Summary:

Campari is the sixth largest branded spirits in the world.  Since its IPO in 2001 the company has a truly enviable history:  Sales, EBITDA and net income have all compounded between 10-12% annually with only one slightly down year in EBITDA and net income.  Though acquisitions have been a key part of the corporate strategy (more below), all have been cash purchases and there has been minimal share creep for options (0.3%/year), so shareholders have almost fully participated in this record.

I have owned the stock since 2004 and considered writing it up for VIC many times:  It never seemed quite cheap enough and it doesn’t now.  But I am increasingly looking for compounding machines -- stocks that I can own for a very long time and I know that at least some others on this board are as well.  Campari is cheaper than its peers and I think clearly sells at a discount to its business value.

Recent History:

The Campari of today is a much different company than that of 2000.  Over 85% of sales then were in Europe and, of that portion, two-thirds were in Italy.  Moreover,  only two of its current leading brands were part of the portfolio and Cinzano had just been acquired in 1999.  (Note:  Campari, an aperitif developed in 1860, is the foundation of the modern company; like Coca-Cola the formula is secret and supposedly only known by one person). The Americas are now the largest geography (35%) and Italy is 24% of sales rather than 58%.  Though very modest exposure to Asia is a weakness relative to companies like Diageo or Pernod-Ricard, Campari now has growing positions in emerging markets like Brazil, Argentina and Russia.  

Management is focused on both organic growth and external growth.  Long-term, they believe organic growth can approximate 5%.  Sources include strong marketing and support behind strategic international and regional brands, steady growth in key local brands, and increased presence in faster growing emerging markets.  Additionally, acquisitions can leverage existing distribution networks in major markets and bring local brands that can be a basis for new owned distribution in hitherto underpenetrated markets.

Key Brands:

1. Aperol (12% of 2011 sales):  A low-alcohol (11-15%) aperitif acquired in 2003.  This has been a truly amazing success story:   Sales have more than quintupled since its purchase and continued to grow units in double-digits in 2011, even though distribution has largely been in just three markets:  Italy, Germany and Austria.  Key to its success is the Aperol Spritz, a drink made with Aperol, prosecco and club soda, usually garnished with an orange.  (Try it--even if you aren’t enthused by the stock you will have a delicious new drink in your repertoire.)  The company successfully introduced a pre-mixed version in 2011 in Italy and Austria for at home consumption.  From a very small base sales are growing very rapidly in other European markets.  There are two other interesting attributes of the brand:  there is no direct substitute and it requires no aging as opposed to many spirits, which yields very high cash flow.

1. Campari (11% of 2011 sales):  Also an aperitif though somewhat higher in alcohol (low 20s), the flagship brand dates from 1860 and still grows, on average, in mid single-digits in value.  Key markets are Italy, Brazil, Germany and France, though US growth has been accelerating around renewed popularity of the Negroni cocktail.  As with Aperol, there is no direct substitute and no aging is required.  A pre-mixed drink, Camparisoda represents an additional 5% of sales:  this is only popular in Italy and sales have trended down slightly of late.

1. SKYY (11% of 2011 sales):  An American vodka acquired in 2001, SKYY has been very successful even though sales gains have moderated in recent years.  The US vodka market, which represents 80% of SKYY sales, is extremely competitive.  Flavored vodkas have been growing faster than the market and the SKYY range of Infusions have done well.  Going forward I believe that growth in international markets will be the key to the value of the brand.  SKYY was introduced to Brazil, where the company has placed a lot of resources around the strength of Campari there, and the brand is doing well there.  Whatever multiple one attaches to brands--and acquisition multiples have ranged from 8-20X EBITDA in the industry in recent years--I would put a lower multiple of SKYY than the three other leading corporate brands.

1. Wild Turkey (9% of 2011 sales):  Campari acquired this brand family from Pernod-Ricard in 2009 for $575MM, or 12X forward EBITDA.  America is the key market (60%) of sales; Australia and Japan are the other countries of consequence today.  Performance has been quite strong supported by a new look and heavy marketing, including television in the US.  Organic growth in 2011 was 7% for core Wild Turkey (5% of Campari) and 25% for the overall franchise.  American Honey, a bourbon based liqueur, grew 33% last year and comprises 2% of corporate sales and Wild Turkey RTD, a bourbon and cola mix available only in Australia (also 2% of corporate sales), is also growing in double-digits.  Going forward, there is clear potential to introduce Wild Turkey into other strong corporate markets where bourbon is popular (e. g. Germany).  Also, its strong presence in Australia and Japan can serve as a jumping off point for other corporate brands.

1. Cinzano (9% of 2011 sales):  This franchise includes both sparkling wines (5%) where strong markets are Germany, US, Italy and Sweden and vermouth (4%), where strong markets are Italy, Russia and Argentina.

Capital Allocation:

As can be seen above, Campari has been a very acquisitive company.  To my knowledge, it has never used stock to make an acquisition and, though willing to lever up, has preserved an investment-grade rating, which translates into an effective ceiling of net debt:EBITDA of 3.5:1.  So today Campari has roundly EU600MM of borrowing power.  Though another deal like Wild Turkey would be terrific (iconic brand, fair price, ample scope for heightened marketing support in existing markets and development in new geographies), smaller acquisitions can also be valuable over time.  Here are two examples in the last 24 months:

Late in 2010, the company bought three brands from William Grant:  Carolans (Irish cream liqueur), Frangelico (hazelnut liqueur), and Irish Mist (whiskey/honey liqueur) for EU129MM, or around 8X EBITDA, accretive in the first year.  Though unlikely to be a game changer, these are solidly profitable niche products with room for more marketing support and geographic expansion.

In mid-2011, it purchased Sagatiba, an ultra-premium cachaca, for EU18MM plus an earnout for eight years that is a percentage of the brand’s top line.  Cachaca, made from fermented sugarcane juice, is the most popular distilled spirit in Brazil.  As noted above, Brazil is an important market for the company on the back of the Campari brand:  Sagatiba has grown rapidly in recent years and should continue to do so with the stronger distribution and support that Campari will bring to it.

Ownership:

The Garavoglia family owns 51% of Campari through a private holding company; its holdings have not changed. Cedar Rock, a successful London-based investment management firm, owns another 10% and my sense is that it is a very long-term shareholder.  Though I have never met any of the family members, I think they are smart enough to have hired and supported a very strong management team and hence are a plus to the thesis.

Valuation:

Campari trades at around 11X current EBITDA and slightly over 10X my forecast for 2013 EBITDA. Note that the large public comps (Diageo, Pernod Ricard, Beam and Brown-Forman) are anywhere from 2-4 points higher.  The free cash yield--even given a bulge in capital spending this year and next for a new US bottling plant--should approach 7% next year.  Though I would not imagine Campari will sustain double-digit growth over the next decade, mid-high single-digit growth seems readily attainable, especially considering management’s willingness to spend aggressively (18% of sales) on advertising and promotion, which, of course, is expensed.  So if not compelling, the valuation seems relatively modest for a very powerful branded goods story with very high profitability.