Revenue growth - egade.csf.itesm.mx · Diageo and Bacardi (Don Julio and Patron, respectively) show...

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the securities mentioned.

October 15th, 2018

Becle S.A.B. de C.V.

CUERVO * /BMV

Initiating coverage:

Recommendation: Hold

Price: MXN 29.2 IPC (MEXBOL INDEX): 47,739.09

Analysts:

Antonio Kalifa

Maite Bengoechea

Hector Elizondo

Daniel Villegas

Jocelyn Montalvo

Research Advisors:

Mª Concepcion del Alto, PhD

Edgar Sosa, CFA

Company Overview

Location: The headquarters are located in Guillermo Gonzalez Camarena 800-4, Delegación Álvaro

Obregón, Colonia Santa Fe, Mexico City, Mexico.

Sector: Consumer staples

Industry: Distillers and Vintners

Employees: 6536

Internet webpage: www.cuervo.com.mx

Stock data (MXN)

52-week range 25.21 – 37.40

Return LTM

Avg. Daily volume 2,146,801

BV per share 13.02 Source: Capital IQ and Bloomberg

Shares outstanding (mm) 3,654

Market cap (mm) 108,744

Float (%) 15%

12-month Beta 0.37

Stock data (MXN) 2017 2018E 2019E 2020E

EBITDA margin 27.6% 28.3% 28.7% 30.2%

Revenue growth 6.4% 3.1% 8.0% 8.0%

Gross profit 62.1% 62.8% 62.9% 64.1%

EPS 1.42 1.32 1.45 1.61 Source: Capital IQ and team calculation

• We issue a hold recommendation on Cuervo with a target price of 29.2 MXN, which

implies a 0.68% downside potential from the closing price of October 15th of 29.4 MXN,

considering the current risk-free yield curve, where the opportunity cost is investing in the

risk-free rate, which current yield a 7.75%. Valuing this investment from an opportunity cost

approach, we believe the hold recommendation has a strong fundament. This valuation is

based fully on the Discounted Free Cash Flow to Firm model.

• We stressed the results in two different scenarios, a base scenario with a weight of 80% and a

more optimistic scenario, with a 20% weight in the target price, where a successful M&A

action is executed by the company. It is worth noting that Cuervo’s comparables do not sell

tequila as their main spirit, consequently a multiple analysis would not be appropriate to use.

• Our recommendation is founded on the following arguments: (1) Questionable managerial

decisions (2) Lower volume sales in the US vs industry, (3) Challenging market share growth

in an expanding category, (4) Complex environment for M&A synergies due to acquisitions

at high EBITDA multiples in spirits industry, and (5) High control by the Beckmann family

shareholders

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INVESTMENT SUMMARY We issue a hold recommendation on Cuervo with a target price of 29.2 MXN, which implies a

0.68% downside potential from the closing price of October 15th of 29.4 MXN, considering the

current risk-free yield curve, where the opportunity cost is investing in the risk-free rate, which

current yield a 7.75%. Valuing this investment from an opportunity cost approach, we believe the

hold recommendation has a strong fundament. This valuation is based fully on the Discounted Free

Cash Flow to Firm model. We stressed the results in two different scenarios, a base scenario with a

weight of 80% and a more optimistic scenario, with a 20% weight in the target price, where a

successful M&A action is executed by the company. It is worth noting that Cuervo’s comparables

do not sell tequila as their main spirit, consequently a multiple analysis would not be appropriate to

use. Our recommendation is founded on the following arguments: (1) Questionable managerial

decisions (2) Lower volume sales in the US vs industry, (3) Challenging market share growth in an

expanding category, (4) Complex environment for M&A synergies due to acquisitions at high

EBITDA multiples in spirits industry, and (5) High control by the Beckmann family shareholders.

1) Questionable managerial decisions. Since the IPO, managerial decisions have not been

accreting for the shareholders. The managers’ decisions in their investments (Pendleton and

Bushmills) and disinvestments (Don Julio) have not been optimal, which makes the shareholder

question the company’s decision making. Additionally, the recent resignations of two key personnel

are raising alerts, that those investment results are not going the way they expected. It will be

interesting to continue monitoring Cuervo’s decision making, because of the amount of cash they

currently have (around 13,000 million MXN), and their recent trend to diversify their portfolio even

though results have yet to show the strategy is working.

2) Lower volume sales in the US vs. industry. Cuervo is struggling to maintain its current position

as the world market share leader in tequila, with a YoY decline in volume sales of 9L cases of 4.9%

for 2017. Meanwhile, its main competitor (Diageo) showed a YoY growth of 2.5% bolstered by

their tequila category in their latest report. Cuervo’s negative results was caused by the

company’s increment in prices of their tequila brands in 2017, which generated overstocking in

all three levels of distributors (Importer, Wholesaler, and Retailer). Consequently, Cuervo has

not lived up to their guidance for 2017 and 2018, causing their working capital to rise by the

inventory overstock and affecting their operating cash flows. We expect Cuervo to increase its

sales and reach previous growth levels, however not in the short term.

3) Challenging market share growth in an expanding category. We expect Cuervo’s tequila

brands to have a challenging growth for the upcoming year. The new acquisitions made by

Diageo and Bacardi (Don Julio and Patron, respectively) show better results than Jose Cuervo

and 1800 family, due to these brands being sold in more premium categories. Last year Diageo

had a 35% tequila volume YoY growth and recently acquired Patron (January 2018) showed a

1% YoY growth, whereas Cuervo’s volume sales decreased in 4.5%. Additionally, competition

has consolidated to a few big players holding most tequila brands and we believe companies with

better distribution system in the US will excel in their volume growth. It is worth noting that Cuervo does not have exposure

to California and New York, which are the #1 and #5 states in tequila consumption. Considering these two states as

premium markets, we believe Don Julio and Patron will continue to obtain better results, even if Cuervo decides to enter these

markets.

4) Historical acquisition at high premiums in Spirits Industry. In the last couple years Cuervo acquired two whisky distillers

(Bushmills and Pendleton). We expect the company to continue looking for a new possible M&A, since the company

currently has around 685 million USD in cash. However, with the current management restructure, we believe this will be

challenging. This year Patron was acquired by Bacardi, paying 25x EBITDA, an operation that will change the premium

expected to be paid for possible new acquisitions in the industry, making it difficult for Cuervo to find a new attractive

opportunity to buy.

5) High control by the Beckmann family shareholders. 85% of the shares outstanding are in complete control of the

Beckmann family, and 15% free float. This comes with an implied risk of liquidity and the possibility of the Beckmann family

taking decisions that might not be in the best interest for the company. Additionally, it is worth noting that any shareholder that

wants to acquire 5% or more of the shares outstanding has to notify and get the approval of the Beckmann family as an anti-

takeover program that Cuervo applies.

Key figures (MXN)

Outs. share (mm) 3,654

12-month beta 0.37

Enterprise value

(mm) 105,152

Dividend yield 1.70%

52 weeks low 25.21

52 weeks high 37.40

Free float 15%

Market cap (mm) 108,744

Valuation date: 10/15/2018

METHODOLOGY WEIGHT PRICE

DCF 100% 29.2

12-month target

Price 29.2

Target downside

return% -0.68%

Dividend yield 2018 1.70%

Total 12 month

return % 1.02%

:

Key financials 2016 2017 2018E 2019E 2020F 2021E 2022E

EBITDA margin (%) 24.8% 27.6% 28.3% 28.7% 30.2% 31.2% 31.5%

Revenue growth (%) 32.1% 6.4% 3.1% 8.0% 8.0% 6.4% 6.0%

Gross profit (%) 59.3% 62.1% 62.8% 62.9% 64.1% 64.9% 65.1%

EPS (%) 0.86 1.42 1.32 1.45 1.61 1.78 1.92

Recommendation

HOLD

Share Price (MXN) 29.4

Target Price (MXN) 29.2

Downside 0.68%

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CURRENT HIGHLIGHTS Resignation and appointment of new CFO. In June 2018, Daniel Elguea Solis resigned from

his position as CFO and alternate in the Board of Directors. In September, Fernando Suarez

Gerard, former CFO of Volaris, was hired as the new CFO, due to his experience in debt and

capital markets and strategic planning for growth companies.

Resignation of CEO of Proximo Spirit’s Inc. During June 2018 it was announced that Mr. Mark

Teasdale, President and CEO of Proximo Spirits (Becle’s USA Unit), resigned from his positions

due to personal reasons. Provisionally, Mr. Michael Cheek, member of the Board of Directors,

will be in charge of this position. As of today, a new CEO is yet to be appointed.

Acquisition of the Pendleton Whisky Brands. In February 2018 the company completed the

acquisition of Pendleton Whisky Brands, which is a super-premium Canadian whisky brand,

acquired from Hood River Distiller, Inc. Pendleton Whisky, launched in 2003, has seen its sales

volume grow in volume to more than 250 000 nine-liter cases annually by the time of the

acquisition.

BUSINESS DESCRIPTION

José Cuervo is a Mexican company that produces, sells and distributes alcoholic and non-alcoholic

beverages, as well as, ready-to-drink cocktails. Cuervo, is one of the oldest companies in Mexico

and it has been controlled by the same family for eleven generations Jose Cuervo was privately

held from its foundation in 1758 until February 2017, when the company was listed in Bolsa

Mexicana de Valores (BMV). The company has a global presence, with distilleries and processing

plants in Mexico, the USA and North Ireland. Cuervo sells its over 30 brands portfolio in 85

countries worldwide. As reported in the 2Q 2018, it employs 6.536 employees.

Products. The portfolio consists of over 30 different brands of alcoholic (tequila, Irish and

American whiskey, rum, vodka, gin and mezcal), non-alcoholic and ready-to-drink beverages. As

reported in the 2Q 2018, the tequila portfolio represented the larger proportion of the net sales

(57%), followed by non-tequila spirits (19%), non-alcoholic (12%), and ready-to-drink (12%). By

volume, tequila is also the most sold product with 43.1% of the volume sold, followed by non-

alcoholic (22.62%) ready-to-drink (18.26%) and other spirits (16%) (Fig. 1). Most of these

products compete in the premium and ultra-premium segments.

Regions. United States and Canada represented in 2Q 2018 63% of the total revenues (Fig. 2),

Mexico 23% and rest of the world (ROW) 13%. Jose Cuervo is the tequila brand with major

distribution globally in terms of sales volume and with a global market share of 29.7% in the

tequila category.

Distribution channels and vertical integration. The company controls the distribution network

in its major markets around the world. In Mexico, they distribute their own brands and several

other third-party brands through their own distribution channels (Fig. 3), which represent the

second largest distribution network of alcoholic beverages in the country (4Q 2017: 4 200 points

of sale). In the US, they own the 9th largest distribution network of the country. In 24 states the

distribution is carried out through 5 wholesalers (Breakthru Beverage Group, Republic National

Distributing Company, Southern Glazer’s Wine and Spirits, Young’s market Company and

Johnson Brothers Liquor Company), in 9 states through independent distributors and in 17 states

the state has control over the distribution of distilled beverages. Besides, in the US there is a three-

step system called “tied house laws”, which regulates the relationship between the importer of

distilled alcoholic beverages, wholesalers and retailers. For the rest of the world (ROW), strategic

Figure 2: Net sales by region (%)

Source: Annual report 2017

Mexic

o 23%

United States and Canada 63%

RoW

13%

Figure 3: Distribution network in

Mexico


Figure 1: Sales by product (%)


Tequila

57%Non-tequila

19%

RTDs

12%

Non-Alcoholic & Other 12%

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alliances are made with independent distributors. Jose Cuervo is also working to achieve vertical

integration of its production, especially in the tequila market. They control from the agave crops

to the distribution of the finished product. With this system, the goal is to secure the supply of key

raw materials (especially important due to the volatile nature of the prices of agave) and control

the quality in each step of the process. Currently 70% of the agave used is grown internally and

the objective is to increase this number to 90% in 2019.

Market strategy. Regarding their current strategy, Jose Cuervo is focused on increasing their

global presence, based on their (a) leadership of the tequila market, (b) development of brands, (c)

investments in innovation, product development and premiumisation strategy and (d) organic and

inorganic development. Since tequila accounts for the greater part of the volume sold, the company

plans to work on the development and expansion of its consumption worldwide by increasing their

presence in the already existing markets, where the potential of growth is believed to be important

(especially in the USA). The company focuses on creating a unique positioning for each brand,

with emphasis in their own premium brands, which bring a greater profitability. The goal is to

make sure that these brands are recognized as of quality, innovative and stylish. With this objective

in mind, the company invests in differentiated marketing, promotion and distribution strategies.

Another goal is to continue investing in the premiumisation of the tequila portfolio in the US and

Mexican markets. For this, the ongoing development of the premium, ultra-premium and prestige

segments are expected to continue. In addition, Jose Cuervo plans to grow focusing on innovation

by creating brands internally, such as the “cristalino” category that competes in the Ultra-Premium

category. Besides, a growth strategy based on mergers and acquisitions is being followed, such as

the acquisition of Bushmills in 2015 to enter the Irish whiskey market. Three requirements are

needed for an acquisition: (a) strong brands, (b) premium and scalable brands and (c) a ROIC greater

than 14% within 5 years. With the acquisition of Bushmills and island2island, the company has

seen how its distribution network has strengthened in the UK, the Republic of Ireland and Asia-

Pacific. This distribution system optimizes the distribution costs and helps in the expansion of their

portfolio.

INDUSTRY OVERVIEW AND COMPETITIVE POSITIONING

INDUSTRY OVERVIEW Macroeconomics. GDP growth, level of disposable income, consumer confidence and preference,

and changes in the regulations are the main drivers of the spirits market. In 2018, there has been

uncertainty in the international markets due to commercial tensions between different economies.

Similarly, there has been a strengthening of the dollar and increases in interest rates by the Federal

Reserve, which is expected continue reviewing its monetary policy with more dynamism than other

developed economies. Besides, according the Bank of Mexico, there has been volatility in the

international financial markets and greater aversion to risk. According to the new trade agreement

between Mexico, the United States and Canada, the alcoholic beverage industry remained

unchanged and, therefore, Becle expects no further complications related to commercial

regulations exporting its products to its main markets.

Mexico. The Mexican economy, which is one of the Company’s main markets, has grown at an

average rate of 2.5% during the last five years and expects a forecasted GDP growth of 2.4% from

2018-22 (Fig. 4). As for inflation, during 2017 there was a rise, reaching 6.77% (Fig. 5) in

December 2017, which caused the Bank of Mexico to maintain a prudent monetary stance and

focus on the behavior of the factors that affect inflation, adjusting in June 2018, 25 basis points, up

to a level of 7.75%. On the other hand, the inflation target proposed by the Bank of Mexico of 3%

has been delayed until the first half of 2020, due to the greater-than-expected increase of energy

prices, mainly gasoline and L.P. The confidence balance had a decrease from December 2016 to

January 2017 of 19.20%, which we consider should be due to the uncertainty of the presidential

elections in the United States. However, throughout 2017 and so far in 2018, the index has once

again stabilized and even improved 17.8% from August 2017 to August 2018, therefore, we

believe, consumers have recovered their intention to purchase and we forecast will result in a

stable growth rate for sales in the spirits industry.

United States. In 2017 The U.S. economy experienced a significant economical acceleration, with

a real GDP growth above expectations of 2.5% (Fig. 5). In 2015 and 2016 there were increases of

2.0% and 1.8% respectively. Besides, the unemployment rate dropped 0.6%, reaching 4.1%, its

lowest level since December 2000 and 2.2M jobs were created with an average of 181K jobs per

month. Consumer spending, which represents the biggest part of the economy, grew 1.8%, as did

the consumption confidence index, which increased a 5.45% in 2017 and grew at an average rate

of 4.89% in the last 5 years. We consider that the United States remains a strong region of

sales for Cuervo and will remain so in the future, growing at stable rates.

Figure 7: Consumer expenditure

CAGR (%)

2012-2017 CAGR CAGR

Historic Forecast

USA 1.8% 4.1%

Mexico 3.0% 3.8%

ROW 1.5% 2.5%

Source: Euromonitor

Figure 5: Inflation by country (%)

Source: Euromonitor

2,8

6,0

4,83,9 3,5 3,3

1,3

2,12,6

2,4 2,1 2,0

1,4 1,7 1,8 2,0 2,2 2,2

2016 2017 2018E 2019E 2020E 2021E

Mexico USA ROW

Figure 6: CAGR by spirits category

(%)

CAGR CAGR

2012-2017 Historic Forecast

Tequila and

Mezcal 4,75% 3,25%

Whiskey 5,24% 2,88%

Rum -0,05% 0,33% Source: Euromonitor

Figure 4: Real GDP growth (%)

Source: Euromonitor

2,9

2 22,4

2,42,6

1,6

2,2 2,72,5

2,11,8

2,0

3,2 2,7 2,6 2,4 2,3

2016 2017 2018E 2019E 2020E 2021E

Mexico USA ROW

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Spirits. The Spirits Industry is composed by Rum, Whisky, Tequila and Mezcal. In 2017 the

industry sold 1,600M liters in Cuervo’s main countries in term of sales. The Industry has had a

Historic CAGR of 3.84% from 2012-17, which makes it an industry with constant growth in sales

volume. The five countries that represent the largest volume of sales with 13B Liters in 2017 are

China (27.8%), India (13.0%), USA (9.6%), Russia (5.9%) and South Korea (6.5%). Becle has

implemented strategies for its expansion in the United States, which is the most profitable market

for the company. The main categories in which the company has greater participation are, Tequila

and Mezcal with 277M of Liters sold in 2017; Whisky with 970M of Liters sold in the same

year; and Rum with 371M of Liters sold. Tequila, Mezcal and Whisky categories have grown at

solid rates and are expected to continue growing above 2% during the next years (Fig. 6). In the

case of rum, the growth forecast is more moderate. As for the consumer spending, in Mexico it

reached MXN$0.060B, and sales in the industry of Bars and Restaurants, where the products of

the company are sold the most, of MXN$0.35B in 2017. In USA it has reached MXN$0.60B, and

sales in the industry of Bars and Restaurants MXN$12B in 2017; Rest of the World it reached

MXN$0.60B, and sales in the industry of Bars and Restaurants MXN$8B in 2017. In these three

geographical areas the consumer spending growth rates are expected to increase in the following

years (Fig. 7). Therefore, and given that Cuervo’s main markets have historically grown at

constant rates, we believe that the future sales of the Company’s products will continue

growing in the next five years.

Tequila. The company leads the tequila industry with 29.7% of the market share. As for the

market structure, there are approximately 150 tequila producing distilleries, mostly in Jalisco,

with around 1,700 brands. Currently there are around 300,000 people involved in the manufacture

of this product directly or indirectly. There two types of tequila: tequila 100% agave and tequila.

“Tequila 100% Agave”, has had a growth of 52% in the last five years, with 151M Liters sold in

Volumes of 40% Alcohol and the highest Historical CAGR of 10.37%. “Tequila”, a spirit

enriched and mixed with other sugars before fermentation, had a decrease of 5.41% in the last

five years, with 121M Liters sold in Volumes of 40% alcohol and a Historical CAGR of 1.34%.

In these two indicators is reflected the increasing trend of the industry towards

premiumisation.

COMPETITIVE POSITIONING

Jose Cuervo is the leader Company in the tequila market worldwide (Fig. 8). This market has a

size of 276 million liters (31,2mm of 9-liter cases, as of 2017) and USD$277 906 million of sales

value, which represents the 1% of the global spirits category. The company operates in a highly

competitive market, with many competitors offering similar or substitute products.

Tequila: leader in a concentrated market. As far as tequila market is concerned, the Company

has a 29.7% (2Q 2018) of the global market share, which represents 2.3x the market share of its

closest competitor Beam Suntory (12.9% of the market share). The closest competitors in this

market are Beam Suntory, Tequila Patron and Brown Forman. These 3 American companies have

another 27.5% of the market share and, with the exception of Brown Forman, are privately owned.

These 4 companies have 57.2% of the global market share, therefore, tequila market is

concentrated. Considering this market concentration and the larger size and resources of its

competitors, we believe that it will be challenging to further increase their market share but

that Cuervo will maintain its current market share in the tequila market in the short term.

Fragmented customer base and consolidation of suppliers. The company works with a

diversified client base around the world, from large companies, such as supermarket chains or

big retailers to restaurants or operators of vending machines. The company claims to maintain a

solid relationship with these customers, as well as to attend their specific demands. Therefore, we

believe buyer power to be low (Fig. 9). On the other hand, the purchase of raw materials is

realized through short and mid-term contracts. As a habit, the company uses a minimum of three

suppliers for the main materials, and maintains a program to continue developing new suppliers,

in order not to depend heavily on just a few of them. As reported in 2017, the company purchased

80% of the used materials from 67 of their main suppliers (this percentage was purchased from

130 suppliers in 2015). For this reason, we think supplier power is moderate and that it has

increased over the last years.

Control of distribution channels as a way to penetrate new markets. The company controls

a far-reaching distribution channel both in Mexico and the USA. With the merger with Proximo

in 2016, not only did the company manage to control the distribution in the USA, but it also

allowed them to gain distribution capabilities in Canada, UK and the Republic of Ireland. In

addition, in 2017 the acquisition of island2island Beverage Co. PTY, Ldt was completed, which

manages a sales infrastructure in Australia. We believe that this allows a better management of

distributing costs and better control of the brands, and also will help the introduction of new

products in those markets.

Figure 8: Market share: tequila (%)

Source: Team calculation

4,6%

6,8%

7,8%

12,9%

29,7%

Diageo

Brown Forman

Tequila patron

Beam Suntory

Jose cuervo

Figure 10: Appellation of origin:

Tequila

Source: Consejo Regulador del Tequila

Figure 11: Net (mm) vs Volume sales

(m)


11.500

11.700

11.900

12.100

12.300

12.500

12.700

12.900

10.000

12.000

14.000

16.000

18.000

20.000

22.000

Net Sales (US) Volume Sales (US)

Figure 9: Porter’s five forces


6

Barriers of entry: Appellation of Origin and cultivation time of agave. Due to the Appellation

of Origin of the tequila, the main raw material (agave) can only be planted in specific states of

Mexico (Fig. 10), and it takes between 5 to 7 years for the agave to be ready for the production of

tequila. Jose Cuervo currently owns the largest plantations of agave inside the allowed area (20

000 hectares). Therefore, in the short run, their market share could be only threatened by the

inorganic growth of their competitors. We believe, that in the short and medium term, their

market share in the tequila market is not strongly threatened.

FINANCIAL ANALYSIS Revenue growth. The first half of 2018 has been a challenging year for the Company with a

negative (3.1%) year over year growth in terms of revenue, primarily driven by lower volume sold

in United States and Canada. With a negative (9.3%) YoY growth in the same frame of time in

terms of volume (9-liter cases) (Fig. 11). However, 2017 showed a similar performance of (4.2%)

in the 1st half of 2017 which could indicate a seasonality of the demand. This was related to a

reaction of the market to avoid next year price increases by anticipating their sales orders. In a full

year basis, 2016 YoY growth was 32.1% (Fig. 12), of which 6.9% was related to the acquisition of

Bushmills, 19.6% to price/mix and 5.6% organic growth. On the other hand, 2017 YoY growth was

6.4% of which 6.7% was related to price/mix and volume with a negative (0.3%). The increase in

price/mix is mostly related to changes in consumer preferences (premium brands) and price

increases. Also, excluding the price / mix effect and the Bushmills acquisition, Jose Cuervo legacy

brands overall are growing slower than the industry in volume (9-liter cases). Therefore, our

forecast considers a recovery in the 2nd half of 2018 to get a 3.1% full YoY growth, primarily

driven by Whiskey 4.1% (including the acquisition of Pendleton), RTD’s 12.6% and the rest of the

brands growing 2.1%. For 2019 to 2024 our base scenario sales projection considers a blended

CAGR of 5.8% (Fig 11). Our scenario is not considering additional M&A’s or brand divestiture.

Costs improvements and sustainable growth. Historically Jose Cuervo has improved its margins

in a YoY basis with the exception of 2016, in which reported a margin of 59.3%. However, we

expect Jose Cuervo to continue improving its margins in a YoY basis. The main driver is the

agave insourcing, which represents an opportunity of improving in 34% the current cost of agave,

its main raw material, once their vertical integration plans are completed up to a 90% of vertical

integration (from a 70% of internal production to a 90%), a process that can also be noticed by

looking at the upward trend of the levels of long-term inventory of agave (Fig. 13). Our forecast

considers a gradual cost improvement, which will represent a 1.8% COGS improvement in 2019

and another 1.8% cost improvement on top of the prior improvement for 2020. In addition, the

growth in North America and the premiumisation strategy will allow the company to improve their

margins. Our forecast considers that Jose Cuervo will be able to reach margins of 66%-67%

in 2023-2024, mainly coming from Agave insourcing and following the historical trend of margin

improvements. On the other hand, the company has maintained the operating expenses in a level

of 36%/sales in 2015, 2016 and 2017. LTM June 2018 showed a 37.1%, primarily related to the

sales decrease in the 1st half of 2018, which is expected to be reverted and maintain operation

expenses at 36% as percentage of sales. A 70% of the operating expenses is related to Selling and

Marketing and 10% to outbound freight, which are both variable, and our forecast considers them

to growth at the same rate as the Company’s revenues in order to push the top line and company

potential YoY growth rates.

Growth possibility of Cuervo’s EBITDA margin. Cuervo’s EBITDA margin of 27.6% for 2017

(Fig. 14) is a below the industry’s average (29.6%) but considering Cuervo’s negative performance

of the first two quarters of 2018 their EBITDA margin has shown weakness, nevertheless we

fully expect Cuervo to turn things around this upcoming semester. LTM EBITDA margin of

Cuervo is 24% to an industry average that has remain constant at 29.0%, which is caused by the

slow volume sales that Cuervo has had in their main market during 2018. For the second half of

the year we expect Cuervo to grow 13, 3% (3, 1% in a full year basis) in revenues, and

consequently, we believe Cuervo will have outstanding top line results, since Q4 is their strongest

quarter, however, their EBITDA margin is expected to be slightly below the industry average, Also,

we estimate an EBITDA margin YoY improvement for the following years, primarily driven

by higher gross profit and G&A economies of scale.

Dividends and Dividend Policy. Cuervo does not have a dividend policy per se, but they do wish

to pay dividends. The Beckmann family has most of the shares outstanding and can decide whether

to pay a dividend for the shareholders. The Company can exclusively pay dividends according to

the last retained earnings and once their amortizations and fiscal losses are absorbed. Cuervo paid

dividends for last year’s net income of 0.508 MXN cents per share (50% of net income), but they

expect to pay dividends around 35% of net income in following years. In 2017 the company was

not able to generate enough cash flow from operations to cover their investing requirements, as

Figure 15: Cash flow 2017 (mm)


Figure 14: EBITDA margin (%) vs

Revenues (mm)


20%

25%

30%

35%

0

5.000

10.000

15.000

20.000

25.000

30.000

35.000

Figure 13: Agave inventory (m)


500 359 353 453

860 1.0401.336

1.813

1.359 1.3991.689

2.266

2014 2015 2016 2017

Long-Term Agave InventoryShort-Term Agave Inventory

Figure 12: YoY growth rate (%)


20,6%

32,1%

6,4%3,1%

8,0%

2015 2016 2017 2018 2019

Volume Price

7

well as to pay dividends, having to partially pay them from the proceeds of the IPO (Fig. 14),

however we do not forecast that this situation is going to repeat in future years. We expect the

company to continue distributing its annual dividend according to the net income,

converging to 35% of such financial indicator.

Long Term Debt. Per year-end 2018 Cuervo’s gross long-term debt was worth $9,828 million

pesos, accruing at a 3.75% fixed rate with a BBB issuer rating according to S&P. This debt is

constituted solely by senior notes acquired in the international markets for 500 million USD in

2015, with a maturity of 10 years (interest payments semiannually). This was used to acquire the

100% of Bushmills’ stocks, however the company also gave the Don Julio’s brand to Diageo as

an additional payment. We forecast a continuing trend in the increment of the US rates and, if

Cuervo wishes to have any new issues of debt, we forecast a cost of around 5.50% as a fixed

rate. Historically the company has shown a strong balance sheet with a low Debt to Equity ratio

of 0.21 for 2017, but we expect for the company to incur additional debt, so that it reaches a

level of 2x EBITDA by 2020.

Working capital. The company reports at the end of 2017 7,419 million MXN of total current

inventories, up from 5,942.6 million MXN in 2015, a trend that continues on 2Q 2018 (8,119

million MXN). This has been mostly affected by the increasing of the finished goods inventory

(Fig. 16), and bulk beverages in aging. The unusually high level of finished goods inventory, we

believe is partially affected by the lower-than-expected sales volume of the 1Q and 2Q of 2018,

which increased the days in inventory up to 268 days (190 days in 2016 and 248 in 2017),

negatively affecting the operating cash flow. On the other hand, the increasing of bulk beverages

in aging, goes in line with the premiumisation strategy that is being followed. Accounts payable

decreases from 2,118 million MXN in 2017 to 1,977.8 million in 2Q 2018, with decreasing

average days payable from 73 in 2017 to 58 in 2018. We forecast that it will reach a normal

sustainable level of 60 days.

VALUATION Based on our valuation we issue a HOLD recommendation on Jose Cuervo with a target price of

MXN 29.2 (Fig. 17), representing a downside of 0.68% vs October 15th, 2018 closing price of

MXN 29.4. Even if our valuation is showing a hold recommendation, we expect Jose Cuervo to

grow top and bottom line. Our analysis covered discounted cash flow analysis and multiples

valuation. Finally, we only use the DCF for the valuation. Multiples, due to the lack of sufficient

comparable companies, was not considered for the final valuation. Dividend discount model, due

to lack of history and no dividend policy or guidance from the company, was not considered

either.

Our valuation is based on an 80/20 mix of base scenario and bullish scenario (Fig 18). Base

scenario considers a price per share of 27.6 vs a bullish scenario of 35.4. The base scenario

assumptions are to continue operating with the same brands, growing according to business

strategy, industry, etc. The bullish scenario recognizes a potential M&A that would generate

additional revenue, operational leverage and, by consequence, higher free cash flow. Revenues

and FCF were projected for this scenario according to Patron and Pendleton acquisitions

multiples. Due to the complexity and high multiple paid in prior M&A transactions in the industry,

we decided to assign 20% weight to our bullish scenario, which it represents the likelihood of this

acquisition being successfully executed. This valuation, therefore, is calculated as a base price per

share of 27.6 plus an optionally of 1.6 per share, which represents a 6% upside from the base

price, to a target price of 29.2.

Revenue growth 2019-2024. The Discounted cash flow model considers top line growth of

5.8% (CAGR 2019-2024), with US region growing 6.3%, Mexico 4.1% and ROW 5.6%.

Figure 18: Valuation of the scenarios

Base Bullish

Volume CAGR 2.7% 3.3%

Revenues CAGR 5.8% 6.4%

EBITDA margin

2014 33.2% 35.3%

2018 EBITDA

multiple 13.33x 17.10x

Exit EBITDA

multiple 7.95x 9.28x

TV/Revenue 3.77x 4.18x

TV/EBIT 11.97x 12.41x

TV/EBITDA 11.35x 11.83x

Exit Earnings per

share 2.4 2.7

Price per share 27.6 35.4

Weight 80% 20% Source: Team calculation


Figure 17: Target price valuation

summary

Volume CAGR 2.8%

Revenues CAGR 5.9%

EBITDA margin 2014 33.6%

2018 EBITDA

multiple 14.08x

Exit EBITDA

multiple 8.22x

TV/Revenue 3.85x

TV/EBIT 12.05x

TV/EBITDA 11.45x

Exit Earnings per

share 2.4

Price per share 29.2

Weight 100% Source: Team calculation

Figure 16: Inventory finished goods

(mm)


0

1.000

2.000

3.000

4.000

2014 2015 2016 2017

0

10

20

30

40

50

60

20

25

30

35

40

Vo

lum

e in

mil

lio

ns

Pri

ce

8

Revenues projection is aligned with the industry growth by region but also takes into consideration

the demonstrated performance by Jose Cuervo on 2016, 2017 and 1st half of 2018, which indicate

that the grow could be below average in US and Canada.

Strong 2nd half 2018 to recover a disappointing 2018 in terms of volume, primarily in the

US. Our forecast considers ending 2018 with a YoY growth of 3.1% in revenues and 2.2% in

volume, primarily driven by ROW growing 6.4%, Mexico 3.4% and US 0.7%. This represents a

challenging scenario, since Cuervo needs an outstanding execution in 2018 2nd half, which could

generate pressure in margins to push the top line. On the other hand, the change in consumer

preferences to premium brands and price increases are also driving to a higher sales value per sold

liter with a 3.0% CAGR 2019-2024. In terms of volume (9-liter cases) we are projecting a

growth of 2.7% (CAGR 2019-2024) with CAGR growths of 2.8% for US, 2.6% for Mexico and

2.1% for ROW.

Pressure in short term EBITDA margins with YoY improvement primarily driven by higher

sales value per sold liter, agave insourcing in the upcoming years and G&A operating

leverage. Margins in the short term are forecasted to be lower than expected by the market, due

to the agave insourcing still at levels of 70%. By the other hand Jose Cuervo had demonstrated

year over year improvement in gross profit margins, reaching levels of 62% historically

(excluding 2016). Our projection considers gross profit margins to improve in a year over year

basis and reaching levels of 66% in 2023-2024. The main improvement is coming from the

Agave insourcing, in which we are considering Cuervo to continue with the vertical integration

strategy and insource 90% of their agave requirements. The vertical integration could represent

challenges in terms of supply chain, but this is not an unknown operation for Jose Cuervo who

currently insources 70% of their agave consumption. Also, our forecast considers the Mexican

peso to depreciate in a year over year basis based in historical data. The peso depreciation implies

a margin improvement as the current business model. In terms of operating expenses, we expect

a decrease as percentage of sales primarily driven by G&A operating leverage. For 2024, we

projected operating expenses to decrease 100bps. Depreciation expense is considered to remain

in 1.7% as percentage of sales.

Working Capital stabilization. Working capital has been one of the main challenges in terms of

cash flow for Cuervo, due to the lower sales volume which is expected to stabilize for the end of

2018. For the upcoming years we are projecting Inventory days 220, Days Payable Outstanding

(DPO) of 60 days and Days Sales Outstanding (DSO) from 96 days in 2018 to 90 days in 2024.

Even though, we expect Cuervo to continue with negative working capital in terms of cash flow

due to their business model.

Capital expenditures to support profitability and growth. CAPEX projected from 4% to 5%

as percentage of sales for refurbish, maintenance and other operational projects based on historical

data. In addition, 2019 and 2020 consider higher capital expenditures for capacity expansion as

informed by Jose Cuervo management. In terms of operating taxes, 2017 was an unusual year in

which the US tax reform pushed the effective blended tax rate to levels of 11% for 2017.

Nevertheless, we consider this is not sustainable and tax rates will reach levels of 28%-30% in

US. For Mexico and rest of the world we are considering 30% as effective tax rate.

Perpetuity growth rate. Due to the focus on the company on the fast growing ultra-premium and

prestige segments, which have caused an increase in the sales price per 9-liter cases, plus the

industry growth expectations by region, we projected a 4.1% of perpetuity growth rate in terms

of revenue.

Weighted Average Cost of Capital. The cost of equity was calculated using CAPM, with an

adjustment for country/sector risk (Fig. 19). We calculated different betas for the distillery sector

in each country, by using the unlevered beta methodology for the different companies. The market

risk premium considered was 5.50% as stated by Damodaran in “Equity Risk Premium:

Determinants, Estimation and Implications 2018 Edition”. The risk-free rate of 8.40% was based

on the latest 10-year Mexican Bond yield plus a 25-bps spread, considering a possible increment

in the interest rates. The cost of debt obtained before tax is 4.50% based on the current cost of debt

of the Company and a 75-bps spread for the additional debt they might incur in the future. Finally,

we obtained two different WACCs: 10.30% for all countries equally weighted companies, and

10.01% only using companies from the US (Appx. 1). For the final valuation, we decided to use a

WACC of 10.30%, since we believe, it represents more accurately the different markets where

Cuervo’s products are sold.

Multiple analysis. For the relative valuation we have used a widely accepted multiple:

EV/EBITDA. We use this indicator because it does not consider the interest paid and the non-cash

expenses, since the current capital structure of Jose Cuervo is unusual in comparison with the

industry, due to a lower debt level than its competitors. Based on this multiple and our forecasted

financial information, we obtain a 1-year target price of MXN 35.48 per share (Fig. 20). For this

calculation, we considered peers that are public companies (some of the main competitors are

Figure 20: Relative valuation

Peers

EV/EBITDA

2019E

Becle 11,35

Brown Forman 21,14

Diageo 16,10

Pernod Ricard 15,08

Corby Spirits and

wine 11,81

Median 15,08

Becle info.(mm)

EBITDA 8285,16

Shares out. 3.654

Cash 14.623

Debt 9.875

Min. Int. 54,0

Implicit EV 124.940,21

Target Price E2019 35,48 Source: Team calculation

Figure 19: WACC calculation

World

Unlevered Beta 0.51

Relevered Beta 0.56

Market Risk

Premium

5.50%

Risk Free Rate 8.40%

Cost of Equity 11.27%

Cost of Debt

before tax

4.50%

Taxes 28.90%

Cost of Debt

after tax

3.20%

Debt % 12%

Equity % 88%

WACC 10.30% Source: Team calculation

Figure 21: Exit-multiple approach

(mm)


EBITDA 2024 12,680

Industry multiple 15.1

Implied enterprise value 191,214

PV Enterprise value 116,699

Cash 2019 16,823-

Debt 2019 9,875

Min 54

Implied Equity Value 123,593

Total Shares 3,654

Price per share 33.82

9

private companies, without limited public information), which have an important presence in the spirit categories and markets

Jose Cuervo is involved in. However, due to the consolidation process that the industry is facing, there are only a few companies

that are similar in size and in portfolio mix, therefore we consider that this methodology does not give a fair valuation for Cuervo.

(App. 6).

Exit multiple approach. For this method we calculated our forecasted EV/EBITDA multiple at the end of the year 2024 and it

was discounted to the valuation target date of 2019, obtaining an implied target price of MXN 33,82 (fig. 21). This, however, we

do not think is an appropriate method in this case, since, as it has been mentioned in the previous point, takes into account the

industry average values, and there is not enough amount of comparable companies for it to be trustworthy.

RISKS TO TARGET PRICE

Sensitivity analysis. Based on our DCF analysis, we considered it would be essential to perform a sensitivity analysis on the

perpetual growth rate and WACC (Fig. 22), which have impacted the model. Cuervo would need to turn things around

quickly in terms of volume sales in the US and Mexico, as well as making a successful acquisition, for us to change our

recommendation to BUY. Since it will send a message that they have overcome the effect of the increment in prices from

2017, which have slowed down their sales globally. On the other hand, if Cuervo maintains its current market share in tequila

(27.9%) and continues to have a decrement in their volume sales in the US, it is probable that the share price will have a

contraction.

Montecarlo simulation. During our Monte Carlo Simulation, we analyze the two main

variables in our projected income statement: revenues and the cost of goods sold

(COGS) (Appx. 13). The revenues, were we evaluate how the changes in growth rates

would impact our scenario, are mostly driven by our estimated growth of sales in the

US. For the second variable, COGS, we stressed the simulation in YoY growth driven

by the increase in raw material prices. After running the simulation, we observed a 68%

potential of finding a target price under MXN$30 per share, which supports our

recommendation of HOLD (Fig. 23), leaving us a 32% probability of obtaining a target

price per share above MXN$30. As the results showed, we conclude that the variable

with the highest sensibility is the COGS.

CORPORATE GOVERNANCE Group Structure. Cuervo, with its headquarters in Mexico City, is composed of the

holding company (Becle S.A.B. de C.V.), 2 subsidiaries in Mexico, 3 in the United

States, 1 in Canada, and 1 in the United Kingdom. Becle also has 2 distribution

companies (in Australia and USA).

Group Executive Committee & Board of Directors. Cuervo’s Board of Directors

(BoD) is composed by 7 members (Appx. 2), 2 of them being proprietary counselors

and 5 of them being independent. All of them have been in the company since its IPO, with the

possibility to be re-elected annually, and have education and proficiency in administration,

finance, or economics. There is no diversity gender-wise in the BoD. Juan Domingo Beckmann

(CEO), who is a member of the BoD has recently announced (Sept. 2018) that Cuervo has

appointed its new CFO Fernando Suárez, ex-CFO of Volaris. We believe this is a step in the

right direction for the company, given Suarez’ large expertise in financial discipline, costs

control, and investments during his time in Salomon Brothers and as Volaris. However, it is

concerning that Fernando Suarez was not generating the best results during his time in

Volaris, with the company often in difficult situations and financial troubles. Our second concern

falls upon the amount of shares Juan Francisco Beckmann (Chairman) and family hold. This is

because for certain corporative decisions or to bypass any new event in the company, it is required

for 60% of the shareholders to be in favor. Juan Francisco Beckmann and family currently own

Figure 24: Corporate governance

assessment


Figure 22: Sensitivity analysis WACC-Perpetual growth rate


29.40$ 10.05% 10.10% 10.15% 10.20% 10.25% 10.30% 10.35% 10.40% 10.45% 10.50%

3.6% (8.7%) (9.5%) (10.3%) (11.1%) (11.8%) (12.6%) (13.4%) (14.1%) (14.8%) (15.5%)

3.7% (7.3%) (8.2%) (9.0%) (9.8%) (10.6%) (11.4%) (12.2%) (12.9%) (13.7%) (14.4%)

3.8% (6.0%) (6.8%) (7.7%) (8.5%) (9.3%) (10.1%) (10.9%) (11.7%) (12.5%) (13.2%)

3.9% (4.6%) (5.5%) (6.3%) (7.2%) (8.0%) (8.9%) (9.7%) (10.5%) (11.3%) (12.0%)

4.0% (3.1%) (4.0%) (4.9%) (5.8%) (6.7%) (7.5%) (8.4%) (9.2%) (10.0%) (10.8%)

4.1% (1.6%) (2.6%) (3.5%) (4.4%) (5.3%) (6.1% ) (7.0%) (7.9%) (8.7%) (9.5%)

4.2% (0.1%) (1.0%) (2.0%) (2.9%) (3.8%) (4.7%) (5.6%) (6.5%) (7.4%) (8.2%)

4.3% 1.5% 0.5% (0.4%) (1.4%) (2.3%) (3.3%) (4.2%) (5.1%) (6.0%) (6.8%)

4.4% 3.2% 2.2% 1.2% 0.2% (0.8%) (1.8%) (2.7%) (3.6%) (4.5%) (5.4%)

4.5% 4.9% 3.9% 2.8% 1.8% 0.8% (0.2%) (1.2%) (2.1%) (3.1%) (4.0%)

Figure 23: Monte Carlo simulation


Figure 24: Shareholders (%)


Juan

Francisco

Beckmann

and Family

85%

Tamesek

Capital

Pte Ltd.

3%

Free Float

12%

10

85% of the company. The third concern is that the Supervisory Board (SB) is composed by the

same members that make the BoD. As best practices dictate, the SB should be in aid of the BoD,

since they are the same members, whatever the BoD wants to approve the SB will approve.

Environmental Sustainability and Social Responsibility. Environmental sustainability seems to

be a concern for the Company, since all of its building’s own certificates in quality management,

such as “Industria Limpia”, ISO9000, and APPCC. Also, the company is in compliance with every

sustainability metric in Mexico and the world. However, Cuervo is not as proactive as other

companies in this area, since it does not appear to have any active program to promote

environmental sustainability. On the other hand, Cuervo is a socially responsible company, giving

its workers a safe work environment, a pension fund for retirement and is actively fomenting

tourism in the city of Tequila, Jalisco (“Pueblo Mágico”).

Shareholder base. The company has 3,654 million shares outstanding, although Juan Francisco

Beckmann and family hold 85% of the total shares (Fig. 24). In 2017, Cuervo announced a net

dividend of $0.4572 per share, to be paid in May 2018. Currently, the biggest shareholder of

Cuervo, aside from Juan Francisco Beckmann and Family, is an investment company from

Singapore “Temasek Capital Pte Ltd.”, holding 3% of the shares. We do not expect that Juan

Francisco Beckmann and his family will sell any shares in a foreseeable future, maintaining the

free float at a level of 15% or below.

Corporate Governance Grade. After analyzing the company’s corporate governance we gave

Cuervo a grade of 64.28% (Fig. 25). The grade is composed by an ESG metric (Appx. 4) were the

quality of three areas were valued: Governance, Environmental Care, and Social Responsibility.

Cuervo did not excel because there was information which the company did not provide, making

Cuervo less transparent regarding the information they release, and in Environmental Care,

because Cuervo does not have an active strategy to emit less CO2 gases or any less pollutant

solution. Overall, Cuervo is above average in their ESG grade within Mexican companies.

INVESTMENT RISKS Strategic Risks.

Demand may be affected if customers change their preferences: Nowadays, there is a trend

worldwide towards a healthier living style. Tequila and the rest of Cuervo’s products do not fall

into the “healthy” category, which could negatively impact the volume sold and, therefore its

financial performance.

Increasing competition: Cuervo operates in an industry that is highly competitive, internationally

as well as locally. In the last two decades the industry has consolidated significantly and, as a result,

there are now in the market large companies that offer a wide variety of products worldwide.

Market Risks.

US interest rate could cause an increment in the company’s financial costs: If Cuervo decides

to get further indebted and interest rates continue their upwards trend, then the cost of this debt might

be higher, negatively affecting its financial results (Fig. 26).

Mexico as a country risk: Since Cuervo is headquartered in Mexico and they are part of the

Mexican index MEXBOL, the company has an additional risk regarding its location in an emerging

market.

85% of shares controlled by the Beckmann family: This is a major concern since the family can

“control” the Board of Directors and the decisions to be taken by the company.

Participation in an M&A: Up to date, the management has not made any comments about being

acquired by any industry giant, neither have they mentioned anything about acquiring a specific

company. Although, with the amount of cash the company currently owns, they have the resources to fulfill an acquisition in

the next years.

Not meeting the guidance given: if the guidance given is not meet and the results are disappointing investors’ expectations,

it could raise concerns about the future development of the company and its ability to resolve adversities.

Financial Risks.

Foreign Exchange Risks: Cuervo accounts most of its revenue in USD, which could be beneficial for the company

considering the past evolution of the exchange rate (Fig. 27). As the Mexican Peso continues to depreciate against USD,

Cuervo shows a gain related to the exchange rate, however, if the MXN appreciates against USD, then it could have a negative

impact in the revenues of the company. Considering that Cuervo is not actively hedging their USD exposure, they could

present some volatility in their results.

Operational Risks.

Risks related to Cuervo’s quality and heath sanitation regulations: Cuervo is proud of the quality of their products.

However, a potential sanitary accident, such as the raw material getting contaminated, could result in certain product not

meeting the quality expectations, or even causing health hazards.

Figure 27: Depreciation of

USD/MXN


11

13

15

17

19

21

23

Figure 26: Interest rates Mexico vs

US (%)


BANXICO

7,75

FED

2,25

0

2

4

6

8

10

12

/1/0

8

10

/1/0

9

8/1

/10

6/1

/11

4/1

/12

2/1

/13

12

/1/1

3

10

/1/1

4

8/1

/15

6/1

/16

4/1

/17

2/1

/18

Figure 25: Corporate governance

assessment


11

Cost increments in energetics and raw materials: One key driver for Cuervo’s profitability is the COGS which in this case,

is heavily impacted by the price of their raw materials, such as “agave azul”, and the energetics for all transportation used to

export the product.

Failures in major distilleries, bottlers, or warehouses: If any of these facilities suffer any damage or failure the production

of any of their products, would be affected and the company might not be able to fulfill all of the demand.

Scarcity in raw materials: If Cuervo cannot acquire the agave needed to fulfil the demand because third party suppliers are

not able to provide enough agave quantities, the company won’t be able to reach the expected production. This risk is already

being addressed by the company with their plan to use their internal production of agave from a 70% level of the end of 2017,

to 90% by the end of 2019.

Stoppage of third-party brands distribution: If third party brands do not give any more licenses to Cuervo to distribute

their brands, the Company will see certain loss of sales in Mexico.

Inability to retain or bring new talent: Cuervo has had a successful directors and employees in their payroll, if they are not

able to retain that talent or bring new one to the company, so that they grow and boost innovation, they might start to get behind

their competitors.

Regulatory Risks.

The decrease in social acceptance, and adoption of new political actions against the consumption of alcohol: In recent

years the industry has been subject to growing concerns regarding the harmful effects caused by alcohol. In the US, their main

market, there is a trend to implement new governmental measures to limit alcohol consumption, by making increasing their

price and, also, by requiring more strict permits for retailers to sell alcoholic beverages.

Increment in taxes: Since Cuervo is an international company, they are subject to any change in the tax regulation from any

country where their products are sold, which may increase their operational cost and/or their liabilities. This would also apply

to any new tariff that may apply for imports and exports.

Patent expiry and Copyright infringement: Cuervo depends on its capacity to protect their own brands, commercial names,

and the appellation of origin. We believe this risk would be ranked low in the probability (Fig. 28).

Appellation of Origin of Tequila: Cuervo relies heavily in this appellation because it states that Tequila must be made in

certain territories inside of Mexico. If countries stop recognizing the appellation they could start producing and selling their own

tequila.

Natural Risks. Any natural disasters in the locations where Cuervo has its buildings or any drastic weather changes than may

compromise the growth of the agave, sugar or any other raw material needed to produce Cuervo’s products may affect negatively

the company’s results making the share price decrease. Although this could have a high impact for the company, we believe the

probability of a hard-natural disaster in the city of Tequila is likely.

Figure 28: Risk matrix


12

APPENDIX 1: Weighted Average Cost of Capital

A. Unlevered Beta

For the unlevered betas, we obtained different betas from companies from the distillery sector in different countries

(USA, UK, France, Japan, and Chile). After that, we unlevered those betas with their respective financial leverage

structure and giving them the same weight to each company and afterwards giving the same weight to each country.

At the end we got an unlevered beta of 0.51 for all the countries and of 0.46 for USA only.

USA

Company Beta Tax D/E Unlevered Beta

Constellation Brands 0.72 17.26% 0.96 0.40

Brown-Forman 0.78 17.36% 0.80 0.47

MGP Ingredients Inc. 0.73 30.58% 0.22 0.63

Castle Brands Inc. 1.05 45.64% 2.73 0.42

Crimson Wine Group 0.39 28.99% 0.11 0.36

Equally Weighted Unlevered Beta 0.46

UK


Diageo 0.90 33.79% 0.85 0.58

Stock Spirits Group 0.52 24.87% 0.27 0.44


France


Pernod Ricard SA 0.68 24.91% 0.80 0.49

Remy Cointreau SA 0.80 24.52% 0.33 0.64 Marie Brizard Wine & Spirits 0.72 10.34% 0.25 0.59

LPE 0.36 31.47% 0.81 0.23


Japan


Takara Holdings 0.93 32.07% 0.24 0.80

Oenon Holdings 0.85 30.52% 0.24 0.72

Yomeishu Seizo Co 0.62 25.10% 0.03 0.61


Chile


Vina Concha y Toro 0.70 23.18% 0.53 0.50

Vina San Pedro Tarapaca 0.53 27.61% 0.19 0.47

Vina Santa Rita 0.34 14.65% 0.56 0.23


B. WACC Computation

For the WACC computation first we unlevered the beta of each and every company that is in the same sector as

Cuervo in the countries we chose (we only used companies with more than 1B USD in market value). After, we

relevered the Beta with what we expect Cuervo’s capital structure to look in December 2019. The market premium

of 5.50% as stated by Damodaran in “Equity Risk Premiums: Determinants, Estimation and Implications 2018

Edition”; for our cost of equity we used a risk-free rate of 8.40% which is the 10-year Mexican bond with 25 bps

spread for a possible increment in the rates in the next year. For our cost of debt after tax we used the 3.75% fixed

rate that Cuervo has and 75 bps spread because of a possible new debt Cuervo might ask, and an effective tax rate

of 28.90%. Cuervo’s capital structure is 12% debt and 88% equity, considering that Cuervo’s optimal capital

structure. So, that is how we obtained our WACCs.

13

World USA

Unlevered Beta 0.51 0.46

Relevered Beta 0.56 0.50

Market Risk Premium 5.50% 5.50%

Risk Free Rate 8.40% 8.40%

Cost of Equity 11.27% 10.94%

Cost of Debt before tax 4.50% 4.50%

Taxes 28.90% 28.90%

Cost of Debt after tax 3.20% 3.20%

Debt % 12% 12%

Equity % 88% 88%

WACC 10.30% 10.01%

APPENDIX 2: Cuervo’s Executive Committee and Board of Directors

APPENDIX 3: Various financial indicators of Jose Cuervo

and its competitors Profitability

Company Name LTM Gross Margin

%

LTM EBITDA

Margin %

LTM Net Income

Margin %

LTM Return on

Assets %

LTM Return

on Equity %

Becle, S.A.B. de C.V. 59.4% 24.0% 20.9% 5.9% 12.0%

Brown-Forman Corporation 67.8% 34.1% 22.46% 13.4% 53.0%

Constellation Brands, Inc. 50.7% 36.9% 41.85% 7.4% 34.1%

Pernod Ricard SA 62.4% 28.5% 17.55% 4.9% 11.1%

Rémy Cointreau SA 67.5% 22.9% 13.15% 5.9% 10.9%

Castle Brands Inc. 43.8% 6.7% (0.67%) 5.1% 13.1%

Diageo plc 61.9% 33.9% 24.85% 8.1% 26.5%

Bacardi Limited - - - - -

Corby Spirit and Wine Limited 62.6% 28.8% 17.52% 9.3% 14.2%

Beam Suntory Inc. 58.2% 31.0% 14.2% 4.8% 7.5%

Average 59.4% 27.4% 19.1% 7.2% 20.3%

14

Growth analysis

Company Name

LTM Total

Revenues, 1 Yr

Growth %

LTM EBITDA,

1 Yr Growth %

LTM EBIT, 1 Yr

Growth %

LTM Net

Income, 1 Yr

Growth %

NTM LT EPS

Growth Rate

Becle, S.A.B. de C.V. 7.2% (9.8%) (10.0%) 87.5% -

Brown-Forman Corporation 7.69% 3.79% 3.13% 5.12% 10.01%

Constellation Brands, Inc. 6.22% 7.74% 6.31% 88.63% 12.13%

Pernod Ricard SA (0.26%) (1.50%) (1.51%) 13.21% 8.02%

Rémy Cointreau SA 2.93% 4.79% 4.69% (22.12%) 12.12%

Castle Brands Inc. 14.24% 82.76% 127.76% - -

Diageo plc 0.94% 6.10% 6.49% 13.52% 7.14%

Bacardi Limited - - - - -

Corby Spirit and Wine Limited 1.89% 0.57% 0.13% 0.18% -

Beam Suntory Inc. 3.56% 6.63% 6.12% (5.89%) -

Average 4.9% 11.2% 15.9% 22.5% 9.9%

Solvency

Company Name LTM Total

Debt/Capital %

LTM Total

Debt/EBITDA

LTM EBITDA /

Interest Exp. Becle, S.A.B. de C.V. 0.1748 1.6x 12.3

Brown-Forman Corporation 64.5% 2.2x 15.2x Constellation Brands, Inc. 0.4624 3.4x 8.5

Pernod Ricard SA 34.0% 3.0x 7.2x Rémy Cointreau SA 0.2501 1.8x 21.9 Castle Brands Inc. 83.7% 7.6x 1.4x

Diageo plc 0.4637 2.5x 9 Bacardi Limited - - -

Corby Spirit and Wine Limited - - - Beam Suntory Inc. 28.7% 2.6x -

Average 43.2% 3.1x 10.8x

Operating metrics

Company Name FQ Avg. Cash

Conversion Cycle

FQ Inventory

Turnover

FQ Avg. Days

Inventory Out.

LTM Current

Ratio

LTM Quick

Ratio

FY

Capex as

% of

Revenues

Becle, S.A.B. de C.V. 265.62 1.4x 253.29 8.7x 6.0x 4.1

Brown-Forman Corporation 509.77 0.69x 535.34 3.0x 1.0x 3.9

Constellation Brands, Inc. 135.47 2.25x 163.47 1.8x 0.5x 13.9

Pernod Ricard SA 479.51 0.55x - 2.1x 0.6x 4.2

Rémy Cointreau SA 817.87 0.32x - 2.6x 0.6x 3.0

Castle Brands Inc. 287.48 1.32x 274.84 4.9x 1.1x 0.4

Diageo plc 359.82 0.88x 415.82 1.4x 0.5x 4.8

Bacardi Limited 200.23 1.97x 186.95 - - -

Corby Spirit and Wine

Limited 249.65 0.97x 375.68 5.0x 3.2x 3.4

Beam Suntory Inc. 510.57 0.70x 526.08 - - 5.0

Average 381.6 1.11x 341.43 3.7x 1.7x 4.7x

15

APPENDIX 4: Corporate governance assessment The methodology of corporate

governance scorecard Sections: Max Score Grade Score

The scorecard has three main

features that each have their own

sub features:

Governance: Includes all

relevant stuff with shareholders

and the different boards.

Environmental: Is about how

the company is using its

resources to be the most

ecofriendly company as possible.

Social: In this feature we cover

topics of workforce, human

rights and the community.

Governance 50% 63.80% 31.90%

Environmental 30% 50.00% 15%

Social 20% 86.89% 17.38%

Total 100% 64.28%

Governance: This segment of the corporate governance features the shareholders rights and voting policy, the

management board with its independent members, the supervisory board, and its role in the company. How

transparent is the company with all of its filings and the ease to find them, and the quarterly and annual reports.

Governance % Quality Weighting Grade Score

Shareholders 25.00% 60.00% 15.00%

Management Board 30.00% 71.43% 21.43%

Supervisory Board 10.00% 80.00% 8.00%

Transparency & Governance 25.00% 37.50% 9.38%

Reporting & Auditing 10.00% 100.00% 10.00%

Total 63.80%

Environmental: This segment grades how the company uses its resources and how they reduce their emission to

be a greener company and help the environment be cleaner. Also, we graded their ability to innovate programs to

help the environment.

Environmental % Quality Weighting Grade Score

Resource Use 33.33% 100.00% 33.33%

Emission 33.34% 0.00% 0.00%

Innovation 33.33% 50.00% 16.67%

Total 50.00%

Social: This segment features if the company has had any strikes, if there is any labor union, the human rights of

all of the employees and how the company tries to help their employees and their community to be a better place

to live.

Social % Quality Weighting Grade Score

Workforce 33.33% 94.00% 31.33%

Human Rights 33.34% 66.66% 22.22%

Community 33.33% 100.00% 33.33%

Total 86.88%

16

APPENDIX 5: SWOT analysis Strengths

Weaknesses

1. Holds majority of the global market share

(29.7%) of tequila, more than double as next

competitor.

2. Have a strong vertical integration from

planting the raw material to the sell point. In

which they will produce 90% of their agave

needs, up from 70%.

3. 2nd highest premiumization of spirits in the

industry, only behind Brown-Forman.

1. Does not have a strong position in other

countries not being USA and Mexico.

2. Earnings exposed to a cyclicality where

sometimes a year there are good sales and

the rest of the year is low.

3. Showing slow couple of last quarters in

terms of volume sales.

4. Slow inventory turnover, because of the

time agave takes to be fully mature.

Opportunities

Threats

1. With the acquisitions of Pendleton and

Bushmills, Cuervo could enter and grow in

new markets and expand their portfolio.

2. Tequila and Irish Whisky are of the highest

spirits in CAGR in the last years (4.75% and

5.24% respectively from 2012-2017).

3. USD/MXN foreign exchange if USD

appreciates they would have better results.

1. Competition investing highly in tequila and

they are winning market share. Bacardi just

bought Patron, and Diageo has Don Julio.

2. Any other spirit could take away any trend

to consume tequila.

3. Spirits social acceptance is going down for

health reasons.

APPENDIX 6: Competitor size vs Becle comparison

Becle

Brown

Forman Diageo

Pernod

Ricard

Castle

brands

Rémy

Cointreau

Constellation

Brands

Corby

Spirit and

Wine

Revenues (mm)

25,586

61,981

300,841

195,973

1,586

24,576

148,913

2,127

Employees

6,536

4,800

29,917

18,442

57

1,861

9,600

172

Asset value (mm)

63,988

93,438

776,270

683,387

1,096

56,951

386,180

3,464

ROI (%)

11

20

13

8

11

9

13

13

Market capitalization (mm)

105,140

426,097 1,535,704

745,290

3,106

110,843

798,638

8,332

Enterprise value (mm)

101,648

468,900 1,807,606

901,096

3,976

117,035

986,439

7,317

EPS

1

28

30

134

-

0

65

323

13

Shares outs Mil (mm)

3,654

312

2,448

265

169

5,701

168

24

17

APPENDIX 7: Porter’s five forces analysis

THREAD OF NEW ENTRANTS- LOW

Due to the Appellation of Origin, the main raw material for tequila, which is agave, can only be cultivated in

specific states of Mexico, and it takes between 5 and 7 years for that plant to grow so that it can be used in the

production. Therefore, for a company that wishes to start the production of tequila, this restriction as well as the

capital requirements to build and run a distillery will count as a barrier of entry. Besides, as the oldest distiller in

Mexico, Cuervo is the most experienced tequila producer in the market. In Mexico, the control of the distribution

channels is also a barrier for new entrants, in the other markets where the company participates, however, this

does not represent a significant barrier for competitors. On the other hand, if a competitor plans to entry the market

by an acquisition, because of the concentration of the market, will not easily find a company to acquire so that its

additional production will bring an important participation in the market share of the acquirer.

THREAD OF SUBSTITUTES- HIGH

There are many different products in the spirits market, as well as different price segments in the same spirit

category. Besides, there is no switching cost between the different alcoholic beverages, therefore, brands rely on

consumer preference and their ability to retain consumer loyalty. Furthermore, in the case of Cuervo, the

premiumisation strategy and the price increases could affect its volume, since its customers could easily migrate

to lower priced and similar spirits. For this, we believe the threat of substitutes to be high.

BARGAINING POWER OF CUSTOMERS- VERY LOW

In the tequila market, buyer concentration is low, where the customer base consists from large companies (such

as, supermarkets or big retailers) to restaurants or vending machines. Besides there are similar tequila products in

the market, as well as other spirits that could be a substitute product and it does not represent a basic necessity for

customers.

BARGAINING POWER OF SUPPLIERS- MODERATE

Cuervo makes short and midterm contracts with suppliers. They also have a minimum of 3 suppliers for their

main materials, as well as a program to continue developing their supplier base. As reported by Cuervo, 80% of

the materials were acquired from 67 suppliers in 2017, down from 130 suppliers in 2015 for the same percentage

purchased. For this reason, we believe the bargaining power of suppliers to be moderate.

INDUSTRY RIVALRY- VERY HIGH

Tequila market is highly concentrated, with 57, 2% of the global market share in the hands of 4 companies and

high rivalry among them. The market consists of large and international competitors that have a diversified

portfolio of spirits and presence worldwide. Due to the fact that Cuervo’s 57% of the sales come from the tequila

market, we believe its financial results could be more impacted by the fluctuations of this market than in the case

of its competitors.

No threat 0

Very low 1

Low 2

Moderate 3

High 4

Very high 5

18

APPENDIX 8: Forecast assumptions (base scenario)

APPENDIX 9: DCF valuation: base scenario (mm)

2017 2018 2019 2020 2021 2022 2023 2024

Volume (9L cases) % Growth 0.3% 2.2% 2.9% 2.9% 2.8% 2.7% 2.6% 2.5%

Sales % Growth 6.4% 3.1% 8.0% 8.0% 6.4% 6.0% 4.3% 4.2%

COGS % Sales 37.9% 37.2% 37.1% 35.9% 35.1% 34.9% 33.9% 33.3%

Working Capital % Sales 77.2% 69.4% 68.8% 68.1% 67.5% 66.9% 66.2% 65.6%

EBITDA % Sales 27.6% 28.3% 28.7% 30.2% 31.2% 31.5% 32.6% 33.2%

Adj. EBITDA % Sales 25.9% 26.6% 27.0% 28.5% 29.5% 29.8% 30.9% 31.5%

Depreciation &

Amortization% Sales 1.7% 1.7% 1.7% 1.7% 1.7% 1.7% 1.7% 1.7%

EBIT % Sales 25.9% 26.6% 27.0% 28.5% 29.5% 29.8% 30.9% 31.5%

Interest Rate 3.8% 3.8% 4.5% 4.5% 4.5% 4.5% 4.5% 4.5%

Taxes % Pretax Income 11.7% 28.4% 28.4% 28.3% 28.3% 28.3% 30.0% 30.0%

CAPEX % Sales 4.1% 4.0% 8.8% 8.6% 4.5% 4.5% 4.5% 4.5%

FCF % Sales 13.3% 22.7% 8.0% 9.7% 15.5% 15.9% 17.3% 17.8%

DCF Base Scenario 2017 2018 2019 2020 2021 2022 2023 2024CAGR 24-

19

Volume 20.492 20.942 21.556 22.172 22.787 23.396 23.997 24.587 2,7%

YoY Growth 2,2% 2,9% 2,9% 2,8% 2,7% 2,6% 2,5%

Revenues 25.958 26.763 28.895 31.206 33.199 35.198 36.711 38.235 5,8%

YoY Growth 6,4% 3,1% 8,0% 8,0% 6,4% 6,0% 4,3% 4,2%

COGS 9.837 9.958 10.721 11.192 11.644 12.282 12.435 12.741

Gross profit 16.121 16.805 18.174 20.014 21.555 22.916 24.276 25.494 7,0%

Margin / Sales 62,1% 62,8% 62,9% 64,1% 64,9% 65,1% 66,1% 66,7%

Operating Expenses 9.402 9.694 10.380 11.120 11.770 12.425 12.941 13.463 5,3%

Op. Exp. / Sales 36,2% 36,2% 35,9% 35,6% 35,5% 35,3% 35,3% 35,2%

EBIT 6.719 7.111 7.794 8.894 9.785 10.491 11.335 12.031 9,1%

EBIT / Sales 25,9% 26,6% 27,0% 28,5% 29,5% 29,8% 30,9% 31,5%

EBITDA 7.154 7.566 8.285 9.425 10.349 11.090 11.959 12.681 8,9%

EBITDA / Sales 27,6% 28,3% 28,7% 30,2% 31,2% 31,5% 32,6% 33,2%

Operating EBITA 6.731 7.111 7.794 8.894 9.785 10.491 11.335 12.031 9,1%

Operating EBITA/Sales 25,9% 26,6% 27,0% 28,5% 29,5% 29,8% 30,9% 31,5%

Operating Cash Taxes 753 1.917 2.106 2.326 2.574 2.769 3.190 3.398 10,0%

Operating cash tax rate % 11,2% 27,0% 27,0% 26,2% 26,3% 26,4% 28,1% 28,2%

NOPLAT 5.978 5.194 5.688 6.568 7.211 7.722 8.145 8.632 8,7%

NOPLAT/Sales 23,0% 19,4% 19,7% 21,0% 21,7% 21,9% 22,2% 22,6%

Depreciation & Amortization 435 455 491 530 564 598 624 650 5,8%

CAPEX (1.067) (1.071) (2.538) (2.687) (1.494) (1.584) (1.652) (1.721)

Increase/decrease WC (1.886) 1.486 (1.317) (1.372) (1.143) (1.148) (765) (774)

Free cash flow 3.460 6.065 2.324 3.040 5.138 5.589 6.353 6.788 23,9%

Discount period 1,000 2,000 3,000 4,000 5,000

Discount factor 0,907 0,822 0,745 0,676 0,613

PV Free Cash Flow 2.756 4.224 4.165 4.292 4.158

Perpetuity Growth Rate 4,1% Multiples

WACC 10,3%

Terminal Value 143.956 2018 Est. EBITDA Multiple 13,33x

PV Terminal value 88.176 Exit EBITDA Multiple 7,95x

Enterprise value 107.771 TV/Revenue 3,77x

Cash & Equivalents (16.823) TV/EBIT 11,97x

Debt 9.875 TV/EBITDA 11,35x

Implied Equity Value 100.823

Total Shares 3.654 Exit Earnings Per share 2,4

Price per Share 27,6

19

APPENDIX 10: Forecasted P&L: base scenario (mm)

APPENDIX 11: Forecasted cash flow statement: base scenario (mm)

Balance Sheet Base Scenario 2016 2017 2018 2019 2020 2021 2022 2023 2024

Sales 24.396 25.958 26.763 28.895 31.206 33.199 35.198 36.711 38.235

COGS 9.936 9.837 9.958 10.721 11.192 11.644 12.282 12.435 12.741

Gross profit 14.460 16.121 16.805 18.174 20.014 21.555 22.916 24.276 25.494

Margin % 59,3% 62,1% 62,8% 62,9% 64,1% 64,9% 65,1% 66,1% 66,7%

Selling & Marketing 6.811 6.607 6.812 7.355 7.943 8.450 8.959 9.344 9.732

Outbound freight 750 918 946 1.022 1.103 1.174 1.245 1.298 1.352

General & Administrative 1.436 1.660 1.711 1.771 1.833 1.897 1.963 2.032 2.103

Other Operating Expense (138) 218 224 232 240 249 258 267 276

Operating Expenses 8.859 9.402 9.694 10.380 11.120 11.770 12.425 12.941 13.463

Op. Exp. %/Sales 36,3% 36,2% 36,2% 35,9% 35,6% 35,5% 35,3% 35,3% 35,2%

EBIT 5.601 6.719 7.111 7.794 8.894 9.785 10.491 11.335 12.031

EBIT % 23,0% 25,9% 26,6% 27,0% 28,5% 29,5% 29,8% 30,9% 31,5%

Depreciation & Amortization 451 435 455 491 530 564 598 624 650

EBITDA 6.052 7.154 7.566 8.285 9.425 10.349 11.090 11.959 12.681

Other non operating 519 283 356 370 675 690 703 703 703

Pretax Income 5.082 6.436 6.755 7.424 8.219 9.095 9.788 10.632 11.328

Tax rate 30,3% 11,7% 28,4% 28,4% 28,3% 28,3% 28,3% 30,0% 30,0%

Income taxes 1.540 753 1.917 2.106 2.326 2.574 2.769 3.190 3.398

Net Income 3.542 5.683 4.838 5.318 5.893 6.521 7.019 7.443 7.929

Net Income % 14,5% 21,9% 18,1% 18,4% 18,9% 19,6% 19,9% 20,3% 20,7%

Non-controlling interest 0 4 4 4 4 4 4 4 4

Net Income attributable to Shareholders 3.542 5.679 4.834 5.314 5.889 6.517 7.015 7.438 7.925

Diluted Shares Outstanding: 3.654 3.654 3.654 3.654 3.654 3.654 3.654 3.654 3.654

Earnings Per Share (EPS): 0,97 1,55 1,32 1,45 1,61 1,78 1,92 2,04 2,17

Cash Flow Base Scenario 2018 2019 2020 2021 2022 2023 2024

EBIT 7.110,9 7.793,9 8.894,1 9.784,9 10.491,2 11.335,1 12.030,7

Depreciation & Amort. 455,0 491,2 530,5 564,4 598,4 624,1 650,0

EBITDA 7.565,9 8.285,2 9.424,6 10.349,3 11.089,5 11.959,2 12.680,7

Other non Operating 0,0 0,0 0,0 0,0 0,0 0,0 0,0

Taxes 1.916,8 2.105,6 2.326,0 2.573,6 2.769,1 3.189,6 3.398,3

Net Income w/o Interest 5.649,1 6.179,6 7.098,6 7.775,7 8.320,5 8.769,6 9.282,4

Change in Acc. Receivable 219,9 (481,7) (516,1) (422,5) (413,1) (280,7) (275,3)

Change In Inventories 1.416,7 (460,0) (283,7) (272,4) (384,7) (91,8) (184,6)

Change in Acc. Payable (208,3) 146,4 90,3 86,7 122,4 29,2 58,7

Change in non current Inventory (2.950,8) (523,4) (322,8) (310,0) (437,7) (104,5) (210,0)

Change in Other 344,6 58,0 (39,6) (21,5) 31,8 (72,4) (28,8)

Cash from Ops. 4.471,2 4.918,9 6.026,7 6.836,0 7.239,3 8.249,4 8.642,3

Capital Expenditure (1.070,5) (2.538,3) (2.686,7) (1.494,0) (1.583,9) (1.652,0) (1.720,6)

Intangible assets (3.184,9) (700,0) (700,0) (700,0) (700,0) (700,0) (700,0)

Cash from Investing (4.255,4) (3.238,3) (3.386,7) (2.194,0) (2.283,9) (2.352,0) (2.420,6)

Common Dividends Paid (2.177,1) (2.260,2) (2.357,2) (2.445,6) (2.456,7) (2.604,9) (2.775,3)

Interest and Other financing (356,3) (370,3) (675,1) (689,9) (703,0) (703,0) (703,0)

Long term debt (280,5) 375,0 5.126,5 328,5 292,0 0,0 0,0

Cash from Financing (2.813,8) (2.255,5) 2.094,2 (2.806,9) (2.867,7) (3.307,9) (3.478,3)

Net Change in Cash (2.598,0) (574,9) 4.734,2 1.835,2 2.087,7 2.589,6 2.743,5

Beg Balance 19.995,9 17.397,8 16.823,0 21.557,1 23.392,3 25.480,0 28.069,6

Ending Balance 17.397,8 16.823,0 21.557,1 23.392,3 25.480,0 28.069,6 30.813,1

20

APPENDIX 12: Forecasted balance sheet: base scenario (mm)

APPENDIX 13: EBITDA Roadmap: base scenario (mm)

In Millions

(MXP) 2015 2016 2017 F2018 F2019 F2020 F2021 F2022 F2023 F2024

Last year

EBITDA 3,517 4,857 6,052 7,154 7,566 8,285 9,425 10,349 11,090 11,959

Volume 1,874 3,606 926 (231) (15,193) 0 0 0 0 0

Productivity /

Mix 300 (396) 735 (697) 0 0 0 0 0 0

Other Op. Exp. (834) (2,014) (1,661) (174) 13,680 (2,233) (3,372) (4,297) (5,037) (5,907)

Year EBITDA 4,857 6,052 6,052 6,052 6,052 6,052 6,052 6,052 6,052 6,052

YoY Growth

rates 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024

Volume 53.3% 74.2% 15.3% (3.2%) (200.8%) 0.0% 0.0% 0.0% 0.0% 0.0%

Productivity /

Mix 8.5% (8.2%) 12.1% (9.7%) 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

Other Op. Exp. (23.7%) (41.5%) (27.4%) (2.4%) 180.8% (26.9%) (35.8%) (41.5%) (45.4%) (49.4%)

EBITDA 38.1% 24.6% 0.0% (15.4%) (20.0%) (26.9%) (35.8%) (41.5%) (45.4%) (49.4%)

Balance Sheet Base Scenario 2016 2017 2018 2019 2020 2021 2024

Cash 5.128 19.996 17.398 16.823 21.557 23.392 30.813

Accounts Receivable 6.397 7.261 7.041 7.522 8.038 8.461 9.430

Other Receivables 1.574 1.243 1.282 1.384 1.494 1.590 1.831

Total Receivables 7.971 8.504 8.322 8.906 9.533 10.051 11.261

Inventory 5.943 7.419 6.002 6.462 6.746 7.018 7.679

Other Current Assets 684 679 700 756 816 869 1.000

Total Current Assets 19.725 36.598 32.423 32.947 38.652 41.330 50.754

Gross Property, Plant & Equipment 6.846 7.854 8.925 11.463 14.150 15.644 20.600

Accumulated Depreciation (2.205) (2.574) (3.029) (3.520) (4.051) (4.615) (6.487)

Net Property, Plant & Equipment 4.641 5.280 5.896 7.943 10.099 11.029 14.113

Long-Term Investments 66 90 90 90 90 90 90

Goodwill 5.992 6.274 6.274 6.274 6.274 6.274 6.274

Other Intangibles 11.771 11.365 14.550 15.250 15.950 16.650 18.750

Deferred Tax Assets, Lt #VALUE! 944 472 472 472 472 472

Non current Inventory 3.178 3.878 6.829 7.352 7.675 7.985 8.737

Other Long-Term Assets 314 503 503 503 503 503 503

Total Assets 45.688 64.933 67.037 70.832 79.716 84.333 99.693

Accounts Payable 2.413 2.118 1.910 2.056 2.146 2.233 2.443

Accrued Exp. 1.540 2.041 1.966 2.117 2.210 2.299 2.516

Curr. Port. Of Lt Debt 53 48 48 48 48 48 48

Other Current Liabilities 451 896 907 976 1.019 1.060 1.160

Total Current Liabilities 4.457 5.103 4.831 5.198 5.424 5.641 6.167

Long-Term Debt 10.207 9.781 9.500 9.875 15.002 15.330 15.622

Def. Tax Liability, Non-Curr. 2.759 2.820 2.820 2.820 2.820 2.820 2.820

Other Non-Current Liabilities 213 243 243 243 243 243 243

Total Liabilities 17.636 17.947 17.395 18.136 23.489 24.034 24.853

Common Stock 6.353 11.623 11.623 11.623 11.623 11.623 11.623

Additional Paid In Capital 3.698 16.426 16.426 16.426 16.426 16.426 16.426

Retained Earnings 12.118 15.345 17.579 20.716 24.344 28.504 43.375

Dividends #VALUE! (2.600) (2.177) (2.260) (2.357) (2.446) (2.775)

Retained Earnings 12.118 12.745 15.402 18.456 21.987 26.059 40.600

Comprehensive Inc. And Other 5.853 6.137 6.137 6.137 6.137 6.137 6.137

Total Common Equity 28.022 46.931 49.588 52.641 56.173 60.244 74.786

Minority Interest 30 54 54 54 54 54 54

Total Equity 28.052 46.985 49.642 52.695 56.227 60.299 74.840

0 0 0 0 0 0 0

Total Liabilities And Equity 45.688 64.933 67.037 70.832 79.716 84.333 99.693

21

APPENDIX 14: Revenue roadmap: base scenario (mm)

In Millions (MXP) 2015 2016 2017 F2018 F2019 F2020 F2021 F2022 F2023 F2024

Last year revenue 15,314 18,475 24,396 25,958 26,763 28,895 31,206 33,199 35,198 36,711

Volume growth by region

Mexico 2 267 314 196 162 165 171 178 187 196

ROW 291 229 427 206 38 55 74 89 106 123

U.S. and Canada 600 1,809 (806) 127 596 617 631 623 606 572

Volume growth 893 2,304 (66) 528 796 837 875 891 899 890

Price / Mix by region

Mexico (205) 337 453 46 88 92 96 100 104 109

ROW 558 401 (60) (1) 195 215 159 158 82 87

U.S. and Canada 1,914 2,879 1,234 232 1,052 1,167 863 851 427 438

Price / Mix growth 2,268 3,617 1,627 277 1,336 1,474 1,118 1,109 613 634

Year revenue 18,475 24,396 25,958 26,763 28,895 31,206 33,199 35,198 36,711 38,235

YoY Growth rates 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024

Volume growth by region

Mexico 0.0% 1.4% 1.3% 0.8% 0.6% 0.6% 0.5% 0.5% 0.5% 0.5%

ROW 1.9% 1.2% 1.7% 0.8% 0.1% 0.2% 0.2% 0.3% 0.3% 0.3%

U.S. and Canada 3.9% 9.8% (3.3%) 0.5% 2.2% 2.1% 2.0% 1.9% 1.7% 1.6%

Volume growth 5.8% 12.5% (0.3% ) 2.0% 3.0% 2.9% 2.8% 2.7% 2.6% 2.4%

Price / Mix by region

Mexico (1.3%) 1.8% 1.9% 0.2% 0.3% 0.3% 0.3% 0.3% 0.3% 0.3%

ROW 3.6% 2.2% (0.2%) (0.0%) 0.7% 0.7% 0.5% 0.5% 0.2% 0.2%

U.S. and Canada 12.5% 15.6% 5.1% 0.9% 3.9% 4.0% 2.8% 2.6% 1.2% 1.2%

Price / Mix growth 14.8% 19.6% 6.7% 1.1% 5.0% 5.1% 3.6% 3.3% 1.7% 1.7%

Year over year growth 20.6% 32.1% 6.4% 3.1% 8.0% 8.0% 6.4% 6.0% 4.3% 4.2%

22

APPENDIX 15: DCF valuation: Bullish scenario (m)

DCF Bullish Scenario 2017 2018 2019 2020 2021 2022 2023 2024CAGR 24-

19

Volume 20.492 20.942 21.556 23.064 23.649 24.231 24.817 25.394 3,3%

YoY Growth 2,2% 2,9% 7,0% 2,5% 2,5% 2,4% 2,3%

Revenues 25.958 26.763 28.895 32.461 34.454 36.453 37.966 39.490 6,4%

YoY Growth 6,4% 3,1% 8,0% 12,3% 6,1% 5,8% 4,1% 4,0%

COGS 9.837 9.958 10.721 11.192 11.644 12.282 12.435 12.741

Gross profit 16.121 16.805 18.174 21.269 22.810 24.171 25.531 26.749 8,0%

Margin / Sales 62,1% 62,8% 62,9% 65,5% 66,2% 66,3% 67,2% 67,7%

Operating Expenses 9.402 9.694 10.380 11.120 11.770 12.425 12.941 13.463 5,3%

Op. Exp. / Sales 36,2% 36,2% 35,9% 34,3% 34,2% 34,1% 34,1% 34,1%

EBIT 6.719 7.111 7.794 10.149 11.040 11.746 12.590 13.286 11,3%

EBIT / Sales 25,9% 26,6% 27,0% 31,3% 32,0% 32,2% 33,2% 33,6%

EBITDA 7.154 7.566 8.285 10.680 11.605 12.345 13.215 13.936 11,0%

EBITDA / Sales 27,6% 28,3% 28,7% 32,9% 33,7% 33,9% 34,8% 35,3%

Operating EBITA 6.731 7.111 7.794 10.149 11.040 11.746 12.590 13.286 11,3%

Operating EBITA/Sales 25,9% 26,6% 27,0% 31,3% 32,0% 32,2% 33,2% 33,6%

Operating Cash Taxes 753 1.917 2.106 2.326 2.574 2.769 3.190 3.398 10,0%

Operating cash tax rate % 11,2% 27,0% 27,0% 22,9% 23,3% 23,6% 25,3% 25,6%

NOPLAT 5.978 5.194 5.688 7.823 8.467 8.977 9.401 9.888 11,7%

NOPLAT/Sales 23,0% 19,4% 19,7% 24,1% 24,6% 24,6% 24,8% 25,0%

Depreciation & Amortization 435 455 491 530 564 598 624 650 5,8%

CAPEX (1.067) (1.071) (2.538) (2.687) (1.494) (1.584) (1.652) (1.721)

Increase/decrease WC (1.886) 1.486 (1.317) (1.372) (1.143) (1.148) (765) (774)

Free cash flow 3.460 6.065 2.324 4.296 6.394 6.844 7.608 8.043 28,2%

Discount period 1,000 2,000 3,000 4,000 5,000

Discount factor 0,907 0,822 0,745 0,676 0,613

PV Free Cash Flow 3.894 5.255 5.100 5.140 4.927

Perpetuity Growth Rate 4,1%

WACC 10,3% Multiples

Terminal Value 164.890

PV Terminal value 100.999 2018 Est. EBITDA Multiple 17,10x

Exit EBITDA Multiple 9,28x

Enterprise value 125.316

Cash & Equivalents (5.823) TV/Revenue 4,18x

Debt 9.875 TV/EBIT 12,41x

Implied Equity Value 129.368 TV/EBITDA 11,83x

Total Shares 3.654

Price per Share 35,4 Exit Earnings Per share 2,7

23

APPENDIX 12: Corporate structure

APPENDIX 13: Montecarlo simulation

Base scenario

Trials 5,000

Mean 29.19

Median 29.25

Standard Deviation 1.66

Variance 2.77

Skewness -0.1414

Kurtosis 3.01

Coeff. Of Variation 0.057

Minimum 23.64

Maximum 34.6

Standard Error 0.05

Simulation Statistics

Tornado chart:

24

Bullish scenario

Final scenario: 80% base and 20% bullish

Tornado chart:

Trials 5,000

Mean 35.4

Median 35.3


Variance 4.3

Skewness 0.0486

Kurtosis 3.01


Minimum 27.9

Maximum 42.4


Trials 5,000

Mean 29.2

Median 29.23


Variance 2.81

Skewness -0.0219

Kurtosis 3.12


Minimum 22.83

Maximum 36.14

Standard Error 0.02


Tornado chart:

25

APPENDIX 14: Dupont analysis

In Millions of MXN except Per

Share FY 2016 FY 2017 2018E 2019E 2020E 2021E 2022E 2023E 2024E

Tax Burden

Net Inc to Comn/Pre-Tax Profit % 0.70 0.88 0.72 0.72 0.72 0.72 0.72 0.70 0.70

Adjustment Factor

Normlzd Net Inc/Net Inc to Cmn 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00

Interest Burden

Pre-Tax Profit/EBIT % 0.91 0.96 0.95 0.95 0.92 0.93 0.93 0.94 0.94

Operating Margin

EBIT/Revenue % 0.23 0.26 0.27 0.27 0.29 0.29 0.30 0.31 0.31

Asset Turnover

Revenue/Avg Assets 0.58 0.47 0.41 0.42 0.41 0.40 0.40 0.40 0.39

Leverage Ratio

Avg Assets/Avg Equity 1.63 1.47 1.37 1.35 1.38 1.41 1.39 1.37 1.34

Adjusted Return on Equity 13.70% 15.15% 10.01% 10.39% 10.82% 11.19% 11.22% 11.06% 10.97%

26

The Latin America Burkenroad Reports from ITESM are financial analysis of companies listed in the

Mexican Stock Exchange, and capital budgeting of medium and small companies. They are elaborated

by students of both the Master in Finance program of EGADE Business School, and the Bachelor in

Finance and Accounting; under the supervition of recognized professors.

Instituto Tecnológico y de Estudios Superiores de Monterrey (ITESM), Instituto de Estudios

Superiores de Administración de Venezuela (IESA), and Universidad de los Andes from Colombia,

along with Tulane University, started the Latin America Burkenroad Program with the support of

Multilateral Investment Fund of the Interamerican Development Bank in 2001. Actually it has been

expanded to other countries, the Universidad Catolica de Perú, to Ecuador by the EAFIT, ICESI, and

the Universidad Del Norte, as well as Argentina by the Universidad de Belgrano.

This program enriches human capital by providing training in financial analysis and valuation

techniques, and also intends to facilitate access of companies to financing sources by providing

financial information to investors and financial institutions.

The reports prepared by this program, evaluate financial conditions and investment opportunities in

Latin American companies. Financial reports of listed companies are distributed to national and

foreign investors through websites, publications and media recognitions such as Reuters and FactSet,

where EGADE Business School is a contributor.

Business plans, evaluation of investment projects or financial diagnoses of private companies are only

distributed to beneficiary companies for future private presentations to financial institutions or

potential investors.

For more information about the Burkenroad Latin America Program please visit the following

websites:

https://egade.mx/burkenroad/

www.latinburkenroad.org

María Concepción del Alto Ph.D.

[email protected]

Research Director

Burkenroad Reports, Mexico

EGADE Business School

Tecnológico de Monterrey

Tel +52 1 86256000 ext. 6050

https://egade.mx/burkenroad/

http://www.latinburkenroad.org/

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