Foster's Australian dollar ache

The Foster's de-merger of its beer and wine businesses is a complex and, given the presence of circling predators, delicate affair. The soaring Australian dollar adds another layer of complications on both the practical and strategic fronts.

When Foster's presented its results in August the presentation pack included a slide showing it's the sensitivity of its earnings to currency fluctuations.

A 13.1 cent appreciation in the Australian dollar against the US dollar in 2009-10, from US75.04 cents to US88.14 cents, wiped $61 million off the earnings before interest, tax and the accounting treatment for inventories (EBITS) of its wine division and a 9.5p strengthening of the dollar against the British pound, from 46.23p to 55.79p, a further $57.3 million. That's an indication of just how significantly the division's performance can be impact by exchange rates.

Interestingly, at a group level, the impact was more muted, with the net effect costing Foster's $85.2 million. That's probably because most of its borrowings – about $US1.6 billion of the $A2.5 billion – are denominated in US dollars.

Foster's also provided indicative sensitivities for its exposures to the US dollar and pound this financial year. Each 1 cent movement in the AUD/USD relationship would affect wine EBITS by $A4.5 and group earnings by $1.9 million. A 1p movement in the AUD/GBP relationship equated to a $A5 million impact on wine division earnings and a $A4.9 million impact on the group result.

Since the start of this financial year, of course, the dollar has strengthened further against both currencies, rising about 10 cents against the US dollar and buying about 5p more today than it did at 30 June.

If those relativities were to hold – and the probability is that there will be further appreciation – it would knock about $70 million off the wine division earnings. The impact on the group overall would be about $45 million.

Foster's is working towards a demerger of the beer and wine businesses next year in the knowledge that the separation of the prized beer division and unloved wine business (rebadged Treasury Estates) may attract trade buyers previously deterred by the combination.

Indeed, to the market's surprise, Foster's revealed last month that it had already received one approach from private equity – for the wine business. The indicative and non-binding offer, which was instantly rejected, was worth between $2.3 billion and $2.7 billion. The division has a heavily written down book value of $3.2 billion.

The challenge the strength of the Australia dollar poses for Foster's is that, if sustained, it will significantly reduce the reported earnings of its US wine businesses and its Australian wine exports, devaluing them in the eyes of its primarily Australian investors.

Given that potential trade buyers for Treasury Estates are almost inevitably going to be foreign – probably North American private equity funds – however, the value of the business to them isn't affected by movements in the Australian dollar. They'll fund an acquisition in mainly US dollars.

If the private equity groups return, Foster's will have to convince its shareholders to see the value of Treasury Estates through American eyes if it is to maximise its value and avoid the market simply reducing its valuation by $600 million or $700 million by capitalising the Australian dollar version of its earnings.

Normally, the apparent loss of value caused by the strength of the dollar would be mitigated by its impact on Foster's borrowings. With $US1.6 billion of US dollar borrowings, the exchange rate would reduce that by about $200 million when expressed in Australian dollars at today's exchange rate.

Foster's, however, plans to leave the bulk of its debt next to the beer business, which generates very strong and stable cash flows, which means that the impact of the strong dollar on Treasury Estates' profitability will appear more exaggerated that it would if it were more leveraged with US debt.

For the group overall, the benefit of swapping the US dollar debt into local currency means that there will be less debt to refinance and the cost of swapping it will be lower than it might have been.

The "upside" in the currency movements, apart from their impact on the group's borrowings, is that the Carlton & United Breweries business isn't materially adversely affected, although it does generate income from licensing or exporting its beer brands offshore.

All the likely predators for that business – the big global beer groups – are, however, based offshore and, for them, the cost of acquiring CUB has risen very significantly over the course of this year and is likely to increase further if, as most expect, the Australian dollar breaks through parity in the not-too-distant future.

Given that CUB, while it remains highly profitable, operates within a tough, mature, no-growth market, that could provide some protection against the giant brewing groups that have been pursuing opportunities in developing and higher-growth markets.