UK: Scottish-Newcastle revenue up 6.0% at £1,994 million for the six months to June 30 2006

Scottish-Newcastle Breweries announced August 08 its interim results for six months to 30 June 2006. S&N UK has firmly established its market leadership with around 26% beer market share despite shedding 1% market share by passing the control of MGD and Beck’s back to the brand owners and the licensing of Kestrel in 2005.

Adjusting for this portfolio rationalisation, the branded beer and cider business showed strong growth with 4.9% volume increase and net sales up 6.4%. This compares with total beer and cider market volume growth of 2.8%, 2.2% in the on-trade and 10.4% in the off-trade. The top four brands, Foster’s, Kronenbourg 1664, John Smith’s and Strongbow continue to grow well ahead of the market with volumes up 8.9% and net sales up 10.3%.

In the UK, S&N maintained marketing spend at over 10% of branded net sales in the six months to June.
Investing in innovation continued to be a priority; new products launched during the period included the premium ciders Bulmers Original and Jacques. In the UK, we are driving a virtuous growth cycle of higher A&P spend leading to higher brand sales and margin, which in turn has allowed higher spend on A&P and technical innovation.

With the formation of the distribution joint venture with K+N the full £60m cost savings are now announced. Taking all initiatives into account an incremental £7m of the £60m cost savings have been realised in the first half of 2006.

Excluding the Waverley TBS on-trade wholesaling business UK net sales and operating profits have grown by 5.1% and 4.3% respectively, resulting in a modest margin decline of 10 basis points. This is largely attributable to the adverse packaging mix in the off-trade towards larger packs during the World Cup, increased investment in R&D and innovation, as we seek to replicate our recent brand success going forward and significant increases in commodity and energy prices. In addition, last year we sold two tranches of our trade loan book. Whilst positive for cash and returns and neutral to earnings, this reduces operating profit.

France

Brasseries Kronenbourg (BK) is the market leader in France with a 36%3 market share. In a soft economy beer market volumes fell 1.5% overall, while BK’s branded beer volumes were down (2.5%).

In the first half of 2006 BK has refocused on three brands: Kronenbourg Red&White in the mainstream, and in the premium segment 1664 and Grimbergen. The three brands represent over 80% of BK’s branded beer volumes and gained 80 basis points of market share. Whilst BK lost overall market share in the first half, this was largely due to the volume loss from low priced Kanterbrau to private label.

Portugal

Central de Cervejas is the number two brewer in Portugal with an estimated 42% beer market share5, led by the Sagres brand. Domestic branded beer net sales increased by 7.5%. Central de Cervejas gained market share in both the on and the off-trade in the period. Sagres Bohemia continued to contribute strongly to the overall performance of the Sagres brand. In total Sagres grew volumes by 8.3% and net sales by 7.4%. The implied price/mix decline is largely due to a shift in packaging towards larger packs.

Domestic water volumes were flat, but pricing was up strongly. Including the brand extensions Fresh and Fresh Sabores the Luso brand increased volumes by 1.5% and net sales by 4.2%.

Belgium

Alken-Maes is the number two brewer in Belgium. Its branded business declined by 1.5% in volume terms, stabilising it’s market share at 12%. Net sales were up 2.6%, showing a strong price/mix performance in a difficult market. The roll-out of Maes Super Chilled in the on-trade has improved throughput in the outlets in question by around 10%, which is similar to the improvements that we have seen in other markets. S&N is planning to install around 1,400 founts in the on-trade by year-end. In the premium segment, Grimbergen shows strong growth, adding positive mix to the performance.

Finland

Hartwall is one of the leading beverages companies in Finland with market share just above 40%. Its leading brands include Lapin Kulta and Karjala in beer, as well as Hartwall Jaffa soft drinks, the water Hartwall Novelle, and Upcider. Finland recently announced the appointment of a new Managing Director to strengthen our overall management team. In total the branded business declined by 1.8% in volumes and grew net sales by 3.6%. In cider, soft drinks and water categories Hartwall has gained volume market share combined with strong price/mix improvements. Water and soft drinks have grown net sales by 6.5% and 3.5% respectively. Although branded beer volumes were down in the period, pricing was up 5.5% as S&N focus its efforts on establishing a premium segment in the Finish beer market.

Greece

Mythos Breweries – of which we now own 100% - is the number two brewer in Greece with a 9% market share led by Mythos, the leading Greek national lager brand. Domestic branded beer net sales in Greece are up 13.3% driven by the Mythos brand.

USA

Newcastle Brown Ale (NBA) achieved exceptional growth with volumes up 20.7% in the US market, benefiting from a level comparable in the first half 2005, which had been caused by temporary supply shortage. The volume performance is combined with strong price increases. The import market is a growing segment in the US and NBA is outperforming within this high value segment, with continued double digit growth.

Venture markets

In Venture markets volumes increased by 5% in the first six months of the year and pricing has been firm.

Asian Development Markets

The Asian beer market has seen strong growth in the first half of 2006. S&N continues to believe the market has great potential based on rising consumer incomes and current low per capita consumption.

India

Volumes for the combined UBL and MAPL business grew by 18% in the first half of 2006 with net sales growth of 24%. The combined business continues to hold nearly half of the market and in Kingfisher Lager and Kingfisher Strong has the leading brands in both the Mild and Strong beer segments respectively. Good top line growth, allied to a rigorous focus on cost reduction, has resulted in a 54% increase in operating profits.

With continuing high levels of economic growth and rapid development in consumer spending habits, growth of the Indian beer market has accelerated over the last 15 months. In addition to strong underlying growth, recent government liberalisation in respect of retail licensing and distribution in certain states has delivered a step change in the demand for beer. In conditions of such rapid growth, S&N has been working closely with the UBL management to deliver a substantial increase in capacity. This includes improvements in processes and efficiency to better utilise existing capacity. S&N believes that the potential for growth in the Indian beer market is high and UBL is uniquely placed to exploit this.

China

Chongqing Brewery Company Ltd, S&N’s Chinese joint venture with Chongqing Beer Group is a public listed company and does not announce its half year results until the end of August. Performance in the first quarter was very encouraging with volumes growth of 25%, sales growth of 27% and operating profits growth of 64%. On the back of this performance the company moved into its peak season for beer sales with great optimism.

Pricing & Margin Growth

Pricing has improved across all markets. Price per liter has grown by 7.2% in local currency driven by a volume shift into premium and licensed brands. Package mix is now having much less of an impact on net sales as we see a 0.3%pts reduction across the period. Reported margin has been strong at 19.9% (230bp) growth, after the additional marketing spend of £3m. The improvement has been driven by synergies, administration and production efficiencies as we benefit from operational leverage.

Russia

The beer market in Russia grew by 6.1% in the first half of the year, within which BBH volumes grew by 4.2% and we have seen market share improvement in each of the last four months. This has resulted in a market share of 35.6% compared with 36.3% for the same period last year. Initial estimates indicate that we have gained share in premium and licensed segments and conceded share in discount and lower mainstream. This is in line with our strategy of balancing value and volume. The share losses have been driven primarily by the introduction of large pack PET volume by the competition. Local pricing on beer was up 6.4%, slightly below Russian food and beverage inflation.

The legal merger of BBH’s four Russian businesses continues to progress on schedule for completion by the end of 2006. In accordance with previously stated intentions, in July, BBH has exchanged its holdings in Pikra, Vena and Yarpivo for newly issued shares in Baltika. With this transaction Baltika replaces BBH as majority shareholder in these companies with shareholdings of 92.0% of the shares in Pikra, 97.5% in Vena and 91.4% in Yarpivo.

Ukraine

In Ukraine S&N now has a new management team in place with the priority of finalising a turnaround and step-up plan to improve the performance of the business. For the half year, BBH Ukraine sales volumes grew by 12.4% against market growth of 15.5%, resulting in market share of 17.7%. Although 1.4%pts below the previous year, this represents an improvement on the recent trend as we have taken steps to enhance distribution arrangements for our brands. In March, BBH Ukraine began to brew Baltika beer which will strengthen the brand’s position as the undisputed leader of the licensed segment in the Ukrainian market.

The Baltics

All three markets in the Baltics showed continued growth in the first half of 2006 resulting in a combined market share gain of 1.0%pt to 43.8%. Volume growth driven by strong performance in the premium segment is delivering on our strategy of developing a strong brand portfolio for margin growth.

Kazakhstan

S&N continues to see outstanding growth in the Kazakhstan beer market which has grown by 22.4% compared to the same period last year. With volume growth of 39.5%, BBH has extended its leadership in the market taking its share to 29.6%, an improvement of 1.8% pts. S&N is doubling capacity in Kazakhstan in order to meet the demands of a growing market.

BBH enters Uzbekistan

In May 2006, BBH announced plans to invest in a new brewery in Tashkent, Uzbekistan which will be operational in 2007 with a capacity of one million hectolitres. This is consistent with BBH’s strategy of entering into emerging markets. BBH will team up with a local partner in Uzbekistan, Sarbast Plus, and will hold a 75% share in the business.

Medium term outlook

S&N believes the Russian beer market will grow by 5% to 6% in 2006. We expect to gain share whilst achieving price increases just below the level of local food and beverage price inflation. The legal integration of our Russian businesses is on track to be completed by the end of 2006. For the full year S&N expects margins to move towards 21%.

Whilst S&N has continued to increase our investment in sales and marketing, it expects this to accelerate in the second half of the year. In addition, S&N plans to increase capital expenditure to between €250 and €280m for the full year to meet both capacity constraints and further volume growth.

Financial Review

Exceptional Items

Net exceptional items were a loss of £10m. Restructuring initiatives in the UK and International totaled £32m including £17m of asset write down. In addition, there was net financial income of £14m arising from movement in the fair value of financial instruments which are held for hedging purposes, but which do not qualify for hedge accounting under IAS 39.

Interest

Net interest costs (excluding net interest on the pension liability) of £45m compared with £41m in 2005. Net interest on the pension liability was a net income of £5m compared to a net cost of £2m in 2005. The change was driven by higher asset values in the pension scheme. For the six months to June 2006 EBITDA interest cover (excluding net interest on the pension liability) was 7.0x compared with 7.2x in the first half last year. On a similar basis operating profit interest cover was 5.0x, the same as the first half last year.

Cash flow and Net Debt

For the six months free cash flow before dividends (cash flow from operating activities and investing activities, but excluding the purchase of the Foster’s brand, acquisitions and disposals) was an inflow of £130m. Cash flow from ordinary operating activities was £198m and £21m was spent on reorganisation and onerous contracts to give a net cash flow from operations of £177m. Net interest paid was £36m. There was an inflow on tax of £6m as the Group benefited from tax refunds. Dividends of £43m were received from joint ventures including £40m from BBH.

Capital expenditure was £58m, split £26m UK and £32m International. Depreciation and amortisation was £53m. Fixed asset disposals generated proceeds of £17m mainly from the disposal of surplus properties. There was a net outflow on investments of £19m mainly on trade loans to customers.

Dividend

The Board has declared an interim dividend payment of 7.22p per share for the six months to 30 June
2006, an increase of 2.5%. The interim dividend will be payable on 16 October to shareholders on the
register at 15 September 2006.

The final dividend for 2005 cost £126m and £313m was spent on acquiring the Foster’s brand in May. There was a net spend of £7m on smaller acquisitions/disposals to give a net cash outflow of £316m. Net debt increased from £2040m at 31 December 2005 to £2130m at 30 June 2006. This was primarily due to the net cash outflow of £316m partially offset by a share placing of £208m to help fund the Foster’s brand acquisition and a £14m benefit from changes in the fair value of interest rate swaps. Gearing at 30 June 2006 was 65% compared to 67% at 31 December 2005 and 73% at 30 June 2005.

Commenting on the results Sir Brian Stewart, Chairman, said: “This is a strong half year with comparable operating profit growth of 7.6% and earnings per share up 11.1%. The UK business is clearly continuing to outperform the market; we are seeing early positive signs after taking action in France, and our strong brand portfolio across Western Europe is driving growth. In Russia and elsewhere in the CIS, our BBH joint venture is continuing to deliver the merger benefits we promised, and Baltika is rapidly emerging as one of the world’s strongest beer brands.

Our continuing investment in building our brand strength has clearly delivered in terms of both consumer appeal and appropriate financial return. S&N is now benefiting from its balanced portfolio in both mature and emerging markets, where we are establishing leadership positions.

Tony Froggatt, Chief Executive, said: “We have made very good progress against our key financial targets, with sales up 6.0%, improved margins, and strong cash generation of £130m. Our brand strength is the key to both growing value in mature markets and rapidly expanding our positions in developing markets. The resulting geographic and brand mix provides a sensible balance between risk cover and real growth potential.

“We are achieving these results through our continued focus on our four strategic priorities. First, we invest behind our brands and in innovation. Secondly, we constantly improve our operational efficiency and thirdly we continue to build the capability of our people. Lastly we investigate all investment opportunities for growth in both our existing and new markets. I believe that we are delivering on all four counts. Our investment programme focusing on brands and consumers has driven organic branded beer and cider volume growth of 4.8% and sales growth of 7.3% year-on-year. The World Cup clearly had a positive impact on our volume performance in the UK, but at the same time the impact on other European markets was negligible. Also, whilst the weather did have a positive impact on June volumes across the UK and Continental Europe, this effect is more or less offset by the adverse weather in the preceding months. In May of this year we acquired the Foster’s trademark in Europe and the CIS, which allows us to accelerate the development of the brand across these markets. Following the deal, we have launched the first brand extension in the UK - Foster’s Twist - in June this year.

“Over the last six months the focus on the operational side of the business has not diminished. We announced exclusive talks with Frankfurter Brauhaus over the sale of Champigneulles brewery and we aim to complete this deal within the coming months. In the UK the transition of our distribution operation into the joint venture with Kuehne + Nagel has been accomplished without any disruption. A number of potential customers have expressed interest in joining this national distribution platform.

In procurement we are making strides to leverage our scale across our European footprint and we are also confident that we will be able to achieve synergy savings across our joint ventures. Energy costs will remain a challenge. However we are tackling this through both a group wide renewable energy programme and forward purchasing.”

E-malt.com, the global information source for the brewing and malting industry professionals. The bi-weekly E-malt.com Newsletters feature latest industry news, statistics in graphs and tables, world barley and malt prices, and other relevant information. Click here to get full access to E-malt.com. If you are a Castle Malting client, you can get free access to E-malt.com website and publications. Contact us for more information at marketing@castlemalting.com .