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CFA Institute Research Challenge - CFA Society France Team K Hosted by
CFA Institute Research Challenge
            Hosted by

        CFA Society France
             Team K
CFA Institute Research Challenge - CFA Society France Team K Hosted by
Beverages                                           BUY
Pernod Ricard SA                           Alcoholic beverages
                                                                                               Target Price: €153
January, 22nd 2018                                                                             Current Price (as at 01/22/18): €130.0
                                           Exchange: Euronext Paris
                                                                                               Upside: 17.7%
                                           CIQ Ticker: ENXTPA:RI

                                           That’s the spirit
 Market data
 Current price                 €130.0
 52-week high                  €133.6
                                           HIGHLIGHTS
 (01/11/18)
 52-week low                               We initiate coverage of Pernod Ricard with a BUY recommendation and a target price of
                               €106.7      €153 (17.7% upside). Pernod Ricard is the #2 largest spirit player globally and is well-
 (02/10/17)
 Market cap (m)             €34,326.7      positioned to take advantage of key trends in the industry.
 Shares out. (m)                264.1
 Free float                    58.3%
                                           Our investment case relies on the following points:
 EV (m)                     €48,409.8              Pernod Ricard is the #2 largest spirit player globally in a profitable industry
 EV/EBITDA 2018e                17.8x      The industry is concentrated as Top 5 spirits companies (including Pernod Ricard) account
 P/E 2018e                      29.7x      for 63% of global volumes. Pernod Ricard brands portfolio is highly diversified in terms of
Source: Capital IQ                         categories (white and brown alcohol) or geographies (emerging countries accounted for
                                           38% of Pernod Ricard sales in FY17). Those brands are mainly positioned on the premium
                                           market segment (more than 70% of Pernod Ricard brands are premium), generating high
PERNOD RICARD STOCK                        margins (the group EBITDA margin reached 29.0% in FY17).
PERFORMANCE OVER 3 YEARS
                                                    An attractive industry expected to grow at 4-5% in the next 5 years, driven
                                                by emerging markets and premiumisation
  130
                                           The spirits industry has grown from 4% to 5% per year historically due to upscaling and
  120                                      consumption growth in emerging markets: the Chinese and Indian spirits market
                                           respectively grew by 14.4% and 5.6% in revenues between 2011 and 2015 and are
  110
                                           expected to continue to do so. Pernod Ricard will benefit from this trend with a 42% market
  100                                      share in cognac in China and a 45% market share in premium spirits in India. Moreover
                                           developed markets are recovering: in the US, growth is expected to reach 3 to 4 % p.a. in
   90                                      the next 3 years despite stagnating volumes growth. This growth is driven by innovation
   80                                      (1/3 of the growth), and increasing prices allowed by premiumisation. We believe Pernod
                                           Ricard is well-positioned to capture future growth from these trends: we assume a growth
                                           of 3.4% (2017-2022e CAGR) for our topline forecast.

         Pernod Ricard       SBF 120
                                                    Pernod Ricard generates strong cash flows
                                           In FY17, Pernod Ricard reached a historical high in its cash flow generation (+61% in 2
Source: Capital IQ                         years), thanks to efficient operational initiatives (Allegro program). This gives the group an
                                           opportunity to strengthen its balance sheet by deleveraging. The group net debt/EBITDA
                                           decreased from 3.7x in FY14 to 3.0x in FY17 allowing Pernod Ricard to consider M&A
VALUATION SUMMARY (€/SHARE)
                                           opportunities again.
                                                     An undervalued company offering a strong upside potential
 Trading
                             159.0         According to our valuation Pernod Ricard is undervalued: the group is trading at 16.0x
 comps
                                           2018e EV/EBITDA (according to the market) vs 18.3x for its peers. We believe the market
                                           undervalues the following points: (i) Pernod Ricard has room for improvement in terms of
     DCF                  149.4
                                           margins and positioning (both categories and geographies), (ii) Pernod Ricard’s
                                           performance could be even stronger in emerging countries such as India and China and
Source: Team estimates                     (iii) Pernod Ricard has improved its financial position while remaining the #2 largest spirit
                                           player in the world.
KEY FINANCIALS
In €m, as at June, 30th                         2013         2014         2015        2016         2017       2018e        2019e      2020e
Sales                                         8,575.0      7,945.0     8,558.0      8,682.0      9,010.0     9,289.4      9,671.4   10,035.2
  % Growth                                           -       -7.3%        7.7%         1.4%        3.8%         3.1%        4.1%       3.8%
EBITDA                                        2,424.0      2,259.0     2,454.0      2,503.0      2,613.9     2,718.0      2,831.2    2,960.8
  % Margin                                      28.3%       28.4%        28.7%       28.8%        29.0%        29.3%       29.3%      29.5%
EBIT                                          2,104.0      1,815.0     1,588.0      2,094.0      2,230.9     2,308.7      2,405.6    2,514.6
  % Margin                                      24.5%       22.8%        18.6%       24.1%        24.8%        24.9%       24.9%      25.1%
Net income                                    1,206.0      1,025.0       878.0      1,254.0      1,419.9     1,362.6      1,418.4    1,531.3
  % Margin                                      14.1%       12.9%        10.3%       14.4%        15.8%        14.7%       14.7%      15.3%
FCF                                           1,725.7      1,427.8     1,473.0      1,815.8      2,065.6     2,262.3      2,353.2    2,459.3
EV/EBITDA                                       -            -           -            -            18.5x       17.8x        17.1x      16.4x
 Source: Team estimates, company reports

  This report is published for educational purposes only by students competing in The CFA Institute Research Challenge.                    1
CFA Institute Research Challenge - CFA Society France Team K Hosted by
BUSINESS DESCRIPTION
           COMPETITIVE POSITIONING OF                                                              THE WORLD #2 IN SPIRITS AND WINES
           PERNOD RICARD PORTFOLIO                                                                 Pernod Ricard was founded in 1975 with the merger of the two anise producers Pernod
                                                                                                   and Ricard. Today, the firm is the second spirits and wine player ‒behind the British
                                                                                                   Diageo‒ with 70 million liters sold, a world volume share of 4.9% and sales of €9.0 billion
                                                                                                   in 2017. The company produces a broad range of liquors (including scotch, whiskey, anise,
                                                                                                   cognac, brandies, rums, gin, vodka, wine, and champagne – Appendices 1 and 2) and has
                                                                                                   a strong international presence with 101 production sites spread across 23 countries. Asia
                                                  100%
                                                         100%
                                                                100%
                                                                        100%
                                                                               100%
                                                                                      100%
                                                                                                   and the Rest of the World (RoW) contribute over 40% of the group’s sales with #1 position

                                                                                             72%
                                                                                                   in spirits sales in China (Martell) and India (Jameson). Pernod Ricard ranks second
                                            62%
                 50%
                        50%
                               50%
                                     50%

                                                                                                   following Diageo in its core regions -Western Europe and North America- which represent
                                                                                                   respectively 22% and 16% of its global revenues. Boosted by a strong growth in emerging
                                                                                                   markets (China alone grew by 14.4% CAGR in revenues between 2011 and 2015), group
                                                                                                   sales have grown at a 4.2% CAGR since 2006.
                               Gin
                          Aniseed

                            Rhum
                 Liqueurs & Bitters

                          Bourbon
                           Whisky

                           Mezcal
                 Cognac & Brandy

                           Overall
                          Tequila
                           Vodka

                      Champagne

                                                                                                   For the past few years, the value creation strategy of the company has revolved around
                                                                                                   four main axes:
                                                                                                          (i) Investing heavily in communication and premiumising its international strategic
                                                                                                              brands to attract and gain the loyalty of affluent individuals to boost the growth of
                                                                                                              its brand portfolio.
                                                                                                         (ii) Seizing emerging markets opportunities (e.g. the IMF expects Asia to grow by
                                 Premium                        Standard                                      20% in the next 4 years): Pernod Ricard has been successful in India; in particular
                                                                                                              its whiskey portfolio (local brands Royal Stage and Imperial) enabled the firm to
           Sources:                  Company                    reports,                team
           analysis
                                                                                                              thrive in the Indian peninsula.
                                                                                                        (iii) Deleveraging and restructuring following the acquisition of Vin & Spirit in 2008.
                                                                                                        (iv) Implementing a Corporate Social Responsibility policy to advocate for
           PERNOD RICARD PORTFOLIO IN                                                                         responsible drinking.
           VOLUME
                                                  Tequila                                          The most premium portfolio in the spirits industry
                            Brandy                  7%                    Whiskey                  Pernod Ricard leads several European and American markets with its Iconic Global Brands
                              3%                                           40%                     (such as Absolute, ranking second on the vodka category in terms of sales volume and
                       Liquor
                                                                                                   Chivas Regal, the number two whiskey worldwide in the super-premium category). Almost
                        7%
                                                                                                   80% of Pernod Ricard’s portfolio is premium, making it the spirits company with the highest
 Champagne                                                                                         share of premium spirits in the industry. Nonetheless, most of these brands still have room
    7%
                                                                                                   for improvement as many of them are ranked #2 or below. Pernod Ricard’s spirits portfolio
                Pastis                                                                             strategy is twofold. First, upscaling its portfolio to create value and accelerate growth by
                 7%                                                                                placing its International Strategic Brands at the core of its activity. Second, using its Local
                                                                                                   Strategic Brands to penetrate local markets, leverage its distribution platform and ultimately
                          Gin                                                                      convince customers to trade up for their most exclusive (and profitable) beverages. This
                          10%                                                                      balance enables Pernod Ricard to enjoy a premium positioning whilst its standards brands
                                        Rhum
                                                                                                   finance the upscale brands development.
                                             Cognac                            Vodka
                                         7%
                                               6%                               6%                 In terms of brand growth, results are diverse: Martell grew over 15% in 2017 while Kahlua
                                                                                                   shrank by 3%. However, 14% of its International Strategic Brands performed strongly,
           Sources:                  Company                    reports,                team       namely Jameson and Martell. 36% of its international brands are ‘cash cows’ with Kahlua
           analysis                                                                                and The Glenlivet having the highest world market shares. A question remains for
                                                                                                   Beefeater, Malibu, Ballantine’s and Chivas Regal which grew more slowly and have a weak
                                                                                                   market share.
           BCG MATRIX: PERNOD RICARD
           TOP 13 BRANDS (APPENDIX 6)                                                              Overall, Pernod Ricard’s International Strategic Brands exhibit a strong growth and
                                                                                                   potential for further improvement.
                                  20%
          StarsBrand market share                                              Question
                                        Jameson                                marks               Important marketing expenses to power premium brands
Volume growth

                                                         15%                                       Marketing expenses are key to develop brands and increase their value. Since 2014,
                                                                Royal                              Pernod Ricard’s marketing expenses represent around 19% of its revenues. Advertising
                              Martell                           Salute
                                                                                                   and Promotion (A&P) expenses focus on creating premium brands and responding to the
                                                         10%                    Perrier-           needs of new customer categories such as Millennials (which represent 26% of the world’s
                                                  Havana                         Jouët             population), who look for innovative and exclusive products. Additionally, the cocktail scene
                                                   Club
                                                                       Chivas Regal                is growing and bartenders have an essential role: to set the quality standard and as opinion
     2.0%                1.5%              1.0%          5%
                                                          0.5%            0.0%     -0.5%
                                                                                                   leaders. Therefore, an important part of the marketing expenses focuses on training
  The                                   Beefeater                              Ballantine's        mixologists to serve Pernod Ricard’s spirits. Further, Pernod Ricard’s size, its
Glenlivet
                       Kahlua              Absolut
                                                         0%            Malibu
                                                                                                   decentralized organization and its large distribution network allow them to increase the
                                                                                                   sales of a local ‘craft brand’ overnight, supporting its growth strategy.
                                Mumm
                                                                                      Dogs
                                                                                                   Pernod Ricard was built through acquisitions targeting mainly Premium and Super-
           Cash cows                                     -5%
                                                                                                   Premium brands that they integrated with great success. On top of that, the group manages
           Sources: Team Estimates, Company                                                        the new brands to achieve a great performance as the Drinks International Magazine 2017
           reports                                                                                 Annual Bar Report proved by naming Monkey 47 as the most trending spirits brand in the
                                                                                                   world. This is a key advantage of Pernod Ricard as having the best portfolio and the ability
                                                                                                   to develop brands is essential in this industry.

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CORPORATE GOVERNANCE
SHAREHOLDER STRUCTURE
                                           SHAREHOLDER STRUCTURE
                                           Pernod Ricard is listed on the NYSE Euronext SA Paris Eurolist and belongs to major
                                           indexes such as the CAC 40. Pernod Ricard is originally a family-owned company but the
                       14.2%
                                           family’s share (Société Paul Ricard) has progressively been diluted to a 15% stake and
                                           19% of voting rights. The majority of Pernod Ricard shares are traded publicly.
                         7.5%
                                           GOVERNANCE
       58.3%              10.2%
                                           Overall we do not foresee any governance issues with Pernod Ricard’s governance which
                                           we rate as strong:
                        9.8%
                                           Executive Management - Strong: Pernod Ricard executive management is a team of
                                           qualified and experienced managers acquired through several years in the group and/or
      Société Paul Ricard *                across the Food & Beverages industry. The former CEO retired in February 2015 and
      Groupe Bruxelles Lambert *           Alexandre Ricard took the head of the company.
      Capital Group Companies
      MFS Investment Management            Rights and Obligations of Shareholders - Strong: One-share-one-vote policy at the
      Float                                exception of shares held for more than 10 years from the 12 May 1986 that are eligible to
                   * > 10% voting rights   double voting rights within the limit of 30% voting rights. This approach tends to protect
Source: Company Data, Capital IQ           and support historical and long-term investors.
                                           Board of directors - Medium: 6 out of 15 members are independent directors, one third
                                           are women and two directors are employees’ representatives (Appendix 3). Moreover, Mr
                                           Ian Gallienne is an independent director but also CEO of Groupe Bruxelles Lambert that
GOVERNANCE STRENGH                         holds 10.9% of voting rights in Pernod Ricard. With the ownership of less than 10% of the
ASSESSMENT (RATED ON 5)                    shares, the status of Mr Gallienne is compliant with the regulations but we could challenge
                                           the status of independence regarding the capacity of voting rights of this director.
       Executive                           Disclosure, Transparency & Engagement - Strong: Strong investor relations
                                       4   department, providing strong and high-quality reports. Compensation is disclosed.
      Management
                                           Resources are deployed to conduct internal audits and compensation incentives are
       Rights and                          consistent with shareholder interests. Three members of the Board are employee
      Obligations of                   4   representative, one is a non-director.
      Shareholders
                                           Takeover Defence - Medium: 58.3% of the shares are floating publicly, the main
                                           shareholder is Société Paul Ricard (14.2% of the shares and 19.8% of voting rights) as of
 Board of Directors                3       30 June 2017.

     Disclosure,                           CORPORATE SOCIAL RESPONSIBILITY
   Transparency &                      4
    Engagement                             By clearly defining its policy and an action plan, Pernod answers expectations from
                                           consumers, builds a story around the group and its brands and consolidates its marketing
                                           position. To do so, Pernod involved more than 1,300 stakeholders through a survey and
 Takeover Defence                  3
                                           identified four actions to promote in its CSR policy:
                                                   Promoting responsible drinking: 86% of affiliates carried out at least one
Source: Company data, Team estimates                responsible drinking initiative in 2016/2017
                                                   Protecting the planet: Paul Ricard Oceanographic Institute (IOPR) was created in
                                                    1966 and promotes the knowledge and protection of marine environments
                                                   Promoting engagement: 1,142 suppliers signed the Supplier CSR commitment
                                                    Empowering all employees: brand positive impact with the Chivas Venture project
                                                    that supports social entrepreneurs.

                                           INDUSTRY OVERVIEW AND COMPETITIVE POSITIONING
                                           Historically the spirits market has grown in value at an average of 4-5% per year. Yet, for
GROWTH BY COUNTRY (GDP                     future trends we need to differentiate developed and emerging economies.
PER CAPITA)
                                           Traditional markets still hold opportunities
                           India: 8.7%     The US and the European economy are engaged in a slow but consistent recovery,
 8%                                        contributing to the disposable income of consumers and therefore the spirits industry. In
                          China: 7.9%      the US and Europe the spirits market is well-established, alcohol has been part of the
                                           culture for decades. Despite a decrease in volume in Europe, the price-mix balances the
 6%
                                           downturn. Growth is stable in the US with an expected 3-4% CAGR expected for the next
                        The US: 3.4%       three years. Vodka and Whisky dominate the sales in most Western markets. Premium
 4%                                        brands gather most of the growth, overall volumes remain stable but value increase
                                           through upscaling.
 2%                                        Strong emerging markets drive economic growth
                                           The Chinese and Indian spirits market grew 14.4% and 5.6% (CAGR) in revenues
                                           respectively between 2011 and 2015 (vs GDP growth of 7.3% and 8.1% respectively).
                                           Growth is expected to continue as IMF forecasts an increase of Asian GDP of 20% over
Sources: IMF, OECD data                    the next 4 years. China GDP per capita growth should slightly decrease but India’s will
                                           continue to grow reflecting strong economic performance in the region, improved
                                           urbanization and the rise of its middle class. As the effects of the anti-corruption measures
                                           implemented in China since 2013 are now fading, Cognac sales are expected to recover.

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In India, the restrictions induced by the GST and the highway ban should be more
                                             moderate than initially thought.
                                             LATAM and RoW growths are more vulnerable due to political and economic instability.
                                             Overall, a growth ranging from 3% to 8% is expected in the main emerging markets (see
   PRICE EVOLUTION (PRICE PER                appendix 5)
   UNIT, BASIS 10)                           Premiumisation: a trend pushed by increasing incomes and millennials
                                             Disposable income increases in both developed and emerging markets. Since spirits
 16                                          consumption is perceived as a social distinction and income increase, there is room for
                             LATAM
                                             price growth. The premiumisation is also explained by a stronger competition in standard
 15                                          prices. Premiumisation takes different aspects according to spirits type: the production
                                             process of brown spirits (loss in volume with aging) justifies upscale prices and premium
 14                                          brands. In white spirits or liquors however, it is enabled by innovation. We assume that
                      India
                               N.America     premium brands generate an additional margin after advertisement and promotion.
 13
                                             Marketing & innovation are key success factors as Millennials shape the future of
                                             the industry
 12
                                China        Consumption of spirits is more popular among younger generations but women recently
                                             also increased their consumption (cocktails). Millennials represent 1.7 billion people in
 11                                          2017, close to 25% of the global population, and their purchasing power is bound to grow
                               Europe
                                             significantly in the coming years. They are demanding customers, require transparency
 10                                          from companies and look for unique, premium products but also convenience and
                                             experiences.
                                             Since millennials are sensitive to experience new products, innovation is key to reach this
   Sources: Statista, Team analysis          pool of consumers. Global brands lose their appeal as they lack the capacity to answer
                                             specific and new expectations. Digitalization shapes their expectations and consumption
                                             habits, spirits companies diversify their marketing strategy to compete:
                                              (i) Companies have implemented online platforms to buy their products online (links
   MONKEY 47 WEB ENTRIES
                                                  towards e-commerce platforms on most of their brands websites).
   (GOOGLE MEASURE)
                                             (ii) Brands keep introducing new flavored products and extensions of existing brands,
80                                                (Pernod Ricard’s Black Barrel is priced 25% above its mother brand, Jameson).
                                            (iii) Brands advertising is strong on social media; promotion also plays on product
65                                                placement or celebrity sponsorship (US rapper P.Diddy for Ciroc vodka).
                                            (iv) Companies try to influence bartenders, key opinion leaders who set the quality
                                                  standard with a growing cocktail scene.
50
                                             A highly regulated industry
                                             Direct and indirect taxes represent most of a retail spirit bottle price (e.g. 50 to 80% of retail
35                                           price in France or in the United States). Taxes limit profit margins, so price must be high
                                             enough to cover the costs, which is easier to achieve with a premium brand.
                                             To prevent harmful alcohol consumption most countries enforce restrictions: a minimum
20
                                             drinking age (21 years in the US), a minimum purchasing age (sellers are required to ask
  Jan-16            Jan-17           Jan-18
                                             for ID in Swedish liquor stores) and production, advertising and sales channels are also
                                             often regulated by governments. Restrictions can extend to ban in several countries
                                             (mostly in Middle East such as Kuwait or Iran).
   Sources: Google trends
                                             No major M&A deals expected
                                             The spirit & Wines industry is highly concentrated: Diageo and Pernod Ricard have close
   TAXES IN A BOTTLE OF SPIRITS              to 15% volume market share in 2016. When considering premium spirits, their share
         Whisky, 75cl sold €15 in France     increase to 41% as of March 2016. The top 5 represents 63% of the global volume within
                                             this segment. A new wave of M&A started in 2014 (Suntory’s acquisition of Beam, Diageo
     100%                                    taking control of United Spirits) and since then, deals have targeted small companies
                  2.5                        focused at the top end of the market (Campari’s takeover on Grand Marnier). High multiples
      80%                    VAT             have been paid by acquirers (more than 20x EBITDA), making the operation dilutive in
                  2.2
                                             most cases. Given Pernod Ricard’s size, we can expect it to play the role of an acquirer in
                             Social          the future.
      60%
                 4.8         contributions

     40%                     Indirect tax    COMPETITIVE OVERVIEW
                                             The spirits industry is an attractive industry, highly concentrated and that can be difficult to
                             Non-taxed       enter.
     20%         5.4         value           Raw materials supply is abundant (A)
                                             There are two main spirits categories: (i) the white spirits, such as vodka or gin and (ii) the
       0%
                                             brown or ageing spirits, such as cognac or whisky. Both are produced from agricultural
  Source:    French    government,    team   products such as grains or other vegetals. Vodka can be made from potatoes, beetroots
  analysis                                   and other ingredients, so supply sources are wide, and manufacturers can switch from one
                                             to another. Some raw materials choice can be limited: Brandy or Cognac are made from
                                             wine and global production went down 8.2% in 2017 to reach its lowest in 50 years.
                                             New players can shake the big ones (B)
                                             Despite high entry barriers (capital to set up facilities, instore brand awareness and
                                             licenses to produce), some players managed to play their hand and be successful as
                                             crafters. Tito’s vodka grew 37.4% in volume in 2016 to sell 3.8 million cases and seize
                                             market shares from traditional players (as Absolut) in the US market. Spirit crafters boomed
                                             following the craft brewing trend, and raised equity on crowdfunding platforms (Santamania
                                             raised £400k in less than a week) or from the numerous private equity funds specialized in
                                             spirits.

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Consumption trends and counterfeit moderately threaten the Spirits Industry (C)
PORTER’S     FIVE               FORCES    Health and wellness trends push consumers to buy more non-alcoholic beverages. In
(APPENDIX 4)                              emerging markets, such as China, counterfeit is difficult to measure but is common
                                          practice, as empty bottles are refilled with substitute alcohol.
                      A
                  5                       End-consumers lead the trends but distributors are constrained (D)
                  4                       Alcohol is not a first necessity product and consumers have a strong bargaining power
                  3                       both on-trade and off-trade with low switching costs and a broad range of choice in terms
                  2                       of beverages both alcoholic and non-alcoholic. Despite a large choice of supplier
     E                                B   distributors power is more limited, the influence of some brand on customers can push
                  1
                                          them to sell without margins (Pernod Ricard’s Pastis).
                  0
                                          Competition is fierce (E)
                                          The industry is strongly concentrated as Top 5 spirits companies account for 63% of global
                                          volumes. To thrive in the beverages industry, a firm must master three key success factors:
                                          (i) be differentiated: players should allocate an important portion of the sales to marketing
           D                      C       expenditures to generate brand awareness and customer loyalty – crucial in an industry
Legend                                    where consumer have a myriad of choices; (ii) better segment their customer base and
0 – No threat to the business             improve their advertising targeting, invest in big data and digitalization: such investment
5 – High Threat to the business           will enable firms to have a more granular understanding of their customer base and hence
Sources: Company data, Team estimates     generate customer loyalty and (iii) sell in high volumes to offset the fixed costs incurred by
                                          the producers of alcoholic drinks.

                                          NO PREMIUM FOR SIZE IN VALUATION

                                                       30.0x
                                                               Rémy Cointreau
                                                                                                               Large diversified spirits
                                                       25.0x
                                                                             Brown-Forman
                                                                                               Constellation
                                                                                                                                    Diageo
                                                       20.0x       Campari                       Brands
                                                                             Small
                                           EV/EBITDA

                                                                             specialists
                                                               Marie Brizard
                                                       15.0x                                      Pernod Ricard

                                                                                                                                               EV (m€)
                                                       10.0x Stock Spirits
                                                                Group

                                                        5.0x

                                                        0.0x
                                                               -               1,000        2,000         3,000             4,000            5,000
                                                                                                EBITDA (m€)
                                          Source: Team estimates, Capital IQ

                                          Luxury is an acquired taste
                                          Pernod Ricard is undisputedly the most premium spirits producer of all with almost 80% of
                                          high-end brands. Pernod Ricard made premiumisation one of their priorities after divesting
                                          Orangina in 2001 to clarify in their offer. Since then, the company focused on deleveraging
                                          and carrying out bolt-on acquisitions to build a more prestigious portfolio. As we stated
                                          before, size is a crucial asset in this industry because it enables new brands to be known
                                          worldwide thanks to an extensive distribution network. Pernod Ricard clearly intended to
                                          take advantage of its size and acquired super-premium companies and developed more
                                          craft spirits. This strategy proved to be a success in 2016 as they acquired a majority stake
                                          in Monkey 47. In 2017, the Drinks International Magazine 2017 Annual Bar Report declared
                                          Monkey 47 as the most trending brand in the world. Indeed, thanks to the deleveraging
                                          that the company has achieved, we believe that Pernod Ricard intends to pursue this
                                          differentiation path with Smooth Ambler and Del Maguey, bourbon and mezcal brands
                                          respectively.
                                          Pernod Ricard strong position in India and China
                                          In Asia – mainly China and India which together account for 17% of Pernod Ricard total
                                          sales – the group will benefit from a strong recovery after subdued last 2 years. Especially
                                          as it is positioned on the premium segment, expected to post double-digit sales CAGR
                                          over the next 5 years. In India, Pernod Ricard is only exposed to the fast-growing premium
                                          segment while its main competitor United Spirits is not (only ~50% of its sales). This will
                                          help the group to increase its domination on the local market (45% market share as of
                                          FY16). In China, Pernod Ricard will benefit from the recovery of the cognac market (Martell
                                          represents 80% of the group’s sales in the country). As well as in India, Pernod Ricard is
                                          in the right place to both seize the Chinese premium opportunity and fill in the absence of
                                          International spirits in China (only ~1% of alcohol volumes).

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INVESTMENT SUMMARY
                                             We issue a BUY recommendation with a target price of €153, an upside of 17.7% from
                                             valuation date’s closing price of €130.0. Our recommendation is based on (i) a steadily
                                             growing market offering opportunities for leading players, especially in emerging markets
                                             (ii) a well-balanced and well-diversified brand portfolio and (iii) an undervalued company
                                             with a strong cash generation.
                                             GOOD GROWTH PERSPECTIVE
                                             We believe that Pernod Ricard has a unique positioning to capture growth especially in
                                             emerging countries. Indeed, the spirits industry is historically steadily growing (in terms of
2017 SALES BREAKDOWN BY                      value) at a 3% to 5% growth rate p.a. Growth is and will be driven by emerging countries
GEOGRAPHIES                                  (in particular by China and India), with a growth range of 3% to 8% in main emerging
                                             countries next years. Historical markets (mainly Western countries) are engaged in a slow
                                             but consistent recovery: in the US, growth is expected to reach 3% to 4% p.a. growth in
                                             the next 3 years. Simultaneously, spirits industry is affected by 2 major trends: innovation
                         Americas
         Europe           30%                and premiumisation. We believe that Pernod Ricard is particularly well-positioned (i) to
          31%                                benefit from growth in both emerging and historical markets when taking into account its
                                             geographical positioning and (ii) to maintain its #2 rank on the market thanks to a voluntarist
               Asia / RoW                    innovation policy and a strong positioning on premium brands. As a consequence, Pernod
                  40%                        Ricard’s strategy focused on high-end brands and emerging countries will help improve its
                                             topline and margins.
                                             A STRONG CASH GENERATION ALLOCATED TO DEBT REDUCTION
Sources: Company data
                                             Thanks to the implementation of efficient operating measures and a strong financial
                                             discipline, Pernod Ricard achieved a 5.7% improvement in its cash generation (FCF/sales),
                                             reaching 22.9% of sales in FY17. We believe, this trend will continue in the future (24.5%
EVOLUTION           OF          FCF/SALES    in 2020e). Pernod Ricard historically generated margins above its peers (21.3% 1992-2017
RATIO                                        EBITDA margin in average vs 20.0% for peers). We expect this outperformance to continue
                                             in the coming years (29.5% EBITDA margin in 2020e). This improved cash generation will
                               24% 24% 25%
                         23%                 strengthen the group’s financial position through deleveraging: the group net debt/EBITDA
   20%             21%
         18% 17%                             now stands at 3.0x vs 3.7x in FY14. This improvement provide an opportunity to reconsider
                                             strategic acquisitions in the future after years of financial restrictions.
                                             AN UNDERVALUED COMPANY VS PEERS
                                             Our valuation suggests that Pernod Ricard is undervalued: the group is currently trading
                                             at 16.0x 2018e EV/EBITDA (according to the market) vs 18.3x for its peers. Pernod Ricard
                                             is also undervalued compared to its key competitor Diageo (#1 largest spirits player
                                             globally), which is trading at 17.6x 2018e EBITDA (Appendix 9). We believe the market
                                             currently underestimates the quality of Pernod Ricard positioning mainly in India (45%
                                             market share in premium spirits) as well as its ability to deleverage thanks to its cash flow
Sources: Company data                        generation. Moreover, spirits is a highly attractive industry in which multiples offered are
                                             high (at around 20.0x EBITDA) for craft brands, which are really popular with millennials.
                                             Pernod Ricard is already positioned on this market and has already invested in such brands
                                             (Del Maguey Mezcal acquisition in FY17) and should strongly benefit from these
                                             developments.

                                             FINANCIAL ANALYSIS
EVOLUTION OF PERNOD RICARD                   A STEADILY GROWING INDUSTRY, DRIVEN BY EMERGING MARKETS
REVENUE (€M)
                                             Pernod Ricard sales reached €9,010m in 2017 compared to €8,682m in 2016
                                             (+3.8% YoY), with the following breakdown: Europe (30%), Americas (30%) and Asia
                                             (40%). Its decentralized business model allows the group to capture growth and benefit
                                             from growth drivers in all countries in which it is present and to gain protection against a
                                             potential slowdown in some areas. Pernod Ricard organic sales growth amounted to 4%
                                             in 2016, in line with the average historic growth in the sector, reaching 3% to 5%. This
                                             performance reflects a strong operating efficiency of the group entities (growth is not only
                                             driven by acquisitions). However, Pernod Ricard’s performance has to be mitigated by a
                                             relatively low 2013-2017 sales CAGR (1.0%). Indeed, the group has been strongly affected
                                             by a challenging environment but has since implemented operational improvement
Sources: Company data                        projects, such as Allegro.
EVOLUTION OF PERNOD RICARD                   Pernod Ricard grew in all regions in FY17 but with different profiles:
TOPLINE GROWTH (ORGANIC)                     America recorded a 7% organic growth in spite of a slowing market (+3.1% in FY17 vs
                                             5.9% in FY 16 according to Nielsen). In the US, the 5% growth was mainly driven by
                                             international strategic brands such as Jameson and Martell (+15% and +25% respectively).
                                             America -excluding the US- achieved a 11% growth driven by Canada with a 6% organic
                                             growth and Mexico, which returned to growth. The latter was mainly driven by Chivas.
                                             Asia RoW recorded a 1.0% organic growth, in spite of the strong Korean decline. In China,
                                             Pernod Ricard achieved a sustainable rebound with a 2% growth in FY17 vs -9% in FY16,
                                             driven by cognac Martell (+6%) which dominates the Chinese market with a 42% market
                                             share. In India, FY2017 was rather difficult (only 1.0% growth) due to changes in
                                             regulations but Pernod Ricard confirms its leading position with a 45% value market share.
Sources: Company data
                                             Europe achieved a strong 3.0% organic growth in FY17 driven by 3 countries: Spain, UK
                                             and Russia. In Spain, Seagram’s gin drove the strong local performance (+5%), and allows
  This report is published for educational purposes only by students competing in The CFA Institute Research Challenge.                        6
EVOLUTION OF PRICE PER 9L                   Pernod Ricard to keep a 24% market share. In Russia, the group benefitted from a strong
CASES                                       positive pricing (variation in the RUB/EUR exchange rate) and from the growth of strategic
                                            international brands such as Absolut or Ballantine’s. In France, Pernod Ricard maintained
                                            its leading market share (30%) but recorded only a 1.0% organic growth after adjustments
                                            for advance shipments at end of FY15.
                                            Innovation is a key consideration for Pernod Ricard
                                            Innovation accounts for nearly one third of organic growth and is mainly concentrated in
                                            the fastest growing brands. In FY17, innovation delivered 1.0% incremental topline growth.
                                            The group expects that innovation will drive 20 to 25% of the group’s future growth.
                                            Price and volume both increased in FY 2017
                                            Sales in strategic international brands are driven by both growth in price and volume: sales
Sources: Company data, team estimates       per 9L cases remain flat between FY17 and FY16 (-0.1% YoY), in spite of a slightly forex
                                            impact but improved by 3.5% yearly between FY14 and FY17. Price per 9L cases
EXPENSES        BREAKDOWN              IN   increased over the period by €11.6 from €106.0 to €117.5. We believe these results
FY17                                        illustrate the premiumisation strategy undertaken by the group.

                                            PREMIUMISATION AS A CATALYST FOR MARGINS GROWTH…
                                            Pernod Ricard places operational excellence among the “four essentials” to attain
                                            leadership status by 2020
                                            The group tries to improve its business performance delivering significant savings in (i)
                                            COGS, advertising and promotion expenses and (ii) in working capital requirements. As at
                                            2016/17, approximately one quarter of the savings of the operational efficiency roadmap
                                            have been delivered, amounting to €400m over the period 2015-2020.
                                            Gross margin, amounting to 62,2%, improved due to a better product mix, lighter price
Sources: Company data                       pressure and tight management of cost of goods sold.
                                            Advertising and Promotion (A&P) investments were up +3% to €1,691m. The operational
EVOLUTION OF PERNOD RICARD                  excellence initiatives drove stronger efficiency: half of savings on costs are reinvested in
PRO                                         A&P. Expenditure on A&P is a decisive factor in the success of a brand, in order to meet
                                            premium clients and to convince bartenders. A&P expenses were refocused on key
                                            markets, including the US, but were also allocated to key projects.
                                            General and administrative costs increased less than sales, due to a strong discipline
                                            (Allegro program) to achieve 60 million euros in savings in FY17. These savings mainly
                                            dealt with supply chain with a better freight and negotiation cost and an optimized
                                            procurement policy.
                                            Profit from recurring operations (PRO) increased by 40bp reaching 26.6% of sales, driven
                                            by the good performance of the Americas (+ 8% on a like-for-like basis) and a 2% positive
                                            forex impact. From a global point of view, PRO breakdown followed the same trends and
Sources: Company data                       reparation as topline. We note a slight decrease in PRO margin in Asia due to India in spite
                                            of a positive price effect in China.
EVOLUTION OF PERNOD RICARD
                                            A historically strong financial performance compared to peers (Appendix 9)
AND PEER EBITDA MARGIN
                                            To better understand Pernod Ricard’s business, financial performance and environment,
 30.0%                                      we analyzed the group financial performance in comparison with a sample of 30 companies
                                            over the world, specialized in spirits, wine or champagne for nearly 30 years. It appears
 25.0%                                      that Pernod Ricard margins are well above peers’ average since 2001: Pernod Ricard 2017
                                            EBITDA margin was nearly 8% higher than peers’ average. It is mainly explained by the
 20.0%                                      fact that Pernod Ricard’s business model, in comparison with peers, includes businesses
                                            with higher margins such as wine or champagne. At the same time, Pernod Ricard
 15.0%                                      historical margins are relatively stable but progressing over the time, at around 26% since
                                            2012. In 2017, the group EBITDA margins increased by 40bp due to the effectiveness of
 10.0%                                      the cost savings program implemented in 2015. Consequently, Pernod Ricard achieved
                                            higher operating margins than its peers as described above (Pernod Ricard operating
                                            margins are higher than peers since 2001).
           Pernod Ricard EBITDA             Despite the rise in the income tax, the net result stood at 16.4%, favorably impacted by the
           margin                           fall in the cost of debt (3.3% in FY2017 vs 3.8% in FY2016) and the rise of the PRO.
           Aggregated peers EBITDA
           margin                           A highly profitable company well above peers
Sources: Capital IQ, company reports        Net margin amounting to 15.8% in FY17 stood above 5 previous year net margins (550bp
                                            above FY15 net margin) mainly due to a strong decrease in financial expenses and, once
EVOLUTION OF PERNOD RICARD                  more, effects from the Allegro cost reduction program. Furthermore, Pernod Ricard
NET DEBT TO EBITDA                          recorded a historical net margin average of 10.5% over 1992-2017 well above peers
                                            average, standing at 5.6% (median 7.3%).

                                            …ALLOWING A BETTER CASH GENERATION…
                                            In FY17, the group generated very strong FCF (+22.4% YoY), reaching a historical high,
                                            with +61% in 2 years, particularly thanks to operational efficiency initiatives.
                                            The working capital requirements decreased between FY17 and FY16, amounting to 184
                                            days of sales vs 194 days, thanks to Allegro program (€50m in savings in FY17) favoring
                                            a better demand and stocks management.
                                            The high cash conversion rate (86.0% in FY17) is based on (i) a 3.3% increase in profit
Sources: Company data
                                            from recurring operations, (ii) a controlled increase in long-term stocks (for whiskey), (iii) a

  This report is published for educational purposes only by students competing in The CFA Institute Research Challenge.                        7
EVOLUTION OF PERNOD RICARD                working capital down €123m thanks to improved logistics and (iv) finally capex up to €20m
ROIC                                      in line with sales growth.
                                          The net cash generation comes out at €801m in FY2017 vs €461m in FY2016 and allows
                                          a reduction of the net debt to €7.9bn. The net debt/EBITDA ratio at average rates was 3.0
                                          as at 30/06/17, significantly down from 3.4 at 30/06/16. Indeed, the group pursues a strong
                                          deleveraging strategy for years, improving its credit profile.

                                          …OFFERING AN ATTRACTIVE PROFILE FOR INVESTORS
                                          Strong and stable ROIC
                                          ROIC historical average over 5 years reached 7.9% and stood well above WACC. The
                                          ROIC including goodwill of Pernod Ricard amounted to 8.3% in 2017 against 6.4% in 2015.
Sources: Company data, team estimates     This increase and the return to historical levels is explained by (i) an improvement in the
                                          EBITA margin (+ 700bp) and (ii) an optimization of assets. After restating the goodwill
EVOLUTION OF PERNOD RICARD                resulting from the acquired brands, the ROIC reached 26.9% in 2017, which is 340bp below
ROE                                       the historical average (Appendix 13).
                                          ROE is quite stable over the period, standing above peers level
                             10.2%        Pernod Ricard ROE is relatively stable over the time at around 10% but the group ROE
                     9.3%                 returns to its 2013 level in 2017 and reached 10.6%. A DuPont analysis (Appendix 14)
    8.7%                                  shows this is due to lower financial expenses, despite an increase in corporate income tax
                                          rate. According to our historical analysis, Pernod Ricard trailing median ROE over 5 years
            6.6%                          is above peers level that stands at 8.6% vs 9.3% for Pernod Ricard.
                                          An attractive pay-out ratio
                                          Pernod Ricard strongly improved its dividend policy in FY17 which reinforces the
    2014     2015    2016     2017
                                          attractiveness for Pernod Ricard stock. The group distributed €2.02/share dividend in FY17
Sources: Company data, team estimates     (+7% YoY, +23.2% vs FY14). This represents a pay-out ratio of 36%, which accounted for
                                          around 1/3 of the group net profit from recurring operations. In our forecasts, we expect
                                          Pernod Ricard’s pay-out ratio will follow the same trend (+11.0% in FY18e).
                                           In €m, as at June, 30th          2013     2014     2015    2016     2017       2018e   2019e   2020e
                                           EBITDA margin                   28.3%    28.4%    28.7%   28.8%    29.0%       29.3%   29.3%   29.5%
                                           Net margin                      14.1%    12.9%    10.3%   14.4%    15.8%       14.7%   14.7%   15.3%
                                           ROE                             10.6%     8.7%     6.6%    9.3%    10.2%        9.9%   10.2%   10.9%
                                           ROIC (incl. Goodwill)            8.9%     8.2%     6.4%    7.6%     8.3%        8.3%    8.5%    8.7%
                                           EBIT/interest                      3.9     3.6      3.1      4.4     5.4         9.5     9.4     9.5
                                           Net debt/EBITDA                    3.6     3.7      3.7      3.5     3.0         2.9     2.9     2.9
                                           Cash conversion                 87.5%    87.9%    86.8%   86.7%    86.0%       87.2%   87.2%   87.3%

                                          Source: Team estimates, company reports

                                          VALUATION
                                          Our valuation leads us to a EUR 153 target price which implies a potential upside of
                                          17.7%, based on the discounted cash flow method and trading multiples-based method.
                                          We also conduct a Monte Carlo simulation which supports our buy recommendation
                                          (Appendix 19).

                                          DCF VALUATION – EUR 149.4 TP – 15.0% UPSIDE
                                          We made our forecasts on an 8-year period (2018e-2025e), completed by a terminal value
                                          (TV). Our assumptions are relatively conservative, in line with market trends. We assume
                                          a top line CAGR of 3.3% for the period 2018e-2023e (in line with industry market forecasts),
                                          a 29.5% EBITDA margin in 2020e, a stable level of capital expenditures (3.7% of sales on
                                          the first 3 years of our model) and 7.7% WACC for the first two years of our model, a 7.9%
                                          WACC for the next two years and a 8.0% WACC for the remaining years. We base our
                                          terminal value on a 2.2% sales growth rate, a 30.2% EBITDA margin and 3.3% capex/sales
WACC CALCULATION FOR YEAR
                                          ratio.
1&2
                                          P&L Forecast explanation – We split Pernod Ricard revenues in 3 geographic areas to
        WACC calculation
                                          show different growth profiles. The decentralized organization enables the group to seize
 Risk-free rate               1.8%        every opportunity for growth. Hence, we assume a long-term growth rate of 2.8% (until
   Incl. premium of               -       2025e). We estimate that sales growth will be stronger in Asia with 3.8% organic growth in
 Beta                          0.94       FY18e versus 2.3% in Europe, which is the least dynamic zone. We consider that margins
 Market risk premium          7.6%        will constantly improve thanks to the savings plan that runs until 2020. We maintain stable
 Cost of equity               9.0%        A&P expenses (in line with recent years) but we favor the savings measures initiated by
 Pretax cost of debt          3.2%        the group in terms of structural costs. Higher A&P expenses could allow the group to
                                          increase sales as well. We expect (i) a reduction in net debt more conservative than
 Marginal tax rate           33.3%
                                          assumed by the group, despite the rise in the cash conversion rate and (ii) an improved
 After-tax cost of debt       2.1%
                                          working capital management, in line with the Allegro cost reduction plan.
 % equity                    81.4%
                                          WACC – We determine Pernod Ricard’s WACC using the Capital Asset Pricing model. To
 % debt                      18.6%        account for the current low level of interest rates (that will probably increase over the next
  WACC                    7.7%            few years), we gradually increase Pernod Ricard’s WACC. Our calculation leads us to a
Sources : Team estimates, company         7.7% WACC for the first two years in our DCF model (i.e. 2018e and 2019e), a 7.9% WACC
reports, Capital IQ                       for the next two years (i.e. 2020e and 2021e) and a 8.0% WACC for the rest of our DCF
                                          model, from 2022e (please see WACC calculation in appendix 17).
                                          Beta: to reflect market trends as well as possible and since France represents a significant
                                          part of Pernod Ricard’s sales, we used the SBF 120 index as a benchmark to compute
  This report is published for educational purposes only by students competing in The CFA Institute Research Challenge.                           8
WACC SYNTHESIS                                              Pernod Ricard’s beta. Using monthly 5-year monthly returns against this index, we obtain
                                                            a 0.94 beta.
                                      8.0%
                                                            The market risk premium is based on the average SBF 120 yearly performance over 9
                                                            years and is equal to 7.6%.
                    7.9%
                                                            The risk-free rate is based on French government bonds over 30 years to consider the
                                                            current low levels of interest rates. As explained above, we assume interest rates will
       7.7%                                                 increase over the next few years. We applied a 0.2% premium for the first two years of our
                                                            DCF model (2020e and 2021e), and a 0.4% premium for the next years. This calculation
                                                            leads us to a 1.8% risk-free rate for the first two years of our model.
                                                            Cost of debt: We take into account Pernod Ricard credit rating, (i.e. BBB with a positive
                                                            outlook according to S&P) and obtain a 3.2% pretax cost of debt and a 2.1% after-tax cost
                                                            of debt.
Sources: Team estimates, company
                                                            TRADING MULTIPLES MODEL – EUR 159.0 TP – 22.3% UPSIDE
reports, Capital IQ
                                                            Given the diversification of Pernod Ricard, we select 2 types of companies, representative
                                                            of Pernod Ricard’s core business: (i) global spirits leaders including Diageo ‒that we
                                                            identified as Pernod Ricard main competitor‒ and (ii) regional leaders. We decide to
                                                            exclude the group regional diversified leaders from our calculation because these
                                                            companies are less similar to Pernod Ricard’s core business than the former ones but we
                                                            kept them as a benchmark. In the same way, we don’t select companies specialized in
                                                            wine or champagne as they are structurally different from spirits (lower A&P expenses and
                                                            lower margins for example). As the great majority of Pernod Ricard sales are generated by
                                                            spirits, we mainly focus on spirits-based companies. Moreover, as Diageo is the best
                                                            comparable for Pernod Ricard due to similar product offering and geographical reach, we
                                                            apply a discount of 10% on all trading comparables, except Diageo.
                                                            We focus on the EV/EBITDA multiple, allowing the comparison of firm’s ability to generate
                                                            cash flow regardless of their capital structure and depreciation policies. We overweight the
                                                            first group of trading comparables, i.e. global spirits leader, at 70%. As a result, we obtain
                                                            an average of 18.4x 2018E EBITDA multiple, i.e. an enterprise value of €42,021m (€159.0
                                                            per share).

                                                                              EV/Sales             EV/EBITDA           CAGR Sales    CAGR EBITDA     EBITDA margin     Net debt/EBITDA
                 Name                         Country           EV
                                                                         2018e 2019e 2020e     2018e 2019e 2020e       2018e-2020e   2018e-2020e   2017a 2018e 2019e        2017a
    Pernod Ricard SA (our est.)            France           48,409.8      4.4x   4.2x   4.0x   17.8x   17.1x   16.4x      3.9%          4.4%       29.0% 29.3% 29.3%        3.0x
    Pernod Ricard SA (market est.)         France            42376.7      4.7x   4.5x   4.3x   16.0x   15.1x   14.3x      4.8%          5.6%       28.8% 29.4% 29.7%        3.0x
  Group 1 - Global spirits leader

    Diageo plc                            United Kingdom    85,205.1      6.1x   5.8x   5.6x   17.6x   16.5x   15.6x      3.9%          7.6%       32.2% 34.6% 35.5%        2.1x
    Brown-Forman Corporation              United States     22,941.2      8.6x   8.1x   n.a.   23.8x   22.1x    n.a.      6.5%          9.0%       35.0% 35.9% 36.6%        1.7x
    Becle, S.A.B. de C.V.                 Mexico             5,058.9      4.5x   4.1x   n.a.   16.6x   14.3x    n.a.      5.3%          9.2%       26.6% 27.4% 29.7%        n.a.
                                          Average Group 1                 5.9x   5.6x   5.6x   18.0x   16.4x   15.6x      5.2%          8.6%       31.3% 32.6% 33.9%        1.9x
                                          Median Group 1                  6.1x   5.8x   5.6x   17.6x   16.5x   15.6x      5.3%          9.0%       32.2% 34.6% 35.5%        1.9x

  Group 2 - Regional leader

    Davide Campari-Milano S.p.A.          Italy                8,983.5    4.9x   4.8x   4.5x   20.6x   19.4x   18.2x      5.1%          7.3%       23.6% 24.4% 25.0%        3.0x
    Rémy Cointreau SA                     France               5,879.7    5.1x   4.8x   4.5x   22.2x   20.2x   18.5x      5.7%          8.2%       22.5% 23.1% 23.7%        1.6x
                                          Average Group 2                 4.5x   4.3x   4.1x   19.3x   17.8x   16.5x      5.4%          7.8%       23.1% 23.8% 24.4%        2.3x
                                          Median Group 2                  4.5x   4.3x   4.1x   19.3x   17.8x   16.5x      5.4%          7.8%       23.1% 23.8% 24.4%        2.3x

  Group 3 - Diversified regional leader

    Constellation Brands, Inc.             United States    42,588.4      6.7x   6.3x   5.9x   17.9x   16.3x   15.0x      5.9%          6.5%       36.9% 38.0% 38.8%        3.2x
    Emperador Inc.                         Philippines       2,565.0      3.7x   3.5x   n.a.   15.6x   14.9x    n.a.       n.a.          n.a.      25.1% 23.4% 23.7%        2.4x
    Marie Brizard Wine & Spirits SA        France              357.6      0.8x   0.7x   0.7x   14.8x    8.9x    6.5x      6.2%         36.4%        3.8% 7.1% 9.0%          n.a.
    Lucas Bols N.V.                        Netherlands         253.8      2.7x   2.6x   2.6x   10.1x    9.7x    n.a.      7.3%         10.6%       23.0% 25.3% 26.0%        1.8x
                                          Average Group 3                 3.1x   2.9x   2.7x   13.1x   11.2x    9.7x      6.5%          17.8%      22.2% 23.5% 24.4%        2.5x
                                          Median Group 3                  2.8x   2.7x   2.3x   13.7x   11.0x    9.7x      6.2%          10.6%      24.1% 24.4% 24.9%        2.4x
  Peers average (incl. a discount of 10%, except for Diageo)              5.5x   5.2x   5.1x   18.4x   16.8x   15.9x      5.3%          8.2%       27.2% 28.2% 29.1%        2.1x
  Peers median (incl. a discount of 10%, except for Diageo)               5.6x   5.4x   5.1x   18.1x   16.9x   15.9x      5.4%          8.4%       27.6% 29.2% 29.9%        2.1x

  Source: Team estimates, company reports, Capital IQ

                                                            COMPARABLE TRANSACTIONS MODEL – EUR 178.3 TP – 37.2% UPSIDE
                                                            Within this methodology, we select a range of key transactions specialized in Pernod
                                                            Ricard core business, i.e. spirits industry (group 1 in the table in the Appendix 24). For the
                                                            same reasons as above, we don’t consider deals in the wine and champagne industry
                                                            because multiples are different from the one of spirits industry. This method provides us a
VALUATION SUMMARY                                           median EBITDA multiple of 20.2x, leading us to an enterprise value of €47,111m (i.e.
(€/SHARE)                                                   €178.3 per share). Nevertheless, we believe that a potential acquisition of Pernod Ricard
                                                            is not realistic mainly for antitrust purposes. For that reason, we decide to exclude this
 Trading                                                    methodology for our target price calculation.
                                          159.0
 comps
                                                            VALUATION CONCLUSION – EUR 153 TARGET PRICE – 17.7% UPSIDE
     DCF                            149.4                   We base our calculations only on the DCF methodology and the trading comparables-
                                                            based methodology. We overweight the DCF one at 60%. This results in an equity value
                                                            of €40,496.6m, resulting in an enterprise value of €48,409.8m (€153 per share).
Sources:     Team        estimates, company
reports

  This report is published for educational purposes only by students competing in The CFA Institute Research Challenge.                                                                  9
INVESTMENT RISKS
RISK MATRIX                                   Pernod Ricard faces diverse risks that could impact our recommendation.
                                              BUSINESS RISKS
                                              Overpaying for M&A targets
                                              After a strong deleveraging in 2012-13, Pernod Ricard acquired highly specialized small
                                              companies (Monkey 47, Smooth Ambler). If prices paid were undisclosed, we have
                                              reasons to believe they topped average deals in the sector. Recent acquisitions, such as
                                              Campari / Grand Marnier, reached 20-25x EBITDA. As premiums increase, payback on
                                              acquisitions lengthens. However, we think Pernod Ricard will be able to integrate future
                                              M&A targets as it did in the past.
                                              Pressure on vodka in the US
                                              Absolut vodka is Pernod Ricard’s most selling brand, representing 23% of total sales. It
Source : Team analysis                        faces pressures in the US coming from fierce competition and new entrants (i.e. Tito’s
ABSOLUT US SALES, NIELSEN                     vodka) in the premium segment. This country accounts for a third of Absolut volumes and
VALUE $                                       its growth has been driven by high-end / super premium vodka (+6.9% in 2016 vs +0.9%
                                              for premium vodka). Absolut’s positioning prevents Pernod Ricard from catching this
                                              growth, that’s why the company launched super premium Absolut Elyx in 2015. At a price
    2014     2015      2016       2017        of $40 per bottle, it will undeniably head towards growth in the US. As of today, Absolut
                                              Elyx is said to account for 1% of Absolut value sales in the country: that is €1.1 M assuming
     -2%                                      a market share of 5% for Absolut in the US.
                       -3%                    Failure to achieve cost-cutting promises
                                              In 2015, the group launched a roadmap targeting gross P&L savings of €200m over the
                -5%               -5%         FY16-20 period. Meanwhile, it aims at lowering working capital by €200m through supply
                                              chain improvements. During FY 17, savings were delivered as planned but a failure to meet
Source : Company data
                                              these commitments would impact accordingly future operating margins.
HAVANA CLUB MARKET SHARE                      ECONOMIC & GEOPOLITICAL RISKS
AND RANK, IN VOLUME                           US embargo on Cuba goods
                                              Due to the embargo on Cuba, Pernod Ricard is not allowed to sell its Cuban rum (Havana
     #1                                       Club) in the US territory. If Obama administration lifted partially the ban, with US citizens
                      #1                      now entitle to bring back up to $100 of Cuban rum into the US, the embargo is a serious
             #1                               constraint on Pernod Ricard’s development in the country. In 2016, 24.7m 9-liter cases
    25%                                       were sold in the US (respectively #1 and #2 in terms of value and volume). The premium
            17%       20%     #6              positioning of Havana Club is a serious opportunity in the US, given this segment has been
                                         #3
                              6%         4%
                                              growing faster than value rum (0.8% vs -3.5% in 2016). Assuming a penetration of 10-15%,
                                              like Western Europe, Pernod Ricard could sell about 2.5m 9-liter cases of its rum (almost
                                              60% of FY17 Cuba volume) in Cuba.
                                              Instability in Africa
                                              Pernod Ricard employs 500 people in 7 Sub-Saharan Africa countries where it has been
                                              experiencing a strong growth (CAGR 2012-17 at 15%). Recent drop of oil prices impacted
Source: Company data, Team analysis
                                              growth of producers such as Nigeria and Angola. In FY17, the group reported only 1%
PERNOD RICARD RECOVERY IN                     growth, but a rebound is expected from 2018 thanks to stabilization of oil prices. In FY17,
CHINA                                         this region accounted for only c.4% of Pernod Ricard revenues. But the company bets on
                                              its development to stand out in the long term.
  30%                                    8%
  15%
                                              Slowdown in China
                                              China weights more than 30% of Pernod Ricard Asia sales (9% of global sales) but growth
   0%                                    7%
                                              has been stalling in recent years. The low penetration of international spirits so far (
APPENDICES

                                             APPENDICES

 This report is published for educational purposes only by students competing in The CFA Institute Research Challenge.   11
Appendix 1 – Pernod Ricard products

                                                    Strategic international brands

                                                             Strategic wines

                                                         Strategic local brands

Appendix 2 – Positioning of Pernod Ricard brands portfolio by category
                                              Premium             Premium          Standard         Standard           Total
                                             Brand Unit               %           Brand Unit           %            Brand Unit
              Whiskey                            8                   62%               5              38%               13
              Vodka                              1                   50%               1              50%                2
              Cognac & Brandy                    2                  100%               0               0%                2
              Rhum                               1                   50%               1              50%                2
              Gin                                3                  100%               0               0%                3
              Aniseed                            1                   50%               1              50%                2
              Champagne                          2                  100%               0               0%                2
              Liqueurs & Bitters                 1                   50%               1              50%                2
              Mezcal                             1                  100%               0               0%                1
              Tequila                            2                  100%               0               0%                2
              Bourbon                            1                  100%               0               0%
              Overall                              23                72%                9              28%                32

Source: Company website

  This report is published for educational purposes only by students competing in The CFA Institute Research Challenge.          12
Appendix 3 – Composition of the Board of Directors & Committee

                                                         Related to                                       Nomination,
                                                          Mr Paul         Strategic         Audit         Governance Compensation
             Board of Directors (30/06/2017)
                                                          Ricard         Committee        committee         and CSR   committee
                                                          Family                                           committee

        Executive Directors
           Mr. Alexandre Ricard*                         X            X
           Mr. Pierre Pringuet                                        X                                                   X
        Independent Directors
           Ms. Nicole Bouton                                                                        X                     X
           Mr. Wolfgang Colberg                                       X              X              X
           Mr. Ian Gallienne**                                        X                                                   X
           Mr. Gilles Samyn
           Ms. Kory Sorenson                                                         X                                    X
           Ms. Anne Lange                                             X
        Directors & employee representative
           Mr. Cesar Giron*                              X            X                             X
           Ms. Martina Gonzalez-Gallarza
           Mr. Paul-Charles Ricard (Societe Paul
                                                         X
        Ricard representative)
           Ms. Veronica Vargas                           X
        Directors representing the employees
           Mr. Sylvain Carré
           Mr. Manousos Charkoftakis                                                                                      X
           Mr. Hervé Jouanno (non director)
        * Executive member
        ** CEO of Groupe Bruxelles Lambert, holds 7,5% of Pernord Ricard's shares and 10,95% of voting rights

Source: Company reports

Appendix 4 - Porter 5 forces

                                                                 Threat of
                                                                 suppliers
                                                                  5
                                                                  4
                                                                  3
                                              Industry            2                   Threat of new
                                               Rivalry            1                     entrants
                                                                  0

                                                 Customers                       Threat of
                                                   Power                        substitutes

                                         0 No threat to Pernod Ricard - 5 High threat to Pernod Ricard

Threat of suppliers – INSIGNIFICANT
          Low bargaining power: a myriad of suppliers produces the ingredients.
          Low forward integration threat.

Threat of new entrants – MODERATE
         High barriers to entry as important capital is required to set up and maintain the equipment and facilities.
  This report is published for educational purposes only by students competing in The CFA Institute Research Challenge.             13
     To thrive on the spirits industry, an extensive distribution network is key.
                Brand awareness and customer loyalty require high expenditures on marketing.
                New players need licenses to produce alcohol and they need to deal with tightening government regulations
                Profits are strongly dependent on volume sales hence scale economies are essential in this industry

Threat of substitutes – LOW
                Competition is spread between alcoholic and non-alcoholic drinks.
                Producers compete for a share in the consumer budget regardless of the type of beverage.
                Consumers have low switching costs between beverages.
                Health and wellness trend might induce consumers to buy more non-alcoholic beverages.

Threat of Buyers – SIGNIFICANT
                Low switching costs
                Moderate cost sensitivity
                Differentiated products
                Alcohol is not first necessity product

Rivalry - HIGH
                Highly competitive (mostly in international spirits and wine segments) where the production is highly fragmented.
                The industry is strongly concentrated as Top 5 spirits companies account for 63% of global volumes
                Operational margins are traditionally high (28.5% in 2017 for Top 5 companies in spirits).
                Competition is strongly determined by marketing and distribution expenditures: crucial to promote brand awareness and
                 create customer loyalty.

Appendix 5 – Industry & Macroeconomic key metrics
                                  CAGR (in revenues)                  Population (in m illions)                         GDP per Capita (USD)           Urbanisation Rate

                                2015-2017    e2018-2021        2017            e2020         Grow th %           2017          e2020       Grow th %         2016

                  Europe          2.0%          1.9%             674.6           675.0            0.1%           37,267         39,212         5.0%         73.0%

                  LATAM           7.5%          5.8%             383.1           394.7            2.9%            9,985         11,330         11.9%        80.0%
 Region

                   Asia           5.0%          3.9%            3,478.2         3,550.7           2.0%            6,754          8,059         16.2%        48.0%

               North Am erica     5.8%          3.4%             362.1           369.8            2.1%           57,993         64,255         9.7%         82.0%

                   China          4.5%          3.0%            1,383.9         1,391.2           0.5%            8,481         10,644         20.3%        57.0%
 Country

                   India          9.7%          7.7%            1,339.3         1,384.3           3.3%            1,850          2,358         21.5%        33.0%

                  The US          6.1%          3.5%            325.50           332.4            2.1%           59,609         66,194         9.9%         82.0%

Sources: IMF, World Bank, United Nations, Eurostat, Nielsen, Team Estimates

CONSUMPTION EVOLUTION BY GEOGRAPHY

                                                                                                          2.8%
                                            Oceania
                                                                                                   2.0%
                                                                                 -0.7%
                                Africa/Middle East
                                                                                                                               5.4%
                                                                                                            3.2%
                                               Asia
                                                                                                           3.1%
                                                            -3.5%
                                            LATAM
                                                                                          1.2%
                                                             -3.4%
                                  Eastern Europe
                                                                                          1.2%
                                                                                             1.6%
                                  Western Europe
                                                                                          0.0%
                                                                                                               3.8%
                                   North America
                                                                                                             3.5%
                                                   -4.0% -3.0% -2.0% -1.0% 0.0% 1.0% 2.0% 3.0% 4.0% 5.0% 6.0%

                                                               Volume % change             CAGR 2005-2016

Source: Company reports
   This report is published for educational purposes only by students competing in The CFA Institute Research Challenge.                                              14
Appendix 6 - BCG Matrix on International Strategic Brands

Methodology:
Three variables have been considered as we built this chart. On the horizontal axis, the worldwide market share of the brand. On the
vertical axis, we have the brand growth from 2016 to 2017. The size of the bubbles is determined by the relative market share of the
brand in respect with Pernod Ricard’s largest competitor (i.e. Diageo).

The portfolio of Pernod Ricard’s International Strategic Brands has the following characteristics:
        On the most dynamic side, Martell and Jameson are its stars accounting with the highest growth and an important market
         share.
        The cash cows that finance the development of the stars are Kahlua, The Glenlivet, Mumm, Absolut.
        The question marks are Royal Salute and Perrier-Jouët who have a fairly high growth but a low market share.
        The dogs are Beefeater, Malibu and Ballantine’s and Chivas Regal who according to this chart might be draining the
         resources of Pernod Ricard.

Appendix 7 - SWOT analysis
Strength
        Pernod Ricard’s brand portfolio is well positioned with 83% Premium brands and famous worldwide (e.g. Absolut, Jameson,
         Martell, Havana Club).
        Pernod Ricard has one of the best distribution systems in the spirits industry which enables it to integrate successfully newly
         acquired brands and almost guarantee successes.
        Its sales are balanced between the Americas, Europe and Asia/ Rest of World, each representing a third of the producer’s
         revenues. The firm has proven to be successful in India which alone represents 25% of revenues in the Asia – RoW division.
        Pernod Ricard’s margins are higher than its peers’ and carried out a smoothly managed deleveraging policy.
Weaknesses
        Among Pernod Ricard’s stars, the company has several brands with a weak growth and a low market share such as Malibu
         or Ballantine’s.
        The French spirits producer is dependent on fluctuations on volatile emerging markets as it derives 38% of its sales in
         2016/2017 from Asia, Eastern Europe and Latin America.
        As it is a highly internationalized company, Pernod Ricard is strongly exposed to currency risk with sales in different
         currencies and an outstanding debt in dollars.
        Outsiders can take stakes of Pernod Ricard as 76.4% of its shares are free floating.
Opportunities
        Emerging countries, in particularly China and India with revenues having grown to a CAGR of 14.4% and 5.6% respectively
         between 2011 - 2015, offer a bright future for the company. Indeed, these countries are going through cultural changes and

  This report is published for educational purposes only by students competing in The CFA Institute Research Challenge.              15
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