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fa Alerted by the TA breakout
good accumulation

sanfords FA at 5.36c fully priced



Date of Publication
19 Nov 2002 Code Last +/- %
LNN 544 -6 -1.1%

Snapshot taken at 10:42:15 AM
Friday, 6 December 2002 AEST


Lion Nathan (LNN.AX) Hold
Distillers & Brewers Australia

Price@18/11/2002: A$5.23

12 month range: A$5.43 - 4.20

Valuation: A$5.36

Price Target: A$5.64 (+8%)

Market Cap: A$2,798.3m/US$1,573.0m

Shares on Issue: 535.0m

Average Volume (000's): 869


Source: Sanford

Source: Company Data and Sanford Estimates

Investor Conference Round-up.


The company reaffirmed its FY03 profit guidance of $180m (Sanford at $178m) driven by 6% growth in EBITA growth from LNA, China reducing its losses and c50% growth in wine.


We value LNN at $5.36 (DCF – WACC @8.8%) with a $5.64 price target (1+WACC – PV Dividends). At the current price, we believe LNN is fully priced, maintain Hold rating.

Event


Investor Conference – Management Presentations on 14 & 15 November 2002.

Impact


Guidance for the full year of NPAT of $180m (Sanford - $178m) and EBITA of $410m was reconfirmed on the condition that Australian beer pricing returns to normality post Christmas. Management believes the NSW and Queensland markets are still experiencing price competition at the expense of margins and profitability as volume increases will not be sufficient to maintain forecast profitability levels.


Despite an encouraging FY02 for wine, building up an effective distribution network remains the key critical success factor for LNN Wine and if it is to build volumes sufficient to achieve it’s cost of capital.


NZ Beer is performing strongly and comfortably in its duopoly structure with competitors following Lion Nathan’s pricing lead, resulting in an expected increased performance.

Valuation


No change to our $5.36 valuation (DCF – WACC @ 8.8%) and $5.64 price target (1+WACC – PV Dividends).

Action


We maintain our Hold rating.
Lion Nathan Australia

LNN Australia is set for a 5-6% increase in EBITA in FY03 with the beer market showing signs of stabilising. LNN will continue its focus on core brands, paying particular attention to the regional portfolio.

Table 1: Regional Strategy

State
Strategy

NSW
Continue growth in new equity and price. Tooheys New performing well.

QLD
Grow XXXX Gold.

VIC
Some volume stalling in recent months – continue to build awareness, long term approach.

SA
Turnaround story- growth West End Draught.

WA
Recapture mid strength volume (XXXX Gold, Sovereign) and grow Swan Draught equity.


Source: LNN, Sanford estimates

The most concerning aspect as highlighted in the FY02 profit result is the impact of the drought on the cost of barley. This has so far accounted for higher costs of $4.2m in FY02 with $5.8m already booked for FY03. We remain watchful of further drought related higher barley costs in the short to medium term.

The chart below illustrates LNN price risk mitigation strategy in the event of a deteriorating pricing environment in 2H03. The strategy is to drive through improvements in price/mix, COGS (net of drought), savings in media/overheads and the benefit of increased volumes on the back of lower pricing – thus preserving LNN’s FY03e EBITA guidance of 6% growth.



Source: LNN, Sanford estimates. Estimates based on pre-restated divisional accounts.

In FY02, LNN Australia achieved solid earnings growth with EBITA up 7% to $318m in an increasingly competitive market (growing RTD market and a poor summer in Southeast Australia). LNN grew share by 0.1% (to 42.2%) in the year with positive gains in the Eastern Seaboard (accounts for 80% of volume). The result was driven by growth in the higher margin premium segment, a commitment to cost control, higher volumes and contributions from the export business and increased pricing. EBITA brewing margins increased 0.9 ppt to 32%.

Lion Breweries New Zealand

LNN will take on the industry leadership role in this region in leading price, preferably with price increases of 1% + inflation pa. The company put through a 4.9% price increase in June with the full benefits expected to come through in FY03 (8 months contribution).

LNN’s NZ brand performance in the last year is comforting. In particular, 4 of the 5 core national brands grew with the weaker Lion Red brand decline slowing. In FY03, the company plans to increase advertising by c6% (9.7% CAGR since FY00). LNN believes that they have also been able to gain market share from DB breweries.

The NZ beer market has show some signs of growth in recent months and over FY02:


LNN’s pack volumes grew steadily supported by overall category growth driven by a 26% increase in grocery channels. Groceries in particular has increased its share to 29% of the total pack market, predominantly at the expense of independent retailers.


Flattening of declining tap volumes that can be considered a small positive given total decline in tap volumes. Pricing for tap did improve in FY02, initially through discount reduction, then driven by a 4.9% price list increase in June. Pricing in FY02 was also influenced by mix changes.

LNN also stated that one of the key goals is to hold COGS (tighter control of discounting) and overheads below inflation (increase productivity, scale leverage).

In FY02, LNN New Zealand posted a strong result with increased volumes (+2%), revenue, EBITA up 5% (mix shift towards high margin premium products, stronger pricing and a commitment to cost containment), and market share with the NZ beer market now showing signs of recovery.

Wine

LNN highlighted that the main issue confronting its Wine operations is the lack of distribution platform in the US. The company indicated that there were 5-6 distribution strategies that they are currently considering.

Although export volumes were up 43% to 411,000 cases in FY02, building up an effective distribution network remains the key critical success factor for Wine. Discussions have also been held with Kirin on distribution of the Company’s wines in Japan while NZ Wines and Spirits is now distributing several brands in NZ.

Vintage 2002 is reported to have been down in some areas such as Mornington Peninsula. LNN does not anticipate any impact on its portfolio, following the strong buffer provided from previous vintages. The company estimates that they have c75% of premium fruity supply locked in from contract/leasing arrangements and from their own vineyards – supporting company projected sales growth of 23% assuming average crop yields.



Source: LNN, Sanford estimates. Estimates based on pre-restated divisional accounts.
China

Growth in this region is expected to be driven by its core brewing business supported by increased utilisation of its modern Suzhou brewery. For instance, LNN increased utilisation in Suzhou by entering into an agreement with Coors to brew beer for its Asian customers. LNN is currently pursuing a similar opportunity with Kirin Brewery.

The business is now in a much healthier cost structure, generates stronger revenue per litre and industry best debtor management. In the last 2 years for example 54% of EBITDA improvement has been driven by margin increase due to volume growth and favourable mix. The remaining improvement was supported by lower costs in manufacturing, materials and sales.

LNN will target for regional market dominance by expanding to adjacent regions and fill in core markets in driving profitability – brand building/investment will feature prominently on the growth agenda. LNN believes execution will be the key differentiator in the success or failure in this region.

LNN’s core markets are in Wuxi and Suzhou. They are #2 in Nanjing with LNN having only a premium presence in Shanghai (with Steinlager) and are #2 behind Budweiser. The company is currently expanding into North Jiangsu, Zhejiang and Nationally. 4 new products are currently planned for release in the coming months.

The business expects to be cash flow break even in FY03, profit break even in FY04 and profitable in FY05. In FY02, China achieved strong volume growth (up 27%) in China brought the business closer to cash flow break even – with loss reducing to A$14.7m. This is a particularly strong result considering that the market is estimated to have grown by less than 5%. Local mainstream brands performed well in the year with leading brand Taihushui growing 50%, with market share up to 65% driven by innovative new products. In the on-premise higher margin premium market, LNN’s Steinlager grew by 25%.

Investment Risks

Investment risks include the competitive pricing environment and the impact of the drought in Australia resulting in higher input costs (ie barley).