Chris Brook-Carter

No signs of indigestion at Pernod

By Chris Brook-Carter | 28 September 2004

Pernod Ricard has made progress since it bought a group of major brands from Seagram in 2002, not least in turning round some of those very brands. But in spite of a generally positive performance and outlook, investors remain concerned about some individual markets. Chris Brook-Carter reports on the group's first-half results.

Any fears investors had that Pernod Ricard would struggle to swallow the huge round it bought itself when it acquired the Seagram drinks portfolio alongside Diageo in 2002 must surely now be quelled. Not only did the French group down the lot, from Chivas Regal to Martell and The Glenlivet, but it appears to have done so without having to suffer much of a hangover at all.

In fact, the group has turned a number of ailing brands around - in particular Chivas Regal and Martell, both of which were victims of mismanagement by Seagram - and these same brands are now driving much of the growth Pernod unveiled at its first-half results last week.

The French group reported a slight rise in operating profit to €280m from €279m in the first half last year. However, in organic terms, operating profits of its wines & spirits division, which now dominates the company's commercial activities, rose by 11.1%.

The results prompted the group to revise its full-year expectations upwards, from an estimated organic growth in wines and spirits of 7% to a figure of between 8% and 10%.

Driving this success has been growth in Pernod's premium brands, including those it bought from Seagram, justifying the increase in marketing spend the company has made over the last 12 months.

Chivas Regal saw sales rise by 11%, with strong growth in all regions, but most notably in Chinese Asia where volumes doubled. Martell sales were up by 8%, with Asia again the leading growth region. Chinese volumes were up 20%, while Malaysia, Taiwan and Duty Free grew by 23%. There were even signs that Martell's troubles in the US - where it had performed poorly under Seagram - were coming to an end, with depletion growth of 2%.

"We think we have turned the corner in the US," said Richard Burrows, Pernod's joint managing director. "In a vibrant market I have to say that the competition is doing extremely well, but we are in a position to start challenging."

Meanwhile, the Glenlivet was up by 11%; Royal Salute and Jameson both rose by 12%; and Havana Club was up by 8%. Jacob's Creek, the group's flagship wine was also up by 8%, despite the competitive nature of the wine markets in the UK, Australia, New Zealand, the US and Ireland.

"Within the portfolio, those brands that are premium are growing faster," said Burrows. "We are getting leverage. That sales growth is being translated into higher profit growth."

That leverage is demonstrated in the gross margin figures, which also show the importance of the ex-Seagram brands to Pernod's development. The company's gross margin/sales rate has grown from 65.8% in the first half of 2003, to 66.6% in 2004. At constant rates, it reached 67.8% in 2004 H1, which represented an increase of 200 basis points.

Pernod's top 12 brands have a gross margin/sales rate of around 75%, with Chivas, Martell Cordon Bleu, The Glenlivet and Jameson now producing 60% of the growth in gross margins. And in constant currency terms, operating margins increased from 18.6% in 2003 to 19.7% in 2004, helped by Pernod's now well-established control on costs.

All this should add up to a pretty heady brew for investors. However, the results were greeted with a muted response from the City, which was made only slightly better by the increase in full-year estimates.

Pernod does have problems in individual markets. Although there have been significant improvements during the second quarter in South and Central America, where Chivas is the principal growth driver, there are still problems at home in France and across the rest of Europe.

In Europe as a whole, sales rose by 3% to €586m and the company said it had seen an improvement in Ireland. However, Spain continued to be disappointing, especially for gin. And Poland, where domestic producers were chasing volumes by cutting prices, hit Pernod as it stood firm with its pricing policy.

France also continues to be troublesome with only a 1.6% rise in sales. Although there had been good progression in whiskies, vodkas and rums, the poor weather this year accelerated the plight of the aniseed category.

"Despite enjoying international success, question marks remain over the French firm's performance in its home market," said an analyst at the consumer goods research company Datamonitor. "The wider macroeconomic conditions in France have dampened consumer spending. More specifically, the dramatic clampdown on drink driving instigated by the French government in the last couple of years has also hit on-trade sales. Adapting to the changing drinks sector in its home market is the next major challenge for Pernod Ricard."

All that said though, Pernod's biggest battle is not with lawmakers or market trends but with the exchange rate. The effects of the exchange rate wiped a massive €29.5m off the operating profits and €47.1m from the sales column.

"We took a strong impact from the weakness of the dollar, the strength of sterling and the weakness of other currencies against the euro," said Burrows. Specifically, the group took a €14.4m hit in the US; €5m in Asia; €3.6m in Australia and €1.1m against the Venezuelan Bolivar.

Despite the strong underlying growth, Pernod may well need to look hard at its hedging policy before investors greet the company's stock with the same enthusiasm as consumers are currently greeting its products.

Sectors: Spirits

Companies: Pernod, Diageo

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