In fact, explains E.T. (Ted) Kunkel, president and chief executive officer of Melbourne-based Foster’s Group, the company is now “all about beer and wine.”
In October 2000 Foster’s paid $1.5 billion to acquire Napa Valley, California, winery Beringer Wine Estates Holdings and its affiliated brands, including the venerable Stags’ Leap and more middlebrow Meridian. Combining Beringer with the smaller Mildara Blass winery, which Foster’s purchased in 1996, the company saw its wine sales surpass beer sales for the first time: In the fiscal year ended June 2002, wine revenues totaled $1.1 billion (A$1.9 billion), versus $950 million for beer.
The gap between the two is widening. For the six months through December, the most recent semiannual reporting period, the consolidated wine unit, Beringer Blass Wine Estates, reported that revenues climbed 7 percent, to $693 million, even as beer sales increased 5 percent, to $633 million.
Despite the aggressive marketing of Foster’s Lager in the U.S. and the U.K., international beer sales are a relatively small part of the company’s business, at about $50 million. Foster’s domestic beer operation, Carlton & United Breweries, which dominates the Australian market, is ten times the size.
Still, beer division profits are even frothier: $185 million of operating income for the half-year, compared with wine’s $168 million. Foster’s also took in more than $30 million from ancillary hotel, gaming and real estate activities, bringing the total to about $385 million. After interest, taxes, amortization and the application of a controversial accounting rule called SGARA (self-generating and regenerating assets), Foster’s netted $221 million, a year-over-year gain of 4 percent.
The 59-year-old Kunkel, a New Zealand native and Auckland University graduate who started out as a Carlton & United assistant brewer in 1968, has transformed Foster’s into an Australian-accented multibrand conglomerate, with 40 percent of earnings coming from outside its home country.
Beer and wine making and distribution remain “our core competency,” says Kunkel, who was elevated to CEO in 1992, having spent five years running Foster’s Carling O’Keefe and Molson Breweries operations in Canada. (Foster’s sold its 50 percent share of the Canadian venture to its partner, Molson Cos., in 1998.) If anything, Kunkel wants to make Foster’s even more focused. “There are other businesses hanging off of that base,” he notes, among them pubs and gaming, which support the core activities but which the company has said it might sell. Foster’s is winding down a suburban property development arm started more than a decade ago, says Kunkel, because it’s not a core business.
With the proceeds of any asset sales and a market capitalization of $6 billion, Foster’s could be positioned for another big acquisition. It has been rumored to be a suitor of money-losing Australian wine maker Southcorp, producer of premium brands such as Lindemans and Penfolds, but Kunkel declines to comment on the speculation.
Although he boasts that Foster’s has been delivering “strong results in challenging conditions,” the company’s shares on the Australian Stock Exchange in Sydney have recently been trading at about A$4.20 ($2.77), just 8 cents above their 52-week low on March 7, and 77 cents below their high last August 30.
Analysts say that the Australian dollar’s appreciation against the U.S. dollar -- 14 percent in the first half of 2003 -- clouds Foster’s earnings outlook, along with declining wine prices and the possibility of a dilutive acquisition. But David Roberton, Sydney-based head of food and beverage research for UBS, believes these are short-term concerns and rates Foster’s a buy. He calls it “an exceptional platform for sustained earnings growth.”
CEO Kunkel discussed Foster’s strategy in a recent interview with Institutional Investor Assistant Managing Editor Jeffrey Kutler.
Institutional Investor: At a time of economic uncertainty, can you be comfortable with a less-diversified business mix?
Kunkel: Beer and wine are our core competency, with by far the greatest proportion of our sales, and we intend to capitalize on that further. We have about 60 to 65 percent of our capital employed in wine, which drives upwards of 40 percent of the profits, and most of the rest of the capital is in beer, which drives between 55 and 60 percent of the profits.
Why do you emphasize premium wines?
For us the premium market starts at about [U.S.] $4.50 a bottle, and it goes up to $150 for Beringer Private Reserve -- and beyond. The premium focus has been absolutely critical to our strategy; there is much more intense discounting at the lower price points. If you look at our profitability and margins per case -- which are in the high 20s -- we are clearly in the premium category.
Given its cyclicality, isn’t the wine business tough to manage?
Analysts have never questioned the long-term growth in the wine business. They do question the returns -- it’s highly capital-intensive, and the issue is whether a company can recover its cost of capital. We are proving that premium wine can both deliver growth and reach its cost of capital; over three years we will have increased the return on capital from 7.5 percent to 13.5 percent. We have done that by improving the core wine trade business and by introducing two new, less-capital-intensive businesses that account for about 20 percent of wine revenues and profits: the direct mail, or club, channel; and wine services, including contract bottling, warehousing and packaging.
How do you gain a competitive advantage in the premium arena?
That’s driven by the margins we can attract. Those margins come from competing at the high end of any given price point -- $4.50 to $6, $6 to $8, $8 to $10, $10 to $12 and on up to the luxury categories. To succeed with this strategy, you need an absolute commitment to quality -- which applies to beer as well as wine -- and third-party endorsements that measure that commitment. For example, our Wolf Blass Winery was judged the best winery in the world in the 2002 International Wine and Spirit Competition. Another way to look at it is the number of listings -- currently four -- that Beringer has year after year in the Wine Spectator Top 100.
Does it become difficult to maintain quality as the company gets bigger?
The last thing I’d want to do is tell the head of Beringer Blass or the managing director of international beer how to run his business. I can set a tone for the culture and set up processes and remuneration systems that reward certain behaviors over time. When you have big brand names like we do, combined with the quality, you can transcend rather than be limited by the various market segments and price points. Take, for example, Beringer blush wines, which cost around $5. They command a premium margin over other players in the blush category because Beringer is a household name in the U.S. The higher-end Beringer wines, such as Stone Cellars and Founders’ Estate, work the same way.
How similar is your beer strategy to the wine strategy?
In terms of how we think about quality and about commanding the top end of the price points, it’s absolutely similar. Carlton & United Breweries’ Crown Lager was the best premium beer at the 2002 Australian Liquor Industry Awards, while CUB’s premium and imported sales volumes were up 9.4 percent in the last half-year. Victoria Bitter, the best-seller in Australia, with a 25 percent market share, commands a premium margin. And in the light-beer segment, we have two premium entries: Cascade Premium Light and the recently launched Carlton Sterling.
How does Foster’s play in emerging Asian markets?
Half the world’s population is in Asia. It offers strong growth, and it has to be attractive to a company like ours that has aspirations to grow as a world brand. We’ve opened breweries in China, India and Vietnam, and we are positioning Foster’s as a premium brand in these markets. But it’s a long-term proposition. Asia is a developing market, and it’s not an easy place to do business. We’re bringing a brand strategy into markets where generic beers are well entrenched. In China and Vietnam we compete against state-owned breweries.
Is the slow economy affecting your ability to hit financial benchmarks?
One of the key measures on which we drive this company is 10 percent normalized growth in earnings per share. Our first-half EPS was up 7.5 percent, but that was for macroeconomic rather than structural reasons. We didn’t get to 10 mostly because of appreciation in the Australian dollar versus the U.S. dollar. At the exchange rates of a year earlier, we would have posted 11 percent growth.
What’s your beef with Australian accounting standards?
Under SGARA, grapes are valued at the market price, basically, when they are picked, without regard to the underlying cost. The market price of a ton of chardonnay grapes may be $2,000, and your cost of producing them may be $1,000. The standard makes you value them at $2,000; therefore, the profit you book on that is somewhat artificial. SGARA makes you take the profit or loss early -- and in three years’ time, when you sell the wine, your cost is inflated or deflated. We try to strip that out and normalize our results. We can’t know the full effect [of SGARA] until we have a complete Australian vintage.
