The Foster’s cash-generating machine has few parallels in Australia but the company is in grave danger of being acquired for a fraction of its worth because directors have not spelled out a clear distribution policy.
And in today’s KGB interview (KGB: John Pollaers), I did not fully appreciate what I now believe is an error of judgment by the board so I did not engage CEO John Pollaers in debate. Accordingly, I may have contributed to the looming Foster’s tragedy.
Australian institutions are not known for their sophisticated valuations and the US institutions are making a currency fortune on Foster’s, so SABMiller knows if they can get around the Corona “poison pill” (Can SABMiller swallow a Foster’s poison pill?) and offer about $5.50 they will pick up Foster’s for a song. And like the French Axa group, they will be able to publicly celebrate with their overseas shareholders the stupidity of Australian institutions (The great Axa rip-off).
These are strong statements but the figures that Foster’s revealed yesterday back them up. Foster’s has a sustainable distributable cash surplus of about $650 million. If directors decided to distribute that sum as dividends — and they can — the stock would yield about 6.8% using a $5 price. There is every likelihood the surplus will rise in coming years so the yield will rise well beyond 7% (after franking credits). And there is very low risk.
While Foster’s gives shareholders all the figures to do their calculations, directors have not spelled out that they have $650 million to distribute. And they appear to have announced that they will distribute only about $400 million in dividends with the balance by way of capital return or some other mechanism. It is true there is a $500 million buyback from the bonanza that came from winning the tax court case, but this has not been linked to the trading surplus.
There is nothing wrong with distributing $400 million in dividends and $250 million in yearly buybacks but the policy needs to be spelled out so shareholders can see the real return. Once shareholders realise the level of distributable cash that has been achieved by Foster’s on a sustainable basis and what looks likely to be achieved, there is no way it would consider selling at $5.50. But my fear is that the institutions have already made the decision.
To get to $650 million in distributable cash I need to take you through simple sums using the figures that Foster’s reveal. I am going to round off the figures to make it easy to understand but I occasionally will put the exact figures in brackets so you can do your own checking.
Split away from wine, Foster’s 2010-11 earnings before interest and tax were about $820 million ($816.7 million). The company pays no tax but the interest bill is about $120 million, which is very high on a debt of $1.5 billion but this reflects the old US dollar wine debt, which has been hedged into Australian dollars. So Foster’s is earning at an annual rate of $700 million before tax but for the next two years it will not pay tax. To get to the distributable cash flow, we have to add back depreciation/amortisation and deduct likely capital expenditure. In the accounts, depreciation and amortisation is about $56 million but given the high levels of capital expenditure I have used $60 million for depreciation. Beer capital expenditure is about $80 million but for the next two years IT expenditure will take capex to about $110 million so we will use that figure. Those simple sums give us distributable cash of $650 million before the major cost cuts that have been announced. Readers will want to ask at least two questions — first, what happens when Foster’s resumes paying tax in two or three years? The tax can be distributed as franking credits and the yield to Australian shareholders will not change.
Second, what if there is a major additional capital expenditure or hiccup? With only $1.5 billion in debt and high sustainable cash flow, Foster’s can borrow more money or it can explain to shareholders that distributions will be reduced for a year or two because of a major outlay.
The surplus cash is so great that SABMiller could theoretically borrow about $US11 billion on US interest rates to buy all of Foster’s at $5.50 and still be left with a handsome return to its shareholders.
When it comes to how much of the $650 million is to go to shareholders via distribution, last year Foster’s distributed just over $500 million in dividends (but that included wine). This year, the company has declared that it will pay a dividend of 80% of after tax earnings but those “after-tax earnings” will be reduced by a theoretical tax provision that brings the likely dividend distribution down to about $400 million.
SABMiller, on reading that distribution policy, must have cracked the champagne. Foster’s is doing all the right things to lift earnings — cutting costs, introducing a new IT system, increasing promotion of its brands and negotiating better deals with supermarkets. The brewer is now increasing market share and running the business in a way that has not been done for decades. John Pollaers and his people are brilliant managers but have little idea of how to handle a takeover of this sort. As in Axa, Australian investors look as though they may be taken to the cleaners.
*This first appeared on Business Spectator.