Froth hides tasty investment

By Peter V O'Brien

Friday 6th June 2003

The long-fashionable idea that the two listed brewing companies should be avoided as investment options fails to square with the facts.

Pundits point to declining beer consumption a head of population, in favour of other drinks and a consequent fall in margins.

Such people lack appreciation of the difference between monetary and percentage margins.

It is more than coincidence that brewers pushed "premium" and those boutique beers in which they have an interest while consumption of out-of-the-keg draught offerings were falling.

The issue relates to a relatively small percentage mark-up on a low-priced product as opposed to dollar/percentage on a higher price.

For example, say a 10%, margin on a $4 product gives the seller 40c. The same margin on a $5 product realises 50c.

Construction of arguments favouring, or disapproving, distinctions between monetary and percentage markups was a lucrative occupation for lawyers, accountants and other relevant professionals in the days when the old Price Tribunal and later regulatory pricing authorities made decisions.

It always vexed politicians and often left-wing officials that increases in taxes on liquor, tobacco, petrol and other products (the last related to historical sale taxes) resulted in retail prices in monetary terms well above the dollar tax impact.

They now accept that regular tax movements, in line with consumer price index changes, finish up at a retail price more than the old price plus the new tax rate.

Percentage margins are the reason.

Politicians and public servants seem blind to the fact that a product tax increase aids producers' dollar profit, provided they maintain turnover at the new price.

Blindness also affected the viewpoint of people who considered brewing a mature industry, with declining consumer consumption.

DB Breweries and Lion Nathan had the capacity to diversify into new products, associated alcohol drinks and (in Lion Nathan's case) to countries outside New Zealand.

There can be no quibble with share price growth (see table), suggesting some investors saw merit in the sector.

Sceptics seemed to ignore three matters:

* capacity to adjust to change;

* financial strength;

* brewing companies have always been defensive stocks. People may defer expenditure on high-priced consumer items but there is always a core of those who drink.

Financial strength is a feature of both companies but particularly applicable to DB. The company had no term debt in the six months ended March 31 and $30.7 million of current liabilities as borrowing related mainly to bank facilities presumed to roll over at maturity. Shareholders' equity to total assets, including minorities, was 69.2%.

Those figures suggested DB could, subject to shareholder approval, return more capital to the owners after earlier substantial distributions. Any decision about that would depend on 76.91% majority shareholder Asia Pacific Breweries.

The chief shareholder has international brewing investments, which define its financial assessments but it could eventually see merit in taking out cash, to the benefit of minority shareholders.

Every textbook says a company, under modern tax legislation, has a theoretical misuse of capital if it carries no term debt, assuming it has capacity to lift earnings after servicing (tax-deductible) interest costs.

A share buyback or cancellation has merit for shareholders, because they get cash, the share price tends to rise, assuming maintenance of earnings a share on lower capital and a consequent improvement in the price to earnings ratio.

It is doubtful Lion Nathan will take such a strategic path, given its financial structure and commitments, but the company's international thrust has paid off, despite ongoing deficits in China.

Defensive stocks have boring images when markets are bullish.

Current markets are torn between bulls and bears, a volatile situation. Defence is best when volatility rages beyond the palisade.

Brewers' share price performance (c)

Company price price %change 2003 2003

30.5.03 11.11.02 Nov-May high low

--------------------------------------------------------------------------------

DB Breweries 660 600 -10.0 680 560
Lion Nathan 660 590 +11.9 660 545

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