I’ll Just Have A Beer Thanks

This story features FRUGL GROUP LIMITED. For more info SHARE ANALYSIS: FGL

By Greg Peel

In retrospect, one could have easily predicted the stock market crash of 1987 when freshly deregulated Australian banks started quickly buying up stockbroking firms in the mid-eighties so as not to miss out on the bonanza.

In a similar vein, the writing should have also been on the wall in the food & beverage sector when after about the twenty years or so that saw Australian wine rise from local curiosity to major export market, beer giant Foster's ((FGL)) decided to acquire Australia's largest wine distributor Southcorp.

Weather conditions had a bit to do with it, but realistically it was a combination of so many vintners both experienced and inexperienced attempting to cash in on the global popularity of Australian wine that just afterward Australia suffered a wine glut. Throw in the fact the British and Americans had by then “done” Australian wine to death, and were moving towards sampling new South American, Eastern European, South African and even domestic wines, and pretty soon off-licences in London and Quik-e-marts in Los Angeles couldn't give the stuff away. The Australian wine industry all but collapsed, and Southcorp, now Foster's, led the charge.

Yesterday Foster's management provided its first FY10 profit guidance of $1.05-1.08bn which included another write-down of the wine business to the tune of $1.3bn. That's a total of $2.6bn , notes Macquarie, that Foster's has written down since the Southcorp acquisition in 2005.

In June 2008 Trevor O'Hoy, the Foster's CEO behind the acquisition, fell on his sword. The GFC which was to follow clearly meant a forced postponement but basically ever since that day stock analysts have been wondering when Foster's would finally bite the bullet and admit defeat.

It's not only that the discounted value of the wine business within the market's group valuation has been undermining the value of the core beer business trapped within, it's that in constantly trying to battle its way out of a weak wine business, Foster's has neglected to keep a sufficient eye on the beer business. One might have thought Australian beer would sell itself forever without difficulty and that iconic brands like Carlton Draught and VB would remain perennial market leaders, but that has not proven the case.

The good ol' Aussie beer drinker has become quite discerning these days, as he holds up the bar in his blue singlet and Stubbies.

Australia has embraced premium local beer from brewers such as Hahn, Boags and Coopers along with foreign offerings such as Corona, Peroni and Heineken. We are also now happy to lash out and buy truckloads of the more expensive boutique microbrewery offerings such as Little Creatures and Blue Tongue. In short, if you're still drinking VB you are sooo twentieth century.

For decades the major rival to Victoria's Carlton United Breweries was New South Wales' Tooheys, which was successfully snapped up by New Zealand brewer Lion Nathan (sacrilege!). Lion Nathan was happy to let Foster's CUB be distracted by chardonnay and shiraz while it went about reading the beer market correctly and swallowing up popular brands such as Hahn and Boags and marketing them against even its own staple, Tooheys New. Lion Nathan has since been taken out at a premium by another astute brewer, Japan's Kirin.

And all the while, sales of of VB have been declining. John Mellion would be turning in his grave.

Throughout the rally of 2009, Australian companies took the opportunity to raise capital, acquire, divest, demerge and consolidate in the wake of the GFC. Analysts assumed all year that any day now the inevitable announcement would come from Foster's. The market began pricing FGL as two entities in anticipation. But the announcement never came.

But here we are sitting at what hopefully is the bottom of the biggest stock market correction in over twelve months and suddenly – there it was. Yesterday Foster's announced it was proposing to pursue a demerger of its wine and beer businesses. Analysts raised a withering toast.

Two brokers – Citi and GSJB Were – responded by raising their ratings on Foster's from Sell to Hold while Credit Suisse was excited enough to move from Hold to Buy (strictly Neutral to Outperform). That brings the Buy/Hold/Sell ratio in the FNArena database to 4/5/1. Interestingly, in raising to Buy Credit Suisse joins, among others, Foster's harshest critic in BA Merill Lynch. Merrills was dead against the Southcorp acquisition at the get-go and hasn't let up about it for five years.

But that did not stop the analysts deciding more recently that the valuation of the combination of the two businesses was heavily discounted on weak sentiment to the net valuations of two separate entities. In other words, Merrills was looking to the upside of the demerger it knew must one day come.

Credit Suisse puts it nicely in suggesting that Foster's share price has recently reflected a full case of beer with a half-price carton of wine thrown in, so deeply has wine sentiment dragged the group down. UBS is less poetic, suggesting separate valuations for beer and wine of $4.69 and $0.79 respectively. Foster's paid $4.26 for Southcorp in 2005 when its own share price was around $5.30. So you could say that in five years Foster's has turned $9.56 into $5.60 (today's price).

All brokers note that demerging to unlock value is not without cost, particularly given the need to replicate head offices and so forth. This is something the Hold-raters are taking into account in deciding the market has already priced in a demerger outcome. Deutsche Bank, like Merrills, already had a Buy given it had anticipated the demerger and believes such a move will continue to unlock value. But Deutsche was surprised by the timing.

Macquarie, too, was very surprised. In an acerbic note, the Macquarie analysts ask “So what provoked this announcement?” They asked Foster's if someone had made a bid for CUB and the answer was no. Is Foster's trying to attract a bid for CUB perhaps? Or maybe it's because FY11 earnings will be flat to down on FY10 the way things are going, they drily pondered. And they left their rating at Underperform, suggesting a demerged Foster's is no different to a merged Foster's unless someone does actually buy the beer division.

The reality is that despite one assuming Foster's would want to offload the wine division and keep the beer division, it's not going to get any premium for the wine division. International beverage distributors like Constellation or Diagio could have snapped it up ages ago if they actually wanted it. So in demerging, analysts are assuming Foster's is hoping someone will come along and pay a tidy premium for CUB, leaving it with enough cash and time to concentrate on making something out of wine.

Because the signs are that things in the Australian wine industry are actually now on the improve, from very low depths. Given the market so poorly rates Foster's wine, the only way could be up.

When all said and done, the general view is that two Foster's is better than one. Brokers then remain largely split on whether or not demerged value is already accounted for, noting it could be several months yet before the split finally occurs.

The average target on Foster's in the FNArena database today rose from $5.66 to $5.75.

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