The following stock has become quite popular among the Substack crowd, but I remain on the fence as to its prospects. This shorter discussion post is intended as an invitation to readers to share their thoughts.
Laurent-Perrier (LP) is one of three, family-owned (65%; Nonancourt) and publicly-traded champagne producers. It owns five champagne houses positioned across the upper-middle to ultra-high-end quality range: LP, Salon, Delamotte, and Champagne de Castellane. In FY23, the firm sold 11.7m bottles at an average price of €26, though one can imagine the actual price range is extremely broad, from perhaps €10 to €100s for exclusive vintages and prestige cuvées. 87% of LP’s revenue originates from exports to big markets like the EU, USA, UK and Japan, with 13% from France (the largest single market).
Champagne, due to its economic value to France, is strictly regulated by the Comité Champagne (CIVC), insulating producers from competition. In short, it must be produced in the Appellation d’Origine Contrôlée (AOC), a designated area of 34,200 hectares east of Paris which envelops 3 regions, 5 departments, 370 champagne houses, 16,200 winegrowers, 130 cooperatives, and more than 300 crus, or wine villages. Moreover, champagne production consists of 25 stages, and the quality of grapes used must exceed an 80% rating, past which they are categorised as either cru, premier cru, or grand cru. The defining element of production is a double fermentation: first in the vat, then in the bottle itself.
Champagne is considered non-vintage if it is aged at least 15 months, and vintage if aged more than 36 months from the bottling date. Grapes are the critical input, and comprise 3/4 of the cost of goods. About 1.2kg are required to make a standard 750ml bottle of champagne, with a typical cost per kg of €5. LP produces 10% of its own grapes, which is below the 20% average of houses and uses a higher quality of grapes, with a rating of 91% compared to an 88% average. LP has 1,200 suppliers, with whom it has staggered contract renewal dates. Its brands are sold through different distribution channels or in different price ranges, ensuring they do not cannibalise each other.
As in other luxurious product categories, margins are relatively high, and houses like LP, Mumm, Möet & Chandon, Veuve Clicquot, etc., tend to focus on pricing discipline and generating brand power instead of raw volume. Other crucial actors in the champagne operation are growers - who own 90% of vineyards - and cooperatives. These sometimes produce their own product, but they reap a small fraction of the rewards, in part because they lack the brand power of houses.
As to the market, champagne’s annual TAM stands at around €6bn, with about 300m bottles shipped. Volumes have increased since the end of the last century and throughout the 2000s but have stagnated since then, whilst typical prices have constantly risen by an average of about 150 bps annually, from €10.1 in 1998 to €19.4 today, as one would expect from a protected (cartel?) network of producers.
Of the 325m bottles shipped in CY22, 42.5% went to France, 19.0% to the EU, and 38.5% to other important markets, like the US, UK, and Japan. Houses reap most of the rewards of export, as shown by their disproportionately higher share of value relative to volume, and though Non-vintage Brut is the most popular type of champagne by volume, Prestige Cuvées seem to be driving the best margins.
LP has a four-pronged strategy.
Single business: production and sale of premium champagnes exclusively.
High-quality inputs through a partnership approach with grape growers.
Portfolio of complementary brands that do not cannibalise each other.
Active control of worldwide distribution.
Execution on the first pillar has the greatest impact on revenue and margin growth. So far, performance has been quite good, with an increase in the percentage of sales from premium champagnes like the Cuvée Rosé and Grand Siècle of 34% in 2H10 to 46% in 1H24. Further execution of the premiumisation strategy and an increase in the share of higher-value exports will undoubtedly be the biggest determinants of LP’s future performance.
And about here is where it gets (more) interesting. Though LP’s recent performance has been very good, we have no clue as to whether this can go on without speaking to management. This makes me reluctant to build a growth forecast. With an earnings power valuation that assumes a conservative status quo on FY18-23 figures - certainly justified because LP has, for a long time, not shown a growth trend - the value per share comes out at €54, which is super unattractive at a current share price of €120. Even if we turn very optimistic, and use FY23’s revenue and EBIT margin, the value estimate increases minimally to €84 per share.
However, on book value per share, LP is worth €92, and certainly much more, if we consider that the bottles in its cellar are valued at the weighted average unit cost excluding financial expense. But how much more?
What follows is a rough but not unreasonable series of calculations that excludes raw materials and work-in-progress components. With FY23 COGS and the number of bottles sold (11.7m), we can approximate the average cost per bottle (€11.4), and from champagne revenue we know the average wholesale price too (€25.8), which indicates a gross margin on a unit basis of 56% - in-line with what one would expect. More importantly, we now also know that the price/cost factor is around 2.3, which we can use as a multiplier on the book value of finished goods (€468.6m) to estimate the market value upon sale (€1059.7). Now, we have a TBV per share of €187 instead of €87, relative to a current share price of €120.
Of course, this calculation is somewhat flawed. For example, we can assume that a good proportion of the bottles in LP’s cellars still need to age before the true market value can be realised, and we have no insight into product mix e.g., what proportion is non-vintage, and therefore has to age for no more than 15 months at most? From statements in the annual report, I think the land is valued at market, so there is no further upside from that (correct me if I am wrong).
Overall, a strong case can be made that LP stock is an asset value investment first and foremost, instead of one based on earnings and cash flow. But if that is the case, and a liquidation or sale are out of the question because of the family’s legacy and current profitability of the business, then the TBV per share is a purely theoretical exercise.
I would rather invest in a firm that produces real free cash flow, year-on-year; a bird in the hand is worth two in the bush. However, the operating cash flow is tied up in stock replenishment and fails to come through, returns on capital are quite bad (though good for an agro biz), and generally there is little information provided to potential investors.
Most importantly, it is also entirely plausible that the bump in revenue and earnings FY21-23 is the result of inflation: the aging required before a bottle is sold means that pre-inflation wave costs are matched to post-inflation wholesale prices, resulting in an artificial, high margin that is not the result of strategic success. See the widening disconnect between COGS and wholesale prices per bottle below. Thus, with a full inventory turn every four years, we should expect margins to normalise in FY27-28, if inflation drops back to a reasonable range.
LP is lodged in an awkward middle-ground between a very high-margin, brand power, low volume business (gross margins for ultra-premium brands like Salon could exceed 95%) and a high volume, low-margin producer.
There are also other, not-so-small risks to consider.
Climate change either alters the taste of champagne or forces relocation of the vineyards northwards at great cost. LP claims the dispersion of its operations mitigates this, but they are all in Champagne and uninsured.
Over-reliance on pricing for growth, or a rise in grape prices (perhaps due to the above) that forces price hikes leads the houses to slowly price themselves out of the market and share is lost to rising alternatives like prosecco.
Liquidity issues as cash is absorbed by inventory replenishment.
Family conducts a move that is not in the interest of minority shareholders.
Wine cellars and their contents are damaged.
Overall, then, LP does not seem attractive: there is no margin of safety here.
Disclaimer: this write-up describes the author’s own research and opinions, and does not constitute investment advice, whether explicit or implied. Invest at your own risk and do your own due diligence. I do not hold a material position in the issuer’s securities.
I like your analysis.. I think you should also apply a NPV discount for inventory, not only for vintage issues but it is also almost 4 years of sales, so, at the very least, applying a 10% pa discount would dramatically lower the NPV of it.. However, I think not all investments need to be super charged, and given the defensiveness of this business and steady state nature of margins, visibility and all, it is not a bad one, quite defensive, good inventory support and well protected, high barriers to entry.. I caneasily see a 10%+ IRR, many years out..
Salon is way more ultra-premium than Armand de Brignac (LVMH). Salon can easily cost >1000€, sometimes several thousand € per bottle. They are extremely picky on quality, produced only 44 vintages in 120 years.