If you think about what investors prize these days in the alcoholic beverage space – leverage to growing emerging markets, leverage to premium (especially super-premium brands), leverage to off-premise consumption – then Davide Campari-Milano (OTCPK:DVDCY) (“Campari”) has… very little of that. What it does have, though, is strong organic growth, and I believe that is largely responsible for the robust valuation of this company.
I certainly see organic growth potential, and I think Campari has done a laudable job of shifting its marketing message during COVID-19 to drive increased at-home consumption. Still, for a company with what I see as less prospective revenue growth and margin leverage than more reasonably-priced players like Pernod Ricard (OTCPK:PDRDY), I don’t quite understand the valuation here.
A Slower-Growing End-Market Mix
There are many potential growth drivers for beverage companies, but underlying end-market growth has to count as a meaningful one. In countries like China, the growth opportunity in liquor/spirits sales is being driven by rising incomes and changing tastes, while growth in the U.S. is more a byproduct of younger consumers being less interested in beer than their parents and grandparents. While changing tastes can be powerful (it has driven meaningful growth for the spirits category in the U.S.), I prefer to rely on population and income growth as a longer-term driver.
Campari doesn’t score so well there. Unlike Diageo (DEO), Pernod, and Remy Cointreau (OTCPK:REMYY), China just isn’t a particularly meaningful market for Campari today, accounting for less than 2% of sales (versus around 20% for Remy and over 10% for Pernod). The same is true for India and most everywhere else in Asia other than Australia.
Part of the issue is that China is only just starting to adopt Western spirits (about 1% of volume and 4% of value), and cognac is far and away the preferred beverage – Campari acquired a cognac business a few years back (Bisquit), but it’s tiny and I don’t believe it has been launched in China (its major markets are South Africa, Belgium and Switzerland). Likewise with India, which is more of a whisky-drinking country, and where stiff import tariffs (150%) discourage consumption of Western imports.
That leaves Campari much more exposed to markets like Italy (21% of sales), Germany (10% of sales), and the U.S. (over 25% of sales), where there’s much more of a cocktail-drinking culture – relevant as a lot of Campari’s major brands are known mostly as cocktail add-ins.
There’s still growth potential in emerging markets, but Campari has to work harder for it. SKYY vodka (25% of U.S. sales) has to deal with the ongoing declines in the vodka category in the U.S., though Wild Turkey and Grand Marnier have performed considerably better since Campari acquired those brands (2009 and 2016, respectively).
Management Has A Valuable Skillset
It is easy to dislike Campari’s lack of exposure to growth markets; emerging markets are only about one-quarter of sales, versus 40%-plus for Diageo, Pernod, and Remy. It’s likewise easy to dislike the company’s noticeably higher on-premise exposure (more than 45%, driven again by that cocktail angle, which people make/drink at home less often).
On the other hand, Campari is not without a solid and valuable skillset.
For starters, Campari has a knack for buying and turning around lagging brands. Aperol, Wild Turkey, and Grand Marnier have all done considerably better under Campari’s ownership, with Aperol acquired 17 years ago and still going strong as the company’s primary growth driver. With a manageable debt load and plenty of orphaned, or at least neglected, spirits brands out there, I have little doubt that Campari will find a suitable target in the relatively near future.
Tied to that turnaround ability is a solid advertising and promotion effort. A lot of what has made those aforementioned brands stronger performers under Campari’s umbrella is not just advertising resources, but properly-used advertising resources. The successful branding/ad campaign of Wild Turkey featuring Matthew McConaughey is a case in point.
Another sign of that marketing acumen has been visible since COVID-19 started hitting the on-premise market. While most analysts expected Campari to get hammered by the closures of bars and restaurants, Campari has actually held up better than most of its peers so far, with about 20 full points of organic revenue outperformance in the June quarter. Not having exposure to suddenly-weak emerging markets certainly helps, but Campari has also done a very good job of quickly adapting its marketing message and coaxing consumers to look at cocktails as perfectly appropriate at-home drinks, and brands like Aperol, Campari, and Grand Marnier were all down around 10% to 12% in the second quarter.
Clearly, I’m impressed with Campari. Management has delivered very solid 5% organic growth in the half-decade leading up to COVID-19, and that’s with an Italian market that has been declining (about 2% a year) on economic weakness and a U.S. market that is increasingly driven by super-premium brands that don’t really fit Campari’s wheelhouse.
The “but” is the valuation. I’m comfortable with modeling assumptions that work out to long-term revenue growth of around 4.5% to 6%, and I see upside from further M&A. I’m also comfortable with further margin leverage assumptions, with operating margin heading from around 20% to the mid-to-high 20%’s (whatever you’d call 27%). But the resulting double-digit FCF growth (using 2020 as the starting point) doesn’t come close to supporting today’s price.
Likewise, you pretty much have to use an M&A-type multiple on EBITDA (close to 30x) to get to an attractive fair value. Sure, alcoholic beverage company valuations do change in response to interest rates and today’s low rates argue for a higher premium to market multiples, but that seems excessive to me.
The Bottom Line
This is a pretty classic “I like everything but the price” sort of story. Sure, I’m concerned about the lack of exposure to China and other growing emerging markets, and the lack of premium products is likewise an issue that management needs to address. But I believe that, over time, they will address those issues. My issue is just the valuation, as I can’t see what is so special about Campari to deserve the sort of premium it has today.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.