Premiumization, or shifting a product portfolio mix toward higher-priced and typically higher-margin products, is an inescapable word in discussions of alcoholic beverage companies, and for good reason – in the developed world, premiumization in spirits has driven almost all the market growth over the last decade. Premiumization is a significant driver in emerging markets as well, with premium (as well as “above-premium”) products seeing 5% to 10% better growth, on average, than the underlying category prior to COVID-19.
For Remy Cointreau (OTCPK:REMYY) (RCOP.PA), a spirits company that is almost completely premium-focused, that premiumization trend is a significant positive tailwind. Even so, the company is attempting to broaden its revenue mix by focusing more attention on neglected products, and management is also shifting its focus from price management toward margin management, with a robust operating margin target of 33% for the end of this decade.
Remy competes with some significant rivals, and the company’s focus on the cognac segment could be a risk in markets where consumer tastes are more fickle. My bigger concern is valuation; while low interest rates support a robust EBITDA multiple for the sector, Remy trades at a premium within the sector that I’m not convinced is completely merited.
China Not Recovering As Quickly As Hoped
China now accounts for over 20% of Remy Cointreau’s revenue mix, and it has turned into a key market for premium-priced products like Club and 1738, as well as the almost-unbelievably premium-priced Louis XIII (over $4,600/liter). Unfortunately for Remy, it is still a largely on-premise market, with an estimated 75% of consumption occurring in night clubs, bars and the like.
While there are some signs of normalization in China and Hong Kong post-COVID-19, business is not yet back to normal, and doesn’t seem to be recovering at quite the hoped-for pace. Data from the French Cognac Bureau (Bureau National Interprofessionnel du Cognac, or BNIC) show a 36% decline in shipments of cognac to Asia in August after a 54% decline in July, while growth in shipments to the Americas has remained in the double-digits (up 57% in July and 10% in August).
On top of weaker on-premise consumption, the steep decline in air travel has also had a noticeable impact. Duty-free sales, largely in China, are a noticeable contributor to Remy’s sales, around 10% or so, and this has created another headwind for the business.
Shifting Management Priorities Make Sense, But Do Carry Risk
Remy has a new CEO in place (Eric Vallat) and a new plan to drive improved financial results over the next decade. Trailing performance has frankly not been all that impressive – over the last decade, Remy’s sales have growing only a little more than 1% on an annualized basis and only a little more than 1.5% over the past 15 years. Margins have improved more meaningfully over that time (up about 500bp from FY’11 to FY’20), but free cash flow generation has been neither impressive nor consistent.
There are multiple parts to this new plan, but I’m going to focus on three major ones.
First, management wants to emphasize its XO cognac business, particularly in the U.S.. Remy enjoys around 16% global share for cognac (slightly less in the U.S.), but only 8% in the XO category, where Martell (owned by Pernod-Ricard (OTCPK:PDRDY)) and Hennessy (co-owned by LVMH (OTCPK:LVMUY) and Diageo (DEO)) basically dominate the category with 46% and 36% share.
VSOP makes up about 75% of U.S. cognac sales for Remy Cointreau, and I do see some risks that this move could hurt its lead product. The higher margin available with XO, in addition to the share growth potential, makes this an understandable target, but I want to see and hear more about how Remy is going to make this work, particularly in the U.S.. At a minimum, I would expect that a major market share shift will require some changes in branding and marketing strategies. In the U.S., cognac is a very popular category with African-Americans (over 50% of consumption), but Remy currently has no major endorsement deals with any African-American celebrity.
A second part of the plan is to focus more on margin than price. Premium (and I’m including all of the “above-premium” categories here) products can generate exceptional margins, but Remy has at times been more focused on on-the-shelf prices than actual margins and market share. Remy has seen its market share in the U.S. fall over the last ten years (largely to the benefit of Diageo, Pernod, and Bacardi), and I believe that in some cases it has “lost the forest for the trees” when it comes to managing for price (and presumed brand image) over margin.
Last and not least is an increased focus outside the cognac business. The Liqueurs & Spirts has some decent products, including Cointreau (10% of total revenue) and The Botanist (gin), and gin in particular can be an exceptionally profitable spirt category given that the product doesn’t have to age.
I think building up the non-coganc business is particularly important for long-term results in the U.S. and Europe. The long-term shift away from beer toward spirits has been driven by young consumers, and these consumers haven’t shown any particular loyalty to specific types of spirits – vodka was hot for a few years, tequila and cognac are hot now, and who knows what may be popular in 2025. A more well-rounded portfolio could help reduce some of the long-term volatility should tastes move away from cognac.
Rising wealth in China and the prestige of spirits like cognac works in Remy’s favor, and I do see some significant opportunities in prioritizing margins over price and giving more support to the non-coganc brands. While revenue growth over the past decade-plus hasn’t been so strong, I believe management’s plan can drive mid-single-digit revenue growth across the next decade, with rising consumption, market share, and further premiumization all contributing.
I’m not so confident that management will hit its 33% operating margin target in 2030, but my model has them getting close (around 30%), and if they’re more successful in building share in the XO category, there could certainly be some upside. With that, I think mid-teens FCF margins are attainable, with upside into the high teens, which would drive strong double-digit FCF growth from an admittedly low starting point.
The Bottom Line
While I do believe Remy has a credible growth story, it’s not exactly easy to reconcile that with the share price today. There has long been a strong correlation between bond yields and premiums to market multiples for the alcoholic beverage category, and with rates where they are, a 50% premium is not out of line. Still, a forward EBITDA multiple of 34x (in line with that premium) doesn’t get me to an attractive fair value, and forget about discounted cash flow as a value-driver.
Acknowledging that near-term EBITDA is being impacted by COVID-19, going out to FY’23 is more supportive, and I can get a fair value about 15% above today’s price after discounting back two years at 8%. That still sounds like a stretched valuation to me, but maybe less price-conscious investors will find more to like here in the self-improvement story, the high short interest, and the relatively negative/bearish slant of most sell-side coverage.
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.
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