FREE KIC - NO. 12 SEPTEMBER 06

MAGNERS MAGIC

 On September 14th I went on a trip to see the Bulmers (Magners) factory in Clonmel. I really love this part of my work because I have this nerdish love of trying to understand the dynamics of a real business and the people making the decisions. You can imagine my delight walking around the apple cleaning, crushing, bottling and warehousing facilities and then sitting down to lunch with Maurice Pratt (CEO of parent company C&C and former Quinnsworth marketing guru!) This was my first time to really have a chance to chat with Maurice because there was only one other Danish fund manager at our table and boy did I enjoy lunch (even though I didn’t try the apple soup on offer!)
  Before I tell you about what I learned on the visit I would like to take you back a stage to give you a bit of background on C&C and my interest in it.
  I have been following the C&C story since it attempted to float on the stock exchange back in 2002. At that time the venture capital owners failed to sell/ float the company because the stock market was going through its post technology bubble burst and the company was seen as a stagnant beverages company. I remember the discussion we had in Setanta at the time trying to work out at what price we would participate. The consensus was that this company had to be really cheap in order to get us interested. Nobody at the discussion suggested that this could be a great growth story.
 Having failed to sell at the first attempt they finally managed to come back to the market in 2004. The Setanta consensus at the time was that this was a share only suitable to a high yield fund because it had a 5% dividend yield. As one member of the team stated “I drank Bulmers and ate Tayto when I was a teenager” suggesting that these were unfashionable brands.

Passing the test of time


 Up until this point my opinion pieces have never really touched on what it is I look for when investing in a share and I do not intend to go into detail here but I want to highlight that when I saw a dividend yield of 5% it made me interested. At the time the best an investor could achieve risk free was less than 4% in Euro government bonds so C&C was offering a return higher than what I could get risk free (if the share price stayed unchanged). In addition to the high yield the company was generating a lot of free cash flow. (I will return to this in another opinion piece but I have sort of touched on it in my opinion pieces on Japan because part of the reason why I am confused about Japan is that I do not think there will be a lot of free cash flow from Japanese companies). The good free cash flow in C&C made me feel that the dividend was secure and could possibly grow.

  In September 2004 I took redundancy from Setanta and I had a bit of time to decide where to invest my redundancy money. I decided to do more work on C&C. One of the first pieces of research I read at the time was written by one of the leading Irish stockbrokers and I have kept it to this day so that I can look back at what was said. At this stage the share price had risen by about 10% from its original issue price and the yield was below 5% but still at an interesting 4.5%.

 At the time I read this I remember thinking to myself that here is a company that is managing to still grow Bulmers in the Irish market and at the same time grow Magners in Scotland and Northern Ireland with “nothing built into the current share price” for growing in the rest of the UK. I liked the way the Bulmers brand had been repositioned in Ireland but was unsure as to how well the Magners brand could be established in the UK. I knew that at the end of the day this was a story based on an intangible asset called a brand with very little in the way of tangible assets backing the share price.

 Now I have to admit that I did not foresee what was about to happen. I have to admit that when I bought shares at €2.58 in Nov 04 I thought I was buying into a moderate growth story with a risk that the expansion in the UK might not work and that management could waste some of their free cash on a big advertising campaign.
 I was delighted with myself as the share price quickly went through €3 as Magners began to sell reasonably well in London.
 In July 2005 when I received authorisation from the Financial Regulator to set up  my own business, part of me wondered whether the easy money had already been achieved when I recommended to a client that they buy at €3.77. I am delighted to report that they did buy.

  I wasn’t the only analyst underestimating just how successful Magners was becoming in the UK. The following chart highlights just how wrong another analyst was. This chart shows the actual share price of C&C and also shows the analysts target price over time. As you can see he has consistently had to increase his target price as the success story continued. This analyst would be typical of all analysts. 

graph

 Having taken you through the history of C&C / Bulmers / Magners It brings us up to the current day and brings me back to the most difficult issue of all – is C&C still a buy at €10?

 This brings me back to my visit to the factory and the issues that were discussed with management.
Brendan McGuinness the CEO of Bulmers gave a presentation that concentrated on their new investment plan. He said that they were capacity constrained during the summer months and that this highlights the fact that management have been “pleasantly surprised” by the rapid growth they have achieved in the UK market. In fact reading between the lines I think that they have been stunned by the speed of their own success. They may have thought that on a 5year view they could get where they are now but they certainly did not anticipate what happened this summer. Having been caught on the hop they are now going to make sure that they add a significant amount of capacity. They even went as far as to highlight that they are even thinking beyond this expansion phase by showing where they have room on the site to build even more capacity.
  The current expansion will take them to a capacity of 500m litres. Their current capacity is about 200m litres. When you think that last year they sold just over 70m litres in Ireland and about 30m litres outside Ireland you can see why they may have thought that they still had plenty of capacity.
 The management presentation did not give estimates for sales going out over the next few years. All they did was highlight that they intend to have plenty of capacity.

  The next stage of the presentation concentrated on how they intend to try and sell that capacity. Maurice Breen the Marketing Director went through the advertising campaign and other marketing initiatives like sponsoring the Magners League (formerly the Celtic League) and Wasps rugby club.
 In my opinion this was the most important presentation because at the end of the day this is essentially an exercise in branding and I believe that they continue to do a fantastic job in terms of creating momentum behind the Magners brand.
 During the coffee break I was talking to Brendan McGuiness about the music they use in their advertising campaign because I think that this has been one of the really brilliant aspects of what they have done and he pointed out that his kids really like it and that it has resulted in re-releases for some of the music they have used.
  I think that they are getting the brand right and that is why I called this opinion piece “Magners Magic”. I think that the analyst community may still be underestimating just how big this brand might be.

 As recently as August 18th one leading stockbroker had the following estimates for Magners in Great Britain

Feb   06 07 08 09 10 11
Total on trade volume (m litres) 20.2 65.3 104.9 117.3 116.8 116.2
  % growth 223.2 60.7 11.9 (0.5) (0.5)
  % off / on 18 17 22 25 25 25
Total off trade volume (m litres) 3.6 11.3 22.9 29.3 29.2 29.0
  % growth 213.3 102.8 28.3 (0.5) (0.5)
Total volume (m litres) 23.8 76.6 127.8 146.7 146.0 145.2

 This broker felt that 300m litres would be enough capacity to supply the UK and Ireland out as far as 2011. The company as I mentioned before are now putting in capacity for 500m litres. I think that they will fill it but I don’t think that the analysts believe it yet because the analyst mentioned above changed his estimates on September 18th to the following

Feb   06 07 08 09 10 11
Total on trade volume (m litres) 20.2 92.3 136.9 153.2 152.5 151.7
  % growth 356.8 48.4 11.9 (0.5) (0.5)
  off % of on and off 15.1 19.7 24.1 28.6 28.6 28.6
Total off trade volume (m litres) 3.6 22.6 43.5 61.3 61.0 60.7
  % growth 528.9 92.3 40.8 (0.5) (0.5)
Total volume (m litres) 23.8 114.9 180.5 214.5 213.5 212.4

  In one month this analyst has increased his Great Britain peak demand by 68m litres thus suggesting that capacity of probably 350m litres is all that should be required. Therefore if the full capacity of 500m litres is used it will require this analyst to significantly increase his estimates.

The consensus amongst analysts is that competition is so much greater in the UK that Magners will never achieve the same dominance as Bulmers does in Ireland. This seems to make intuitive sense because the UK market is far more fragmented with leading brands like Guinness having a 6% share and Bud having a 2% share.  (Bulmers has a 10% share in Ireland.)
 If Bulmers sells 60m litres in a population of 4m people then with 60m people in the UK a rough approximation for Magners would be 900m litres (if they achieved a similar market share and if per capita consumption of alcohol is the same as Ireland.) This is a very simplistic analysis and I am not suggesting that it is likely to happen but what I would be more comfortable in saying is that I think half the level of consumption might be possible given my belief in the strength of the brand. In other words 450m litres is not out of the question. This analysis would suggest that 500m litres capacity is a prudent capacity expansion plan.
  Brendan McGuinness also mentioned that they are looking to test market Magners in another European city. He acknowledges that cider is not really understood in Europe but in many countries there is some sort of alcoholic apple drink. The Danish fund manager sitting at our lunch table said that he had brought a few bottles back to Copenhagen to try on his friends and none of them guessed that it was an apple based drink. He said that his friends seemed to enjoy it and at the end of the day people have to like the taste. Success in Europe is not discounted in the share price.


 Over lunch I talked to Maurice Pratt about the other divisions within C&C. There are some good parts and some not so good parts but at this stage in the companies development it has primarily become a cider story.

  In conclusion I just want to say that the analyst community might still be too cautious in terms of its assumptions about Magners and this makes the shares a buy.
 My final comment is that if you still have not tried a pint bottle of Bulmers/ Magners over ice you are missing out on a nice drink and as the add says “Enjoy the C&C share price sensibly” because as another add says “share prices can go down as well as up”.

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Killeevan Investment Consultants Ltd, trading as KIC, is regulated by the Central Bank as an Investment Intermediary.
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Directors: Kenneth Power (Managing) B.Comm, MBS, ASIP, Regular Member of the CFA Institute.
Siobhan Power