EUR 850.00 For Business Accounts Only

Morningstar | Very Strong First Half by Pernod Not Likely Sustainable but Shows Company Firing on All Cylinders

Pernod Ricard beat our estimates in the first half of fiscal 2019 thanks to better-than-expected sales growth in Asia and a strong performance on cost control. Although this strong performance was boosted by technical factors, not least the timing of the Chinese New Year, and growth will likely normalize in the second half, management has raised guidance on EBIT growth for the rest of the year. We have nudged our fiscal 2019 estimate of operating profit slightly higher, based on a higher gross margin estimate, and we are raising our fair value estimate to EUR 134 per share from EUR 124. This is driven by EUR 3 from the time value of money and EUR 7 from a medium-term assumption of a 63% gross margin, up 100 basis points from our previous assumption, and slightly higher near-term sales growth.

Pernod's very strong first half, in which sales grew 7.8% organically and profit from recurring operations, or PRO, by 12.8%, was driven by the Asia/rest of the world segment, which delivered 16% organic sales growth. Technical factors boosted growth in the first half, however, and we expect full-year PRO to be in the region of 7% because channel inventory will be reduced in the U.S. and the second half will contain fewer pre-Chinese New Year shipments this year.

Nevertheless, this should not detract from a strong performance. Almost 44% of sales were derived in the Asia/rest of the world segment, and the growth of Martell means Pernod is increasingly reliant on China. Consistent with other luxury and aspirational consumer products manufacturers, Pernod continues to post strong numbers in China, which it said grew 28% in the first half. Price/mix remains very robust, and the company will implement a further 5% price increase in February 2019. Travel retail is an important market for spirits, however, and if the slowdown in China affects international travel, the duty-free business may feel the pinch over the next few quarters.

Pernod's Transform & Accelerate three-year plan includes a target of an additional EUR 100 million in savings by 2021, on top of the EUR 200 million that will have been achieved by the end of this fiscal year. This may underwhelm some investors who believe there is a great deal more cost to take out at Pernod. We are not getting carried away with the cost savings, however. Pernod's gross margin is already comparable with that of Diageo, and likely to improve as high-margin craft products take mix share, and it is the A&P spending that benchmarks less favourably against competitors. We point to the remarkable brand-building results achieved by Pernod over the last few years as a result of this spending, and caution that in an environment of rising marginal costs, slashing the marketing budget would probably come at the cost of the impressive growth reported by Pernod in this, and other recent, quarters.