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QUALIPORT
By
Carburton Street, London -- Warren Buffett rarely buys into non-US companies. Yet two years ago, he bought a stake in Allied Domecq (LSE: ALLD), the British-based drinks company. Is it a case of "if it's good enough for Buffett, it's good enough for the Qualiport?" No big bold bet First of all, we aren't talking big bold bets with Buffett's Allied investment. His investment vehicle, Berkshire Hathaway (NYSE: BRK.A), owns just 3.15% of the company. With Allied's shares at 424p, the stake is worth "just" £140m. In relation to Buffett's other multi-billion investments, his Allied share certificate represents mere loose change. That said, Buffett hasn't done too badly. Since his purchase, the shares have increased 50%. The business Capitalised at £4.5b, Allied Domecq is a FTSE 100 constituent. Its business can be split into two parts -- Spirits and Wines, and Quick Service Restaurants. Famous names in Allied's drinks cabinet include Ballatine's scotch whisky, Beefeater gin, Tequila Sauza, coffee liqueur Tia Maria and Harvey's Bristol Cream. Those and other tipples contribute around 85% to group revenues and profits. The balance is generated by Allied's franchising of Dunkin' Donuts coffee outlets, Baskin-Robbins ice cream parlours and Togo sandwich bars. It's quite easy to see Allied's long-term investment attraction -- a solid collection of established premium beverages helped along by steady franchisee royalty income. All in all, a simple-to-understand business, with plenty of recognised brand names to help form a competitive advantage. A classic Buffett-type company, although Allied is by no means in the same league as Coca Cola (NYSE: KO.)! The disposals One very attractive feature of Allied is its past transformation. Rather than continuing a merger and acquisition strategy that other consumer goods companies appear to be hooked on, Allied has instead disposed of many lower return businesses. Since 1996, Allied's brewing interests, food manufacturing operations, off licences and numerous pub chains have all been sold. Around £4b was raised, the money either going direct to shareholders or reducing debt. In general, disposals have two shareholder attractions. Firstly, they create that most welcome of company assets, a large injection of cash. But more importantly for long-term investors, they create a more focused and easier-to-manage business. Fewer products mean less opportunity for operational hiccups. Allied's management now have to widen their competitive moat on just the drinks and fast-food operations, and not worry about competitors in brewing, pubs and so on. The financials All the corporate re-jigging has left Allied a somewhat opaque financial record. 1996 1997 1998 1999 2000
Turnover
Continuing (£m) 2,623 2,506 2,398 2,408 2,602
Discontinued (£m) 2,747 1,943 1,910 1,695 30
Total (£m) 5,370 4,449 4,308 4,103 2,632
Operating Profit
Continuing (£m) 427 421 427 430 487
Discontinued (£m) 302 294 294 241 13
Total (£m) 729 715 721 671 500
Earnings per share* (p) 13.3 18.7 20.8 24.2 27.4
(* for continuing operations, adjusted for goodwill and exceptional items)
Overall turnover from continuing operations (drinks and fast food restaurants) has been largely flat, although the record is clouded by a rationalisation of alcoholic brands. Turnover growth of Allied's core sprits and wines has averaged around 5% per annum over the past five years. On the restaurant side, Dunkin' Donuts has been the outperformer, with Allied's franchisees recording annual like-for-like sales growth of between 6 and 10% since 1996. And with margin improvements driving profits forward too, operating margins are now at a juicy 18.7% level.
The slimming down of Allied has made for a far less capital-intensive business. While total sales have reduced from £5.3b to £2.6b since 1996, tangible fixed assets have shrunk from £2.8b to £0.5b over the same period.
Rising margins and a shrinking fixed asset base should ordinarily lead to improving returns on shareholders equity. And undoubtedly this ought to be the case at Allied. But with all the corporate activity, determining the improvement in returns is a Herculean task. So, just using the latest annual figures, Allied's return on equity comes to just 11.8%. Not a spectacular performance, given its aided by £1.2b of net debt.
Summary
Having peered through the last five Allied annual reports, it's easy to discover why Buffett's worth $30b. Two years ago, he was obviously able to dissect the long-term underlying performances of Allied's remaining businesses. Mere mortals like me, however, are only now just getting the picture.
On the face of it, Allied would seem to be an above average business. It's now marketing-led and fixed asset-light, with established brands creating high margins. But in terms of incremental returns for shareholders, the picture is hazy. Certainly Allied has become more efficient with profit reinvestment of late, but the actual level of that efficiency isn't clear. That said, the key elements that drive superior returns on equity do exist at Allied.
So, is Allied fit for the Qualiport? From this brief review, I would hesitantly say that they are, although they would certainly not be at the top of the guest list at present.
In recent months, I've visited a number of other market-leading businesses whose proven financial superiority is, unlike Allied's, quite obvious from their accounts. That niggling uncertainty, plus only a reasonable valuation (at 424p, the shares stand on a prospective price to earnings ratio of 14), prevents me from joining Buffett on the share register for the time being. In the meantime, I'll maintain a watching brief on Allied in the hope that a superior profit reinvestment performance becomes more apparent.
More: I'll Drink To That -- Allied Domecq's interim results
Allied Domecq discussion board