Has Foster's lost its way? July 30, 2010One of the most...

Has Foster's lost its way?
July 30, 2010

One of the most important tasks of long-term investors is to try and pick fundamental changes in industry and their effect on listed companies. A few weeks ago I wrote about the likelihood that in the next two or three years we will see a major change in the iron ore industry as supply grows and Chinese demand is stifled.

Just yesterday there was news of the deal between Rio Tinto and Chinalco to develop iron ore in Guinea and the ambitious expansion plans of the Brazilian giant Vale. We are headed for a major increase in iron ore supply, which will change the dynamics of the industry.

But this week I was strolling along the beach thinking about changes much closer to home. Coca-Cola Amatils new beer thrust had me thinking about the truly dramatic changes taking place in the beer and alcohol market.

Fosters and to a lesser extent Lion Nathan enjoyed a wonderful run with their core beer brands during the 1980s and 1990s, but they are now facing a new series of challenges that they have never seen before. In the past Fosters and Lion Nathan have been able to achieve good margins because the big supermarket chains, Woolworths and Coles, needed Fosters to supply VB and Lion Nathan to provide Tooheys New (NSW) Fourex (Queensland) and Swan (Perth).

All these key brands, but particularly VB, have been affected by basic changes in the industry and the community. VB was brilliantly promoted using the slogan A hard-earned thirst needs a big, cold beer, and the best cold beer is Vic. Victoria Bitter. This slogan perfectly placed the brand for blue-collar drinkers and for those who wanted to align themselves with the working man.

But our society has changed since then. Nail guns have replaced hammers and mechanisation in the building and other industries has made manual labour less physically demanding. The only place many were getting a hard-earned thirst was in sport. Moreover, it is no longer acceptable to drink large quantities at lunchtime or when driving is involved.




VB took too long to adapt and although there are now feverish efforts to change direction and regain momentum, younger drinkers now prefer mixed drinks and spirits plus a variety of boutique beers and cider. This change appears to have also stunted Fosters premium beer Crown.

The stockmarket focus is on how Fosters is trying to salvage wine, but the beer task is even more important. Fosters new head of beer and spirits, John Pollaers, must get it right. He is from the Diageo group, which markets Johnnie Walker, Smirnoff and Guinness.

Fosters most recent interim report said that the VB brand maintained the momentum established in the second half of fiscal 2009, with net sales revenue ahead of the prior year. But a just few months earlier, Lion Nathan chief executive Rob Murray confessed that brands such as Fosters VB and Lions Tooheys New were in significant decline.

Lion Nathan sold out to Japan's Kirin Holdings in 2009, which now looks a good move for its Australian shareholders.

In the food and beverage business, Fosters, Lion Nathan, Coke, Kelloggs, Cadbury and Arnotts have a magnificent asset: their flagship brands are a must stock and display product for Woolworths and Coles. If they lose that status their margins will be killed because Woolworths and Coles are rough with suppliers whose products are not essential to their customers.

That is the danger now facing VB and Fosters. When the going is tough in the marketplace it is amazing how adverse events suddenly multiply. Woolworths has a commanding position in the supermarket industry, and is almost unchallengeable in liquor. It has looked longingly at beer for about two decades and resented the fact that brewers were enjoying big margins on beer while retailers were squeezed.

One of the greatest mistakes Fosters made was to sell its hotels business, which was later acquired by Woolworths. With VB on the decline, Woolworths is promoting a greater variety of brands in its stores and in time it will get Fosters margin down. The winners from beer diversification include Fosters Corona, and Lions Hahn Premium and Coca-Cola Amatils Peroni. None of these brands are must stock and display items for Woolworths and Coles just yet.

It is particularly important for Woolworths to improve its liquor margins. Woolworths has always enjoyed much larger margin on its supermarket sales than its rival but Coles has woken up and has a much more aggressive pricing strategy, which is lifting sales and making it difficult for Woolworths to increase its margins.

The main reason Woolworths makes so much more profit on its sales than Coles is because it has much better logistics and knows precisely how much stock it has in each store. As a result it rarely gets caught with too much or not enough stock and so is much more professional. Big suppliers love that certainty and Woolworths often gets better prices as a result. Coles, under Wesfarmers and Andrew McLeod, understand this weakness and Coles is now revamping its systems so, in time, it will also manage its stock better and gain many of the benefits Woolworths enjoys.

Woolworths does not like being caught on the back foot and will need to be sharper given that it now has a serious competitor. In that situation, given Woolworths dominance of liquor sales in Australia, it would be very useful for it to secure better margins beer.

For Fosters to have its two main major beer brands, VB and to a lesser extent Crown, under challenge at this time is not a happy experience. They are thankful for Corona and Carlton.

The former rising star at Fosters, Terry Davis, left the brewer to head Coca-Cola Amatil in 2001. Davis told me around 2003 that he would be sending Coke into every beverage available except wine. He believes wine is in the province of small operators and that the market is too fragmented to gain the sort of margins large companies prefer. And, of course, back in 2003 Fosters did not agree with Davis and so went deeper and deeper into wine. It has discovered that Davis was right.





Any company in that situation becomes a prime takeover target. There is no doubt Davis and Coca-Cola will look hard at Fosters beer and spirits business, but Davis is even more determined to keep Coca-Cola out of wine.

Assuming Fosters wine business can be sold, Coca-Cola and the other potential buyers of the Fosters beer business will need to determine the seriousness of the VB problem and whether they can solve it.

In the 1980s and 1990s Fosters threw out a fortune at its former flagship brand, Fosters, but could not reverse the downward spiral because the brand had became unfashionable in large areas of the beer drinking market.

Thats what is starting happen to VB. In the next year or two Fosters must be to stop VB from going into a Fosters-style terminal decline. That is going to not only require large marketing dollars but a strategy that works in the new community environment. Nevertheless, VB remains a wonderful beer and, when the fashion police arent looking, it is a most refreshing drink after a long walk on the beach.