels. (25) The federal implementations of the Chinese anti-corruption campaign, initiated in 2012/2013, impacted the alcohol beverage industry. Pernod Ricard s sales materially dropped from 24% and 9% in 2012 respectively 2013 to -23% in 2014 (see Figure 8). (26) Though competitive environment The alcoholic beverage industry is characterized by high entrance barriers due to capital and operational requirements, difficulties in fulfilling regulatory standards, and market access to potential customers via brand awareness. While the wine segment is highly fragmented with various local and international players, the spirit segment is more concentrated. The product differentiation is limited thus the switching costs for end-consumers are relatively low. To compensate this lack of differentiation, alcohol manufacturers are striving for innovative products and the coherent marketing mix as key element for customer acquisition. The bargaining power of suppliers depends on the origin of products and/or services: suppliers from the agricultural sector are powerful because they are highly specialized in monocultures and induce relatively high switching costs for manufacturers based on the uniqueness and required quality of their products. Industrial suppliers (cork, bottles, labels, carton) have low bargaining power due to a low degree of specialization and consequently low switching costs. However, the premium segment remains highly attractive as wine and spirits are offering higher margins compared to other consumer goods and growth-promoting factors (see Figure , Appendix 9). Drivers and trends Aside from an increasing population and wealth as main determinants, the industry is driven by highly divergent consumption habits. In mature markets such as Europe and North America, a growing awareness of health issues and a modern, sportive lifestyle contradicts alcohol consumption as frequency and volume go down. Simultaneously, occasional drinking patterns allow premium manufacturers to promote their products and specialize on a new target group. In this context, product innovation and also individualization of product services are growing. The digitalization does not only offer the chance of using Big Data to systematically contact customers via smart advertising, but also boost e-commerce and reduce costs. Further, higher travel propensity throughout the world offers travel retail opportunities for leading beverage brands, i.e. duty-free shops. The forecasted growth for Pernod Ricard s key markets with focus on fine wine and spirits is very positive. Competitive positioning Pernod Ricard is positioned 2 nd globally in terms of sales after Diageo. With regard to its critical market size, adequate capital facilities, wide distribution network and tight supplier relationships the group is well equipped. Its well-known product portfolio, its power in innovation as demonstrated with its Absolute Vodka variations and its success of the Irish whiskey brand Jameson, its strategic orientation towards a comprehensive premiumization and its broad geographical presence ensure Pernod Ricard s good competitiveness (see Appendix 8). INVESTMENT SUMMARY Investment Thesis We issue a BUY recommendation on Pernod Ricard with a target price of which represents an upside of 14.86%, based on the closing price on 15 th January Our estimation is based on a combination of a DCF-Equity cash flow method and relative valuation. Aware of the fact that peers have different strategies that impacts the accounting treatment and consequently the multiples, we prefer to limit the influence of the relative valuation by devoting a weight of 70% to the intrinsic valuation. As crucial key drivers of our evaluation we detect: 5

7 30% 20% 10% 0% -10% -20% Figure 11:Historic sales growth and future trend of fine wine/ champagne and spirits France China e 2020e US India, Euromonitor Figure 12: Forecasted Sales Growth Strong industry growth: The alcoholic beverage industry benefits from the pickup in consumption due to increasing economic conditions worldwide. In recent years, the growth of the industry outperformed the GDP growth. Especially in emerging markets, the sound environment and the increasing wealth leading to a broader middle-class drives the premium segment. While mature markets such as France and the US are expected to grow from 4.2% to 3.2% and from 6.5% to 4.2% in the next five years, China and India are characterized by growth rates between 7.9% and 6.8%, 12.9% and 5.1%, respectively. Despite the adaptions triggered by the Chinese anti-corruption campaign, the Indian introduction of the GST and demonetization, which will cause a lower growth for Pernod Ricard in 2018, we believe that the strategic and geographic positioning will boost Pernod Ricard s sales and help them to gain even more market share in Asia. This development is accompanied by our positive macroeconomic prospect. Cost efficiency: While do not see great room for improving the gross margin due to the strong ties with (specialized) suppliers, especially for high-quality agricultural products, the initiated cost efficiency program is likely to affect Pernod Ricard s margins. The internal optimization in the cash conversion cycle by reducing the inventory of finished goods as well as externally reduced net interest expenses contribute an increasing EBT margin, which we assume to increase from 20.6% in 2017 to 21.8% in 2020e. Further, gradually growing structuring costs and the management s signaled target margin for advertising and promotion expenses to remain at 19% of the net sales sending a strong commitment towards increasing cost efficiency. We think that modern marketing channels (digitalization, e-commerce) can be a supportive instrument to ease the cost pressure. Product innovation and brand awareness: Pernod Ricard s competitive advantage is its wide portfolio of premium brands in different price ranges. With its local brands, the company already gained great awareness in domestic markets. The decentralized, consumer-centric organization allows to serve various markets individually, which is proven by the innovation track record (Jameson, Chivas, and Absolute). 2017/2018f 2018/2019f 2019/2020f 2020/2021f 2021/2022f 100% 80% 60% 40% 20% 0% 2016/2017 0% 2% 4% 6% 8% Europe (France) Americas (US) Asia (China & India) 2017/2018f 2018/2019f Figure 13: Forecasted Shift in Regional Sales 2019/2020f 2020/2021f 2021/2022f Europe (France) Americas (US) Asia (China & India) Social & technological development: As mentioned, digitalization will strengthen the direct channel between Pernod Ricard and its customers and represents an important marketing instrument. Not only can it reduce conventional advertising costs but adapt to and identify trends in consumer behavior. Pernod Ricard has signaled that the company is eager to invest early in this field to secure market shares. We believe that healthy lifestyles and occasional consumption patterns not necessarily have negative effects on Pernod Ricard s business as they might shift demand to premium segments. VALUATION Intrinsic valuation We decided to use a Discounted Cash Flow (DCF in the form of Free Cash Flow to the Firm) approach because Pernod Ricard is a mature company that generates stable cash flows. In our opinion, the company s demonstrated capacity to sustainably achieve sufficient free cash flows to the firm represents a sound base for our valuation. It also enables us to particularly pay tribute to the company s short-term future growth as well as factors the company s performance is sensitive to. Explicit growth period Based on Pernod Ricard s 2016/2017 geographically allocated revenues, we examined the future industry growth and assessed Pernod Ricard s revenue growth for the key markets France, the US, China and India. Subsequently, we applied these with regard to the particular market share on a specific year-to-year forecast until 2021/2022 (see Figure 12). While we believe that in 2017/2018 Pernod Ricard s growth will still suffer slightly from difficulties in the US with its leading vodka brand Absolute and the last extensions of the Chinese anti-corruption campaign as well as the GST introduction, alcohol ban and demonetization in India, we assume that the following years are overall characterized by high one-digital growths (see Appendix 5). Pernod Ricard may participate above the market growth because of its existing distribution network, brand awareness and product mix that covers the premium, super premium and prestige price range. The differentiation in growth rates consequently leads to a shift in market contribution to the revenue composition (see Figure 13). Terminal Growth: We orientated our residual growth rate, namely 3.62%, on the historical 11-years GDP growth rate for the four key markets and on the historical 11-years industry specific growth for these countries. We weighted them 95:5. In our opinion it is appropriate to consider this weight for the GDP as it will define a natural limit to the company s growth in the long-run, while it includes the positive industry dynamics, which are even likely to continue beyond the explicit planning horizon. By taking the last 11 years we make sure that we cover at least one business cycle and by using the regional revenue strength we respect the variation in growth dynamics according to the projected revenue pattern in 2021/2022 (see Appendix 5). However, as Asian markets are likely to mature, we expect growth rates to converge. Capital Expenditure (CapEx): Hence Pernod Ricard invested steadily in property, plant and equipment, we do not identify an investment lag. However, as operations continue to grow, 6

8 additional capacities may be required. We therefore assume a growth in CapEx, which correlates with the sales, as sufficient capacities are required to maintain an effective production process. Figure 14: Cost of equity Beta Expected market return 9.01% Risk free rate (1) 0.59% Risk free rate (2) 1.79% Cost of equity (1) 7.22% Cost of equity (2) 7.47% Figure 15: Peer Analysis Change in Operating Working Capital (OWC): Linked to the efficiency project, Pernod Ricard was already able to save 50 m in OWC. The ambitious target of saving a total of 200 m by 2020 is realistic. However, we do not believe that this means cutting OWC in general but optimize its utilization to inherently achieve this goal. Capital structure: To follow the deleveraging trend and securing a high investment grade is one fundamental principle of Pernod Ricard s capital structuring. Hence, we believe that next year, outstanding debt of 357 m will be repaid fully. Due to the growth, we assume that no further cuts in the debt will occur but that Pernod Ricard may steadily increase its debt at a low rate. Retained earnings may mainly achieve the deleveraging. Further, we anticipate the change with regard to implementation of IAS 17 in 2019/2020, which may lead to an excursive increase in the long-term debt, as operating leases will be treated as financial leases from that accounting period on. Cost of equity: We computed two costs of equity, taking into consideration a normalization in the interest rate level in the long-run. Hence, cost of equity was calculated according to the Capital Asset Pricing Model: the current German 10-years BUND (0.59%) was used as risk free rate for the specific forecasting period, while the last monthly 5-year s average of the German 10-years BUND (1.19%) is applied for the residual value calculation. The Beta of and the expected market return of 9.01% are estimated with the help of the SBF 250 on a weekly basis over the last 5 years (see Figure 15, Appendix 5). Multiple Valuation: Peer analysis/relative valuation For our relative valuation, we first selected peers from Distiller & Vintners industry, that share the same objective to become market leader, have similar geographical presence, and have the same strategy, consisting in the premiumization, innovation as well as portfolio diversification. After identifying the major industry players (see Figure 15), we compared their performance indicators, in order to eliminate outliers and create a reliable peer group. We used a sale indictor, because the growth of well-established companies is mostly driven by sales, and a ROIC indicator, showing the efficiency of mature companies to generate returns. Calculating ROIC, we used the EBIT instead of the net income to avoid the influence of different tax systems and capital structures. Thus, we identified four comparable companies: Diageo plc, Constellation Brands, Inc., Davide Campari-Milano S.p.A., and Rémy Cointreau. Accordingly, considered P/E, EV/FCF and EV/Net Sales as the most appropriate multiples to realize the valuation. P/E multiple: it can serve as a growth and risk estimator for companies but is biased by the company s payout strategy. As denominator, the diluted EPS allows to consider the impact of any stock option or conversion on the price. Pernod Ricard s P/E ratio that equals to 24.87x, which is a little bit lower than its peers P/E average, indicating also that the company is undervalued. EV/FCF multiple: it well indicates how fast mature groups with stable investments generate and reinvest cash. To calculate this ratio, we took the enterprise value and unlevered FCF, making companies more comparable and removing the impact of capital structure on a firm s valuation. Pernod Ricard has a positive ratio, equaling 32.74x, which is one of lowest compared to other companies. Therefore, it indicates that investors of Pernod Ricard will receive their investments back more quickly than its peers. Millions % % % % % 2012/2013 Figure 17: Revenues ( ) 2014/ / /2019e 2020/2021e Revenue Growth, Pernod Ricard EV/Net Sales multiple: As indicated, the sales highly affect the growth a company such as Pernod Ricard. To buy the sales of the group the price equals to 4.72x of its sales, which is lower than the comparable companies ratio average. Thus, we can perceive that the market undervalues Pernod Ricard. Therefore, buying the stock of Pernod Ricard can be consider as a good investment because investors will receive benefit out of it. Finally, to get our Enterprise and Equity Value we took the average of multiples, which is quite lower than the median, in order to be more conservative. We elaborated a range for the Equity Value from to and the Enterprise Value from to Our analysis concludes on Pernod Ricard s price of (see Appendix 6). FINANCIAL ANALYSIS Increasing sales volume through opportunities in established & growth markets Pernod Ricard achieved an increase in revenues of 9.68% (see Figure 17) over the last five years, highly driven by the global economic upturn mainly propelled by China and India. Pernod Ricard has been able to capitalize on these markets and still create growth thanks to the implementation of various strategies such as the launch of the new Chivas Extra 12, a dedicated brand for the Chinese market, through a multi-year partnership with NBA China, and the use of Amaro Ramazzotti for a campaign on social responsibility as well as for fair and equitable trade in India. Currently, the growth is attenuated by some regulatory changes occurred during 2017 in India, i.e. the total ban of 7

9 65% 64% 63% 62% 61% Figure 18: Gross Margin CFA Institute Research Challenge alcohol in the state of Bihar and liquors selling near highways. However, we assume that these key markets will continue to observe a positive growth in the future, given the strategies implemented by Pernod Ricard to cope with these events reported above. Indeed, it became also evident in the 1QFY 2017/2018 where net sales in Asia/RoW exhibit an organic growth of 7%. This fact, together with a solid growth in the other main markets, led us to establish a positive outlook for Pernod Ricard s revenue generation and growth. (27) 60% 35% 30% 25% 20% 15% 10% 2012/2013 5% 2014/2015 0% Pernod Ricard 2016/ /2019e Davide Campari- Milano S.p.A. 2020/2021e, Pernod Ricard Figure 19: Industry Comparison of Normalised ROA Rémy Cointreau, S&P Capital Operating costs: Stable & under control The gross margin of Pernod Ricard is very stable, floating around % over the last five years (see Figure 18). We believe that this will continue to be the case for the forecasted future given the dependency on high quality supplies and production. The main cost drivers stem from raw materials, labour and marketing/selling costs. In 2017 labour costs account for 18.98% of operating expenses and is in line with industry peers. This might change if the firm decide to increase its production in countries with lower labour costs, however this is not likely to be implemented in the short foreseeable future. Profitability: the impact of the intangible assets In 2017, the ROA of Pernod Ricard s ROA is 4.9%, which is significantly lower compared to its peers. This ratio, however, is affected by the significant amount of intangibles held by Pernod Ricard, which have a book value of 11,775 m, representing 57.01% of its total assets. Nevertheless, the weight of the intangibles decreased over the last five years from its maximum of 61.18% in Such a decrease is also due to impairments, observed almost every year. In particular, during the fiscal year ending on the 30 th June 2017, impairment of intangible assets, resulting primarily from brand impairment, amounted to 73 m. These were mainly driven by the 58 m impairment of Imperial brand. However, since the company has now adjusted the amount of these assets to reflect their current value, we believe that this issue is not going to affect the future profitability of the company significantly. In relation to the past, instead, we believe appropriate to analyse a normalised ratio, adjusted to remove the effect of the intangible assets. It resulted in a ROA equal to 18.33%, in line with the performance of its competitors, with a 4.23% increase in comparison with the last year (see Figure 19). Millions, S&P Capital Figure 20: Debt and Equity Financing ( ) 16,000 14,000 12,000 10,000 8,000 6,000 4,000 2, Total debt Debt/Equity ratio Total equity, S&P Capital Figure 21: Quick Ratio 100% 80% 60% 40% 20% 0% FY2013 FY2014 FY2015 FY2016 FY2017 Quick ratio 5-Year avg. Figure 22: Current Ratio FY2013 FY2014 FY2015 FY2016 FY2017 Current ratio 5-Year avg. Deleveraging to enhance growth opportunities Pernod Ricard has actively been decreasing its Debt/Equity ratio from 92.7% in 2012 to 61.6% in 2017 (see Figure 20). This deleveraging strategy, together with the improvement in profitability (EBIT % in last five years) and a reduction of the financial interest expense (-24.67% over the same time period), resulted in a significant improvement of some important solvency ratios like the Net Debt/EBIT (-14.33% over the last five years) and the coverage ratio (+38.89% over the same time period). This highlights a commitment of Pernod Ricard to increase the solvency of the company and decrease its financial risk, in order to get a better rating to reduce future financial expenses. In addition, the deleveraging increases the firm s flexibility to efficiently finance new acquisitions. It gives us a final positive overview on the real effectiveness of company s effort to improve its solvency, which is also supported by the analysis of the Altman Z-score that reveals a 5-years average score of This implies that Pernod Ricard has a very low probability of bankruptcy (see Appendix 10). Liquidity supported by structured factoring plan The past and current liquidity situation of Pernod Ricard shows a positive trend as indicated by an increase of % in the cash ratio (from 0.12x in 2013 to 0.18x in 2017), of % quick ratio (from 0.43x in 2013 to 0.49x in 2017) and of % in the current ratio (from 1.50x in 2013 to 1.80x in 2017) (see Figures 21 and 22). Pernod Ricard is also exhibiting a good performance in its cash generation cycle. The number of days of sales outstanding decreased to (-14.39% over the last five years) while the number of days of payables increased to (+26.34% over the same time period). It indicates that Pernod Ricard collects its receivables before paying its suppliers, which indicates a good working capital management. In addition, a multi-currency revolving credit facilities of over 2,500 m and Euro- and foreign currency-denominated factoring agreements in Europe and in the Asia-Pacific and Oceania areas, sustain Pernod Ricard s liquidity and flexibility. Changes in accounting standards On 30 th June 2014, the International Accounting Standards Board (IASB) issued some amendments to IAS 16 - Property, plant and equipment and IAS 41 Agriculture, in relation to bearer plants, effective from the 1 st January These amendments required bearer plants being accounted for in accordance with IAS 16, i.e. using either the cost or the revaluation model, moving away from IAS 41 where they were measured at fair value less costs to sell. Pernod Ricard introduced these amendments from the fiscal year started in 1 st July 2016 accounting for the vineyards in accordance with IAS 16. It caused a net decrease in the value of the vineyards, and a corresponding decrease in the equity, for 99 m (0.32% of the FY 2016/2017 total assets) which, in line with the assessment of the firm, we do not consider material. Over the next fiscal years, the company may be also affected by the introduction of the new IFRS 15 Revenues from contracts with customers, IFRS 16 Lease, and IFRS 9 Financial Instruments. After an analysis of the business of Pernod Ricard, we assessed that the impact of these new standards will not be material for the company. (28) 8

10 Satisfactory reported earnings quality We performed the 8-variable Beneish M-score analysis for the last five year-end financial statements to evaluate Pernod Ricard s earnings quality. We observe an average M-score of during the last five years, which is below the threshold considered a concern in terms of financial reporting quality. Accordingly, our analysis indicates that Pernord Ricard exhibits a lower probability of earnings manipulations. Thus, we assess earnings quality of the firm to be adequate (see Appendix 11). Figure 23: Risk Matrix INVESTMENT RISKS (see Appendix 14) Economic risk 1: Deceleration in the global economic growth (Impact: High/Prob.: Low) An extensive downturn in global economic growth would negatively affect the sales in the alcoholic beverage industry as spirits and wine consumption is negatively correlated to economic recession, unemployment and decreases in purchase power. Especially, the premium strategy makes Pernod Ricard suffer in two ways: first of all, the demand sensitivity for premium spirits is higher than for low quality spirits, allowing consumers to down-trade from premium to standard products. Secondly, Pernod Ricard has a limited chance to react on decreasing demand as its premium strategy pursues an exclusivity character and therefore restricts its price range. The risk is partly mitigated by Pernod Ricard s diversified business activity with. A sensitivity analysis in Appendix 13 exemplifies the target price changes due to changes in the terminal growth as consequence of altered economic conditions. Economic risk 2: Troubling emerging markets (Impact: Moderate/Prob.: Moderate) It is seen that the economic and demographic development as well as the low international branded consumption of alcoholic beverages in emerging markets provide significant growth potential. However, an over-estimation of the increasing wealth and wider consumer base in combination with an intensifying competition between international alcoholic beverage companies and local producers can harm the expansion in the emerging markets. Pernod Ricard is sensitive to this risk especially due to its operations in leading emerging markets such as China, India or Russia. Market risk 1: Change in lifestyle & consumption habits (Impact: High/Prob.: Moderate) In the light of the spreading awareness of alcohol-related diseases and general health concerns, maintaining a healthy and sportive lifestyle became the new luxury for younger generations. Supported by federal governments and NGOs, new drinking patterns following wise drinking-mottos discourage the excessive consumption of alcohol. While the reduction of the consumption quantity and frequency negatively affects the producers of alcoholic beverages, the change towards more occasionally drinking can be interpreted as a chance for premiumization as the quality of spirits and wine gathers relevance. Market risk 2: Decriminalization of marijuana raises competition (Impact: Low/Prob.: High) The recent liberalization process in North America with regard to a regulated production, distribution, marketing and consumption can make marijuana not only available for medical but also recreational reasons, creating a potential substitute to alcohol. While surveys indicate marijuana s health concerns being lower or in line with alcohol, the consumption is mainly driven by younger generations and the potential growth to a valuable market size may take time. (29) Accordingly, the substitution effect is seen to be low. Market risk 3: Competition & Market Consolidation (Impact: Moderate/Prob.: High) Despite the high market entry barriers in general, the competitive environment in the alcoholic beverage industry depends on the product. While few, global operating competitors and many small local spirit makers characterize the spirit sector, the wine sector is highly fragmented. The recent consolidation of the market intensifies the competition and emphasizes the risk of losing market share. Also, a growing success of local, artisan producers is recognizable. The risk of inorganic growth extends to the difficulties going along with the effective integration of the acquired company into the group s operational and organizational structure. Pernod Ricard s decentralized structure strongly contributes to a successful integrate as it ensures an extensive scope of independence to its brands. Political risk 1: Tightening of regulatory & legal conditions (Impact: High/Prob.: Moderate) The alcoholic beverage industry is considerably regulated, both statutory, i.e. based on federal or state law, and non-statutory. (30) Besides regulations on production, sales and consumption (prohibition of public drinking) as well as limitations of access to alcohol (minimum drinking age), legal binding restrictions also cover marketing and advertising activities. Possible marketing bans or tightening in the existing regulations as well as the introduction of package regulations in the form of health warnings can be seen as political instruments to curb alcohol consumption. (31) The risk of regulatory interventions similar to the Chinese anti-corruption campaign is regarded to be more likely in developing countries. The geographical and jurisdictional diversification of Pernod Ricard mitigates the impacts of changes in the regulatory environment. Nevertheless, they can indirectly affect Pernod Ricard s revenues from limited product placement and brand awareness, damage reputation and increases in costs. 9

11 Political Risk 2: Protectionism & tax regimes (Impact: Moderate/Prob.: Low) The high sensitivity of the wine and spirit sector to variations in tax regimes, which are not foreseeable, represents a major threat. Similar to future tax increases, protectionist instruments such as import barriers and excise duties become the most important aspects under the global diversification strategy and can adversely affect the profitability of Pernod Ricard. (32) (33) Moreover, the outcome of the Brexit negotiations will influence Pernod Ricard s Scotch whiskey segment. The widely located manufacturing and distribution network of Pernod Ricard partly diminish the extent and the impact of such actions. Operational Risk 1: Price volatility & increasing operational costs (Impact: Low/Prob.: Low) As products of the alcoholic beverage industry are primarily made out of agricultural products, the industry is sensitive to price volatility of these commodities, which are mainly influenced by the weather conditions, the possibility of natural disasters and climate changes. If the suppliers are confronted with a poor harvest, shortages in supply can either lead insufficient production volume or significant appreciation in the raw materials prices. This can result in higher operating costs. Besides, increasing energy, transportation, distillation and other operating costs might also put pressure on the margins. Pernod Ricard mitigates the risk of increasing prices and supply shortfall by entering non-physical hedge agreements and physical supply contracts. In addition, wine yards in possession of the company increases its autonomy from global commodity markets. Ratings Long-term Short-term Outlook Fitch F3 BBB POS Moody's P-2 Baa2 STABLE Standard & Poor's Figure 23: Credit Ratings BBB A-2 POS Source: Bloomberg Operational Risk 2: Product quality (Impact: Moderate/Prob.: Low) Regarding the necessity of a good reputation/image, it is a company s inevitable responsibility to ensure product quality. The risk of contamination of the beverage and defect of relating materials are inherent in the manufacturing process. Pernod Ricard minimizes this risk by implementing an ISOcertified management and control system to actively monitor the procurement of raw materials, the distillation or fermentation process as well as packaging. Further, the company works closely with its suppliers by introducing partnership agreements and integrating quality-ensuring measures such as the Responsible Procurement Policy, the supplier CSR Commitment, and CSR Risk Mapping Tool. Financial risk 1: Increasing interest rates (Impact: Low/Prob.: High) The signals of the ECB s quantitative easing coming to an end and the expectation of the FED to raise the federal funds in 2018 may lead to a slow drain of the extensive market liquidity. As a result, interest rates are likely to increase. The linked risk of higher financial costs is partly mitigated by interest rate risk hedges on a medium and long-term horizon, Pernod Ricard entered. Financial risk 2: Liquidity and Solvency (Impact: High/Prob.: Low) The lack of fulfilling its short- and long-term obligations is a major risk for corporations thus it consequently harms credit and supplier relationships. It can arise from an insufficient cash conversion cycle, insignificant revolving credit facilities, and a poor debtor management. Further, unsatisfying operational results threaten the capability to serve long-term debts in the form of interest payments and reimbursement. Various financing products allow Pernod Ricard to have sufficient short, medium, and long-term credit facilities and provide adequate financial resources to the company. The long-term credibility is further confirmed by the external credit ratings, which are all Investment grade. Financial risk 3: Exchange rate risk (Impact: Low/Prob.: Moderate) The divisiveness of the US-American and European monetary policy, the Brexit and global uncertainty cause fluctuations in foreign exchange rates to which Pernod Ricard is substantially exposed due to its global branches and operations. Though, the decentralized structure of Pernod Ricard guarantees natural hedges. Moreover, the company entered fair value and cash flow hedges in the form of cross currency swaps and forwards in the main currencies USD, GBP and SEK to reduce potential losses going along with variations in exchange rates. Unpredictable risk 1: Explosion risk (Impact: Moderate/Prob.: Low) The risk of explosion is highly present as the alcohol is a very flammable product. It threatens not only the company s facilities, but also employees. Therefore, Pernod Ricard has to be sure to implement all sources of protection and prevention as required by the European Directive ATEX Directive 2014/34/EU. Unpredictable risk 2: Terrorism acts and declaration of war (Impact: High/Prob.: Moderate) In Europe in recent years, terrorism acts were an important subject of concern not only for the government, but also for industries and businesses. In fact, it highly impacts event, travel and tourism industry. As a consequence, it negatively impacts the number of tourists, the sharing moments between friends, evening events, and thus decreases the alcohol consumption. Unpredictable risk 3: Natural disaster risk (Impact: High/Prob.: Low) As the Group is presented in different countries the risk of natural disasters such as earthquake, flooding, hurricane is usually not predicted, but can highly damage places of alcohol storage. Pernod Ricard has to implement specific preventive measures to cover this risk, either by insuring or by distributing the risk with cat bonds, for example. 10

12 Appendix 1: Pro-forma Income Statement in m 2012/ / / / / / 2018e 2018/ 2019e 2019/ 2020e 2020/ 2021e 2021/ 2022e Net sales 8,575 7,945 8,558 8,682 9,010 9,465 10,118 10,775 11,366 11,897 Cost of goods sold -3,224-2,958-3,262-3,311-3,407-3,597-3,845-4,095-4,319-4,521 38% 37% 38% 38% 38% 38% 38% 38% 38% 38% Gross margin after logistic expenses 5,351 4,987 5,296 5,371 5,603 5,868 6,273 6,681 7,047 7,376 62% 63% 62% 62% 62% 62% 62% 62% 62% 62% Advertising and promotion expenses -1,644-1,503-1,625-1,646-1,691-1,751-1,872-1,940-2,046-2,141 19% 19% 19% 19% 19% 19% 19% 18% 18% 18% Structuring costs -1,476-1,428-1,433-1,448-1,517-1,609-1,720-1,832-1,932-2,023 17% 18% 17% 17% 17% 17% 17% 17% 17% 17% Others % 0% 0% 0% 0% 0% 0% 0% 0% 0% Operating income 2,205 2,039 2,219 2,262 2,380 2,508 2,681 2,909 3,069 3,212 26% 26% 26% 26% 26% 27% 27% 27% 27% 27% Net interest expenses % 5% 5% 5% 4% 4% 3% 3% 3% 3% Other non-operating income and unusual items % 4% 8% 2% 2% 2% 2% 2% 2% 2% EBT 1,567 1,332 1,101 1,663 1,859 2,000 2,173 2,393 2,522 2,635 18% 17% 13% 19% 21% 21% 21% 22% 22% 22% Income taxes % 23% 20% 25% 24% 24% 24% 24% 24% 24% Net income to company 1,208 1, ,255 1,421 1,519 1,651 1,817 1,916 2,001 14% 13% 10% 14% 16% 16% 16% 17% 17% 17% Minotiry interests in earnings % 1% 2% 2% 2% 2% 2% 2% 2% 2% Net income 1,189 1, ,235 1,393 1,494 1,623 1,784 1,883 1,966 14% 13% 10% 14% 15% 16% 16% 17% 17% 17% 11

13 Appendix 2: Pro-forma Balance Sheet in m 2012/ / / / 2016 Assets 27,488 27,616 30,398 30,598 30,088 30,724 31,928 33,600 35,067 36,640 Current 6,507 6,648 7,420 7,288 7,531 8,403 9,367 10,850 11,930 13, / / 2018e 2018/ 2019e 2019/ 2020e 2020/ 2021e 2021/ 2022e 24% 24% 24% 24% 25% 27% 29% 32% 34% 36% Cash and cash equivalents ,469 2,026 2,969 3,725 4,677 9% 7% 7% 8% 9% 17% 22% 27% 31% 36% Trade and other operating Receivables 1,159 1,051 1,152 1,068 1,134 1,230 1,366 1,509 1,591 1,666 18% 16% 16% 15% 15% 15% 15% 14% 13% 13% Inventories and work in progress 4,484 4,861 5,351 5,294 5,305 5,371 5,767 6,142 6,479 6,662 69% 73% 72% 73% 70% 64% 62% 57% 54% 51% Other current asset % 4% 5% 5% 6% 4% 2% 2% 1% 1% Non-current 20,981 20,968 22,978 23,310 22,557 22,645 22,774 23,070 23,455 23,839 76% 76% 76% 76% 75% 74% 71% 69% 67% 65% Intangible assets 11,780 11,542 12,212 12,085 11,755 11,755 11,755 11,990 11,990 11,990 56% 55% 53% 52% 52% 52% 52% 52% 51% 50% Goodwill 4,973 4,907 5,494 5,486 5,397 5,397 5,397 5,397 5,397 5,397 24% 23% 24% 24% 24% 24% 24% 23% 23% 23% Property, plant and equipment 1,940 2,012 2,194 2,188 2,298 2,355 2,468 2,577 2,946 3,331 9% 10% 10% 9% 10% 10% 10% 11% 11% 12% Other non-current assets 2,288 2,507 3,078 3,551 3,107 3,138 3,154 3,106 3,122 3,122 11% 12% 13% 15% 14% 14% 14% 13% 13% 13% Liabilities 16,137 15,838 17,111 17,092 16,202 15,957 16,199 16,821 17,181 17,596 59% 57% 56% 56% 54% 52% 51% 50% 49% 48% Current 4,417 3,905 5,138 4,956 4,256 4,131 4,313 4,539 4,714 4,880 27% 25% 30% 29% 26% 26% 27% 27% 27% 28% Trade and other operating payables 1,546 1,463 1,696 1,688 1,826 1,834 1,961 2,129 2,246 2,351 35% 37% 33% 34% 43% 44% 45% 47% 48% 48% Interest burden debt 1,568 1,219 2,052 2,027 1,167 1,008 1,038 1,069 1,101 1,135 35% 31% 40% 41% 27% 24% 24% 24% 23% 23% Other current liabilities 1,303 1,223 1,390 1,241 1,263 1,288 1,314 1,340 1,367 1,394 29% 31% 27% 25% 30% 31% 30% 30% 29% 29% Non-Current 11,720 11,933 11,973 12,136 11,946 11,827 11,886 12,283 12,467 12,716 73% 75% 70% 71% 74% 74% 73% 73% 73% 72% Long-term debt 7,712 7,674 7,458 7,335 7,380 7,306 7,343 7,694 7,810 7,966 66% 64% 62% 60% 62% 62% 62% 63% 63% 63% Other non-current debt 4,008 4,259 4,515 4,801 4,566 4,520 4,543 4,588 4,657 4,750 34% 36% 38% 40% 38% 38% 38% 37% 37% 37% Equity 11,351 11,778 13,287 13,506 13,886 14,766 15,730 16,779 17,885 19,044 41% 43% 44% 44% 46% 48% 49% 50% 51% 52% Capital % 3% 3% 3% 3% 3% 3% 2% 2% 2% Stock premium 3,052 3,052 3,052 3,052 3,052 3,052 3,052 3,052 3,052 3,052 27% 26% 23% 23% 22% 21% 19% 18% 17% 16% Retained earnings and currency translation adjustment 6,765 7,389 9,050 8,912 9,159 10,039 11,003 12,052 13,158 14,317 60% 63% 68% 66% 66% 68% 70% 72% 74% 75% 12

14 Appendix 3: Cash Flow Statement in m 2012/ / / / / / 2018e 2018/ 2019e 2019/ 2020e 2020/ 2021e 2021/ 2022e Net income 1,189 1, ,235 1,393 1,494 1,623 Source: Team 1,784 Analysis 1,883 1,966 Depreciation & amortization Current assets and liabilities (working capital change) Cash flow from operations 1, ,035 1,336 1,642 1,880 1,430 1,652 1,801 2,038 Capital expenditure Other investment cash flows Cash flow from Investing Net debt borrowings Dividend payments Other financing activities Cash flow from financing -1, , activities Cash at the beginning of the ,469 2,026 2,969 3,725 period FX and other effects Cash flow Cash at the end of the period ,469 2,026 2,969 3,725 4,677 Appendix 4: DCF-Calculation Free Cash Flow to the 2016/ 2017/ 2018/ 2019/ 2020/ 2021/ Equity e 2019e 2020e 2021e 2022e Net Earnings 1, , , , , , Depreciation CapEx (Net Investments) Change in OWC Net LT-Debt Repayment Terminal Value = FCFE , , , , , ,677.5 Discounted FCFE 1, , , , , , Equity Value Shares outstanding 37, m 265,421,592 Target Price per Shares* *Target Price per Share based on intrinsic valuation only. 13

15 Appendix 5: Cost of Equity, Tax Rate & Growth We separated the cost of equity for the explicit time horizon and for the residual value; hence we believe that interest rates and consequently the risk free rate are likely to rise in the long run. COST OF EQUITY Our cost of equity is 7.22% for the explicit forecasting period and 7.47% for the terminal value. Our calculations are based on the Capital Asset Pricing Model, using weekly SBF250 s weekly returns of the last 5 years for computing the expected market return. For us, it is reasonable due to low individual company weights and industry diversification; the frequency pretends from contamination because of noise. As proxy for the risk free rate, because of its AAA-rating, high liquidity, and -denomination we selected the German 10-years BUND of 0.59%, respectively the last 5-years monthly average of 1.79% to anticipate a normalization. This is driven by our expectation towards a strengthening European economy and robust inflation, the positive global outlook and the FED s signals to increase rates, which may result in a termination of the ECB s quantitative easing program. Beta Expected market return 9.01% Current risk free rate 0.59% Long-term risk free rate 1.79% Cost of equity (explicit) 7.17% Cost of equity (residual) 7.47%, Pernod Ricard, Bloomberg Average effective tax rate 2 years 5 years 10 years Pernod Ricard 24.05% 22.80% 20.31% Diageo 16.65% 19.92% 20.71% Cointreau 28.15% 32.16% 29.10% Campari 29.60% 32.12% 31.85% Brown-Forman 28.30% 30.08% 31.08% MARGINAL TAX RATE Pernod Ricard s theoretical tax rate was 34.45% in However, the company managed to pay an effective tax rate of 23.56%. With regard to its historical average tax rates, the peers, and the current changes of tax reforms in France and the US, we assume an effective tax rate for the following years of 24.05%. Average 25.35% 27.42% 26.61%, S&P Capital IQ EXPLICIT AND TERMINAL GROWTH We orient the revenue forecasts on Pernod Ricard s key markets France, the US, China and India as they represent the dynamics that are dominant in these regions. Based on the broader fine wine/champagne & spirits expected growth (Euromonitor), we calculated the net sales for Pernod Ricard for the next five years as well as the regional weights of the net sales. Net sales & share Europe (France) America (US) Asia (China/India) Total net sales 2016/ % 2, % 2, % 3, , Overall CAGR 2017/2018e 30.4% 2, % 2, % 3, , % 2018/2019f 29.6% 2, % 2, % 4, , % 2019/2020f 29.1% 3, % 3, % 4, , % 2020/2021f 28.6% 3, % 3, % 4, , % 2021/2022f 28.2% 3, % 3, % 5, , % Weighted GDP growth Weighted industry growth Europe America Asia Terminal growth rate 0.26% 0.42% 3.65% 0.96% 2.94% 6.57% 0.29% 0.54% 2.79% 3.62%, Euromonitor The GDP and industry growth was adjusted for the terminal value to take into consideration the maturing of the Asian markets and economies. Thereby, we obtain a sustainable growth rate. 14

16 Appendix 6: Relative Valuation Market data Financial data Relative valuation Company names Price (share) Market Cap (M) EV (M) Net sales (M) Unlevered FCF (M) Diluted EPS P/EPS EV/UFCF EV/Net Sales Diageo ( ) 2, , , , , ,71x 27,56x 6,09x Constellation Brand (US $) , , , ,95x 60,12x 6,85x Campari ( ) , , , ,00x 34,77x 4,06x Rémy Cointreau ( ) , , , ,37x 50,08x 5,12x MEDIAN of peers AVERAGE of peers Pernod Ricard ( ) , , , , ,87x 32,74x 4,72x PR share outstanding 51, , ENTERPRISE VALUE Market debt 8, Value par share Market debt / share , , EQUITY VALUE Cash Value per share Cash / share 2.55 Equity value/share Enterprise value/share Stock price of , S&P Capital IQ, Pernod Ricard 15

17 CFA Institute Research Challenge Appendix 7: PESTEL-Analysis Politics Economics Society Technology Environment Legislation Change in tax regimes Policies seeking to curb alcohol consumption Anti-corruption campaign Global economic recovery Emerging markets upgrading Health concerns Change in drinking patterns Globalization and increasing brand awareness Premiumization Product innovation and Tastes Digitalization (e-commerce, Big Data) Ecological use of water Reduction of waste and pollution Various legal binding restrictions on advertising, and purchasing,and consumption of alcohol Appendix 8: SWOT-Analysis Global Distribution Network Tight Supplier Relationships Decentralized Organization Structure Growth-focused Premiumization and Diversification Strategy Well-known brand and product portfolio S W O T Good Economic Climate Expansion in Emerging Markets Changes in Consumers' Lifestyle and Consumption Behavior Strategic Acquisitions to Expand Business Regions, Target Groups or Product Mix Digitalization (Big Data, e-commerce, and Marketing) Relatively low Profitability Relatively low Liquidity and Solvency Relatively high Conversion Cycle Low Pricing Flexibility Increasing Regulatory Environment Substitution Risk Higher Health Consciousness Increasing Operating Costs 16

18 Appendix 9: Porter s Five Forces Bargaining Powers of Customers Entrance Barriers Competitiveness Legend: 0 = none 1 = very low 2 = low 3 = moderate 4 = high 5 = very high Bargaining Power of Suppliers Substitution Risk Market entrance barriers: very high (5), Ferent, M. (2016) In the alcoholic beverage industry, market entrance barriers are high due to the required brand awareness and image of the product. To generate presence and visibility by marketing and promotion activities in order to establish a powerful brand, a company requires a strong capital base. A well-working supply chain and distribution network and high investments in PPE further stimulates synergies and economies of scale. Besides complying with legal restrictions on the production of alcohol, commercializing/marketing is limited or partly banned from public life. Therefore, the highly regulatory character of alcoholic products reduces the threat of new entrants. Rivalry of existing competitors: high (4) The rivalry is considered to be high. While for spirits the competitive landscape is characterized by a few global competitors and small local manufacturers, the wine segment is highly fragmented. On the other hand, spirits show a moderate market concentration with Diageo, Pernod Ricard, and Campari. The rivalry, however, is eased as competitors specialize towards certain price or product segments. The compared to other consumer goods promising growth outlook, premiumization trend and relatively high margins raise market attractiveness and avoid pricing wars as the price signals exclusivity. Threat of substitution: moderate (3) The threat of substitutes is moderate. Product differentiation is hard to obtain and often depend on the whole product, not only the beverage itself. Marketing conceptions can contribute to a reduced substitution risk within the product-specific alcohol segment; same effect having excellence in product quality, exclusivity, innovation and extraordinariness in taste which is crucial especially in the premium segment. We therefore interpret the substitution risk of another brand moderate, whereas a cross-product group substitution between beer, wine, champagne and spirits or substitution by other consumption substances such as marijuana is possible but not very likely. The dependency on the economic development as well as social trends towards brands and products are important not to underestimate. In economic slowdowns, the substitution risk for "mainstream" alcoholic drinks will increase. Bargaining power of suppliers: high (4) Overall, the bargaining power of suppliers is moderate. On the one hand, specialized farming firms and wine yards characterize the supply of agricultural products. Their bargaining power is very high as they provide unique, high-quality products, given certain grapes, sugars and other ingredients, but might also cover other value-adding activities, including special treatment of the raw materials. Consequently, the switching costs for alcohol manufacturers are high and they aim for long, sustainable relationships. The fact that Pernod Ricard owns several wine yards and agricultural production sites relaxes the dependency on suppliers slightly. On the other hand, industrial suppliers of cork, glass, and packaging elements have little bargaining power and are easily replaceable because the provided product services are highly standardized and low switching costs would occur. Bargaining power of customers: high (4) In the off-trade channel, end-consumers buy alcoholic products from wholesalers and supermarkets thus purchase and consumption differ timely. Confronted with a great variety of products, it is very easy and cheap for the end-consumers to switch. In the on-trade channel (bars, restaurants, clubs, hotels, events) this situation slightly changes as they only have a limited choice. The fact, that the alcoholic beverage industry recognizes the highly divergent consumption patterns of geographical and cultural regions emphasizes the high bargaining power of the end-consumer. With regard to on-trade vendors, the bargaining power is slightly less as they act as intermediaries between the manufacturer/brand and the end-consumer. Although they can decide for the product mix and independent on-trade vendors might offer a holistic range of products, major players in this industry are pressured by customers' expectations to include well-established brands. 17

19 Appendix 10: Altman Z-score Analysis The Z-score formula for predicting bankruptcy formulated by Altman is a 5 ratios linear combination multiple analysis that indicates the probability of a company to go in bankruptcy within 2 years. With the specified formula taken from Bloomberg, the indicator shows a score, in which below of 1.81 indicates a firm has a high probability of bankruptcy, called Distress Zone, and a score of more than 2.99, Safe zone, indicates a firm is far from a high bankruptcy probability. The formula is: Z = (1.2*X1) + (1.4*X2) + (3.3*X3) + (0.6*X4) + (1.0*X5)* INPUT VARIABLES Current Assets 6,507 6,648 7,420 7,288 7,531 Current Liabilities 4,417 3,905 5,138 4,956 4,256 Working Capital 2,090 2,743 2,282 2,332 3,275 Tangible assets 10,735 11,167 12,692 13,027 12,936 Total Liabilities 16,137 15,838 17,111 17,092 16,202 Retained earnings 9,280 8,938 9,550 9,362 8,547 Sales EBIT 2,283 2,039 2,219 2,262 2,380 Market Value of Equity 53,353 52,331 50,391 48,760 52,405 DERIVED VARIABLES X1: Working Capital / Tangible Assets X2: Retained Earnings/ Tangible Assets X3: EBIT / Tangible Assets X4: Market Value of Equity / Total Liabilities X5: Sales / Tangible Assets OUTPUT Altman Z-score *the formula is taken from Bloomberg L.P. 18

20 Appendix 11: Beneish's M-score Analysis The Beneish's M-score analysis by Beneish measures the earnings quality in their financial results, in regards of earnings manipulation detection. The method contemplates the use of 8 different variables, which identify any earnings manipulation or financial distortions made by the firm. If the M-score is lower than -2.22, the firm is not likely to be a manipulator of earnings, on the other hand if the M- score is greater than it indicates that is likely that the firm is. The formula of the Beneish's M-score is: M = (0.92*DSRI) + (0.528*GMI) + (0.404*AQI) + (0.892*SGI) + (0.115*DEPI) - (0.172*SGAI) - (0.327*LVGI) + (4.679 *TATA) INPUT VARIABLES Sales 8,575 7,945 8,558 8,682 9,010 Cost of Good Sold (COGS) 3,224 2,958 3,262 3,311 3,407 Net receivables 1,159 1,051 1,152 1,068 1,134 Current Assets (CA) 6,507 6,648 7,420 7,288 7,531 Property, Plant and Equipment 1,940 2,012 2,194 2,188 2,298 Depreciation Securities SG&A Expenses 3,131 2,948 3,077 3,109 3,223 Total asset (TA) 27,488 27,616 30,398 30,598 30,088 Current Liabilities 4,417 3,905 5,138 4,956 4,256 Total long-term debt 7,712 7,674 7,458 7,335 7,380 Income from continuing operations 2,283 2,039 2,219 2,262 2,380 Cash Flow from operations (CFO) 1, ,035 1,336 1,642 DERIVED VARIABLES DSRI: Day s Sales Receivables Index GMI: Gross Margin Index ,995 AQI: Asset Quality Index SGI: Sales Growth Index DEPI: Depreciation Index SGAI: SG&A expenses index LVGI: Leverage Index TATA: Total Accruals / Total Assets OUTPUT M-score - 8 variable model

21 Appendix 12: Key Financial Ratios 2012/ / / / /2017 Gross Margins % 62.4% 62.8% 61.9% 61.9% 62.2% Return on Assets % 4.26% 3.69% 2.97% 4.05% 4.59% Intangible Assets % 60.95% 59.56% 58.25% 57.43% 57.01% Normalised Return on Assets 21.27% 18.26% 17.48% 17.36% 18.40% Ratio % Debt/Equity Ratio % 83.4% 75.9% 72.5% 69.3% 61.6% Net Debt/EBIT Ratio % % % % % % Total Liabilities/Total Assets % 55.9% 56.3% 57.4% 59.4% 61.3% Quick Ratio 0.43x 0.43x 0.37x 0.38x 0.49x Current Ratio 1.50x 1.70x 1.40x 1.50x 1.80x Cash Ratio 0.12x 0.14x 0.09x 0.12x 0.18x Days of sales outstanding (DSO) days Number of days of payables (DPO) days Inventory on hand (DOH) days Cash conversion cycle (CCC) days , S&P Capital IQ Appendix 13: Sensitivity Analysis for intrinsic Valuation -20% down Growth Rate (terminal value) +20% up Predicted Price in 2.88% 3.06% 3.24% 3.42% 3.62% 3.78% 3.96% 4.14% 4.32% -20% down 5.98% % % Cost of Equity 7.10% (terminal 7.47% value) 7.85% % % % up 8.97%

22 Appendix 14: Risk Matrix 21

23 Appendix 15: Endnotes (1) Pernod Ricard. ( ). Registration Document 2016/17. Available at: (2) Pernod Ricard. ( ) Shareholders meeting. (3) Diageo plc. ( ). Annual Report Available at: (4) Rémy Cointreau. ( ). Registration Document 2016/17. Available at: (5) Davide Campari-Milano S.p.A.. (2017). Annual report for the year ending 31 December Available at: (6) Brown-Forman Corporation. ( ) Annual Report. Available at: (7) Bacardi Limited. ( ) full report. Available at: (8) LVMH Moët Hennessy Louis Vuitton SE. ( ).2016 Annual report. Available at: (9) Constellation Brands, Inc.. (2017) Summury Annual report.available at: (10) Beam Suntory, Inc.. (2017). Summary of consolidate financial statements as of December 31, Available at: (11) HiteJinro Co., Ltd. (2017). Income statement Available at: DotNet/company.aspx?companyId= (12) Marketline. ( ). Marketline Industry Profile Wine in China. Available at: (13) Frent, Mihai. ( ). The Global Alcoholic Beverage Industry: the market, Market Analysis Trends - Corporate Strategies. Xerfi. (14) The World Bank. ( ). Global Economic Prospect. Broad-Based Upturn, but for How Long. (15) PWC. ( ). France: Corporate Taxes on corporate income. Available at: Corporate-Taxes-on-corporate-income (16) OECD. (2017). Real GDP forecast. Available at: (17) Bureau of Economic Analysis. ( ). National Income and Product Accounts, Gross Domestic Product: Third Quarter 2017 (Third Estimate), Corporate Profits: Third Quarter 2017 (Revised Estimate). Available at: (18) Goldman Sachs. (2017). Macroeconomic Outlook Available at: (19) National Bureau of Statistics of China. (2017). National Economy Maintained the Momentum of Stable and Sound Development and Exceeded the Expectations. Available at: (20) Reuters. ( ). China to cancel a third of iron ore mining rights in fight against smog. Available at: (21) OECD. ( ). China - Economic forecast summary (November 2017). Available at: (22) Woodhouse, Alice. (2018). China s premier expects 6.9% GDP growth for Financial Times, [online]. Available at: [Accessed ]. (23) Data taken from: World Bank. Available at: (24) Stacey, Kirian. (2017). India s economic growth rate ticks up to 6.3% in third quarter. Financial Times [online]. Available at: [Accessed ]. (25) Mitchell, Tom. (2017). China anti-corruption purge hits Central Committee members. Financial Times [online]. Available at: [Accessed ]. (26) Lucas, Louise. (2013). Pernod Ricard whisky sales fall in China. Financial Times [online]. Available at: [Accessed ]. (27) Reuters. ( ). Pernod Ricard beats expectations as China rebound accelerates. Available at: (28) BDO. ( ). IFRS at a glance (IAS 41 Agricolture). Available at: (29) Deloitte. (2016). Recreational Marijuana, Insights and opportunities. Available at: DELOITTE%20Recreational%20Marijuana%20POV%20-%20ENGLISH%20FINAL_AODA.pdfì (30) STAP (2007). Regulation of Alcohol Marketing in Europe. Utrecht: National Foundation for Alcohol Prevention. Available at:

24 (31) O Halloran, Marie. (2017). Alcohol labels to display cancer links under new regulations. The Irish Times. Available at: [Accessed ]. (32) Institute of Alcohol studies. (2017). How have UK alcohol taxes changed over time?. Available at: (33) European Commission. (2017). Excise duties - Alcoholic beverages. Available at: (34) Data taken from: S&P Capital IQ. Available at: (35) Data taken from: Bloomberg L.P. Available at: 23

25 Disclosures: Ownership and material conflicts of interest: The author(s), or a member of their household, of this report does not hold a financial interest in the securities of this company. The author(s), 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 author(s) of this report is not based on investment banking revenue. Position as a officer or director: The author(s), or a member of their household, does not serve as an officer, director or advisory board member of the subject company. Market making: The author(s) does not act as a market maker in the subject company s securities. Disclaimer: The information set forth herein has been obtained or derived from sources generally available to the public and believed by the author(s) to be reliable, but the author(s) 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 CFA Society France, CFA Institute or the CFA Institute Research Challenge with regard to this company s stock. CFA Institute Research Challenge