Fosters board bides its time

Foster’s is making positive noises about improving prospects at its Treasury Wine Estates division, which includes the Penfold’s, Lindeman’s, Wolf Blass and Beringer brands.

Shareholders would expect nothing less in the run up to the probable demerger of wine from the core beer empire next year, but are the changes the group is making drastic enough?

Treasury Wine Estates is valued in the books at A$3.1 billion (about £1.9bn) and Foster’s rejected an indicative offer of up to A$2.7bn only a month ago because it “undervalued” the business.

Given the massive write-downs the group has taken since buying Southcorp in 2005, bruised shareholders will be looking to recoup losses and the board believes that the offer from private equity interests was what Foster’s chief executive Ian Johnston calls a “bottom of the cycle” valuation.

In a full U-turn from Southcorp’s disastrous discounting policy, the wine strategy is now focusing on the premium sector. Stephen Brauer, the head of Treasury’s US operations, sees growth potential in the still-difficult US wine market where wines priced between US$8 and $18 account for 39% of the market’s volumes but generate 57% of the sales value. Treasury is “moving into the luxury category with a focus on profitable growth,” Brauer says.

A matching strategy is evident in Australia where cost savings on packaging, warehousing and bottling and shorter production runs that have reduced stocks are all contributing to cutting overheads by about £70m a year.

The sale of vineyards has been halted in the drive for quality, but in terms of market share and revenues, there will be what the group calls “short-term pain”.

Globally producers are targeting moves up the quality scale at a time when consumers are reluctant to be led up the price ladder.

Success in that segment will be hard won, notably when Australian wines are associated with cheapness in the minds of both trade buyers and the consumer. To counter that the Wolf Blass brand is getting £2m worth of TV advertising in the UK.

Even allowing for one-off items, Treasury’s figures are far from robust and are unlikely to be helped by the strength of the Australian dollar. In its latest financial year, earnings in the Americas fell by almost a third; in Europe, the Middle East and Africa they were 67% lower than a year earlier.

Private equity investors thrive on taking control of a company and slashing costs to improve performance. They make their return from improving dividends, but more importantly by eventually selling on a healthier company to a trade buyer.

Annual cost savings of £70m in Australia are not insignificant but potential bidders will want to identify much more for a deal to be attractive. But timing is also an issue.

If no deal is done before Foster’s almost certainly decides to split its beer and wine arms into two separate companies, each with a stock market listing, the level of debt in each will be an issue.

The group’s net debt of A$2.2bn is not excessive, but if too much of that is loaded onto the beer division, it will become less attractive to a global predator.

The healthy beer brands will attract a premium price but Treasury is less likely to do so.

Directors have a duty to maximise returns for shareholders and although the Foster’s board must make plans for the long-term futures of both arms, they also know that the prospect of owning Australia’s beer market leader is tempting for the global brewers – SABMiller is known to be interested, but not in Treasury.

So beer is not going to be overburdened by debt if the split takes place; however Treasury could start life as an independent company with significant borrowings at the same time as it attempts to make further substantial cost savings.

That prospect opens the door to improved offers before the Foster’s board makes its big decision in six months time.

Finance on Friday, 29.10.2010