Description

Campari Group is a Milan-based spirits company that, despite possessing some highly valuable brand franchises, trades at just 9 times earnings.

The company's brands include the eponymous Campari (16% of consolidated sales), CampariSoda (10%), and other Campari line extensions; Cinzano sparkling wines and vermouth (7%), Ouzo 12 (2%), Cynar liqueur (2%), Tequila 1800, and Skyy Vodka (14%); and, in soft drinks (about 20% of sales), Crodino (9%), Lemonsoda, Oransoda, and Pelmsoda. The product line is well diversified.

Campari is a bittersweet red-colored aperitif whose finest characteristic (to me) is that it is one-of-a-kind. The company guards the formula the way Coke does. Many of Campari Group’s products are characterized as “bitters.” Unlike other types of liquor (such as wine or scotch) that have to be aged for several years, bitters can be shipped out the door within a month of being produced. This is reflected in the fact that Campari Group typically carries a relatively low 3½ months’ worth of inventory. Compare this with a company like Mondavi, which typically carries a year-and-a-half’s worth of inventory.

Campari Group net sales were 717 million euros (about $900 million) for the twelve months ended 9/30/03. Half of sales are within Italy. Thirty per cent of sales are to North and South America, with 20% to the rest of Europe.

The excise tax bite is 10-15% of gross sales.

I’m impressed with how well the management has been able to grow the business lately. Before the effects of shifting exchange rates, organic sales growth was 10.8% in the first nine months of 2003. Despite the surge in the euro relative to the dollar, organic growth net of currency was still 4.3% in the first nine months. Organic growth ex currency was 9% in Italy, 13% in the rest of Europe, and 13% in the Americas. These results compare favorably to other spirits companies.

The weak dollar will continue to be a drag on results in 2004.

Profitability is fabulous. The consolidated operating margin before amortization is 20-22%. The operating margin for the spirits business (80% of revenue) is in the mid-30s. This is a marketing business, as reflected by SG&A spending at close to 40% of sales. Return on assets, defined as operating profit before amortization as a proportion of tangible assets other than cash, runs at 35%, which qualifies as “lush.” The company is a big free cash flow generator. For every hundred euros flowing out of the company (other than interest and taxes), 128 euros flow in.

Campari has joined the trend toward pre-mixed, wine-cooler-type “malternative” drinks of which Diageo’s Smirnoff Ice is the best known. Campari has launched Campari Mixx, Skyy Blue, and other concoctions. There is a fad element here and there’s no denying that the trend might hit a wall one day. It’s good that Campari has solid core brands to fall back on in case that happens. The malternative drinks remain a small part of Campari’s total spirits sales.

Campari was established in 1860. Luca Garavoglia is the chairman. The Garavoglia family owns 51% of Campari’s 29.04 million shares indirectly through a private company. Campari’s free float is 46%.

The downside of the family’s controlling stake is that it precludes a hostile takeover. I’ve been in the business twenty years and these kinds of ownership situations have never fazed me; unless, of course, the family is of a type that shafts minority shareholders or the management hired by the family is inept and/or corrupt. But isn’t inept/corrupt management a risk with any business? And the same investors who complain that a company like Campari can’t get taken over --- not true, by the way --- are usually the same people who instead go out and buy Wal-Mart or Microsoft, which can’t be taken over because the acquirer would need to be able to issue several hundred billion dollars’ worth of stock. (Me, petulant? No.)

Campari would be an extraordinarily attractive takeover target for the likes of Allied-Domecq, Diageo, or Pernod-Ricard.

Campari came public in 2001, selling 49% of its shares outstanding at 31 euros per share. All of the proceeds of the offering went to two minority shareholders, Wessanen Europe B.V. and Gioch S.A.

Acquisitions have been and will continue to be big on management’s agenda. Campari is focused on niche areas of the spirits business that the big liquor companies don’t focus on. The margins can be high on these brands.

The balance sheet shows 259 million euros of cash and marketable securities and 420 million euros of debt, both swollen recently by a recent $300 million bond issue. Management hasn’t said so, but the proceeds from the bond offering will presumably be used for acquisitions. Campari covers its interest charges comfortably at more than 9 times, so I think that the company can and should take on more leverage to enhance the value of the equity.

In early 2002, in one of its biggest acquisitions, Campari brought its ownership stake in Skyy Spirits, the maker of Skyy vodka, up to 58.9%. The indicated value for 100% of Skyy was 421 million euros, or about 11 times EBITDA. This is not a capital-intensive business, so the multiple paid relative to EBITA (the number I’m interested in) was marginally above 11 times.

Sales of Skyy vodka were up 25.3%, excluding exchange rate effects, in the first nine months of 2003. About 90% of Skyy’s sales are in the U.S. The product comes in a bright cobalt blue bottle that really grabs your attention when you see it on the store shelf.

Campari’s dividend is 0.85 euros per share, for a 25% payout ratio on earnings. Clearly there’s room for a much higher dividend.

The company earned 104 million euros, or 3.59 euros per share, for the twelve months ended 9/30/03. These figures are adjusted for special items, extraordinary items, and intangible amortization, which looms large at 30-40% of pretax earnings. I think that Campari can earn 4.00 euros per share in 2004, and that the stock is worth at least 20 times earnings, or 80 euros per share. The current stock price is 37.

It doesn’t make sense that a company with such valuable properties should sell for less than 50 centimes to the euro.

Catalyst

Continued momentum from 2003 (earnings report March 22nd);
Debt paydowns that lower interest expense and thus accelerate net profit growth;
Continued accretive acquisitions;
Potential (Friendly) Takeover.