Stock of the Week Foster’s Group (FGL)


Foster’s Group (FGL) is a brewing and wine company with a global presence, and whose core operations include Carlton and United Breweries, Beringer Blass Wine Estates, and Fosters International.

Foster’s Australia is involved in the manufacture and sale of beer, spirits, ciders and other beverage products. The company also operates four major breweries across Australia.

FGL has experienced difficulties over the last two years, mainly owing to its underperforming wine division, after the group took over Southcorp in 2005.

The company today impressed the market with plans to demerge its beer and wine division, which will cost the group up to $1.3 billion in a one-off charge, but makes excellent strategic long-term sense.  The decision also appears to make FGL one of the shares to buy.

FGL’s underlying FY earnings forecast is between $1.05 billion-$1.08 billion, roughly in line with market forecasts.

The Wine Whine

Over the course of the global economic downturn, FGL suffered from customers moving away from its wine offerings and instead selecting beer as a low-cost alcoholic beverage.

Over FY09, FGL’s best-performing business was its Pacific Beer, Cider and Spirits division. The business contributed the greatest share of earnings, with sales revenues up 2.5% on FY08, and net earnings increasing 2.9%.

FGL undertook a review of its wine business after a disappointing performance following its takeover of winemaker Southcorp, during the bull market but also in the midst of a global grape glut.

FGL decided its Aussie operations would be split into wine and beer and management, as the group closed three wineries in Australia and California.

The group’s wine business review was exhaustive over FY09, and lead to the creation of an Australian beer, cider and spirits business, renamed Carlton and United Breweries, and a stand-alone dedicated Australian and New Zealand wine business.

A shift away from on-premise consumption and luxury wines, and higher costs of sales, reduced FY09 wine earnings by 7.3% to $363.9 million.

A Welcome Demerger

Over the end of last year and into this year, market concerns surrounding FGL have focused on its underperforming wine division.

Today, FGL tackled its wine unit concerns by announcing plans to demerge beer from its underperforming wine operations, with separate listings for the two arms.

CEO Ian Johnson noted that the group’s wine business is showing signs of growth, but continues to be impacted by oversupply in Australia, subdued consumer demand in key international markets and a strong Aussie dollar during FY10 (which, fortunately for FGL, has seen a sharp slide of late).

We expect FGL to allocate a smaller proportion of debt to its wine business post demerger, as the wine business has significantly weaker cashflow compared to the beer business, along with more uncertainty in its near term earnings outlook.

There is likely to be significant valuation upside on FGL if the company can be valued as two separate entities. It will also open the door for merger & acquisition opportunities for both entities, which could unlock more value for shareholders.

A demerger could be very beneficial to FGL. It could increase transparency, allowing investors to more appropriately value each business over time.

A demerger will also allow for flexibility for separate boards and management of Beer & Wine to develop their own corporate strategies and implement capital structures that are business-appropriate.

FGL’s stock rose today on the demerger plans, despite news that the demerger will result in writedowns of up to $1.3 billion on the carrying value of its wine business.

The group said the demerger is unlikely to be implemented until 1H11 at the earliest.

A Hapless Half

On 16 February, FGL reported its 1H results, failing to buoy market sentiment.

Net profit dropped 13.5% on last year to $355.7 million, below analysts’ expectations for $380.6 million.

Total operating revenue for the half fell 4.7% to $2.4 billion whilst FGL declared a dividend of 12 cents per share, flat on the same half last year.

Net sales of wine fell in every region, amounting to a 14% decline in underlying earnings, whilst the beer division was more positive, gaining 6.6% to underlying profit of $486.4 million.

Outlook

Though FGL’s 1H10 results failed to impress the market, today’s news of its plans to demerge beer from its underperforming wine operations, with separate listings for the two arms, was well-received.

Strategically, splitting the operations into two businesses is appealing. There will be short-term negatives associated with the demerger, including a non-cash pretax impairment charge of up to $1.3 billion as well as dividend issues (such as timing and payment).

However, the demerger makes strategic sense and is likely to be a positive for FGL going forward. It may even open up an opportunity for a takeover of FGL’s beer operations, as the global brewing sector is in a consolidation phase.

FGL also today confirmed underlying earnings are expected to be $1.05 billion-$1.08 billion, roughly in line with market forecasts.

In terms of it being one of the shares to buy, the generally defensive nature of FGL’s business, and revenues, is the company’s major appeal in the current climate, as it manages to draw in consumers owing to its famed brand names.