(GS) Pernod Ricard : Absolut value for premium spirits; upgrade to Buy
Source of opportunity
Pernod’s shares have declined 22% since April, underperforming our
European Staples coverage by 17%, leaving the shares at an 18% P/E discount
to the sector, near six-year lows. While Pernod is far from immune from the
current challenging conditions in EM, we believe it should be able to deliver
improving growth driven by stabilization in China, solid growth in India, and
improvement in the US and Europe. If the US$ strengthens, it would also
benefit from transactional FX. Longer term, we view Pernod’s 38% exposure
to aged spirits as attractive. Our FY16-18 EPS forecasts are 2%/3%/4% ahead
of I/B/E/S consensus. We upgrade our rating to Buy from Neutral.
Catalyst
Pernod will report 1Q sales and give FY16 guidance on October 22. We expect
2% group organic sales growth for 1Q and guidance of 1%-3% organic
operating profit growth; our FY16 estimate is 3.5%. Given the company’s
transactional exposure to the US$, the shares should also perform well on
US$ strength. Our economists forecast the US$ to strengthen vs. the euro by
10%, 12%, and 18% over the next 3, 6, and 12 months.
Valuation
We increase our target P/E to 16.5x (from 16.0x) to reflect Pernod’s recent
trading (we continue to apply this to our June 2017 forecasts). As a result,
our 12-month price target increases to €98 (from €97). Pernod trades on a
CY16E P/E of 15.3x, a 23% discount to our European Staples coverage and a
6% discount to its 5-year average. Of the 18 Staples companies we cover
with a market cap of at least $10 bn, only Imperial Tobacco is cheaper.
Key risks
Risks to our view include: 1) weaker growth in key markets (e.g. US, China,
France, India); 2) Adverse FX moves (e.g. US$ depreciation or GBP, SEK
appreciation); and 3) value destructive cash deployment.