Accounting for Management - Beer Industry Analysis.

Foster’s CEO, Ted Kunkel will retire at the end of 2004 after 12 years in the role.

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CORPORATE OVERVIEW - HEINEKEN NV

Heineken NV is the most global of the brewers, with presence across all seven regions. Based in Amsterdam, Heineken has operations in more than 170 countries and employs 48,237 people around the world. Production is based at 110 breweries in over 50 countries. In 2003 the total volume of beer brewed by the Heineken Group was 108.9 million hectolitres, securing the group’s third place in world rankings.

The group’s leading international brands are Heineken and Amstel, which are supplemented and supported by a number of national and regional brands as well as specialty beer.

Net revenue and operating and net profits all increased in 2002, although rate of growth was slower than in previous years, due to a stagnant beer market and economic decline in many regions. In 2002, operating margin reached 12.5%, while Heineken’s net profit has remained at the same level for the last three years.

In recent years Heineken has concentrated its activities on acquisitions and consolidation. The beers brewed by Heineken are positioned in the premium, mainstream and specialties segments of the market, and beer sales account for approximately 83% of the company’s total revenue.

Heineken NV conducts most of its business in Europe. It is noticeably absent from a small number of key markets where local players tend to dominate, including Germany and Japan.

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CORPORATE OVERVIEW - INTERBREW NV SA

Belgium-based Interbrew has grown from a small regional brewer to the world’s second largest in terms of volume . Beer accounted for 99% of the company’s core business in 2001, since expanded to 21 countries, including the United States, Canada, Western Europe, Russia and China. Its products are now sold in more than 120 countries.

Following acquisition of Labatt in 1995, Interbrew has concentrated its efforts on consolidation of the market by purchasing some of the industry’s most dominant brands. Its flagship beers include Beck’s, Stella Artois, Labatt Blue, Bass and Hoegaarden. Beck’s and Stella Artois are among the top import beers in the United States, Canada, Australia and parts of Asia. Interbew holds the number two position in the US import beer business.

In recent years the company has continued to focus on emerging markets. In January 2004 it purchased a controlling interest in the Malaysian Lion Group’s beer business in China, making it the third largest brewer in that country. Acquisitions of brewers is expected to continue as the company focuses its efforts on increasing net turnover and its product base.

This effort of global domination has come with its share of obstacles. After launching a successful IPO on the Euronext Brussels stock exchange in December 2000, UK competition authorities blocked the Whitbread and Bass merger. An appeal in the high court resulted in a compromise, with the company agreeing to sell its Carling Brewers business, producer of the UK’s leading lager.

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CORPORATE OVERVIEW - LION NATHAN LIMITED (LNN)

Lion Nathan (LNN) is an Australian based company with operations in Australia, New Zealand and China but 82% of operational earnings are from the Australian market. With assets of 4.3 billion, LNN is 46% owned by the Japanese Kirin Brewery Company. Net profit after tax increased 11.2% by the end of 2003. The strong operating cash flow derived shareholder benefits with dividend earnings up 35%. LNN brews and distributes around 1 billion litres of beer annually with brands including Tooheys, XXXX and Hahn. LNN has 42% share of the Australian beer market and has pouring rights at Stadium Australia for 10 years. LNN intend to grow its portfolio of premium brands to take advantage of higher margins in this segment.

LNN’s strategy has been mostly regional, with the exception of the Hahn label that is a national brand. This strategy limited sales in Victoria, Australia, so in 2000 LNN purchased 23 pubs in Victoria with the aim of increasing sales of on-tap beer. Now that market share in Victoria has risen to 15%, it plans to sell these venues but maintain distribution rights.

In 2001, LNN began to build its global premium wine business through the acquisition of two of Australia’s premium wine companies - Petaluma and Banskia. So far the wine division has been weak, mainly due to a collapse in the bulk wine market. LNN is focusing on developing distributor alliances in key offshore markets, commencing distribution of its wine in Japan utilising Kirin’s extensive domestic liquor distribution network.

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FINANCIAL PERFORMANCE ANALYSIS

LIQUIDITY RATIOS

CURRENT RATIO

ANALYSIS OF RESULTS

Beer companies typically carry larger inventories than most other industries, and its assets are usually quantified by heavy investment in high-volume brewing equipment and technologies. Company acquisitions have yielded additional restructuring charges and equipment upgrades.

Applying an acceptable current ratio of 1.5:1, Foster’s Group would be considered having achieved the most appropriate balance between assets and liabilities. Its ratio of 1.56 in 2002 and 2001, suggests the company’s investment in working capital is producing the necessary profits. At the other end, Interbrew’s current ratio has been sliding quickly, an indication that the company’s recent acquisitions of small and large brewers are limiting their ability to meet short-term debts. Heineken’s recent acquisitions have led to a declining ratio, down to 1.06 in 2002 from 1.36 the previous year. Lion Nathan is almost matching its assets dollar-for-dollar with its liabilities, which suggests the company, like its rival Heineken, is playing it too close for comfort.

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ACCOUNTS RECEIVABLES TURNOVER RATIO

ANALYSIS OF RESULTS

Managing receivables is a major strength of Heineken, which collected its average receivables 8.4 times, for an average 43.5 days collections period. This would suggest that Heineken has established very strict credit policies and managed to find a balance between increasing sales and time taken for debtors to pay. Foster’s recent collections efforts have become less diligent, and the spike from average receivables of 6.1 times, or 38 days average collection in 2000 to average receivables of 4.3 times or 85 days average collection, is alarming.

At an average receivables of 6.3 times, or collection period of 58 days over the period of analysis, Lion Nathan takes 33% longer than Heineken to collect its receivables suggesting a less stringent approach to granting credit, but still reasonably effective to avoid build-up of bad debts. Interbrew is by far the most lax, taking almost twice as long as Heineken in 2002 to collect its receivables. This poor performance suggests the company could soon have trouble finding funds to pay its creditors. Interbrew has made no conscious effort to improve its collections, with the average collections period increasing more than 22% over the last five years.

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INVENTORY TURNOVER

Note. Interbrew cost of goods figures for 1998 to 2000 are estimated.

ANALYSIS OF RESULTS

Heineken has displayed remarkable efficiency at selling its inventory, achieving ratios of over 10 times during the year that the average inventory was sold. This translates to the average inventory being held for only 35 days in 2000. Interbrew is behind Heineken at 6.8 times in 2002, but its inventory management effectiveness levels have fallen 16% since 1998, responsible in part to its operations extending into emerging markets that feature less volume consumption than the industry’s mature markets.

Foster’s inventory turnover has decreased since 1998. The number of days inventory held jumped to 173 days in 2002, or 2.1 times during the year that inventory was sold. This reflects the company’s increasing reliance on wine sales over beer products, assuming there is considerable difference in inventory turnover rates between the beer and wine product segments. From 1998 to 2001, Lion Nathan turned over its inventory an average 6.48 times a year, recording a respectable 56 days on average between inventories being sold and replaced.

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PROFITABILITY RATIOS

RETURN ON INVESTMENT

ANALYSIS RESULTS

Heineken recorded impressive ROI ratios, increasing from 12.4 % in 1998 to 16.5 % and reflecting increased spending on advertising and marketing. The company has reduced staff, excluding acquisitions, to maximize profitability. Heineken outperformed its competitors by using its assets to make profits.

Interbrew’s profit margins averaged below 7% showing little improvement despite numerous acquisitions during the last 4 years. It is assumed that these acquisitions will improve company profitability. In the long term, improvements on its ROI will be necessary.

Foster’s averaged 12.2 ROI during the five-year period, but it has been decreasing since 1998, a trend that may reduce investors’ confidence in the company’s ability to restructure its recent acquisitions, particularly its wine investments.

Lion Nathan recorded 8.4 ROI in 2002, its lowest level during the five-year period of analysis. Unlike its competitors, assets did not increase due to fewer acquisitions, and it failed to reduce staffing costs to better position its resources and maximize profitability.

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SALES CHANGE

ANALYSIS OF RESULTS

Foster’s negative ratio in 1999 stemmed from the sale of its Canadian brewery interest and reduced its debt expense from $111.4 million to $61.1 million and lowered sales. A sales change ratio increased of 32% in 2001 was followed by a drop of 9% resulting from price increases on alcoholic drinks produced by the introduction of the GST.

After many years of expansion through acquisitions, Interbrew’s rapid sales growth between 1998-2001 was followed by a sharp drop in sales in 2002. The sale of its Carling Brewers business, falling currency exchange rates and an overall stagnation of the industry contributed to this decline.

Lion Nathan’s sales revenue grew marginally in 1998-1999, but improved to an acceptable 12% in 2000. By 2001 the sales change ratio was negative (-5%), The sale of its stake in the Montana wine business and heavy reliance on Australian beer revenue contributed to a negative sales change ratio in 2001.

Heineken produced high sales change ratios between 14% and 15.1% until 2001, before plummeting to 10.3 in 2002. Although the events of September 11, 2001 in the U.S. impacted badly on trade, Heineken’s sales charge ratio of 10.3 in 2002 demonstrated its ability to maintain profitability from interests in other countries.

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RETURN ON EQUITY RATIO

ANALYSIS OF RESULTS

 The rule of thumb for an acceptable ROE is between 5 and 15%. For the alcohol and tobacco industry, ROE is given as 31.8%.

Over the period of review, Foster’s ROE declined from 17.7% to 14%. Although its ROE is healthy, the company’s performance pales in comparison to Heineken, which suggests the a more efficient and profitable entity. Heineken ROE is way above the empirically acceptable range of 5-15%, varying between 19.1 and 26.2%.

Interbrew’s ROE has sharply declined since 1998, falling 41% in value to 9.82%, whereas its competition has realised a range of gains in that time. Interbrew is apparently not reaping enough reward from its shareholders’ equity; it must increase its net profit after tax and reduce its liabilities.

Lion Nathan showed steady but unspectacular ROE, from 5.67% in 1998 to 7.25% in 2002, the exception being 2000, when NPAT was reduced to $3.7million after a $120 pre-tax charge to cover rationalisation and restructuring in China. Its equities are probably not being utilised optimally to increase profit.

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GROSS PROFIT MARGIN

ANALYSIS RESULTS

Heineken recorded the most stable gross profit margin ranging between 32.34% to 33.55% during the period of analysis. Owing to its strong international presence, its customs duties cost is much higher than Foster’s and Lion Nathan, resulting in a lower gross profit margin. With China’s entry into the World Trade Organisation (WTO) and its commitment to eliminate its tariffs on beer, which averaged 70 percent in 1997, Heineken hopes to lower its COGS and seize growth opportunities as the market develops.

Interbrew maintained its ratio at 50% over the last five years. Interbrew's cost of raw material increased between 2000-2002 due to imports. Interbrew has kept its production costs down and improved production efficiency of their acquired and consolidated brewers.

Foster’s produced a low gross profit margin in 1998 and 1999 of only 20%, but improved its gross profit margin to around 50% from 2000-2002 as it shifted from beer to wine and lowered its COGS.

Lion Nathan averaged a gross profit margin of 46% with more than 80 percentage of its revenue derived from its domestic markets. Its customs duties cost as a percentage of revenue is the lowest of the companies reviewed. Lion Nathan achieved 83% growth profit margin in 2002 due to the sales growth in the wine business (27%) and export volumes growth (43% in 2002).

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NET PROFIT MARGIN

ANALYSIS RESULTS

Heineken’s net profit margin ratio remained consistent for the last five years, reflecting the company’s continued focus on acquisition, consolidation and cost reduction. Cost reductions were made by concentrating production through fewer plants, improving supply-chain management, including better demand forecasting, and improving transportation and inventory management efficiency.

Interbrew averaged a net profit margin ratio of 7% for four of last five years except in 2000 when it recorded a net loss from additional costs of its IPO and the Bass Breweries goodwill impairment. The net profit margin rebounded to 7.4% in 2002.

Foster’s net profit margins have outperformed its three competitors in the last five years, supported by its combined beer and wine strategy and delivering overall growth.

 

Lion Nathan’s ratio was in line with revenue growth, with the exception of 2000 when profit was reduced after a $120-million pre-tax charge covering restructuring in China.

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NET PROFIT PER EMPLOYEE

ANALYSIS OF RESULTS

Interbrew proved to be the least productive of the four companies, averaging a net profit per employee ratio of 18.24 over the 5 year period compared to top performer Foster’s, which averaged 34.77. The net profit margin for Interbrew is comparable to the other companies in the analysis, suggesting its employees are not as productive.

Heineken is not far behind Foster’s, averaging 27.18 net profit per employee with values rising year-to-year along with employee numbers. Heineken has managed to maintain its productivity while increasing net profit.

Foster’s proved to have the most productive work force, increasing their employee numbers over the 5-year period while maintaining a net profit of over 10%.

Lion Nathan reduced its employee numbers annually following 1998, after reductions in net profit. Employee numbers later increased in 2002 by 22% following an increase in net profit and acquisition of three wine companies. Lion Nathan’s 5-year average ratio of 27.29 is only slightly behind Heinken’s.

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 PRICE-EARNINGS RATIO

ANALYSIS OF RESULTS

The P/E value for Heineken has decreased to an attractive level of 13.62% in 2002. Given its past record of double digits' growth in EPS in the last five years, EPS for 2003 is likely to increase to 2.2 resulting in a P/E value of just 12% at current market share price.

Lion Nathan’s P/E dropped from a value of 21.7% in 2001 to 17.10% which already reflected its EPS increase from 2001’s figure by $0.07 or 30% to $0.30 in 2002. Given its past record of generally less than 10% growth in net profit, it is hard to imagine it will have the same momentum as in 2002. We therefore predict its P/E level is likely to remain at the same level in the long run.

Foster’s P/E values have been maintained between 17% to 20% in recent years, which is in line with EPS ranging from $.21% in 1998 to highest value at $0.28 per share. In line with its increase in EPS, Foster’s share price reached its highest value of $4.88 in 2002. The moderate increase in EPS, it is expected that its P/E will remain steady.

FINANCIAL STABILITY

GEARING RATIO

ANALYSIS OF RESULTS

Since peaking in 1998, Lion Nathan’s gearing ratio has corrected itself and become more stable with levels ranging between 48.9% and 55%. Equity has remained constant while total assets have increased by 83%, implying a more healthy balance of assets to liabilities.

 

Foster’s gearing ratio averaged 56% between 1998-1999, before dropping to under 45% through 2000-2002. This is owing to shareholder’s equity increasing by 67% over the period of review, except for 2000, in which the value of property, plant and equipment was reduced by $436.6 million with the adoption of Australian Accounting Standard AASB and revision of AASB1010. In contrast, total assets increased by 115.2% from acquisition of Beringer in 2000. Equity has been diluted by net debt.

Heineken’s gearing ratio decreased from 48.13% in 1998 to 37.73% in 2002, while equity increased by 14.9% and total assets by 46.6%.

Interbrew’s gearing has shown a 65% improvement during the period of analysis, increasing from 25.5% in 1998 to 42.11 in 2002 as the company reduced in its dependence on long term debt to fund its global acquisitions. A noticeable shift occurred in 2000 when its gearing increased 42% over the previous year’s gearing. Although it is in a better position than it was five years ago, Interbrew must continue to improve its gearing to reduce its vulnerability to interest rate and currency exchange rate fluctuations.

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ASSET TURNOVER RATIO

ANALYSIS OF RESULTS

Heineken has been very effective in generating more revenue against assets than its competitors, with asset turnover ranging from 126.23% to 138.43%, twice as high as the other breweries analysed.

Foster’s and Interbrew share a comparable average asset turnover ratio at around 60%, although Foster’s experienced a drop from 58% in 2001 to 48% in 2002. This was due to assets increasing at a greater rate than revenue.

Lion Nathan has the lowest asset turnover ratio of the three companies with a value of 39.5% in 2002. This shows the company is lacking the ability to utilize its existing assets to generate revenue. Lion Nathan management need to look at ways to improve this ratio.

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After a slow finish to 1999 and 2000, LNN has seen an increasing trend in net profit this has continued to 2003. Sales revenue follows this trend. Inventory balance stays fairly constant over the period. The exception is 2002 which recorded a big jump in inventory balance, without the same increase in sales, suggesting either a decrease in the expected sales, or an overestimation of inventory needed. The accounts receivables balance has remained steady over the 5-year period. suggesting LNN has an effective collection policy. Cash from operating activities declined initially, in line with falls in net profit, but towards the end of the period an increasing positive trend following restructuring in China. The payables balance has seen a decreasing trend and the amount of cash assets held has halved over the 5-year period. This suggests effective procedures are in place for payments to creditors with effective cash management policies, and little cash sitting in low interest rate accounts. The P/E ratio has seen an increasing trend, after an initial fall in 1999. This suggests the share price is not over- or under-valued for the earnings it pays and the market is positive about potential future earnings.

After an initial decrease, both sales revenue and net profit show an increasing trend. When revenue is compared to inventory, inventory amounts are greater than revenue, suggesting they there is excess stock. The trend for accounts receivable balance increased four-fold in 2002, suggesting lack of control in debtor’s payment. The balance of bad debts should be investigated. There is no observed trend in cash assets, the figures fluctuate, with a decline in 2002. However, the payables balance increases over time, without an increase in cash assets. This suggests they may have difficulties paying creditors. The P/E ratio trend is unstable, quite opposite to the increasing trend in net profit. This suggests that the market is nervous about Foster’s future earnings potential.

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Heineken is the only company in this analysis with consistent profit and sales revenue increase. The inventory balance is optimally managed, increasing at a similar rate to sales revenue. The accounts receivable balance is increasing in line with sales revenue, suggesting that debtor’s are being maintained. Increases in cash from operating activities suggest revenue is being converted to cash. The trend in payables also increased over the review period. Cash assets available to pay the bills has varied over time and Heineken will need to ensure enough funds are available for on-time payments. The P/E ratio trend is in decline, opposite to net profit. The decline in the market price of Heineken shares suggests the market is not valuing the company.

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* Unable to calculate due to previous years negative profit   ** No P/E for previous year available

Sales revenue has steadily increased over the 4-year period to 2001, slightly decreasing in 2002. Sales trend in strongly correlated to the increase in net profit. The exception is 2000, which recorded a net loss after the Bass goodwill charge on $270.5 million euro. Accounts receivable balance increases at a slightly greater rate than sales suggesting either more customers are buying on credit or failure to manage receivables. Cash assets trend increased until 2001, and then reversed. Payables balance increased at a greater rate over the 5-year period than cash assets. In 2002, the payables balance was double the cash assets available, suggesting difficulty with paying debtors. Increases from cash from operating activities are comparable to the net profit trend, suggesting revenue is being converted to cash. The average inventory balance increases in line with sales revenue, suggesting efficient sales and production forecasting. The P/E ratio has declined following the 2000 IPO, opposite to the net profit trend, suggesting the market is waiting for earnings growth before stock investment.

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COMPANY CASH FLOWS

CASH FLOWS FROM OPERATING ACTIVITIES

CASH FLOWS FROM INVESTMENT ACTIVITIES

CASH FLOWS FROM FINANCING ACTIVITIES

Foster’s Group and Heineken have been the most consistent performers, although Heineken may be in a better overall position to maintain balanced growth through investment and financing activities. Heineken’s five-year performance has been predominantly leveraged using cash flows from investment activities and acquisitions producing a 34% increase in cash flows from operating activities between 1998 and 2002. Heineken identified opportunities for cost cutting through restructuring and expansion, and produced a strong operating margin.

Foster’s embarked on a revitalization plan after net sales plunged 36% to $3,125.1 million in 1999 from $4,899.4 million in 1998. Vigilant use of investment cash flows to promote growth and diversification in new markets led to record growth in 2001. In 2002 net sales were down 15.3%, net profit fell 0.4%, and operating profit tumbled 11.6%. Foster’s is now stagnating, brought on by reduced cash flows from financing activities. The company must either look for new opportunities beyond the local Australian market or risk a repeat of 1998’s fall..

Interbrew and Lion Nathan produced mixed results over the period of analysis. With a healthy balance in cash flows activities, Interbrew aggressively launched an IPO in late 2000 in order to pay debts incurred by international acquisitions. Interbrew struggled through 2001 and 2002 to pay its debts and dividends to the larger population of shareholders with operating cash. It sold Carlsberg Brewery to correct cash flow imbalances and sales fell 4%. Although its course was more balanced in 2002, its history of risk clouds its future.

Lion Nathan is a stable organization with increased growth in 1999 due in part to launch of a national brand, Hahn premium light, 45% investment in the company by Kirin Brewery and major investments and advertising in China. Cash flows from operations grew 32.6% in 2002 and further investments improved the company’s financial health as it directed cash flows from financing activities toward growth. In 2001 the company struggled slightly as it used its operating cash to pay debts, but it emerged with a more balanced and healthy financial position in 2002 pointing to sustainable organic growth enhanced by very strong brand recognition and investments.

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CONCLUSIONS AND KEY FINDINGS

Heineken is the only company in the analysis that has shown consistent growth in revenue and profit. Its receivables and inventory are well managed and it is effective in generating revenue and profit from its assets. With a declining P/E ratio and double-digit EPS growth, we believe the shares are undervalued. We therefore recommend Heineken as a global investment.

Foster’s also has excellent profit and revenue growth. However, it is struggling to maintain its receivables balance, the average days receivable equating to 85 days. This figure is three times the industry average and needs to be reduced. As the receivables balance is the only negative finding for Foster’s, we still believe it is a healthy, stable company, maintaining dominance of the Australian market. We recommend Foster’s as an Australian investment.

Lion Nathan has demonstrated profit growth for its businesses in Australia. It is struggling with generating revenue from its acquired assets, in particular wineries. Lion Nathan relies on its regional brand recognition and this may not be enough to sustain earnings in the competitive market. We do not recommend investing in Lion Nathan at this time.

Interbrew has increased its revenue impressively over the analysis period, however this has not been converted into a return on assets and equity. It also has a current ratio of only 0.6:1, presenting a concern in paying short-term debts. Interbrew’s aggressive spending and risk-taking presents an uncertain future. We suggest waiting to see further earnings growth and return on investment before investing in Interbrew.

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