Description

Ginebra is the second most popular brand behind Emperador (Brandy) but it dominates the gin market with 95% market share. In 2018 they sold 31m nine-litre cases (making it the best selling gin globally by far), but their bottling plant is running at 60-70% capacity due to large expansion they did in 2010-2011 when they were at their peak. Gin itself is part of the Filipino culture and Ginebra targets the extremely low end of the market, with their most popular product selling for $1-2 per one-litre bottle, making it cheaper than beer by alcohol content.

Why does this opportunity exist? 

i) Zero coverage, ii) low liquidity, iii) it was long seen as an "ugly stock" with high debt levels, and iv) uncertainty around increased spirits tax

• Although we can't do anything about the first 2 points as the parent company holds ~76% of CSO thus it is not worth the attention of sell side analysts who would rather cover more liquid names that appeal to a wider target audience 
• The company has done very well fixing the third point, gaining back its market share and using its FCF to pay down it's debt 
• As for the fourth concern, everyone knows President Duterte is a loose cannon and detests "sin products" but he knows the amount of revenue the country gets from alcohol and cigarettes is crucial
• After months of negotiation, the government finalised the hike in taxes on spirits from PHP 23 to PHP 42, which was on the lower end of the figures that were being thrown around from 35 to 100)
• The government said the majority of the taxes raised from these measures would fund the implementation of the government's health program, while 20 percent will be spent on improving public hospitals and health facilities
• Both GSM and Emperador aren't very concerned as they think their products are quite inelastic, and will probably be able to fully pass on the price increase by end 2020 through a number of price increases throughout the year 

Brief overview of the company and industry:

• One of the oldest liquor companies in the Philippines with a 186-year history of making gin
• The hard liquor market can be generally split into 3 segments with each company dominating their type of alcohol - Gin (GSM 95% market share), Brandy (Emperador 90%+ market share) and Rum (Tanduay 90%+ market share)
• Prior to 2010, Gin was ~50% of the hard liquor market but Emperador introduced their hit product "Emperador Light" which is a type of brandy with 27% alcohol vs 40% normally. Coupled with some good marketing campaigns, the brandy craze took over, propelling Emperador to become the top company in the Philippines. GSM took some time before it admitted Emperador Light was a threat, thus hard liquor market share went from 50/30/20 in 2009 to 25/60/15 in 2014 for gin/brandy/rum
• However, since gin was the staple alcohol for Filipinos, the responsibility was on Emperador to continually release new products to sustain brandy's market share, which they have failed to do since 2015, thus allowing GSM to gain back some ground and now the split is 30/50/20 as of 2018
• During that period, GSM was also getting into joint ventures to try and expand to Thailand, which I suspect they became distracted
• Unfortunately, right at their peak sales in 2010, they were running at 90%+ capacity, selling ~30m cases of liquor so they embarked on an expansion to almost double capacity to 50m

Management team and relationship with San Miguel

The current CEO and chairman is the person that owns San Miguel, but he is not the CEO of San Miguel F&B interestingly. 

Vice-chairman and president of the company is the CEO of San Miguel F&B, so we have the 2 most important people of the group in Ginebra.

 

According to the IR, the relationship with parent company:

• Each company is run independently and the main related party transactions will be related to packaging which is a business of the parent
• When they tried to piggyback the gin onto the beer business, it didn't work out well because the sales people were not specialised enough in gin
• One smaller benefit is that they can share warehouses

The comeback:

• After the double whammy of operating deleverage in their home country (sales volume fell ~35% in 2011), higher interest expense from debt to fund capex + JVs, and losses from JVs, GSM made a net loss for 5 years straight from 2011-2015
• Management took a good look at their situation and realised they had to refocus back on the Philippines, the market they know intricately, and narrow their product portfolio to only the best performers from 24 (14 alcoholic and 10 non-alcoholic) brands in 2009 to 9 alcoholic in 2018
• They divested the non-alcoholic products to the parent company, San Miguel Food & Beverage
• They cut A&P spend on non-gin products like brandy as they didn't want to continue competing with Emperador directly, thus gin-products contribution increased from ~65% in 2010 to 93% in 2019
• If we delve deeper, there was actually only 1 year which gin sales declined (2012), so while their figures looked bad for 5 years, it was because they lost sales from non-gin products which were now discontinued, particularly Gran Matador Brandy which was 28% of sales in 2010 and non-existent now
• They also countered Emperador Light by releasing a lower alcohol proof version of gin called Ginebra Blue Light (very original I know) and released some good marketing campaigns with the national champion basketball teams and Miss Universe 2015 who's from the Philippines
• Furthermore, Emperador is now making the same mistake GSM did 10 years ago, by trying to grow their overseas exposure with a slew of acquisitions that total almost US$1bn, even acquiring a scottish distillery that owns Dalmore for GBP 430m

Can they continue growing? Gaining traction in the South:

• Very broadly speaking, if we were to break down the consumption of hard liquor by regions
• Brandy appeals to both the North (Luzon, where Manila is and 52% of the country's population) and Southern (Visayas and Mindanao which have the other 48%) regions 
• Gin is predominantly in Luzon, estimated that 70-80% of gin consumption happens in the north
• Rum is opposite, with 70-80% in the south 
• According to an expert on alcohol and spirits in the Philippines, he sees the fastest growing categories as gin and beer (which is dominated by GSM's parent San Miguel who has 94% market share) - he says that Ginebra is doing something right as you can clearly see gin consumption in the south going up and it is eating into Tanduay (rum)
• In the north, GSM probably has the best distribution reach, even better than Emperador, but in the south, they are mainly sold only in big cities in the south - they are actively trying to increase penetration which can continue to drive growth
• These drivers combine to give gin a 7-9% volume CAGR and on average GSM increases their prices by 4-5% per year, even on the low end it'll be 11% topline growth (8% real terms if you minus 3% inflation)

 

 

Using FCF to pay down debt, increased dividends to follow:

Why was debt so high?

• Demand for gin peaked in 2010 so they had to do capex to increase capacity as they were almost 100% utilisation from 30m to 50m cases a year
• Unlucky timing because that coincided with Emperador's rise, crushing GSM's volume which led to losses
• Had to raise debt to keep the company afloat + fund capex

Why is debt coming down now?

• Other than the obvious fact that they got their act together and volumes are back to 2010 levels
• They totally cut dividends from 2013 to 2018 (and only started paying again for the first 3 quarters of 2019)
• Only require maintenance capex as capacity utilisation is at 60-70% now 
• Even in 2014 and 2015 when the company was loss making, it still generated 12-13% FCFy in each of those years

Valuation:

• If GSM is able to maintain EBIT margins of 7.5% (FY19 will probably be 9%+) and even if revenue falls to mid-single digit growth, the company is fairly cheap at ~5x LTM EBIT (company thinks they can get to 12-15% EBIT margin vs Emperador's 20%)
• I am cautious of projecting margin expansion even though the rationale makes sense as they increase utilisation of existing factory and less marketing dollar spend per volume because
• This is their highest margin since 2005 (before that they had 20%+ EBIT margin)
• Emperador has premium spirits in their portfolio and 30% of their sales are international so there's probably a structural difference in unit economics between these 2 firms
• The new spirits tax could have a stronger than anticipated impact on demand 

How has covid impacted them?

 

Ginebra reported great results with sales growth, margin expansion, working capital improvement, debt repayment + cash piling up. The company is super cheap, even by my extremely conservative forecasts to give us sufficient margin of safety to the uncertainty around the company (I expect -5% growth in FY20 and 8% growth thereafter and EBIT margin to fall from 12.9% in H1 2020 to 6.5-7.5% in 2020-2025).  

 

• If we break down the quarterly figures, Q1 sales fell by -9.8% and Q2 rebounded by 14.9% yoy (Q1 is traditionally a bigger quarter so overall sales only +1% in H1). Calls with grocery players in the country seem to suggest that alcohol was one of the popular products even during the lockdown. 
• After an initial period of supply chain issues, the company said they were unable to keep pace with demand, hence EBIT margins for Q2 reached 16.1% (obviously unsustainable in my view). They practically don't need to pay much sales & marketing expenses because regulations don't allow too many promoters to stand inside the supermarkets, but the good thing is that there is no price cap on alcohol! (as compared to other staples like rice or toilet paper)
• They ended 2019 with 6.1bn of inventory, but it's now down to 3.6bn in June. Cash on their balance sheet has exploded from 354 million to 4.2 billion, this is after they paid down 1bn of debt (they are left with 1.3bn of debt) and 164m of dividends
• IR said they are exploring what to do with their cash, if covid situation becomes more predictable, they could choose to pay down all their debt and/or increase dividends. She was clear that there would be no share buybacks because the company is already very illiquid

What does the main competitor (Emperador) say about Ginebra?

When I met Emperador in January, this was what the company had to say about GSM:

• In the last 3 years gin seems to be enjoying a resurgence
• Objectively speaking, Ginebra has managed to improve their ROEs by growing sales and margins, while deleveraging their balance sheet 
• Brandy is losing market share fast to gin after they peaked in 2015
• They have to release a new product constantly to keep market share because gin is actually the default spirit (Philippines is the world's largest gin market), and the population will naturally gravitate back to gin - this was music to my ears because GSM doesn't have to do anything, while Emperador has to continually launch new products and fight an uphill battle 

Catalyst

Continuous operational improvement

Paying down all debt and increase in dividends

Potential delisting by Parentco (however could caution that it would be a huge disappointment if tender is done at current valuations, although San Miguel family does not have the best reputation in the country so I wouldn't put it past them)