By Matthew Curtin
Like its best-selling Absolut vodka, Pernod Ricard /zigman2/quotes/204974112/delayed FR:RI -0.51% would like to be prized for its purity.
But while its full-year results vindicated its strategy of focusing on premium brands, confounding fears that drinkers would trade down to cheaper tipples during the recession, investors will discern the odd imperfection, including slower-than-expected progress on debt reduction, weak links among its top brands, and too much exposure to Europe's sluggish economies. Until they are eliminated, a premium rating for Pernod shares looks unlikely.
Thanks to robust demand for most of Pernod's 14 top brands, notably Martell cognac and Jameson whiskey, operating profit on a comparable basis rose 4% from a year ago to €1.8 billion ($2.31 billion). The top brands contributed 69% of group sales, up a percentage point from the previous year. Pernod feels sufficiently confident to have raised spending on advertising and promotion back to pre-crisis levels of nearly 18% of revenues, with spending tilted toward its faster-growing premium brands. Sales trends in July and August have been encouraging.
But with the shares trading at 13 times estimated 2011 earnings, broadly in line with the sector, and having outperformed arch-rival Diageo /zigman2/quotes/208129584/composite DEO +1.48% this year, the good news is in the price. Risks remain.
Although tight control over advertising and promotion costs has put Pernod ahead of its free cash flow target, net debt remains stubbornly high at 4.9 times earnings before interest, taxes, depreciation and amortization, or Ebitda, compared with 5.3 times at end-June last year. That said, Pernod still has ample time to refinance €7.6 billion in debt maturing in 2013 and 2014, its next major repayment.
But not all of Pernod's top brands are flourishing, so a more thorough clean-out may yet be beckoning following the recent sales of Tia Maria and Wild Turkey. Pernod has written off €100 million off the value of Kahlua. Sales at Jacob's Creek, its Australian wine division, fell 5% as Pernod opted to lose market share rather than lower prices in the cutthroat U.K. market. Whether the creation of a premium wines unit will improve pricing power remains to be seen.
An austerity Europe still accounts for 41% of Pernod sales. So its future isn't as crisp and clear as a premium rating would warrant.
Write to Matthew Curtin at email@example.com