This European company isn’t sugarcoating its coronavirus problem

Pernod Ricard, the maker of Jameson whiskey and Absolut vodka, cut its annual profit growth outlook for 2019-2020 on Thursday, as it said China’s coronavirus epidemic was likely to have a “severe” impact on its third-quarter performance.

The French spirits maker, which generates 10% of its global sales in China, said it couldn’t predict the “duration and extent of the impact,” but stressed it remained confident on overall strategy.

“In our view Pernod Ricard deserves credit for attempting to quantify the impact, which few other companies we follow have done,” said James Edwardes Jones, analyst at RBC Capital Markets.

He added: “We don’t believe that this should weigh heavily on the shares, albeit China is an important market for Pernod Ricard (we estimate 14% of sales and 20% of EBIT [earnings before interest and taxes]) if the lack of reaction for others in the sector is any guide.”

Shares in Pernod

RI, +3.80%

 closed up 3.8% on Thursday.

Pernod’s warning came as the European Union cautioned on Thursday that the coronavirus outbreak had emerged as a “new downside risk” for the eurozone’s growth prospects.

In its winter 2019 economic forecast, the European Commission said: “The longer it lasts, however, the higher the likelihood of knock-on effects on economic sentiment and global financing conditions.”

Paolo Gentiloni, European Commissioner for the Economy, added: “We still face significant policy uncertainty, which casts a shadow over manufacturing. As for the coronavirus, it is too soon to evaluate the extent of its negative economic impact.”

Pernod, the world’s second-biggest spirits group after the U.K.’s Diageo

DGE, -0.87%,

said operating profit from recurring operations would grow between 2% to 4% this year, down from the 5% to 7% it previously predicted, because of the impact of the coronavirus outbreak.

The French spirits maker reported a net profit of €1.03 billion ($1.12 billion), up 1% from a year earlier, while profit from recurring operations was €1.78 billion, up 4.3% on an organic basis. Sales reached €5.47 billion in the six months to Dec. 31, a 5.6% gain on the year earlier, and 2.7% higher on an organic basis.

The company came under pressure to boost its margins and improve its corporate governance in December 2018, after U.S. activist investor Elliot Management built a 2.5% stake in the company.

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Distilling Refinery Data: Early Read On Coronavirus Oil Impact – SPDR S&P Oil & Gas Exploration & Production ETF (NYSEARCA:XOP)

We’ve been tracking refinery margins for a while, and there’s always an interplay between the input costs (i.e., crude prices) and product prices (i.e., gasoline, diesel, jet fuel, etc.). Refiners make the difference between the two and in complex refineries, can dial up or down the production of certain products. So while difficult to pinpoint exactly, it’s helpful to understand what is broadly happening.

In the past month, the coronavirus has severely impacted the crude market and driven it into bear territory on fears of demand destruction. The prevailing narrative is that the Chinese economy is frozen, and fossil fuel demand has fallen off a cliff. Demand for transportation fuel in particular has been materially affected as travel restrictions inside and outside of China have been imposed in an effort to curtail movement inside/outside of the country and contain the spread of the virus.

As we previously noted, JPMorgan (NYSE:JPM) estimated oil demand in China will decline by 500Kbpd in Q1 2020. In its latest STEO, the EIA estimates total liquids consumption in Asia will decline by ~500K bpd from February to April, so roughly in line with JPMorgan’s estimates.

So logically, we’d anticipate product demand to be weak in China and product prices to weaken. Then either products would need to be pushed out of China (i.e., exported) or inventories would balloon. If they are exported, the product prices regionally should in turn decline, and net/net refinery margins regionally and globally should fall despite the fall in crude prices. Since the demand destruction isn’t small, the price cascade should accelerate.

Yet in China, Arab Medium cracking margins averaged minus $1.84/b last week. Negative yes, but an improvement from the week prior when margins fell to near minus $4/b.

Outside of China? This is what we’re seeing.

(The left side is refinery margins on a quarterly basis and the right side is refinery margins on a weekly basis).

Interestingly, refinery margins have rebounded in the past few weeks outside of the US. In the US, the trend is similar…

Now we are the first to admit that we still don’t know the total impact of the coronavirus, particularly as China is just restarting its economic engine after a protracted shut-down. Will the number of confirmed cases increase dramatically given the mass movement of people as they re-enter the workforce? How long will the quarantine of tens of millions continue, and how long will it take for the manufacturing sector and consumer sentiment to recover? Those are obviously unanswered and currently unanswerable questions. So far… dare we say, it seems to be recovering, or at the very least, the number of confirmed cases appears to be falling.

What is noticeable amongst the murky data is that refinery margins are recovering outside of China, which means product demand outside of China is perhaps stronger than the current narrative would have you believe. We’ll continue to monitor this, but if the coronavirus is contained in short order, we’d anticipate refiners inside and outside of China will quickly reverse their throughput cuts and accelerate their crude purchases to take advantage of the healthier margins currently on offer. Ultimately, this would quickly push WTI and Brent pricing higher following the recent sell-off.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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