Who isn’t seeking stability these days? Inflation is hot, the stock market is jittery regarding a potential default of real estate giant China Evergrande Group and COVID drags on, with one wave following another. No matter where investors turn, the landscape shows challenges and uncertainty.
Here at Contra the Heard Investment Newsletter, we have Corby Spirit and Wine Ltd. (CSW.A and CSW.B) tucked away in our portfolio to provide us with a bit of stability during these uncertain times. We purchased the company’s Class A shares in March, 2020, at $14.25 and occasionally toy with the idea of adding more.
For those new to the name, Corby manufactures, markets and imports spirits and wines. The company is based in Toronto but is 51.6 per cent owned by the French-headquartered Pernod Ricard. Corby Spirit’s brands include J.P. Wiser’s Canadian Whisky, Wiser’s Special Blend, Polar Ice Vodka, Ungava Spirits and Lamb’s Rum.
In March, 2020, Corby’s investment thesis (which still applies today) was centred on its stability. The balance sheet is consistently clean with high cash, no debt and ample working capital. Shares outstanding have tallied a stable 28 million for the past decade, which means owners have avoided dilution. The company’s top line has remained steady for the past 10 years and net profit margins are generally in the 15-per-cent to 20-per-cent range. This means that returns on assets and equity have averaged in the low double digits. The dividend policy calls for a quarterly dividend at the greater of 90 per cent of trailing 12-month net income or 60 cents a share annually. Currently, the forward yield is 4.7 per cent.
The business plan is simple and stable, too: Increase market share and brand awareness in Canada while focusing on growth abroad, strong cash flows and high margins. Over time, management has been able to do this successfully owing to its popular brands and distribution agreements with Pernod Ricard. This time last year, for example, Corby and Pernod renewed their representation agreement, which had been set to expire this past June. The new contract lasts through September, 2026, further building upon a mutually beneficial relationship that dates back to 2006.
Of course, there are risks with this enterprise. Perhaps the biggest one, somewhat ironically, is the relationship with Pernod Ricard. While the bond with its majority owner has clear benefits, Corby’s excess cash is deposited to a cash management pool under what’s known as a “mirror netting services agreement.” This structure is a little odd because it means that Corby’s credit risk associated with its cash is dependent on Pernod’s credit rating. Fortunately, Pernod is investment grade and is a large corporation, meaning that it usually has easy access to capital markets.
Another hazard associated with Pernod Ricard is its assumed bargaining power over Corby in their representation agreements. So far, the deals have been mutually beneficial, but there is always the possibility that the parent undercuts its subsidiary. If that happens, Corby’s business model would be significantly affected, and remedies hard to implement.
A further concern is the net defined-benefit pension liability. Corby’s present value of its defined-benefit obligations is $70.3-million, yet the value of the pension’s assets is about $59.8-million. This leaves a gap of more than $10.5-million. Fortunately, this spread is narrowing; in 2019 the liability was $11.9-million, in 2016 it was $24.6-million. Still, it would be better to see it fully covered.
The recent fiscal full year results reflect the consistency of the organization. Revenue was up modestly, net income grew 14.8 per cent and margins were a healthy 19.1 per cent. The dividend continued to chug along, and in the background the balance sheet remained in good shape.
We expect more of the same as management aims to keep increasing Corby’s brand recognition in Canada and abroad, capturing market share, and increasing its margins, cash flow and profitability in the process. This sounds like a dreamy wish list, but it does not seem unrealistic to think management will make progress on all fronts. With all the potential sources of instability in the world today, Corby is bucking the trend and offering investors something unique: stability. That is definitely worth a toast or two.
Philip MacKellar is a writer for the Contra the Heard Investment Letter.
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