We initiate coverage of European beverages. At a time when global growth remains subdued, we see the European beverages sector offering visible structural growth. Buy recommended stocks are ABI, Diageo, Pernod and CCH. Holds are Heineken, Carlsberg, Campari, Remy Cointreau and Britvic.
Robust fundamentals. Although top-line growth will not match the pre-2008 period, we see stocks under coverage delivering organic revenue growth of +3.3%, ahead of global GDP at +2.8 (2016-18E). Average three-year earnings growth for stocks under coverage (+8.7%) is broadly in line with the Euro Stoxx (+8.6%); however, given the wide range (4%-13%), stock selection is key.
Bottom-up stocking picking. We see a more favourable top-line outlook for the spirits industry over beer after several years of subdued reporting. However, our stock picking is not driven by top-down sub-sector preferences. Our highest conviction ideas offer strong, visible returns in a low-growth environment, strong FCF generation and reasonable dividend yields.
ABI (Buy, PT €130). We initiate with a Buy rating and PT of €130, which is predicated on delivery of US$3bn cost cutting from the SABMiller transaction vs guidance US$1.4bn. In our long-range outlook, we think a share price of €180-200 is justified (by 2022) through delivery on the 2020 Dream Incentive Plan. (fullnote attached)
Diageo (Buy, PT 2,500p). We reiterate our Buy rating with a raised PT of 2,500p. We think Diageo could look different under new chairman Ferran. His deep roots in the beverages sector and private equity background will bring fresh perspectives to cost discipline, balance sheet utilisation and growth potential of the business.
Pernod (Buy, PT €115). We upgrade to Buy from Hold, with a new PT of €115. We see growth renewing after several years of hiatus, and expect execution to dial up as Alex Ricard makes his mark on the business. Self-help provides some support to earnings. Pernod is unloved and trades at a discount to spirits peers.
CCH (Buy, PT 2,000p). We initiate with a Buy rating and PT of 2,000p. We believe CCH is attractively positioned to benefit from top-line and margin recovery. Better alignment with KO argues for greater participation in soft drinks consolidation.
We initiate coverage with Hold ratings on Heineken, Carlsberg, Campari, Remy Cointreau and Britvic.
Valuation. The beverages sector is not cheap trading at 18.5x 2018 P/E vs consumer staples 19.8x, a 30% premium to the market. Although it is hard to argue for a significant upward re-rating, our top picks offer earnings momentum and some re-rating potential.