Australia: Foster’s net profit increased 26.8% for 1H 2006

Foster’s Group Limited released August 29 its Preliminary Final Report for 1H of 2006 (figures in US$ unless stated). The company said Group’s earnings per share increased 14.8%, operating cash flow pre interest & tax up 43.2%, net profit after tax up 26.8% to $1.166 million, normalised net profit after tax up 15.4% to $623.1 million, EBIT margins up 180 basis points 22.6%, net debt down $734 million to $3.499 million, on-market share buy-back of up to $200 million.

Foster’s Chief Executive Officer, Trevor O’Hoy said:
“One year on from the completion of the Southcorp acquisition, Foster’s is a fundamentally different company.

“We are successfully integrating Southcorp, realising synergies and re-engineering global supply to be more flexible, responsive and low cost.

“I’m happy to report that the Southcorp integration is now largely complete and synergy capture is ahead of plan.

“We’ve integrated sales and related support functions, rationalised production infrastructure and overheads, and developed a strong pipeline of initiatives to grow wine revenues.

“During a period of integration and transformation, the strength of our core businesses and the benefits of our balanced portfolio shone through.

“For the second consecutive year, normalised earnings per share grew more than 14%, and we expanded EBIT margins in all of our businesses except Wine Clubs and Services. Group margins were up 180 basis points to 22.6%. Pro Forma3 Group margins expanded 370 basis points.

“Significantly, the Southcorp acquisition was neutral to earnings in its first full year.

“We’ve continued to narrow our focus on premium drinks, realising significant value from under-performing or non-strategic assets, from breweries in Asia to wineries in the Hunter Valley.

“Today we took that a step further, announcing our intention to dispose of our Wine Clubs and Wine Services businesses; further reinforcing our focus on core businesses.

“Strong operating cash flows and proceeds from asset sales have contributed to reduce net debt to $3.5 billion, creating the opportunity to return funds to shareholders through an on-market share buy-back.

“CUB delivered another outstanding result, driven by strong revenue growth in our core beer, spirit and ready-to-drink portfolios, and the realisation of supply and overhead efficiencies.

“We’ve reconfigured our Australian customer facing business into a new, customer-focused, service-oriented organisation, creating revenue and margin opportunities for both customers, and Foster’s.

“Our global wine business faced challenges during the period and revenue growth was disappointing. While our focus on integration and synergies created some distraction, innovation is now firmly at the top of the agenda.

“Today, we re-launched Rosemount as a contemporary style leader and we introduced the Lindemans Country of Origin range, demonstrating our unique global sourcing capability. These are just two examples of a range of innovation and new product development initiatives that we believe will drive improved revenue performance in 2007.

“Notwithstanding the cyclical impacts of wine oversupply in Australia, Foster’s is well positioned with balanced supply commitments and significantly increased flexibility in future years. The wine category continues to show growth in all of our markets. Consumers continue to demand high levels of quality and consistency that premium branded products such as ours are uniquely able to provide.

“As a business, we have never been in a better position to grow, with most of the integration activity now behind us, and a strong pipeline of new product initiatives in place to drive revenue growth.

“Looking forward we remain confident of achieving all of the financial targets we put in place at the time of the Southcorp integration.

“Finally, we’ve taken another important step towards being One Foster’s with the introduction of a new consumer-focused regional organisation structure from 1 August.

Full year highlights
As the company continues its transformation to a focussed branded drinks company, fiscal 2006 saw a number of key achievements.
Highlights include:
1. Normalised earnings per share up 14.8% to 31.0 cents with the impact of the Southcorp acquisition neutral in its first full year.
2. More than $1 billion realised from the sale of the Foster’s brand in Europe and India and divestment of our Asian brewing businesses.
3. Announcement of an on-market share buy back program of up to $200 million.
4. Intention to divest Wine Clubs and Services businesses.

Continuing business EBIT pre significant items increased 35.6% to $1,119 million with strong growth from Carlton and United Beverages (CUB) and an initial full year contribution from Southcorp and related synergies.
1. CUB EBIT increased 17.0% to $670 million with a combination of volume growth, pricing, mix shift and the realisation of supply efficiency measures.
2. Wine Trade EBIT increased 81.8% to $431 million. Pro Forma wine trade EBIT increased 31.1% with synergy realisation and growth in the Americas and Continental Europe partially offset by a competitive trading environment in Australia and the United Kingdom.
3. Southcorp integration synergies of $61 million were realised and synergies now expected to reach approximately $165 million by 2008.

Continuing Business Operating Cash Flow prior to interest and tax (OCFPIT) improved 43% to $1.325 billion with strong improvement in Wine Trade operating cash flows.
1. Continuing business OCPFIT/EBITDAS pre significant items improved 9.5 points to 102.7 %.
2. Wine Trade OCPFIT/EBITDAS improved 31.0 points to 103.6%.
3. Net capital expenditure increased 67.3% to $220 million.

The Directors have declared a final dividend of 11.75 cents per ordinary share fully franked, an increase of 9.3% on the 2005 final dividend. After 2-years of transformation, Foster’s has emerged as a fundamentally different company – a focused drinks company that is consumer led, and customer driven.

Foster’s is intent on delivering superior value creation through its diversified premium brand portfolio, a focus on profitable segments and markets, and strong distribution capabilities.

Revenue growth

Reported revenue increased 24.5% to $4,946 million and on a Pro Forma basis revenue increased 1.9%. Growth in Australian beer, spirits, RTD’s and Cider remains solid.

The value of Foster’s consumer and customer insights has been demonstrated in the Australian market with the reinvigoration of Carlton Draught and the successful launch of Pure Blonde with sales of almost 2 million cases in its first full year. Consumer insights have also contributed to the creation and targeting of unique technology enabled marketing campaigns for key brands such as Carlton Draught and VB.

Foster’s has further developed its global consumer and customer insights capability with the establishment of the global wine marketing team in the first half and the regional insights teams now in place in the Americas and Europe to complement the Australian I-Nova team. Following the business reorganisation announced in July, the Foster’s global marketing team will be responsible for driving marketing and brand strategy for all global brands, and work with regional marketing teams to define local execution priorities.

Route to Market Integration

Foster’s has completed the first phase of integration of sales and related support functions in all markets.

In Australia, Foster’s has further developed its multi-beverage business with the integration of the CUB, Beringer Blass Wine Estates and Southcorp route to market activities into one customer facing team, organised into four channels. This multibeverage model will allow Foster’s to service more customers more often and more efficiently with products and services aligned to customers needs.

Foster’s route to market integration in the Americas was completed in the second half with the transition to a direct distribution model in Canada. Additional refinement is continuing with the formation of a specialist luxury on-premise sales team, the Estates Wine Group, to complement the existing Beringer Estates and Limestone Estates sales teams.

Foster’s European route to market integration was completed in the first half. Strong relationships have been re-established with the major UK retailers during the year with promotional programs developed for the next 12 months. The integration has also provided the opportunity to develop dedicated sales teams to target specialist channels such as on-premise and convenience outlets; and has delivered significantly increased scale in Continental Europe where growth in the combined portfolio remains strong.

Innovation and Brand Investment

Innovation and brand investment are key drivers of revenue growth.
In 2006 Foster’s continued to invest heavily behind the core brand portfolio with brand advertising and promotional (A & P) spend across the Group remaining over 9% of net sales revenue. The Carlton Draught and VB campaigns have highlighted the efficiency and effectiveness of innovation in A & P, and strong gains have been made by new, extended or reinvigorated brands including Carlton Draught, Pure Blonde and Cougar.

Supply efficiency

Foster’s supply efficiency initiatives delivered cost reduction and cash flow benefits with EBIT / sales margins increasing 1.8 points to 22.6%, and Pro Forma Group EBIT/sales margins increasing 3.7 points.

Margins in the CUB business increased 3.0 points to 33.4% with mix adjusted Cost of Goods (COGS) in line with the prior period as benefits from the reconfigured Australia brewery network are realised. We expect mix adjusted non-wine unit costs in the Australian multi-beverage business to increase between 3 and 5% in 2007.

Australian Logistics Footprint

Foster’s is transforming its Australian warehousing and distribution networks into a national, low cost multi beverage platform with “one delivery” capability to the largest network of Australian customers. To date Foster’s logistics network has reduced from 41 to 30 distribution centres, with the transformation of the network due to be completed within 18 months.

The former Beringer Blass and Southcorp warehouse and distribution networks were combined as part of the Southcorp integration process in 2006 with multi beverage distribution centres developed in South Australia and Western Australia.

The transformation to truly national multi-beverage capability is now under way. Based on simplified processes and common warehouse, transport and stock picking systems, the development of the national multi beverage network includes warehouse upgrades at major production sites, the development of a national network of multi beverage distribution centres and the transformation of the metropolitan and regional customer delivery networks.

Capital Management

Foster’s announced an “on market” share buy back program of up to $200 million. Strong operating cash flows complemented by proceeds from asset sales have contributed to reduce net debt balances to below $3.5 billion at 30 June 2006. This, combined with expected strong operating cash flows and proceeds from further asset sales including the recently announced sale of our brewing operations in India and Vietnam, have created the opportunity to return funds to shareholders through an on-market share buy-back program.

Reflecting strong cash realisation, Foster’s split credit rating was removed in April with S&P upgrading Foster’s credit rating to BBB flat. Notwithstanding the $200 million share buy back, Foster’s expects continued strong cash flows to reduce net debt below $3 billion in fiscal 2008 – one year ahead of expectations at the time of the Southcorp acquisition. Foster’s remains committed to achieving metrics consistent with a BBB+ / Baa1 credit rating by Fiscal 2008.

Foster’s Brand

The worldwide success of the Foster’s brand continues – with global volume growth of 9.5% in 2006, in a global beer market growing 2.7%. However the value created for Foster’s shareholders by the growth of this great brand has been limited.

Foster’s has implemented a number of initiatives to improve the financial returns of its international beer business including the sale of the Foster’s trademark in regions where the financial metrics supporting a sale were compelling, the sale of the Asian brewing businesses and the rationalisation of global sponsorships and overheads. Together these transactions have generated gross proceeds of more than A$1 billion with less than A$5 million of net earnings forgone.

A pre-tax significant profit of $713 million relating to these transactions was reported in fiscal 2006 with a further pre-tax profit relating to the transactions announced on 4 August 2006 of approximately $230 million expected to be reported in fiscal 2007.

Beyond 2006, priorities for the Foster’s brand include returning the brand to growth in the US market, the development of further strong regional partnerships in Asia, and exploring opportunities to take the Foster’s brand further into new markets including Central and South America.

Organisation Restructure and Regional Reporting

In August Foster’s moved to a new organisation structure based on three regional businesses – Australia, Asia and Pacific (AAP); Americas; and Europe, Middle East and Africa (EMEA). Each regional business is responsible for managing Foster’s regional customer and consumer relationships, reports directly to the CEO and is backed by the resources of a global supply and global marketing. Specialist business support functions of Strategy, Human Resources, and Finance will provide services across the Group.

Commencing in 2007, Foster’s will align its primary statutory segment reporting with the regional business structure.
Net Debt and interest

Foster’s reduced net debt by $734 million to $3,499 million and now expects net debt to be below $3 billion by June 2008, one year earlier than previously anticipated. Following the sale of the Foster’s trademark in Europe, Standard & Poors upgraded Foster’s credit rating to BBB flat from BBB-. Foster’s remains committed to achieving metrics consistent with a BBB+ / Baa1 credit rating by Fiscal 2008.

Foster’s actively manages its debt portfolio to reduce risk and funding costs. Major debt portfolio initiatives in 2006 included:
• The successful launch of a new Foster’s Australian dollar Commercial Paper and Medium Term Note program to improve short term funding flexibility following the offer to repurchase Southcorp Medium Term Notes.
• The elimination of expensive Chinese debt following the sale of Chinese brewing business to Suntory.

The proportion of Foster’s gross debt denominated in US dollars is 73%, pounds sterling 12% and Australian dollars 11%. Approximately 44% of the gross debt portfolio is at fixed rates.
Foster’s net interest expense grew substantially to $243 million. The increase in interest expense reflects higher average net debt following the acquisition of Southcorp. The average interest rate in the period was 5.47%.

Taxation

The Group’s tax expense (excluding tax on significant items and discontinued operations) increased 12% to $265 million. The effective tax rate (excluding significant items and related tax) was 30.2%, 0.2 points above the Australian statutory rate.

Significant items

Net significant items before tax were $525.5 million ($556.5 million after tax) and comprise a $704.9 million post tax profit from the divestment of international brewing assets and brands, $67.7 million post tax restructuring charges relating to the Southcorp integration and reorganisation, and a $80.7 million post tax write down to the carrying value of selected Wine Clubs and Services businesses.

Corporate Expenses

Corporate expenses in the period were $58.7 million, a decrease of $12.6 million over the previous period. The decrease was mainly due to benefits associated with the Foster’s Service Review in 2006, and one time costs recognised in 2005.

Outlook

Foster’s remains confident in achieving all of the financial targets set out at the time of the Southcorp acquisition.

In the AAP region, Foster’s expects revenue growth driven by the beer and spirits portfolio, with the wine market in Australia remaining very competitive whilst the current grape surplus remains. The new Australian multi-beverage route to market is expected to deliver increased service levels and expanded distribution opportunities for the non-beer portfolio.

In the Americas, the focus will be on increasing investment in sales capability, brands and new product development. Value growth in the US market is expected to remain strong in 2007. Industry demand and supply are expected to remain balanced.

In the EMEA region, the UK wine market remains competitive, but strengthened relationships with UK retailers, new product initiatives and increased sales capability are expected to deliver a return to growth. Continental Europe continues to deliver strong revenue growth with the Nordics, Ireland and the Netherlands remaining key growth opportunities for our premium wine portfolio.

Foster’s expects earnings growth to accelerate in 2007, with continued margin expansion in all regions driven primarily by the benefits of ongoing efficiency initiatives including Southcorp synergies. Cash flow conversion is expected to be in the low to mid 90’s as a percentage of EBITDA. Group returns are expected to improve as wine returns grow towards the cost of capital target in 2008.

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