Regional beer maker East African Breweries Ltd (EABL) has long been associated with profit growth. Indeed, even when regulators impose higher excise duty or the economy slows down, the company always remains on a linear profit growth line.
The reason is simple: In most cases, it has passed the excise duty increments to customers through price increases. Secondly, the company has enjoyed near monopoly — and still does — thanks to weak competitors. Finally, the company has kept its costs down by avoiding debt and relying on internally generated funds to finance growth.
But the brewer is increasingly finding itself in unfamiliar territory with rising financing costs and increased competition.
Last week, the firm issued a profit warning ahead of the release of its results. It blamed the projected decline in profit on rising financing costs—expenses associated with securing financing—and the one-off sale of Tanzania Breweries Ltd to SABMiller. (See related story)
EABL management said it expects net earnings for the year ending June to be at least 25 per cent lower than the Ksh11.86 billion ($136.32 million) it reported last year.
“The EABL board is confident that the company will return to net earnings growth for the 2014 fiscal year… we expect to report growth in net sales for the year ended June 30, 2013 compared with last year,” said the company’s board.
So, what is ailing EABL?
In a June business update, EABL executives highlighted a general slowdown in the first four months of 2013. However, the Tusker brand performed to growth expectations. Spirits, too, continued to show improvement.
In Uganda, the economy remained weak, with GDP slowing on the back of higher interest rates and reduced aid that lowered disposable income in that market. Tanzania had significant excise duty increases in the previous financial year.
Despite the weak performance outlook, investors appear undeterred. Analysts at Old Mutual said investors seem to be positioning for the long term when buying into EABL despite the valuation.
“We believe that EABL is somewhat expensive at the current price of Ksh346 ($4.07) (as at Monday) vis-à-vis our fair value estimate of Ksh279 ($3.28) a share. In our opinion, we believe the stock is overvalued in the near term,” said Eric Munywoki, an analyst at Old Mutual.
“In EABL, investors are buying exposure to the African consumer and the anticipated growth that’s on the way. With EABL positioned across East Africa, the company‘s profile improves even further, giving investors wide geographic coverage in a region with a growing middle class,” said Mr Munywoki.
On Wednesday, following the profit warning, the EABL share shed 4 per cent of its value to close at Ksh335 ($3.8) from Ksh349 ($4.07) on Tuesday.
The going may get tougher for EABL. For example, in Kenya, the beer industry is set for a fresh round of shake-ups following the passage of new laws that ban the use of sports to advertise alcoholic products. Again, the Alcoholic Drinks Control (Amendment) Bill 2012, which is now awaiting presidential assent, proposes a levy (treatment and rehabilitation levy) of not less than 2 per cent on the manufacturing or import price of alcohol to support the rehabilitation of alcoholics.
In the year ended June 2012, the brewer’s finance cost jumped 17 times, rising from Ksh272 million ($3.1 million) to Ksh4.5 billion ($51.72 million) on account of a Ksh19.46 billion ($231.1 million) loan from the parent company Diageo to pay for a buyout of SABMiller from KBL.
Thus, considering that the 2012 finance cost covered only a fraction of the year, the costs are expected to rise significantly this year.
“The interest rate charges for the year ended June 30, 2013 cover a full year (12 months of trading) compared with the borrowing for the year ended June 30, 2012 which covered only seven months,” said the EABL board.
The finance costs could rise further, considering that though yields on the 364-day Treasury bills have been on a downward trend over the past year, the rates have jumped from 8.5 per cent to 9.9 per cent over the past month, with expectation being they will continue rising, the country’s inflation rate having jumped by its highest margin in two years to a new 12-month high of 6.02 per cent.
This is likely to pile pressure on firms seeking funds for growth and those holding big loans.
“We expect the rates to trend higher to about 12-13 per cent. But if the planned Eurobond is delayed and the government gives in to demands from the civil service, the rates could rise even further as the government would be forced to borrow more from the local market,” said a bond dealer at a local bank, who preferred anonymity.
Analysts say that though the Diageo loan could continue to put pressure on EABL, it is highly flexible: “It’s from the parent and they can reschedule the payments,” said Kuria Kamau, a research analyst at Kestrel Capital.
In its annual report for the period ended June 2012, EABL disclosed that it made a gain of Ksh3.64 billion ($43.1 million) on the disposal of 58.98 million TBL shares but this gain will not be in this year’s results.
Competition has also been heating up. In Kenya, the country’s second largest brewer, Keroche, is expected to launch a $29 million upgrade of its brewery, which it says will increase its capacity by 10 times, from 60,000 bottles a day to about 600,000.
“Whether they pose a real threat, though, remains to be seen,” said analysts at Old Mutual in a research note.
In Uganda, SABMiller has outlined a capital expenditure worth $150 million on its East African subsidiaries in the next two-three years ($70 million on its Ugandan subsidiary — Nile Breweries and $80 million on Tanzania Breweries plants in Arusha, Mwanza and Mbeya).
In Kenya, SABMiller has been stepping up its presence after it purchased Crown Beverages, taking control of family-owned Crown Foods, the bottlers of Keringet drinking water.
Standard Investment Bank analysts reckon that the battle among brewers could shift to the spirits market as Distell—which is 29 per cent owned by SABMiller— is expected to acquire the government’s majority stake in Kenya Wine agencies.
“Tying in the association between Distell and SABMiller and the move by Distell to set up its own operation to manage distribution and marketing appears like the start of a grand assault on EABL,” said Standard Investment Bank.
The region has also seen the entry of a host of spirit and beer makers, with Heineken establishing a regional office to drive sales. Representatives of Cognac and Blue Moon vodka have also set shop in the country.
Even as regional companies worry about competition, the increasing excise duty poses a challenge for breweries.
For example, in Kenya, remission on keg beer was reduced to 50 per cent from 100 per cent. EABL will now pay excise duty of Ksh35 for every litre of keg — which is half of what other beers pay.
“Volumes are expected to slow significantly for Senator Keg, which targets consumers transiting from the informal market (the informal market accounts for close to half of the Kenyan beer market),” said analysts at Standard Investment bank.
In Tanzania, authorities raised excise duty on beer by 10 per cent compared with 25 per cent last year.
“The majority of our brands were negatively affected by this significant increase in excise and resultant selling prices,” said TBL, adding that Tanzania Distilleries Ltd, another of its subsidiaries, continued to perform well with good volume and earnings growth recorded during the year.
TBL posted Tsh177.12 billion ($109.3 million) profit after-tax during the 12-month period ended March, a six per cent increase when compared with the Tsh166.41 billion ($102.7 million) posted over the 12-month period ended March 2012.
By David Mugwe and Peterson Thiong’o