CUERVO Food & Beverages

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1 March 22, 2017 CUERVO Market Outperformer 2017e Price Target P$37.1 Price Shares Outstanding 3,654 Market Cap 118,427 Float 15.00% Net Debt -10,287 EV 108,140 Dividend Yield 1.86% e 2018e Revenue 24,396 27,027 28,743 EBITDA 6,075 7,249 8,068 Net Profit 3,148 4,695 5,269 Free CF ,791 3,229 EPS P/E 37.6x 25.2x 22.5x EV/EBITDA 17.8x 14.5x 12.7x P/BV 3.5x 2.6x 2.3x Equity and net debt are adjusted to account for IPO procceds (P$18.01 billion) and dividend paid in 1Q17 (P$2.59 billion). Miguel Mayorga Tena +52(55) Miguel Angel Tortolero C. +52(55) ext We are initiating coverage on CUERVO with a 2017e price target of P$37.1. CUERVO should benefit from the momentum that tequila is experiencing in Mexico and the US, along with the long-term potential in other important markets for spirits, which remain underpenetrated by tequila on a consumption per capita basis. Additionally, we expect the company s profitability and FCF generation to be boosted in the medium term, thanks to the upcoming integration in terms of agave, better portfolio mix, and a normalization of CAPEX. Tequila s momentum driving further expansion ahead. While tequila accounts for only 1% of total spirits volume around the world, between 2010 and 2015 it posted one of the highest CAGRs within the industry. Thus, as CUERVO is the undisputed leader in the segment, it stands in a unique position to capitalize from these dynamics through the right product mix, and brand positioning expertise. Strategic product diversification. CUERVO has expanded its product portfolio by acquiring iconic brands, such as Bushmills (Irish whiskey), or by developing from scratch solid hits such as Kraken (rum). In turn, CUERVO will be able to leverage its platform and distribution network to more efficiently position its tequila and other brands in territories such as Europe. Operating efficiencies driven by agave s integration. As part of its strategic plan, CUERVO has increased its efforts to gain maximum control over the agricultural process stage, which refers to being able to almost fully meet agave requirements through company-owned plants. We estimate that this integration alone represents an opportunity to improve the company s gross margin by bps, which should be achieved by Solid bases for FCF generation. CUERVO s FCF generation should be boosted by significant improvements in profitability due to a higher integration and better mix, along with a normalization of CAPEX. As such, FCF conversion from EBITDA should considerably improve in the medium term to levels of 60% (from the current 32%) by Solid balance sheet. After its IPO, CUERVO has one of the strongest balance sheets in the industry, and enough fire power to be prepared if an attractive inorganic opportunity appears. Moreover, it could enhance its global diversification and increase penetration of its tequila portfolio across new geographies.

2 INDEX I. Investment Thesis a. Tequila s momentum b. Strategic product diversification c. Operating efficiencies driven by agave s integration d. FCF generation to improve significantly in the medium term II. III. Valuation Financial Estimates IV. Industry Outlook a. Global Alcoholic Beverage Industry b. Mexico s Alcoholic Beverage Industry c. US Alcoholic Beverage Industry d. Tequila V. Investment Thesis Pros and Cons 13 VI. VII. Company Description a. Main brands b. Company History c. Business Model d. Market Share e. Production and Bottling Facilities f. Agriculture Integration g. Bushmills and Irish Whiskey h. Volume and Revenue Breakdown i. COGS and Expense Structure j. Balance Sheet Structure k. Working Capital l. Corporate Structure m. Main Risks Industry ratios

3 I. Investment Thesis: Tequila s momentum on a global basis, along with the upcoming agave integration, should boost CUERVO s profitability and help it to consolidate as a major global spirit company. a. Tequila s momentum CUERVO is the biggest tequila producer in the world with a 29% market share and 200 years of experience and expertise in the industry. Tequila is one of the fastest-growing categories within the global spirits industry. Tequila experienced a CAGR of 4% in terms of volume between 2010 and 2015 one of the highest in the industry. Tequila s momentum is mainly driven by demographics and changing consumer preferences. These point to an increasing demand for products with perceived superior quality, which comes with features such as unique heritage and innovative characteristics. Expanding footprint in underpenetrated territories. Tequila accounts for roughly 1% of total spirit volumes around the world as its consumption is mainly concentrated in Mexico and the US. However, other low consumption regions such as Europe, the rest of LatAm, and Asia, have shown increasing demand over the past couple of years. For example, regarding Europe, a 1% increase in market share could represent a revenue expansion of approximately US$450 million. CUERVO s strategic plan is to participate more actively in these regions leveraging its brand positioning knowhow. Premiumization driving further growth in Mexico and the US. In recent years, industry dynamics have shown a trend of growing consumer preferences for more premium products. We believe that through further innovation and greater demand for brands such as 1800 and Maestro Tequilero, CUERVO should be able to capture the benefits, translating into a larger customer base and enhancing profitability levels. Total spirit volume by category Volume 9Lc Source: IWSR and Company information 2

4 b. Strategic product diversification CUERVO s well diversified portfolio further strengthens its position in an industry of changing consumer preferences. CUERVO has focused its efforts not only on growing its portfolio in the tequila brands, but on expanding its scope by diversifying to other spirits. To date, through owned brands and through third-party distribution agreements, it stands as an important player in a range of categories such as Irish Whiskey, American Whiskey, Vodka, Gin, Rum, Mezcal, liqueurs, and ready to drink cocktails. This further strengthens its customer base and diversifies risk in an industry with such unique consumer characteristics. Operating synergies still to come. In its aim for continuous diversification within an industry of changing consumer preferences, in February 2015, CUERVO acquired Bushmills. The brand occupies the third place in Irish whiskey sales in the world and the second place in sales volumes in the US, the number one market for Irish whiskey. Bushmills is well positioned with strong brand recognition, particularly in the European and US markets where it distributes 99% of its volumes. Furthermore, it gives CUERVO synergies in terms of geographic presence and platform distribution. Additionally, it helps to expand the tequila brands to territories where Bushmills is already present and enhances its route-to-market strategies, translating into a more effective market penetration in such important markets as the UK and the rest of Europe where tequila represented only 0.9% of spirits retail sales in Spirits Volume CAGR by category Volume 9Lc Rum -0.4% 0.1% Scotch Whisky 1.3% 0.3% Vodka US Whiskey -0.3% 3.3% 5.5% 4.5% World US Tequila 4.0% 5.3% Irish Whiskey 9.8% 17.9% -5.0% 0.0% 5.0% 10.0% 15.0% 20.0% Source: IWSR and Company information c. Operating efficiencies driven by agave s integration Ninety percent agave integration by By 2016, the company met around 65% of supply through owned agave, while the remainder was bought from third parties on the spot market. Prices in this market are driven by supply and demand, and have shown significant volatility over the last several years; this is why one of the main pillars of the company s strategy going forward is to gain maximum control over the agricultural process stage. This means being able to almost fully meet agave requirements 3

5 through owned plants. CUERVO aims to achieve a 90% integration by 2019, which should give it control of the agricultural process, securing supply, controlling quality, and most importantly, gaining flexibility in the main input for production. Profitability levels boosted by desired integration. We believe this transition should result in profitability improvements in future years, as an integrated model from the cultivation to the distribution stage should give CUERVO a competitive advantage within the industry. We estimate that this integration alone represents an opportunity to improve the company s gross margin by bps. Largest Agave plantation, although further integration is in the pipeline Degree of vertical integration vs. Gross Mg. ~65% vertically integrated Source: Company information Source: GBM estimate d. FCF generation should significantly improve in the medium term FCF improvements should come mainly from two fronts: profitability, and CAPEX reduction. As such, FCF conversion from EBITDA rate should follow a solid path of continuous improvements, reaching levels of ~60% (from the current 32%). 1) Profitability. As discussed earlier, profitability should be mainly boosted by two drivers: premiumization and vertical integration. 2) CAPEX. After a couple of years of heavy capital expenditures due to capacity growth plans, CAPEX should stabilize. Thereby, with a gradual drop of CAPEX allocated for growth purposes and with past investments starting to pay off, CUERVO should boost FCF generation. 4

6 II. Valuation Introducing our 2017e price target of P$37.1 with a Market Outperformer recommendation, due to the company s growth potential and profitability improvement. We reached our price target through a DCF approach, with the following assumptions. EBITDA CAGR of 14.6% Normalized effective tax rate of 30% Perpetual growth of 3.5% WACC of 8.95% 2017e 2018e 2019e 2020e 2021e Perpetual FCF EBITDA 7,248,672 8,068,164 9,573,524 10,595,162 12,007,641 12,427,908 Working Capital (+) 4, , , ,892-1,044,248 Taxes (+) -2,012,043-2,258,289-2,712,102-3,032,688-3,458,367-3,579,409 Operating Cash Flow 5,241,452 5,252,378 6,205,956 6,895,583 7,505,025 8,848,499 CAPEX (+) -2,287,350-1,971,000-1,955, , , ,500 Free Cash Flow 2,954,102 3,281,378 4,250,956 6,018,083 6,627,525 8,165,999 WACC 8.95% Total present value 125,246,110 Net debt 4Q16-10,287,453 Minority 29,966 P/BV 3.53x Minority P/BV 105,794 Equity value 135,427,769 Shares outstanding (000 s) 3,654,040 Price Target 2017e

7 III. Financial Estimates Income Statement Margins Volume ( 000 9LC) 18,214 20,400 20,647 21,785 23,000 COGS Margin 39.10% 40.73% 40.00% 39.50% 37.00% Mexico 5,581 5,916 6,040 6,215 6,402 Gross profit margin 60.90% 59.27% 60.00% 60.50% 63.00% US & Canada 10,821 12,444 12,444 13,191 13,982 Admon and selling expenses margin 9.08% 9.05% 8.00% 8.00% 8.00% RoW 1,855 2,040 2,162 2,379 2,617 Other income margin 18.65% 0.66% 1.70% 1.70% 1.70% Net Sales 18,475 24,396 27,027 28,743 31,215 AMP margin 22.32% 24.75% 23.40% 23.00% 23.00% Mexico 4,494 5,123 5,440 5,822 6,236 Distribution margin 3.94% 3.07% 4.88% 4.83% 4.88% US & Canada (MXN) 11,850 16,589 18,185 19,102 20,686 EBIT margin 43.66% 23.05% 25.42% 26.37% 28.82% US & Canada (USD) ,058 EBITDA margin 44.98% 24.90% 26.82% 28.07% 30.67% RoW (MXN) 2,269 2,928 3,402 3,819 4,292 Net icome margin 28.73% 12.90% 17.37% 18.33% 20.27% RoW (GBP) Gross Profit 11,251 14,460 16,216 17,390 19,665 FCF Admon and selling expenses 1,677 2,208 2,162 2,299 2,497 EBITDA 6,075 7,249 8,068 9,574 Other income 3, Change in Working Capital (+) -3, AMP expenses 4,123 6,039 6,324 6,611 7,179 Interests (+) Distribution expenses ,319 1,388 1,523 Taxes (+) -1,540-2,012-2,258-2,712 EBIT 8,067 5,624 6,870 7,580 8,996 CAPEX (+) ,287-1,971-1,955 EBITDA 8,311 6,075 7,249 8,068 9,574 FCF ,791 3,229 4,295 Net Interest Income before taxes 7,619 4,688 6,707 7,528 9,040 Valuation & Returns Taxes 2,310-1,540-2,012-2,258-2,712 EV/EBITDA 13.01x 17.80x 14.54x 12.67x 10.22x Majority net income 5,308 3,148 4,695 5,269 6,328 P/B 5.01x 3.53x 2.59x 2.33x 2.09x P/E 22.31x 37.62x 25.23x 22.47x 18.71x Balance Sheet P/S 6.41x 4.85x 4.38x 4.12x 3.79x Cash and equivalents 4,139 5,128 23,285 26,514 30,810 EPS (MXN) Client receivables (net) 5,293 6,396 5,766 6,069 6,522 ROA 13.7% 6.31% 7.37% 7.64% 8.45% Short term inventories 4,352 5,943 6,439 6,725 6,803 ROE 22.4% 9.38% 10.25% 10.38% 11.19% Property, Plant and Equipment 3,997 4,641 6,550 8,032 9,409 ROIC 12.30% 13.24% 14.75% 16.49% TOTAL ASSETS 38,636 45,688 66,264 71,706 78,113 FCF yield -0.21% 2.36% 2.73% 3.63% Suppliers (Payables) 1,775 2,422 2,641 2,799 2,872 Dividend yield 1.9% Interest Bearing Liabilities Roic = Nopat/ Prom. t0 ((Shareholders equity+ Net debt)+t1(shareholders equity+ Net debt)) + Other long term interest bearingl liabilties 8,490 10,207 10,207 10,207 10,207 From 2016 equity, assets, and net debt is adjusted to account for IPO procceds (P$18.01 billion) and dividend paid in 1Q17 (P$2.59 billion) Total debt 8,536 10,260 10,207 10,207 10,207 TOTAL LIABILITIES 14,990 17,636 18,098 18,270 18,349 Leverage & Other ratios Minority equity Debt/Equity 0.36x 0.24x 0.21x 0.19x 0.17x TOTAL MAJORITY EQUITY 23,647 28,022 48,137 53,406 59,734 Net Debt / EBITDA 0.19x (0.37x) (0.27x) (0.31x) (0.34x) SHAREHOLDERS EQUITY 23,647 28,052 48,166 53,436 59,764 Interest Coverage 59.11x 14.27x 9.40x 10.40x 12.34x Net debt 4,397 5,132-13,078-16,308-20,603 Asset turnover ratio 0.48x 0.58x 0.48x 0.42x 0.42x Current Ratio 3.72x 4.43x 7.81x 8.32x 9.16x Growth Rates Quick Ratio 2.65x 3.09x 6.50x 7.00x 7.85x Volume 12.00% 1.21% 5.51% 5.58% Days of receivables Mexico volume growth rate 6.00% 2.10% 2.90% 3.00% Days of inventory US & Canada volume growth rate 15.00% 0.00% 6.00% 6.00% Days of payables ROW volume growth rate 10.00% 6.00% 10.00% 10.00% From 2016 equity, assets, and net debt is adjusted to account for IPO procceds (P$18.01 billion) and dividend paid in 1Q17 (P$2.59 billion). Pricing consolidated (MXN) 9.46% 0.79% 2.86% Pricing Mexico (MXN) 4.00% 4.00% 4.00% Pricing US & Canada (USD) 3.00% 0.00% 3.00% F/X MXNUSD Pricing RoW (USD) 3.00% 3.00% 3.00% F/X MXNUSD Net sales 32.05% 10.78% 6.35% 8.60% F/X % Chg 6.43% -0.90% -0.81% Mexico sales growth rate (MXN) 14.00% 6.18% 7.02% 7.12% US & Canada sales growth rate (MXN) 40.00% 9.62% 5.04% 8.29% ROW sales growth rate (MXN) 29.00% 16.20% 12.27% 12.38% COGS 29.00% 8.81% 5.02% 1.73% Gross profit 28.53% 12.14% 7.24% 13.09% Admon and selling expenses 31.70% -2.08% 6.35% 8.60% Other income % % 6.35% 8.60% AMP costs 46.47% 4.73% 4.53% 8.60% Distribution expenses 3.16% 75.86% 5.26% 9.72% EBIT % 22.16% 10.32% 18.69% EBITDA % 19.31% 11.31% 18.66% Majority Net income % 49.15% 12.24% 20.10% 6

8 IV. Industry Outlook e. Global Alcoholic Beverage Industry The Global Alcoholic Beverage industry is mainly represented by three categories which, together, stand for 97% of the total industry value. These three categories are: beer, wine, and spirits. Over the past decade, the industry has shown a moderate growth, with the Spirits industry registering the strongest growth ( CAGR of 3.2%), followed by Beer ( CAGR of 3.1%), and Wine. Market Share of Alcoholic Beverages Value Global Alcoholic Beverages Market Share Left axis in USD$ billions Wine, 21% Spirits, 34% Beer, 43% 1,800 1,600 1,400 1,200 1, CAGR: 3.2% Other, 3% Beer Spirits Wine Others Source: Euromonitor Source: Euromonitor Regional Breakdown. The largest markets for the Alcoholic Beverage Industry are Asia-Pacific, W. Europe, and N. America, which together comprise roughly 80% of the global market. In terms of growth, over the past decade, the markets that have shown the highest growth phases are MEA, Asia Pacific, and LatAm, while Europe has contracted. Alcoholic Beverages-Value by region Industry growth by region CAGR W. Europe, 26% North America, 18% LatAm, 10% E. Europe, 6% W. Europe E. Europe Australasia N. America -0.8% -0.7% 0.2% 0.9% MEA, 5% Latin America 2.3% M. East & Africa 3.9% Source: Euromonitor Asia Pacific, 33% Australia, 2% Source: Euromonitor Asia Pacific 4.2% -3.0% 0.0% 3.0% 6.0% 7

9 f. Mexico s Alcoholic Beverage Industry Within the Mexican alcoholic beverage industry, in terms of value, beer stands as the largest segment, accounting for 65% of total sales, followed by spirits (29%) and wine (6%). From 2010 to 2015, the sale of alcoholic beverages in Mexico registered a CAGR of 6.7%, well above most developed and developing countries. Market Share of Alcoholic Beverages Value Spirits, 28% Wine, 6% The following shows a breakdown of the three categories; Beer, 64% Others, 2% Wine: CAGR of 11.8% Spirits: CAGR of 9.3% Beer: CAGR of 5.3% Source: Euromonitor Category Breakdown Volume As for the spirit industry, in terms of volume, Tequila and Mezcal represent 39% of Mexico s consumption. This is more than twice the volume of whisky consumed in 2015; nevertheless, in terms of value, the Tequila industry is only 19% more valuable than the whisky industry. Moreover, the Rum category is the third most sold spirit in Mexico, representing 13% of the total volume. Whiskies, 16.0% Rum, 13.0% Others, 13.0% Brandy and Cognac, 10.0% Vodka, 6.0% Liqueurs, 3.0% The spirits industry in Mexico is worth over US$6.8 billion. Two main categories account for 75% of the total value: Tequila (worth US$2.8 billion) and whisky (worth US$2.3 billion). Within the spirits industry in Mexico, Whisky, Gin, and Tequila registered the strongest volume growth rates from 2010 to Tequila & Mezcal, 39.0% Gin, 0.3% Source: Euromonitor Industry growth by category CAGR Brandy and Cognac Rum Liqueurs Whisky: CAGR of 17.3% Gin: CAGR of 13.4% Tequila & Mezcal: CAGR of 8.2% Vodka Other Spirits Tequila & Mezcal Gin Whiskies 0.0% 5.0% 10.0% 15.0% 20.0% 8

10 g. US Alcoholic Beverage Industry Market Share of Alcoholic Beverages Value As for the US alcoholic beverage industry, in terms of value, beer represents 47% of the total industry, slightly above spirits (31%); wine (19%) is third. Spirits, 31% From 2010 to 2015, the US alcoholic beverage industry posted low single-digit growth (CAGR of 3.7%) in terms of value. The three categories behaved as follows; Spirits: CAGR of 4.2% Wine: CAGR of 3.7% Beer: CAGR of 3.1% Beer, 47% Wine, 19% Others, 3% Specifically regarding the spirit industry, in terms of volume, Vodka leads the division, representing 34% of the total volumes; however, it is not the most valuable as it only represents 26% of the total industry value, making it the second most valuable sector of alcoholic beverages in the US. After Vodka, the most sold category in terms of volume is whisky (25%); nevertheless, it stands as the most valuable sector. Whiskies, 25.0% Category Breakdown Volume Rum, 12.0% Liqueurs, 10.0% Brandy and Cognac, 6.0% Source: Euromonitor Tequila & Mezcal, 7.0% In terms of value, the spirits industry in the US is worth over US$69 billion. The whisky industry alone is worth US$19.6 billion dollars, representing 28% of the total, making it the most valuable; it is followed by Vodka with 26%. The Tequila industry is worth US$5.5 billion. As for volume, the fastest growing industries from are the following; Tequila & Mezcal: CAGR of 7.7% Brandy: CAGR of 6.9% Whisky: CAGR of 6.2% Tequila & Mezcal Brandy & Cognac Whiskies Liqueurs Vodka Rum Gin Other Spirits Vodka, 34.0% Gin, 5.0% Others, 1.0% Source: Euromonitor Industry growth by category CAGR % -1.0% 0.0% 1.0% 2.0% 3.0% 4.0% 5.0% 6.0% 7.0% 8.0% 9

11 h. Tequila Tequila is prepared from the heads of the Tequilana Weber Agave Blue Variety. It is then hydrolyzed or cooked, and subjected to alcoholic fermentation with cultured or uncultured yeast. The musts can be enhanced and blended together in the making, with other sugars at a ratio no greater than 49% of total reducing sugars expressed in units of mass, per the NOM; cold mixes are not allowed. Depending on the type, Tequila is a colorless liquid when matured, or colored when softened unripe. In the NOM-006-SCFI-2005 Mexican Standard, Tequila is defined as: Regional alcoholic beverage distilled from must prepared directly and originally from the material extracted, in the factory premises of an Authorized Manufacturer, which must be located within the territory specified in the Declaration for the Protection of Appellation of Origin Tequila (also called the Denomination of Origin Tequila DOT). Tequila s Production Process Harvesting. After the Agave plant reaches maturity (approx. 6 years), it is harvested through the traditional method used in the Tequila industry for centuries. The harvester (Jimador) removes the agave leaves from the heart of the agave. Each agave heart or piña may produce around 15 liters of Tequila. Cooking. The piñas are piled into large ovens for cooking, which regularly takes up to 36 hours. Through this process, starches inside the agaves turn into sugars. Crushing. Aguamiel or Agave juice is extracted from the cooked piñas by using a mechanical roller shredding mills and presses in order to separate the sugars from the fibers. Fermenting. Fermentation is done in wood open-air tanks, adding a special yeast to convert the sugars into alcohol. This process can take up to 4 days. Distilling. Ferments are separated by heat and steam pressure within stainless steel pot stills or distillation towers. Aging. Normally, containers used for aging are barrels made of white oak. Reposados are aged between two and twelve months; Añejos are aged between one and three years; and Extra Añejos are aged for over three years. Bottling. Tequila is bottled, capped, labeled, and packed in cases for shipment. 10

12 According to the Tequila Regulatory Council (CTR) there is an inventory of 290 million liters available in wineries and more than 300 million blue agave plants of different ages. Moreover, during the period of , the industry posted a CAGR of 1.4% in production. Furthermore, the amount of Tequila exported represents over half of what is produced in the industry. Most of it is exported to the US. In 2015, of the 229 million liters of Tequila produced, 80% was exported million liters to the US alone, representing roughly 83% of total exports during that year. Thus, in terms of volume share by country, the US is the leader (54%), while Mexico is the second largest consumer (30.4%). The remaining volume is consumed among other countries, where the most representative are Spain, Germany, France, Russia, and the UK. 1,300 1, Tequila s Industry Production Figures in 000 s of liters CAGR: 1.4% Tequila 100% Tequila s Regional Breakdown Volume Mexico, 30.0% Tequila Source: CRT As for Tequila companies, in global terms, Jose CUERVO holds the lead in Tequila market share (29.7%), which is more than doubles the second competitor, Beam Suntory (12.9%), followed by Tequila Patron (7.8%), and Brown Forman (6.8%). Tequila in Mexico. In 2015, the most important spirit in Mexico was Tequila. It accounted for 102 million liters, making this the biggest category within spirits where trends suggest that the local consumer is upgrading its taste to more premium Tequilas..CUERVO is the undisputed leader with 32.6% of the market in terms of volume. Beam Suntory stands second, with 13.4% of the market, followed by Centinela (10.6%), and Brown Forman (10.3%) % 90.0% 80.0% 70.0% 60.0% 50.0% 40.0% 30.0% 20.0% 10.0% 0.0% 2.1% 2.8% 3.6% US, 54.0% Row, 16.0% Tequila s Mkt Share Global Volume 23.7% 6.8% 7.8% 12.9% 29.7% 2.7% 3.4% 4.6% Source: IWSR Others Bacardi Luxco Diageo Pernod Ricard Centinela Sazerac Brown Forman Tequila Patrón Beam Suntory Grupo Cuervo Source: IWSR 11

13 Tequila s Mkt Share in Mexico (Volume) Tequila in the US. The US is the biggest consumer of Tequila in the world, as it has imported in the past five years over 750 million liters. Solid growth describes the behavior of the Tequila industry in the US as, from 2010 to 2015, it has shown a 7.8% CAGR in value the highest growth in the last five years compared to other spirits and a 5.3% CAGR in volumes. As for the most representative companies in terms of market share, once again, CUERVO is the undisputed leader, holding 27% of the market in terms of volume, followed by Tequila Patron with 14%, and Suntory with 13%. Tequila in Rest of the World. As we have previously stated, Tequila consumption is mainly concentrated in two major markets (US and Mexico), while the rest of the world represents around 16% of the total consumption. Jose CUERVO is, again, the leader of the rest of the world market share, representing 32% of the total sales, followed by Pernod Ricard (11%). Others, 25.0% Tequila s Mkt Share in US (Volume) Patron, 14.0% Beam Suntory, 13.0% Jose Cuervo, 33.0% Beam Suntory, 13.0% Centinela, 11.0% Source: IWSR Sazerac, 8.0% Brown Forman, 10.0% Diageo, 3.0% Pernod Ricard, 3.0% Bacardi, 2.0% Brown Forman, 5.0% Luxco, 5.0% Others, 21.0% Camarena, 4.0% Jose Cuervo, 27.0% Diageo, 3.0% Source: IWSR Tequila s Mkt Share in Row (Volume) Pernod Ricard, 11.0% Beam Suntory, 10.0% Borco, 10.0% Brown Forman, 6.0% Others, 23% Jose Cuervo, 32.0% Bacardi, 3.0% Diageo, 2.0% Patron, 2.0% Tequilas del Señor, 1.0% Source: IWSR 12

14 V. Investment Thesis Pros and Cons Pros Cons Tequila is a spirit whose per capita consumption on a worldwide basis is among the lowest. High dependence on Tequila, as it represents 57% of total sales. Tequila s growth momentum is solid, as it is among the spirits with the highest growth rate, registering a CAGR of 4% in terms of volume and 7% in retail sales. Albeit not exclusive to CUERVO, the company has large exposure to any fluctuation in Agave prices. Tequila s premiumization is getting traction driven by a more sophisticated consumer. In terms of value, Tequila has posted CAGR s of 3.9% and 7.8% in Mexico and the US. Agave s vertical integration should improve CUERVO s COGS structure. Uncertainty related to the company s plans in terms of cash deployment for M&A. Industry-specific risks coming from the stability of the appellation of origin, tariff duties. Cross selling as a result of Bushmills acquisition should help CUERVO to penetrate non-mature Tequila markets. CUERVO is not the leader in market share within the ultra-premium Tequilas in Mexico and the US. Dominant Market Share in Tequila in the two most important markets. 13

15 VI. Company Description Jose CUERVO owns, produces, markets, and distributes some of the world s most recognized Tequila brands. The company, whose history goes back over 250 years, is today the biggest producer of Tequila in the world. With its unique portfolio of Tequilas, Jose CUERVO has the highest market share in Mexico, the United States, and the Rest of the World. a. Main Brands Apart from the many brands of Tequila, Jose CUERVO has a diversified portfolio of brands that include Whiskies, Rum, Vodka, Gin, Mezcal, RTD, and other non-alcoholic brands. CUERVO has a unique portfolio of over 30 spirits brands that has been developed over the years to participate in key categories with strong growth profiles, target the most relevant spirits markets in the world and address key consumer preferences and trends. CUERVO s main brands Prestige/Ultra-Premium Tequilas CUERVO s prestige and ultra-premium category portfolio comprises four of the most famous and better ranked Tequilas in the world. Super Premium Tequilas This category has three of the most famous Tequila brands in the world with the highest sales compared to other brands in the same category. Premium Tequila Jose CUERVO Especial is the only brand in this category, yet, this brand is the one with the highest sales in terms of volume in the world. Other Brands Apart from Tequila, CUERVO distributes and owns many other brands including some Whiskies, Rum, Vodka, Gin, Mezcal, RTD, and other nonalcoholic brands. 14

16 b. Company History 15

17 c. Business Model CUERVO stands as one of the main players in the spirits industry; it produces and distributes a mix of spirits, as well as ready-to-drink cocktails and non-alcoholic beverages. Its most important products rely on the tequila business. As such, the company operates an integrated platform that allows it to control the process from the agricultural stage to the production, distribution, and route to market of the final product. Agriculture. Agave, which is the starting point of the process, is fully performed by the company. Thus, it is able to control relevant issues, such as the quality of main raw materials, and costs. Distillation and bottling processes. The company controls the distillation and bottling process by operating its own bottling and distillery facilities in Mexico (Tequila), the UK (Irish Whiskey), and the US (Vodka and Whiskey). Distribution and route to market. CUERVO has a direct route to market model. This gives it the benefit of operating a very efficient distribution network that allows it to get the most out of its sales value. In Mexico, CUERVO owns the second largest distribution network. Distribution to supermarkets, convenience stores, price clubs, and wholesalers is done directly and through CUERVO s own sales force. In the US, regulation for the distribution process is more restrictive. Out of the 50 states, distribution in 24 of them is carried out through wholesalers associated with one of 5 major distribution companies, in 9 states the company distributes through independent parties, and in the remaining 17, the state controls all distribution issues of full-strength spirits. In the Rest of the World division, which mainly encompasses the UK, distribution is done through third parties, and CUERVO follows agreements that vary by country depending on the relevant brand to be distributed. Fully integrated business model in Tequila 16

18 d. Market Share within the Tequila Industry CUERVO is the leading producer of Tequila globally by sales volume, with over twice the market share of its nearest competitor. The company s flagship Tequila brand is Jose CUERVO. It is also the most recognized Tequila brand in the world with over 20% of the global Tequila market share (over twice the size of its nearest competitor). Jose CUERVO branded products are sold in more than 85 countries. In addition to the Jose CUERVO brand family, the company has successfully developed other internationally recognized and marketed Tequila brands, including 1800, Centenario, and Maestro Tequilero / Dobel. As such, with a portfolio composed of five brands, CUERVO competes in most Tequila price segments. Lastly, in the two most important markets for Tequila, the United States and Mexico, CUERVO is the market leader with 27.4 and 32.6% shares of each country s total Tequila volume in 2015, respectively. Source: Euromonitor 17

19 e. Production and Bottling Facilities La Rojeña Distillery Location: Tequila, Jalisco. Dedicated to Tequila 100% production Capacity: 55k liters a day. Maturation Capacity: 5 million liters Storage Tank Capacity: 7 million liters Plant Utilization: 89% Los Camichines Distillery Location: La Laja, Jalisco Mainly dedicated to 51/49 Tequila, although it can produce Tequila 100% as well. Capacity: 165k liters per day of 51/49 and 85k liters per day of Tequila 100% Current Mix Capacity: 47 million liters per year Maturation Capacity: 3.3 million liters Storage tanks capacity: 23 million liters Plant Utilization: 95% EDISA Bottling Facility Capacity: 14 million cases Manual bottling capacity for all handcrafted products Tequila, Rums, Vodka, Gins, Mixers, and Perishables are bottled in this facility. Plant Utilization: 65% 18

20 Bushmills Old Bushmills Distillery Location: Bushmills, Northern Ireland Malt distillery using 100% malted barley Capacity: 5 million liters of pure alcohol per year Maturation capacity: 17 warehouses with 350,000 cask spaces Storage tank capacity: 3 million liters Plant utilization: 95% Stranahan s Proximo distillers Colorado (100,000 sq. ft.) Location: Denver, Colorado Distillation: 270k liters of pure alcohol per year; 2.5k barrels filed per year. Storage Capacity: 12k barrels Bottling: semi-automated bottling line with a capacity of over 225k 9L cases per year Plant Utilization: 90% Hangar 1 Vodka Proximo Distillers Alameda (30,000 sq. ft.) Location: Alameda, California Primary production of fresh fruit infusions and fruit distillates for flavoring vodkas. Distillation: 45k liters of pure alcohol per year. Bottling: Mostly manual with some automatic bottling Plant Utilization: 25% Proximo Bottlings Location: Lawrenceburg, Indiana Capable of producing 100ml to 1.75 liter bottles Bottling: 3-shift operation; 12 million cases per year Processing, blending, and filtration on-site Plant Utilization: 80% 19

21 f. Agriculture Integration Largest Agave producer. The company operates its own agave plantations to control the agricultural process. Its goal is to secure sufficient supply of Agave Azul, control the profile and quality of the product, and have visibility into the cost of raw materials. According to the information registered by the CRT, the company is the largest private producer of Agave Azul with a total inventory of over 60 million plants. This represents around a 20% market share. As such, CUERVO is the most vertically integrated producer in terms of Agave, as the company estimates that, to date, approximately 70% of its total Agave needs should be covered with its own plants. Moreover, over the past years, the company has invested in increasing its Agave integration, aiming to reach levels of 90% integration by 2020 remember that Agave maturity is not reached until year 6. This means that these plants are being harvested as we speak, and that each year going forward until 2020, the company s integration level should increase. CUERVO s Agricultural Integration CUERVO s Mkt Share from total Agaves Others, 80.0% Agaves owned by CUERVO, 70.0% Agaves purchased to third parties, 30.0% CUERVO, 20.0% Agave Cycle Planting necessary Agave for the year 6 projected sales Plant maintenance including labor costs, land rents, fertilizers, tractor use, irrigation costs, etc. Agave plant is harvested in order to remove the agave leaves from the heart 20

22 g. Bushmills and Irish Whiskey In its aim for continuous diversification within an industry of changing consumer preferences, in February 2015, CUERVO acquired from Diageo 100% of the shares of Bushmills, including its brands and production and bottling facilities located in Northern Ireland, for US$718.7 million. Bushmills occupies the third place in Irish whiskey sales in the world and the second place in sales volumes in the US, the number one market for Irish whiskey. Bushmills portfolio, which contributed 6% of total sales in 2016, includes Bushmills Original, Black Bush, Bushmills 10-Year-Old Single Malt, Bushmills 16-Year-Old Single Malt, and Bushmills 21-Year-Old Single Malt. Bushmills is well positioned with strong brand recognition, particularly in the European and US markets where it distributes 99% of its volumes. Furthermore, it gives CUERVO synergies in terms of geographic presence and platform distribution. Additionally, it helps to expand the tequila brands to territories where Bushmills is already present and enhances its route-to-market strategies, translating into a more effective market penetration in such important markets as the UK and the rest of Europe. Jumping into the industry, in terms of value, whisky is the most important spirit in the world. It is a distilled beverage made from fermented grain mash. Various grains are used for different varieties, including barley, corn, rye, and wheat. It is a strictly regulated spirit with different classes and types. Global Market Share by Whisky Category Value US Whiskey, 22% CAD Whisky, 15% JAP Whisky, 7% Irish whiskey is pretty much any whisky aged in the Republic of Ireland or in Northern Ireland. The whisky must be aged for at least three years in wooden casks. Scoth Whisky, 52% Irish Whiskey, 4% Specifically, Irish whiskey has the lowest market share among the whisky categories; however, it was the fastest growing in terms of volume in the global spirits market from 2009 to 2015 with a CAGR of 9.8%, according to IWSR. Source: IWSR 21

23 h. Volume and Revenue breakdown CUERVO s volumes are distributed within three main geographic regions. US & CANADA represents the largest region with 61% of the total, followed by Mexico (29%), and lastly, the Rest of the World (RoW) (10%), mainly comprising the UK, Japan, Brazil, Spain, Greece, and Australia, among others. Breaking down volumes by segment, the José CUERVO brand stands as the largest contributor (32% of total volumes) primarily serving the US market. It is followed by the Nonalcoholic & Others segment (22%), and relates mainly to the core capital Tequila business with products such as Sangrita Viuda de Juarez and Margarita Mix. Next, we find Other Alcoholic Categories (19%), and Other Tequilas (14%). Volume by region Unit cases Volume by segment Unit cases RoW, 10% Mexico, 29% Other alcoholic categories, 19% RTDs, 14% Non alcoholic & others, 22% US & CANADA, 61% Other tequilas, 14% José Cuervo, 32% Source: Company data as at 2016 Source: Company data as at 2016 Revenue breakdown. The US & Canada leads the revenue breakdown, followed by Mexico and RoW. What can be observed in the graphs below is that market value for the US stands well above Mexico, not just because of higher volumes, but also explained by having a higher price point in its product portfolio both in the US and the RoW regions. Revenues by region Revenues by segment US & CANADA, 68% RoW, 12% Other tequilas, 20% Other alcoholic categories, 24% RTDs, 9% Non alcoholic & others, 10% Mexico, 21% José Cuervo, 37% Source: Company data as at 2016 Source: Company data as at

24 i. COGS & Expense Structure The company s profitability is heavily dependent on the behavior of key input prices specifically, blue Agave. Furthermore, it is highly vulnerable to the volatility of expenses related to advertising, marketing, and production (AMP) which, within the industry, represent an important portion of company sales. COGS. Blue Agave is the main raw material used to manufacture Tequila. As we mentioned above, it must be planted and grown in the appellation of origin territories. Until 2016, the company bought 30-35% of agave from third parties whose market price is driven by supply and demand issues. As such, the level of vertical integration has a direct impact on the company s profitability. We estimate that blue Agave represents ~23% of total COGS. Other important inputs for production are energy, sugar for distillation, oak casks for maturation, bottling and packaging materials, and in the case of Whiskies, malted barley. We estimate that these inputs together represent ~65% of total COGS. AMP. Expenses related to AMP are relevant factors in the company s cost structure not just for CUERVO but within the industry. In 2016, AMP represented 25% of company sales. The relevance of this line lies in the need to protect the market positions of current brands and increase future demand and brand recognition through marketing initiatives, as well as efforts to introduce new brands among customers. Distribution, selling, and administrative expenses. The last slice of expenses regards administrative and selling expenses, coupled with distribution expenses. While the former is associated with payroll, the later relates to expenses incurred in connection with the delivery of products. Jointly, both lines accounted for 12% of the company s sales during COGS & Expense Structure Admon & Selling, 9% Distribution, 3% AMP, 25% COGS, 41% Total sales as of 2016 Source: Company data as at

25 j. Balance Sheet Structure By 2016, total assets amounted to P$45.7 billion, P$5.3 billion of which were in cash and equivalents. Short-term inventories totaled P$5.9 billion, adding up to P$19.3 billion in current assets. Furthermore, non-current inventory and property plant and equipment stood at P$3.2 billion and P$4.7 billion, respectively, for a total of P$25.9 billion in non-current assets. As for liabilities, the company held P$17.7 billion at the end of 2016, most of it corresponding to noncurrent liabilities (P$13.1 billion). Hence, shareholders equity stood at P$28.1 billion. (Million MXN) Cash and equivalents 4,139 5,128 Inventories 4,352 5,943 Current assets 15,066 19,725 PP&E 3,997 4,641 Non-current assets 23,571 25,963 Total assets 38,636 45,688 Short-term debt Current liabilities 3,267 4,457 Long-term debt 8,490 10,207 Non current liabilities 10,944 13,179 Total liabilities 14,211 17,636 Shareholders' equity 23,647 28,052 Net debt 4,397 5,132 Relevant events On January 19, CUERVO paid its shareholders a dividend of MXN$ 2.59 billion Pre-IPO dividend. On February 8, 2017, the company made and initial public offering in which it issued 548 million new shares (15% float) at P$34 per share, including the exercise of the overallotment option of 71,492,081 shares. This translated into an inflow of P$ billion net of fees which, at the date of this report, remains as part of cash and equivalents. Prior to the IPO, on October 1 st, 2016, shareholders approved the merger of CUERVO and Proximo Spirits, a US-based Company, effective on October 13. Proximo was founded in 2007 by the Beckman family as a US spirits producer, importer, and international distributor. The company started with the distribution of products of the 1800 brand family, and in 2013, took over the distribution of Jose Cuervo in the US, which was previously carried out by Diageo. Proximo also operates the three bottling facilities and two distilleries in the US. It is the ninth largest spirit distributor in that country with the distribution of over 14 own and third-party brands, and its network also reaches Canada and the UK. 24

26 k. Working Capital CUERVO s working capital is primarily comprised of client receivables, short-term inventories, and payables. Accounts receivable. Accounts receivable are financial assets not traded in active markets that relate to trade account receivables, other account receivables, and recoverable taxes. Trade receivables, which accounted for 80% of the total receivables line in 2016, are well distributed among clients. None of the clients holds a predominant portion of this item. As for 2016, client receivables stood at P$7.9 billion, implying a receivables cycle of 120 days. Inventory. Due to the dynamics of the industry in which CUERVO operates, inventories play a fundamental role in the company s working capital cycle. As mentioned before, the agave cycle takes around 6 years from the planting to the harvesting stage, as such; inventory requirements to keep performing in the short term were planted several years before and held as part of long-term inventories until the maturation stage, when such inventories become part of the short-term line. Thus, we should consider that: Zero to six year-old agaves (held as long-term inventory) are part of non-current assets Long-term requirements to supply future demand (agave reposition) are funded with capital expenditures. Six-year-old agaves plus bulk and bottled inventories are part of the company s working capital requirements. As for 2016, the short-term line stood at P$5.9 billion while days of inventory totaled 218 days. Payables. Accounts payable are mainly comprised of notes payable, suppliers, and other accounts payable. The largest slice of this line comprises payables, which represent liabilities owed to suppliers of main ingredients and raw materials used in the production process. Arrangements with suppliers are primarily short- and medium-term ones. By 2016, accounts payable stood at P$2.4 billion with an 89- day cycle. l. Corporate Structure Prior to the initial public offering, the company s capital stock was represented by a total of 3,105,933,737 shares, 15,913 shares of which represented the fixed portion and 3,105,917,824 accounted for the variable portion of the total capital stock. After the consummation of the global offering, total capital stock increased by 548,105,954 shares to 3,654,039,961 outstanding shares with a market float of 15%. Each share of CUERVO s total capital stock is entitled to full voting rights and enables each holder to make use of their right at any shareholders meeting. CUERVO s main shareholders. The main shareholders are Juan Francisco Beckman and members of his immediate family. In conjunction, they own 85% of the total shares. Aranda Investments, a wholly owned subsidiary of Temasek Holdings, a global investment company headquartered in Singapore, owns 3%, and the remaining 12% is listed on the Mexican Stock Exchange. 25

27 Shareholder # of shares % of shares Juan Francisco Beckman Vidal and inmediate family 3,105,933,737 85% Aranda Investments Pte. Ltd. 109,621,191 3% Public investors (Float) 438,484,763 12% Total 3,654,039, % CUERVO s bylaws restrict any person or investment entity from acquiring more than 10% of the total capital stock without the respective approval by the board of directors. Furthermore, any person or entity intending to acquire control of the company must do so through a public tender offer in accordance with Mexican market rules. CUERVO s Board of Directors. The board of directors has seven regular members and three alternates. Each member of the board is elected for a one-year term at the annual shareholders meeting. They can be reelected and may stay in office until the election of a new member. Due to its majority stake in the company, the Beckman family can assign most of the seats on the board, and has the power to approve any matters requiring action by shareholders. Name Juan Francisco Beckmann Vidal Juan Domingo Beckmann Legorreta Nello Raimund Trevisan Michael Verdon Cheek Rogelio Miguel Rebolledo Rojas John Randolph Millian Ricardo Cervera Lomelí Ángel Abarrategui Diez Daniel Elguea Solís Carlos Javier Vara Alonso Position Chairman Board Member Independent Board Member Independent Board Member Independent Board Member Independent Board Member Independent Board Member Alternate Board Member Alternate Board Member Independent Alternate Board Member Senior Officers Name Position Seniority Juan Domingo Beckmann CEO 25 years Mark Teasdale President and CEO of Proximo 19 years Daniel Elguea CFO 4 months Cristóbal Mariscal General Counsel 16 years Alejandro Coronado COO 18 years Jorge Scoria Audit Director 13 years Luis Carlos de Pablo Gómez Director of Investor Relations 16 years 26

28 m. Main Risks Economic and political. Changes and instability in economic and political related issues could adversely impact the markets where the company operates. Changing consumer preferences. CUERVO belongs to a very dynamic industry in which consumer preferences are constantly changing; as such, strategies to overcome those changes are crucial to keep its current position within the market. Governmental actions. The alcoholic beverage industry is subject to government actions such as restriction of operations and tax levying, as well as legal and regulatory issues. Competition. CUERVO operates in a highly competitive industry that has witnessed a process of consolidation in the last couple of years with global companies owning multiple brands around the globe in an attempt to constantly gain market share and consumer acceptance. Increase in raw material prices. Increases in key raw material prices, such as energy, packaging, and bottling materials, among others, could adversely affect the company s operations. Third-party suppliers. As the degree of vertical integration is positively correlated to the company s ability to maintain or enhance profitability levels, volatility in agave prices from third parties could threaten CUERVO s s numbers going forward. Inability to produce enough blue Agave. Given the nature of the industry and agave s agricultural cycle, the inability to produce enough agave to meet demand could translate into volatility at the COGS level, as the third-party market has historically shown severe price fluctuations. Supply and demand forecasts. As the full agave cycle from planting to harvesting takes around 6 years, the inability to forecast future demand and consequently, an inaccurate provision of current plants to meet those needs, represents an important challenge for the company s operations. 27

29 VII. Industry ratios Industry ratios Cuervo Diageo Brown F. Campari Pernod R. Remy C. Industry avg. P/E x 23.3x 27.8x 32.0x 21.4x 31.6x 27.2x 2017e 25.2x 22.0x 27.1x 23.7x 19.5x 34.4x 25.4x 2018e 22.5x 20.3x 25.3x 21.4x 18.0x 29.5x 22.9x EV/EBITDA x 19.0x 13.3x 17.8x 15.4x 18.8x 16.9x 2017e 14.5x 16.9x 18.9x 15.8x 14.5x 20.9x 17.4x 2018e 12.7x 15.8x 17.9x 14.7x 13.8x 18.8x 16.2x P/BV x 6.7x 12.2x 2.8x 2.0x 2.9x 5.3x 2017e 2.6x 6.0x 14.3x 2.8x 2.1x 3.7x 5.8x 2018e 2.3x 5.5x 12.2x 2.5x 1.9x 3.6x 5.1x NET DEBT/EBITDA x 2.7x 0.8x 3.3x 3.8x 2.3x 2.6x 2017e -0.3x 2.1x 1.7x 2.2x 3.1x 1.8x 2.2x 2018e -0.3x 1.8x 1.5x 1.6x 2.7x 1.5x 1.8x ROA % 8.3% 24.5% 3.8% 4.1% 4.4% 9.0% 2017e 7.4% 10.2% 15.7% 5.4% 4.8% 6.6% 8.5% 2018e 7.6% 10.7% 15.6% 5.9% 5.1% 7.3% 8.9% ROIC % 11.5% 35.1% 5.8% 6.6% 7.3% 13.3% 28