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These are tough times to be in the cognac business. While consumers continue to drink alcohol, despite concerns about generational shifts in tastes and the impact of factors like GLP-1 drugs, they are most definitely not drinking as much cognac or brandy as in the past, and when they are, they’re typically trading down to cheaper brands.
I didn’t like Remy Cointreau (OTCPK:REMYY) (OTCPK:REMYF) (RCO.PA) shares back in late December even after a roughly 30% drop in the share price, and punishing double-digit declines in monthly volumes since then have pushed the shares down another 20%-plus, making Remy one of the worst performers in an admittedly pressured sector.
I am guardedly optimistic that Remy’s business may be bottoming out, but a lot of that is coming from easier comps as opposed to any real resurgence in demand. Cognac could once again come into vogue, but trend shifts are notoriously hard to predict and there just aren’t many signs of real momentum in the business. I can see double-digit upside from here on the basis of still-strong margins, but it’s hard for me to imagine a lasting re-rating or outperformance here without a return to growth in its core cognac businesses in China and the United States.
China Investigates Dumping – Too Significant To Remy To Ignore
Early in January, the Chinese government announced that it was investigating European cognac producers for potential anti-dumping violations in the Chinese cognac import market. The reported results of producers like Diageo (DEO), LVMH (OTCPK:LVMUY), and Pernod Ricard (OTCPK:PRNDY) lead me to believe it is unlikely that actual dumping was occurring, and I believe the EU’s investigation of dumping allegations against Chinese electric vehicle producers has far more to do with this (“tit for tat” in other words, as opposed to addressing an actual issue).
Whatever the real motivations may be, the fact remains that cognac sales in China are far too important to Remy Cointreau to just dismiss this as diplomatic posturing. Sales of cognac in China have grown to about 30% of Remy’s overall revenue and they’re profitable sales, generating a disproportionate 40% of Remy’s operating earnings.
Back in 2020, in response to disputes between the Chinese and Australian governments over a range of issues (human rights, activity in the South China Sea and other areas, and the COVID-19 response), the Chinese government hammered Australian wine imports with tariffs of 100% to 200%, and it basically killed that business (Australian exports of wine to China fell about 90%).
I can’t say whether something similar will happen here. As I said, I don’t believe Remy Cointreau has actually done anything wrong, but that may have little-to-nothing to do with the issue, and there isn’t much I can see Remy’s management doing about the situation (moving production to China wouldn’t be feasible).
Looking past this issue, Remy may not be entirely out of the woods even if the Chinese decline to pursue tariffs. As part of an overall rise in nationalist sentiment, there’s a growing movement away from imported products in favor of domestic alternatives. It’s hard to get good enough data to say if this is just online/social media posturing and propaganda, but it’s something to monitor.
On a more positive note, I would note that Remy has hired its first Chinese spokesman (Li Xian) and secured product placement in Blossoms Shanghai, a new TV series that has already hit blockbuster status in China.
Ongoing Weakness In U.S. Sales Is A Real Issue
Despite plenty of doomsaying from the sell-side that the U.S. spirits market is in trouble, evidence from sources like Nielsen and NABCA suggests that the industry is doing okay. The market appeared to grow by more than 5% in 2023 (in line with historical norms), and while more recent data points suggest a slowdown to around 3.5% growth, that’s not terrible (NABCA data suggests weaker growth that’s just above flat).
What has been terrible, though, is the ongoing performance of the brandy/cognac category and Remy Cointreau in particular. Cognac declined by low double-digits in 2023 and recent data suggests declines on the order 5% to 9%. With consumers trading down to cheaper brands, Remy is getting hit especially hard, with volume and volume declines heading into the mid-teens.
This is a continuation of weak trends reported back in January for fiscal third quarter sales. Remy doesn’t offer a lot of detail in its reports, but did report a 23.5% overall organic revenue decline in that period, with Remy Martin sales down 34% and sales in its Liqueurs & Spirits business up about 4%.
Sales declined by double-digits in both China and the U.S., with significant destocking in China and a 14% decline in depletions in the United States. Even with that weakness, inventories are still above pre-COVID levels (5 months versus 3 months), while sales are about 2% above pre-pandemic levels.
Remy Cointreau does have a new ad campaign in the U.S. featuring Usher (“Life is a melody”), but the company has in general been pulling back on advertising and promotional activity – not exactly the traditional remedy when sales and market share are declining. Likewise, while management’s refusal to be more accommodating on price may have long-term value in preserving the perception of the company’s brands, it’s leaving the company highly exposed to customers trading down in what is still an inflationary environment with pressured discretionary income.
Some Good News Later This Month Would Be Welcome
Remy Cointreau is scheduled to report fourth quarter and full-year sales on April 26, with full financial results coming much later (June 6). At this point the consensus expectation is for a roughly 5% drop in sales, but analysts are expecting mid-single-digit growth in FY’25 as destocking trends in the U.S. and China ease or reverse.
It’s tough to make predictions about this quarter for Remy, particularly since there’s not much good incremental information to be had on trends within China. The timing of the Chinese New Year should be a positive on balance and steep restocking heading into the period could have created a set-up where the company can report some growth here. I’m not expecting much good news from the U.S. business, though, and I’d also note that volumes in the EU haven’t been all that encouraging (as per Nielsen).
Remy shares did pop with the third quarter return (about 13% on the day of), largely off of relief that sales weren’t worse than feared. I think that’s a possibility this time around, particularly if there is some evidence of re-stocking in China, but I can’t look at the recent trends in U.S. sales and feel good about where the business is at today.
The Outlook
I’m expecting Remy to finish FY’24 with a 23% revenue decline and only a 2% recovery in FY’25. I do expect a stronger recovery in FY’26 and beyond, helped by a stronger economy, but a lot depends on the situation in China regarding EU cognac imports and whether the company can reverse what has turned into years of market share loss in the U.S. market.
I’m expecting about 2% long-term revenue growth from Remy, with near-term weakness offset by 5%-plus growth for much of the next decade. That may well prove too generous if share reversals don’t reverse, but I do still believe that Remy has good brands and consumers will come back to it in time.
This is a very profitable business even when volumes are under pressure, but I don’t expect a return to 30%-plus EBITDA margins until FY’26 (and I’m not convinced full-year FY’26 margins will get to 30%). I do still see a path to free cash flow margins in the low-20%’s over time, but that’s going to require regaining share and volume growth in the U.S. and a healthy Chinese market.
Using those assumptions with my valuation models, Remy Cointreau looks priced for mid-single-digit returns on discounted cash flow. That sounds bad, and it’s certainly not ideal, but spirits companies often trade at much lower implied costs of capital than other stocks (they’re seen, right or wrong as “all weather” businesses), so it’s not unusual.
Looking at my margin/return-driven approach, I get a fair forward EBITDA multiple of 16.5x, supporting a fair value about 15% above today’s price.
The Bottom Line
Remy Cointreau shares are indeed trading at the lower end of the historical range in terms of metrics like P/E, but I’d also note that growth and margins are not doing well now, so you’d expect some contraction. Moreover, given the fundamental shifts in the company’s markets (consumers in the U.S. and EU are clearly drinking less cognac than in years past), some discount is warranted.
With all of the negativity priced into the stock, it’s tempting to call a bottom and highlight this as a rebound name. I do think alcohol consumption is unlikely to change as meaningfully as some bears predict, but I have no idea how long this shift away from cognac will last, nor what will happen with China’s anti-dumping “investigation”. I’d personally like to see a little more evidence of stability in the U.S. business before jumping in, but I also openly acknowledge that by the time it’s clear that the business has indeed bottomed, the shares could have already jumped 20% or more.
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