Description

Investment Thesis:

Cognac sales spiked during Covid and are now settling back to more normal levels.  Cognac is one of the most attractive segments of the liquor industry, as will be detailed below.  It accounts for roughly 85% of Remy Cointreau’s profitability.  The other major cognac brands are owned by much larger, diversified spirits companies, so it is the only direct public play on cognac.

Remy Cointreau trades at a three year low and very close to its lowest absolute P/E (which was 22) since 2010.  It is not super cheap but I believe it represents excellent long-term value at current levels. It is an irreplaceable asset and an uneven compounder that I think can generate long term earnings growth of 8-10% going forward (as it has done in the past). While the very lofty P/Es reached in

 2020-22  will probably never return, the stock has normally traded at multiples in the mid-high 20s. I do think that is achievable for a company of this quality.

The Cognac Market:

Cognac is brandy that comes from a very defined (AOC designated) area in southwestern France. The eau de vie which comes from double distillation must be aged for at least two years. It is then classified as VS, or Very Special. Longer aging yields more desirable and expensive products:  VSOP after 4 years and XO after 10 years.  Apart from the carrying cost of the inventory, about 3% of the volume is lost through evaporation each year the cognac is in the barrel.  After 10 years or so, the cognac may be transferred to large glass bottles for future aging.  Louis XIII, the ultra high end label of RM–a bottle costs at least €3000, contains eau de vie from 40-100 years old.

 Whiskeys, of course, also require aging which can constrain supply.  Thus, for example, certain bourbon brands have been unable to satisfy demand in recent years because of a lack of sufficiently aged inventory.  But cognac has an additional constraint on supply:  the grapes must come from a strictly defined geography.  Better growing techniques can expand this slightly from year to year, but basically there is finite supply.  Hence, there is solid commercial logic to try to improve the mix to more aged and expensive products over time.

There are five major Cognac producers and hundreds of smaller brands:

1.  Hennessy (a 66/34 joint venture between LVMH and Diageo).

2.  Remy Martin

3.  Martell (Pernod Ricard)

4.  Courvoisier (Beam Suntory–private)

5.  D’Usse (Bacardi 75/Jay-Z 25–private)

VS cognacs account for roughly half the market by volume.  This is an important point that will be expanded upon.  The US and China are far and away the most important geographies. In recent years cognac has somewhat expanded its share of spirits consumption in both the US and China.  In value, Remy is #2 in the US and #3 in China–the company has gained share in both markets in recent years.

Corporate Background/Strategic Goals:

Remy Martin will celebrate its 300th anniversary in 2024.  (Martell and Hennessy also trace their roots back to the 1700s and Courvoisier to the 1800s.) The company is controlled by the Heriard Dubreuil family.  With the Cointreau family  and holdings of an association of grape growers roughly 60% of the stock is closely held.  This has grown a little in recent years given periodic share buybacks and modest insider buying,  Not surprisingly, management is very focused on the long-term. CEO Eric Vallat has a background in the fashion business, was head of the Remy Martin division for years in the 2010’s, left for Richemont and returned to assume his present position at the end of 2019.

Vallat first presented to the investment community in June, 2020 with F20 (3/31) results.  He set out corporate targets for F30:  A 72% gross margin and 33% operating margins (F20 was 66% and 21% respectively).  The company has made significant progress on each:  F23 levels were 71.3% and 27.7%. Cognac operating margins in F23 were 37%--the highest in corporate history and a 7 point improvement over the last four years. The key to this margin improvement has been pricing and a favorable mix shift in cognac.  Remy stopped sales of VS (lowest price point) cognac in 2014.  And in recent years in particular, sales of higher priced cognacs have grown faster than VSOP.  One key statistic: Between F19 and F23 cognac volumes grew 3.7%/year and price/mix 9.1% annually.  Management expects the mix improvement to continue going forward although long-term volume growth should moderate to the 2% neighborhood. Another perspective:  over the last 4 years the global weight of intermediate cognacs (higher priced than VSOP but lower than XO) has grown by 15 points.  

First quarter cognac sales (6/23) were down 45%-- terrible as management had forecast, with the US faring far worse than China, where sales were good helped by on-trade (bars and restaurants) recovery. Inventory destocking, aggressive price promotions from Hennessy and possible share loss on the margin to tequila were all factors.  Management noted that June depletions were positive–a ray of hope–and that field inventories had been brought down but still had more to go. They forecast a flattish current year (3/24) in sales and profits; here is the CFO on the 7/23 Q1 sales call:

In conclusion, Slide #10, we are reconfirming our guidance disclosed end of April. Following 2 outstanding amazing years, Remy Cointreau expects full year '23-'24 to show a continued strong normalization of the consumption in the U.S. However, it will settle at new normal levels significantly above '19-'20 pre-pandemic levels. At the same time, we expect a strong organic sales growth throughout the year in the rest of the world, including China, where we forecast, we expect major sales gains. EMEA and rest of Asia, they should generate very good strong performance and, of course, on top Travel Retail channel, that should reach, this year, pre-COVID levels in terms of sales.

In this global sales context and balance but overall focus in this target, the group expect total sales to remain stable on organic basis for the full year '23-'24 with a strong decline in sales in the first half, reflecting essentially a very strong fall in the U.S. and high basis of comparison and clearly, a very strong recovery in the second half of the year, driven by sharp rebound in the U.S., starting from the Q3.

Meanwhile, Remy Cointreau intends to confirm its organic level of profitability, meaning stability also in terms of organic profit compared to last year, based on 4 different elements. First of all, a continued rollout of our value-driven strategy built on a firm pricing policy and improved price/mix. Second, a resilient gross margin in a persistently inflationary context. Third, stabilization of the A&P ratio as a percentage of sales at group level. Fourth, very important, tight -- extremely tight control of our overhead costs

Liqueurs and Spirits:

Led by Cointreau, this division is 27% of corporate sales but only about 12% of corporate profitability.  The company is investing heavily in marketing behind a number of brands:  First and foremost Cointreau, which has very high margins and no production constraints, but also single-malt scotch (Bruichladdish) and gin (The Botanist), among others.  To get to its corporate goals, I believe margins in this business will need to expand toward the 20% neighborhood over the next several years, which based on industry dynamics seems reasonable. If there is interest I can go into more detail in Q&A.

Finances:

Remy Cointreau has a strong balance sheet with net debt less than 1X EBITDA.  Capital requirements are modest but there are significant working capital requirements (about €115MM this year) for aging spirits.  The dividend has been on an upward path–this year there is a €2 regular dividend and a €1 special dividend.  In 5 of the last 10 years (including 2021 and 2022 but not this year) the company has bought back approximately 1MM shares/year.  

Risks:

–The marked downturn in the Chinese economy impacts consumption.  Short term mitigants are a recovery in duty-free and on trade sales.

–After years of proclaiming minimal desire for acquisitions there now appears to be some interest.  I hope if/when they act that it is very small (similar to Bruichladdish a decade ago).

https://www.remy-cointreau.com/app/uploads/2023/06/Remy-Cointreau-FY-2022-23-Results-presentation.pdf

*Note:  All figures in Euros.

Catalyst

Late October:  First half (9/30) sales report confirms improved cognac outlook.