QUALIPORT
Allied Domecq: Drinks Mix Creates Financial Haze

By Maynard Paton (TMFMayn)
November 1, 2001

Carburton Street, London -- Qualiport watch list member Allied Domecq (LSE: ALLD) published its full-year numbers on Tuesday. While Warren Buffett may have sold his Allied shares, the company's products remain as attractive as ever. But following the group's transformation over the past few years, coupled with some recent acquisitions, getting an accurate handle on Allied's financial performance remains a difficult task.

Drinks cabinet

Capitalised at £3.7b, Allied is one of the world's leading drinks companies. Famous names in Allied's cabinet include Ballatine's scotch whisky, Beefeater gin, Tequila Sauza, coffee liqueur Tia Maria and Harvey's Bristol Cream. Those and other tipples generate nearly 90% of group revenues and profits. The balance is generated by Allied's franchising of Dunkin' Donuts, Baskin-Robbins and Togo food outlets.

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 notable feature concerning Allied has been its past transformation. Since 1996, the group's dowdy brewing, food manufacturing, off licence and pub businesses have all been sold off, leaving Allied to focus on its attractive stable of branded drinks. However, the disposals have left a somewhat complex financial record.

To August 31st            1997    1998    1999    2000    2001

 Turnover

   Continuing (£m)       2,506   2,398   2,408   2,602   2,879
   Discontinued (£m)     1,943   1,910   1,695      30       0
   Total (£m)            4,449   4,308   4,103   2,632   2,878

 Trading Profit

   Continuing (£m)         421     427     430     487     543
   Discontinued (£m)       294     294     241      13       0
   Total (£m)              715     721     671     500     521

 Earnings per share* (p)  18.7    20.8    24.2    27.4    31.0  

(* for continuing operations, adjusted for goodwill and exceptional items) 

Key features

The key features of Allied's latest annual results were:

* Turnover improving 11% to £2,879m and trading profit rising 11% to £543m. The performance was underpinned by higher pricing of spirits and a 4% increase in wine volumes. Dunkin' Donuts was the highlight of the fast food division; it registered like-for-like sales growth of 7%;

* The purchase of GH Mumm and Perriet-Jouiet champagne businesses, and an assortment of smaller wine companies, for a total of £455m (including debt). Annoyingly, Allied haven't detailed their contribution in the latest results. However, exceptional items, which I assume to be related to the purchases, were limited to just £9m over the twelve months, and;

* Following all the corporate activity, net debt increased from £1.25b to £1.85b. However, gross interest cover remains around a reasonable 5.7 level.

Cash flow

After two years of concentrating on its alcohol and restaurant businesses, Allied's cash flow profile is beginning to take shape.

To August 31st                    2000        2001

Operating Profit (£m)              477         521

Change in
working capital (£m)              (101)       (170)

Net capital expenditure (£m)        28         (96)
Depreciation (£m)                   51          56

In general, Allied doesn't seem to be too hungry for working capital or fixed assets. The depreciation charge also appears to be a rough proxy for fixed asset expenditure, although a net £28m was received during 2000 after the disposal of the remaining non-core assets.

As before, with all the ongoing corporate activity, determining any accurate incremental return on equity performance is a thankless task. Using the latest annual figures, Allied's traditional return on equity performance comes to just 12.4%. That's a bit better than last year's 11.8% figure, but still not spectacular given it's aided by £1.85b of net debt.

Peers

While a clear incremental return on equity performance won't be evident for some time, it's worth comparing Allied against a handful of its peers on two key profitability drivers: returns on sales and return on fixed assets.

Company               Operating   Operating   Operating Profit/
                       Profit      Margin       Fixed Assets
                        (£m)         (%)          

Allied Domecq            521        18.1            0.81  
Cadbury Schweppes        778        17.0            0.71
Diageo                 2,128        16.6            0.68
Imperial Tobacco         559        10.7            3.09
Reckitt & Benckiser      455        14.2            0.87
Unilever               3,563        12.0            0.61

The table suggests Allied to be one of the more financially efficient of the six branded consumer goods companies, although Qualiport watch list firm Imperial Tobacco (LSE: IMT) takes some beating. (In the table, the tobacco firm's margins are stated gross of government duty. Excluding that, Imperial's operating margin comes to well over 40%).

Spending spree

Apart from the cloudy historical picture, the main problem for prospective Allied investors concerns the company's acquisition spree. As mentioned earlier, the resulting benefits from the recent purchases are unclear. And since the end of August, Allied have also bought the following:

Company             Product           Purchase Price

Kuemmerling         German spirits        £128m
Bodegas Y Bedibas*  Spanish wine          £174m
Montana             New Zealand wine      £313m

(*pending shareholder approval)

Summary

Overall, I consider Allied to be one of the more attractive branded consumer goods companies on the stock market. That said, prospective Allied investors are now suffering the same old problem that dogs all these types of businesses -- constant corporate activity that muddies the accounts. While the focus on spirits and wines is commendable, Allied's rapid string of acquisitions needs to be monitored.

After adjusting Allied's £453m pre-tax profit by replacing the depreciation charge with net capital expenditure, applying the company's 25% tax rate on the resultant figure, and then subtracting £13m of minority interests, Allied's historic free cash flow comes to 27.8p per share. With a share price of 349p, that equates to a free cash flow yield of 8.0%.

While the shares look very attractive at the moment, any Allied investment must assume the cash currently being spent on acquisitions will generate decent returns for shareholders in the future. That's far from clear at the moment. And unfortunately, there's no past record to give the management the benefit of the doubt.

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