Rémy Cointreau: Top Spirits Franchise, Back to July 2020 Levels

Company Update (RCO FP) (Buy)

Highlights

• RCO shares have fallen 17% since our last update in May

• Sales fell 35% in Q1 FY24, but largely due to CY22 inventory moves

• Growth should improve progressively in the coming quarters

• FY24 outlook implies an organically flat EBIT and a 24.5x P/E

• With shares at €129.85, we see a 55% return (19.1% p.a.). Buy

Introduction

We review our Rémy Cointreau investment case after shares have closed below €130 for the first time since July 2020, having fallen 39% since 2021 year-end, including a further 17% since our last update in May:

RCO Share Price (Last 5 Years)

Source: Google Finance (15-Sep-23).

Since May, RCO has published full FY23 results as well as a Q1 FY24 sales update.

RCO earnings are expected to fall cyclically in FY24, with particular weakness in H1. Year-on-year comparisons are distorted by prior-year inventory movements related to COVID disruption, and there may also be some genuine deceleration in U.S. consumption. Organic Net Sales growth was a negative 35% in Q1 FY24, but this was within guidance and expected to improve progressively across the year. Moreover, while reported sales fell double-digits in Americas, they grew by double-digits in both APAC and EMEA, and U.S. depletions fell only low-single-digits.

FY24 full-year outlook includes “stable” organic sales and implies a flattish EBIT, but higher interest expense and currency mean EPS will likely fall by 8% in FY24. More encouragingly, the planned step-up of A&P spending has been completed ahead of time, so margin expansion should be easier in future years.

With shares at €129.85, RCO shares have a 24.5x P/E relative to our FY24 EPS estimate, though cash conversion is low due to investments in strategic working capital. Our forecasts, which assume a long-term EPS CAGR of 10%, show a total return of 55% (19.1% annualized) by March 2026. Buy.

35% Organic Sales Decline in Q1 FY24

RCO’s Q1 FY24 (April-June 2023) sales update on July 25 showed Net Sales fell by 35% organically year-on-year:

RCO Net Sales By Quarter (Since CY19)

Source: RCO company filings.

This is RCO’s largest such decline since at least 2020 – even with COVID-19, organic Net Sales decline was “only” 25.4% in January-March 2020 and 33.2% in April-June.

However, the 35% organic Net Sales decline was on a prior-year comparable where Net Sales grew by 27% organically. As with other Spirits companies such as Diageo and Pernod Ricard, RCO’s year-on-year comparisons in 2023 are distorted by prior-year inventory movements, including distributors/retailers restocking after running out of inventory during supply chain disruptions, as CEO Eric Vallat explained on the FY23 results call back on June 1:

“The stocks of the retailers and the wholesalers were totally empty at end March ’22. And at that time, we started delivering again beginning April, and we filled the pipe.”

If we plot quarterly sales figures since CY19 on a line chart, we can see that seasonal patterns have become distorted since COVID-19, with April-June 2022 showing a bulge that was unprecedented in the past few years:

RCO Net Sales By Quarter (Since CY19)

Source: RCO company filings.

Moreover, within Q1 FY24’s decline, while reported sales fell double-digits in Americas, they grew by double-digits in both APAC and EMEA, including by “very strong double-digit” in China. Depletions, which unlike reported sales are not distorted by inventory changes, fell only low-single-digits in the U.S.:

RCO Q1 FY24 Comments By Region

Source: RCO results presentation (Q1 FY24).

There may be some genuine deceleration in U.S. consumption. The U.S. consumer has remained resilient in the past few months, but 2023 marks the full normalization after COVID-19, and this will inevitably include some shifts in behaviour and spending compared to 2022. As part of their FY23 results on August 1, Diageo has observed a “moderation of growth” “at the luxury end” of their Spirits business, while Pernod Ricard has expressed a view at their FY23 results on August 31 that U.S. Spirits demand is currently growing at “anywhere between 1% and 2%”. In addition, the continuing strong growth of tequila sales in the U.S. may also be an indirect headwind for RCO’s cognac sales.

A macroeconomic slowdown in China may also be a risk. Pernod Ricard is expecting a soft July-September for their business in China, partly due to a tough prior-year comparable. However, read-across among different Spirits companies in China is difficult due to their different business mixes there. For the same FY23, Diageo sales in China fell -4% organically, while Pernod Ricard’s grew +6% organically; RCO’s China business is different from them both, in being much more weighted towards the “on” trade and thus is more likely to benefit from re-opening this year.

In any case, we expect any slowdown in demand for RCO products to be temporary, given the strong structural trends of growing demand and premiumization in Spirits, and the consumer loyalty and prestige associated with cognacs as well as with RCO’s brands specifically.

V-Shaped Recovery in FY24 Outlook

The sales decline in Q1 FY24 was also within longstanding guidance, because it was predicted as the mechanical result of inventory movements in CY22. As part of the FY23 sales update on April 28, management guided to a “strong sales decline in H1”, followed by a “strong recovery” in H2, including a “sharp rebound in the U.S. from Q3”:

RCO FY24 Outlook

Source: RCO sales update presentation (Q4 FY23).

FY24 outlook has remained unchanged since, most recently reiterated as part of the Q1 FY24 sales update on July 25. The outlook explicitly includes “stable” organic sales and, given it also includes broadly stable margins for Gross Profit, Advertising & Promotion (“A&P”) and overheads, implies a flattish EBIT.

During the FY23 earnings call on June 1, CEO Eric Vallat predicted a progressive recovery in sales growth each quarter:

“We will start slow in the Q1 at group level, will start in the mid-thirties negative … And then sequential improvement, Q2, Q3, Q4, year. Year of two halves, H1 will be negative overall, because the rhythm is start increasing from the Q2, and then positive in the H2 … We will never be at, group level, reaching a lower point, whenever in the year, compared to FY19/20.”

Vallat’s reasons are again partly mechanical (based on lapping specific prior-year comparables), partly macroeconomic (based on moderating inflation, etc.), and partly strategic (based on ongoing price increases).

If FY24 indeed develops as Vallat predicted, then RCO stock should strengthen in the coming quarters as each set of new results provides further datapoints to support the long-term investment case.

Likely 8% EPS Decline in FY24

Notwithstanding the expectations of “stable” organic sales and a flattish EBIT in FY24, higher interest expense and currency mean EPS will likely fall by 8%.

Net interest expense has been guided to “almost double” in FY24, from both higher interest rates and a higher average debt balance because RCO will need to utilise credit facilities more for its short-term cash needs during the sales decline in H1. The average cost of debt is expected to rise to 1.7%, from 1.2% in FY23.

Currency is expected to be a headwind of €10-15m for EBIT, as actual Euro exchange rates (notably for the U.S. Dollar and the Chinese Yuan) fall below where RCO has placed hedges, with most of the negative effect in H1.

Applying the figure above (including our interpretation of management language), EPS will fall by about 8% in FY24:

RCO FY24 P&L Forecast (Our Estimates)

Source: Librarian Capital estimates.

A diluted Adjusted EPS of €5.30 in FY24 would still imply a FY19-24 CAGR of +10.5%.

A&P Step-Up Done Ahead of Plan

More encouragingly, the planned step-up of A&P spend has been completed ahead of time.

Since FY19, A&P as a percentage of Net Sales has risen by 4 ppt from 17.6% to 21.6% (with actual A&P spend more than doubling from €198m to €335m):

RCO Margin Profile (FY19-23)

Source: RCO company filings.

CEO Eric Vallat declared on the FY23 earnings call that A&P has now reached “a normative level in terms of percentage of sales”, and FY24 guidance specifies that A&P ratio will see “stabilization”. This means A&P will only have to grow in line with sales in future years, making it easier for Current EBIT margin to expand to the 33.0% targeted for FY30.

RCO’s Current EBIT, while interrupted by COVID-19 in FY20 and FY21, has a total CAGR of 13.5% across FY15-23:

RCO Current EBIT (FY15-23)

Source: RCO company filings.

Even with a trendline that implies a lower FY23 Current EBIT of €375m, the FY15-23 CAGR would still be 11.6%.

Rémy Cointreau Valuation

With shares at €129.85, RCO shares have a 24.5x P/E relative to our FY24 EPS estimate of €5.30.

However, RCO’s cash conversion has been low in recent years, for example with a Free Cash Flow of just €48.5m vs. Recurring Net Income of €296.6m in FY23:

RCO Earnings & Cashflows (FY19-23)

NB. “WCR” = Working Capital Required; “EdV” = Eau de Vie. FY19 includes €46.3m move in trade payables, "mainly the result of a change in payment terms with eaux-de-vie suppliers". Source: RCO company filings.

The low cash conversion in FY23 is mostly due to strategic working capital, with eau de vie and spirits in ageing process representing a cash outflow of €152.6m. The downward normalization in cognac sales in the U.S. also resulted in a cash outflow. Capital Expenditure (“CapEx”) took another €75.6m.

FY24 will see similar cash outflows, with strategic working capital addition of €110-120m and CapEx of €70-80m.

RCO declared total dividends of €3.00 per share in FY23, including a regular dividend of €2.00 and a special dividend of €1.00; together these represent a Dividend Yield of 2.3% (or 1.5% on the regular dividend alone).

There were €162.7m of share buybacks in FY23. However, the average share count only fell by 0.2% year-on-year, after the dilutive effect of management incentives and the OCEANE convertible bond.

Because of the low cash conversion in FY23, funding the dividend and the buybacks increases the Net Debt from €354m to €537m. However, Net Debt / EBITDA is still at a relatively low 0.84x at FY23 year-end (according to management).

Rémy Cointreau Return Forecasts

We use the following assumptions for our RCO forecasts:

• Net Profit to fall by 7.8% in FY24, then rise by 10% annually

• Share count to be flat

• Dividend to be based on a Payout Ratio of 51%

• Exit P/E multiple of 30x

Our FY26 EPS forecast is €6.42, implying a FY19-26 EPS CAGR of 10.3%:

Illustrative RCO Return Forecasts

Source: Librarian Capital estimates.

With shares at €129.85, our forecasts indicate a total return of 55% (19.1% annualized) by March 2026.

We reiterate our Buy rating on Rémy Cointreau stock.

Ends

Stocks mentioned: RCO FP, DEO 0.00%↑, RI FP. We are long Rémy Cointreau and Diageo.

Disclaimer: This article consists of personal opinions, based on information believed to be correct at the time of writing, but not guaranteed. We undertake no responsibility in updating content in this article. Nothing published here should be taken as financial advice.