Pernod Ricard CFO talks finance & cognac
Gilles Bogaert: "Don't underestimate mature markets"
True to form, the world's second-largest drinks maker had some excellent Q1 results to announce at head office in Paris this week.
Revenues (+13 per cent), earnings (+14 per cent) and full-year guidance for 2010/11 were all up. So top management should have had every reason to reach for their favourite tipple in the ground-floor company bar.
But hardly had CEO Pierre Pringuet finished speaking than the share price began to fall, ending more than 4 per cent lower on the day.
Perhaps some analysts had been expecting even better results, and others had gone in for a spot of profit-taking. Such stock market vagaries are, however, mere water on a duck's back for Gilles Bogaert.
Monsieur Bogaert, global raw material prices are on an upward trend, does that mean that you and your fellow spirits makers are on a downward one?
Not at all. It is true that oil price hikes and increases in grain prices (we make annual purchases of around €100m) could impact our input costs at some point, but we plan to limit the increase in our cost of goods sold in our fiscal year 2010-11 (our costs were up by less that 1 per cent in the first half).
That still comes off your margin…
Higher input prices don’t affect us to the same extent as many other consumer goods companies because our brands have an average gross margin of around 60 per cent, which gives us a good buffer.
Grain prices are obviously relevant to clear spirits, but how about the rest of your portfolio?
Many of the raw materials we purchase for our other products require some ageing before they are sold. We age our Chivas whisky, for instance, for over twelve years. So any price impact will not be felt today, but at some later date when pricing conditions may be very different.
Do you hedge?
Our brand companies sometimes hedge locally, but only short-term, i.e., between three and six months forward.
Pernod Ricard is growing fastest in Asia, but two-thirds of your sales are still in mature markets. Doesn’t this limit the potential to increase the organic growth rate of your operating profit?
Don’t underestimate the potential of mature markets. Admittedly, they have suffered during the current global crisis, but they have started to rebound. Although some markets may take longer to recover than others, there is some growth potential in many mature markets.
Really? Southern Europe is in financial chaos, the UK is committed to an austerity programme, and the US housing market remains weak…
The US remain our number one strategic market world-wide and still represent half of the worldwide spirits market in value. In fact, I am confident that most mature western markets will be able to return to pre-crisis growth rates in the future.
To what extent have you been obliged to reduce your operational costs in order to compensate for lacklustre sales on a number of mature markets?
Your question wrongly implies that a CFO’s only role is to cut costs.
Obviously, we have to be disciplined and optimise our cost base, but the key to enhancing our profitability is not mere cost cutting. It lies in efficient investment in A&P and, above all, innovation, which is the key to growth particularly on mature markets.
Very well, but why increase A&P anti-cyclically?
Such investment will drive the top-line growth of our high-margin premium brands. This will automatically feed into our bottom line.
Isn’t it somewhat of a gamble to pursue the “premiumisation” of your brands during the worst global recession since the Second World War?
No. Premium brands tend to suffer more at the beginning of a crisis, but they also rebound more quickly. If you look back over the various crises of the past 25 years, including the Asian crisis in 1997, premium brands have tended to grow twice as quickly as other brands. This gives us a lot of confidence in the future.
But the fact remains that a considerable number of consumers have been trading down on many markets world-wide. Given the discretionary nature of spirits, isn’t your global rival Diageo with its beers division better placed strategically?
There has been trading down in some markets, but there has also been a significant growth of the premium segment in some other markets.
Obviously, there are some who cannot afford to buy expensive brands and who will be obliged to buy cheaper ones. However, I think that you can address this with specific local brands on a more tactical level.
For instance, we have Absolut premium vodka with a high price positioning, but we also offer local standard brands.
We decided to create a specific brand company organisation for vodka in order to be able to make some suitable brand proposals to the consumers in various segments of the market. So both the higher and lower segments can grow; you just need to address them with different brands.
You spoke just now of “efficient” A&P investment. Do you mean the best media rates?
No, not just that. Our strong investment in A&P must justify why consumers should pay a higher price for our brands. Our marketing communication must explain to customers the taste, origin and care we put into our products in a totally consistently way.
After all, we don’t sell commodities; we sell brands which have an emotional connection with consumers and which give them status. It must also play on emotions…
Which emotions are you trying to evoke?
Our drinks are often consumed on social occasions when people are with their friends and family or in a bar or restaurant. The bottle which they then put on the table is of considerable importance because it is a projection of social status. Few drink our brands alone in the kitchen…
You almost sound like LVMH or Hermès…
We do have a certain similarity with the luxury industry. When one sells products which can cost more than $2,000, one is indeed in the luxury industry.
How then does wine fit your corporate strategy of brand premiumisation – you can’t premiumise your wine brands as much as your spirits?
I disagree. It is perfectly possible to premiumise wine if you have a brand approach and also invest above-the-line in order to create a premium brand. There is no reason why we couldn’t do it.
Why bother when the gross margin on your wines is only half that of your spirits?
We can grow gross margins in various ways. We work the range and focus on premium brands. We are also building a business which is focused on a few brands from different origins in order to cover the different risks and shelf prices.
The fact remains that the ROCE of your wine division is below group average…
In addition to nurturing our wine brands in a creative way, we can continue to make our production and supply base more flexible. Lower inventories mean fewer fixed costs. So, we are confident that our wines business will be able to achieve a return on capital employed significantly above our weighted average cost of capital.
At the end of the day, however, there are very few synergies between your wine and spirits divisions?
There are synergies with spirits. These can vary depending on the country, but in many countries the same organisation sells both spirits and wine. In some countries, and especially in the emerging markets, wine can help to develop spirits in some specific channels such as restaurants.
You also make around 5 per cent of your annual revenues in wine at considerably lower price points. Isn’t your wine division, with all its volatility, simply more trouble than it is worth?
Wine is a more volatile business due to agriculture cycles which can lead to underproduction or, as is the case today, overproduction. However, this could well change in two or three years’ time; so we are confident about the growth potential of premium wines.
Yet, one wouldn’t have thought that you are having much joy with wine in, for instance, the UK?
Clearly, some markets are more attractive than others, and we are trying to be less dependent on the UK. At the same time, the wine business in US and Asia is growing, so we see reasonable growth potential overall.
Despite reducing your indebtedness by €864m during H1 of your current business year, you are still left with a net debt/ebitda ratio of 4.5 and junk bond status. When do you believe that you will be able to obtain an investment-grade rating?
This doesn’t only depend on us! Moody’s already put us on a positive outlook twelve months ago. We are hopeful that we shall become investment grade in the near future, and are doing all that we can to achieve this important goal.
In view of the resultant high level of indebtedness, do you believe with hindsight that you overpaid for the acquisition of Absolut?
“Absolut”ely not! The purchase was a strategic necessity. Vodka is a fast-growing category world-wide, and Absolut has given our global brand portfolio a footprint which will really boost growth. We now cover all major categories and have excellent brands within those categories. So we are exactly where we want to be.
Your CEO, Pierre Pringuet, recently said that you will not make another big acquisition until the company has regained investment-grade rating. Isn’t it frustrating for you as a CFO not to be able to make a bid for the alcoholic business of Fortune Brands etc.?
Clearly, now the focus is on organic growth and deleveraging, but I can assure you that I'm not in the least frustrated!
Related article in German: Interview by Mike Dawson in Lebensmittel Zeitung, no. 11, 18.03.2011
The press conference in Paris was followed by a press trip to south-western France where Pernod Ricard makes its cognac. A few travel notes reveal how the company markets its brands to the media and inculcates a love of product in visiting members of staff from around the world:
Change of scene a three hours' TGV train journey later: Lionel Breton, the director responsible for the brands Martell, Mumm and Perrier-Jouët, hosts an evening meal for a bevy of international journalists at Château de Chanteloup, the former residence of the Martell dynasty near the south-western town of Cognac.
The fact that a goodly portion of his guests are Chinese is certainly not accidental: Pernod Ricard already makes around 30 per cent of its annual revenues in Asia, and China is its fastest-growing market.
With a roguish glint in his eye, Lionel Breton asks his guests for their guess regarding the future concentration of the global spirits sector. He is sitting opposite a row of Chinese visitors when he puts this question. They change the subject with exquisite tact and request permission to sing karaoke in the basement after the banquet.
Given the growing amount of FDI coming from China in an ever-increasing number of western business sectors, perhaps Monsieur Breton had the answer to his question directly in front of him.
The next day all visitors are treated to a tour of Martell's cognac distilleries by cellar master Benoit Fil. One learns, for instance, that the "liquor of the gods" shouldn't be swirled or warmed in large glasses, in order not to mix the aromas.
Ideally, cognac should be drunk at room temperature in tulip-shaped glasses. Apparently, it is even wrong to dip your nose too deeply into the glass for this stops the cognac fully unfolding its bouquet.
Finally, Lionel Breton gives a lecture on the production, ageing and marketing of cognac. Why, one asks, this painstakingly slow path to perfection? Perhaps it is the stuff high margins are made of...