FINANCE: Aussie wine & pub groups

Will Foster’s do an about-turn?

The world’s second biggest wine company has issued a profits warning and slashed A$1.2 billion (£580m) from the value of its wine assets. Chief executive Trevor O’Hoy has fallen on his sword and the group is undertaking a “strategic review” of its wine division, which encompasses brands such as Penfolds, Rosemount Estate and Lindemans from Australia and Beringer from California.

Analysts believe Foster’s could contemplate selling the whole division only three years after it bought Southcorp for A$3.7bn (£1.8bn), a price considered by many to have been more than generous following Southcorp’s previous problems with overstocking and price cutting.

Indeed, Foster’s chairman, David Crawford, has said: “We paid too much for our wine assets… wine returns are not acceptable”.

The strength of the Australian dollar means that the group has struggled with its exports to the US, which account for about 50% of volumes, and is in talks with distributors there about cutting its inventory by a staggering 1.4m cases. 

But who would want to buy the Foster’s wine empire? Diageo looked at Southcorp three years ago and walked away; the group is known to be sceptical about the return on capital from wine and gave up an option to buy Montana in 2005.

Pernod Ricard is already a major player in Australia through its Orlando Wyndham business and has £10bn of debt following the purchase of Vin & Sprit. Constellation owns Hardy’s and has just sold off a parcel of West Coast vineyards for £234m. That seems to rule out the big boys.

Crawford says there is a “strategic rationale and long-term potential growth in the wine category”. That makes it more likely that Foster’s will attempt to sell off its bulk Australian wine business while retaining the premium brands.

First came the credit crisis, which has begun to affect most households: now the City is bracing itself for the covenant crunch to hit indebted companies.

Any business with bank borrowings has to agree certain terms and conditions as part of the loan; not just paying interest on due dates but also to work within specific financial limits such as how many times its profits cover its debts, the adequacy of its working capital and the strength of its cashflow. These benchmarks are set by the lending bank to make sure that the borrowing company will be able to repay the loan by the due date.

In the boom years, companies usually had no problems meeting these obligations, and, even if a business came under pressure, bankers would take a lenient view if one came close to or breached its covenants; there was only a minimal risk of default as the economy blossomed and competitors were only too willing to lend freely. Today, however, the banks are running scared of potential defaulters; indeed some are having to raise capital from shareholders to prop up their own capital ratios. No business can expect sympathetic treatment at the annual review, and if the capital markets have effectively been closed to banks, then they are hardly going to be open to heavily indebted companies.

So shareholders want to know which companies are going to ask them to stump up more cash because the banks won’t lend any more, or worse, will not even renew existing loans. Tim Steer, a fund manager at New Star Asset Management, has developed a screening system that aims to identify them. It is based on Britain’s biggest listed companies in terms of debt, interest cover and cash free conversion, the very criteria used by lenders in setting banking covenants. Worryingly, Steer’s analysis suggests that five of the 20 companies most likely to need to raise capital are pub groups.

They are Punch Taverns (second most likely), Enterprise Inns (fourth), Marstons (sixth), Mitchell’s & Butler’s (ninth), Greene King (tenth) and Fuller Smith & Turner (20th). Surprise, surprise, these are the very groups that have been on expansionist spending sprees in recent years.

Steer is not predicting that any one of them will need to demand more cash from its shareholders, merely that his screen shows them to be among those in the weakest positions statistically. But it hardly bodes well for the pubs sector at a time when the customer is counting the pennies and trade is at its most testing for many years.

db © July 2008