Chavez, Gertrude, Global Finance
Profits plummeting, Asia's San Miguel restructures at home and looks to investments abroad to pay off down the road.
How do you get from here to there? That's the problem facing one of Asia's largest and oldest companies, beer and food producer San Miguel. The 107-year-old Philippine company, with $1.2 billion in market cap and $2.4 billion in sales, has been suffering a contraction in its primary domestic businesses for the past three years. Because of the region's economic downturn, demand will probably slump further before it recovers. An ambitious capital expansion program is weighing it down with overcapacity. At the same time, the overseas operations launched over the past seven years won't be profitable until 2000.
"I think over the next 6-12 months the company will be much more fundamental," says Alberto de Larrazabal, San Miguel senior vice president for treasury. "You probably have to run things as tight as you can-defer totally unnecessary items." De Larrazabal anticipates recovery of the Philippine economy by the last quarter of 1998. Meanwhile, the company is pressing ahead on its three-year-old strategy of restructuring and cost-cutting.
The restructuring is largely focused on San Miguel's food businesses, hit in the last two years by rising raw materials prices, heightened competition, and an epidemic of hoof-and-mouth disease that has hobbled the entire meat-processing industry. San Miguel's food sector, which contributes roughly 28% of its total revenues, registered an operating loss of 120 million pesos ($3.5 million) in 1994 and 770 million pesos in 1995. Losses declined to 280 million pesos in 1996, however.
San Miguel is now deep in talks with conglomerate Ayala ($1.4 billion in market cap) on the possible merger of their processed-meat businesses into a joint venture, a move that could result in a shake-up of the industry. San Miguel currently has a 17% market share of the local processed-meat sector, third behind Swift and Vitarich. "There are areas [of the two businesses] that have excess capacities," says de Larrazabal. "The process of consolidation allows us to be much stronger, resulting in higher margins."
Tina Ibarra, analyst at SocGenCrosby UBP Securities in Manila, notes that the merger should spawn the birth of a powerful player in the processed-meat business. "Instantly, they could become the market leader. With that comes bargaining power in purchasing raw materials and in importations."
The merger talks with Ayala follow the rationalization of San Miguel's ice cream business in response to the appearance of a formidable competitor. San Miguel's Magnolia was the leading ice cream brand in the Philippines for 65 years until Selecta, produced by another Filipino company, RFM, came along and instantly grabbed market share with a host of new flavors. From a high of 80% in the 1980s, Magnolia's market share dropped to 49% in 1995.
San Miguel responded by consolidating its stakes in Nestle Philippines and Magnolia into a 45% interest in a merged company called Magnolia Nestle. This became San Miguel's sole vehicle for its ice cream and packaged pasteurized milk business, creating economies of scale and improving operating margins.
San Miguel also refocused its processed-food strategy by phasing out its Instafood (ready-to-eat meals) business, where competion was shrinking margins, and instead devoted resources to the processed-meat line. It also curtailed its shrimp farming operations, which had a limited market and thinning profit potential. All told, the restructuring has cut fixed costs in the food division by 12% since 1995.
The company's domestic beer business, 32% of revenues, is a different story. Here, where sales have also been sliding, San Miguel has focused on strengthening distribution and enhancing cost efficiencies. According to Jose Salceda, former research director at SBC Warburg, San Miguel has developed a "very efficient distribution machine that is perhaps second only to the national police or the armed forces." The company is also one of the lowest-cost producers of beer in the world. Cash production cost is estimated at $0.25 per liter. This translates into $0.08 to process and package one 320-ml bottle-a gross cash profit of 43% despite recent raw material price hikes in malt and packaging.
Yet even with remarkable efficiencies, San Miguel is facing a dead end in the Philippine beer market, given an already mature market and new competition. Moreover, some of its efforts to stem the tide have proved less than adroit. Moving to head off a perceived threat from Heineken and other imports-still only one-tenth of 1% of the market-the company launched a raft of upscale brands that ended up competing against one another. The real threat comes in the low end of the market, chiefly from Asia Brewery, established in 1982 and owned by Chinese-Filipino tobacco tycoon Lucio Tan. (San Miguel's founding family, the Sorianos, are of Spanish-American descent. They own just 2% of the stock, but family scion Andres Soriano III is chairman and CEO.)
In 1990 Asia Brewery had a mere 5% share of the market. San Miguel had 86%. But through aggressive pricing, Asia Brewery has gained steadily, rising to a 21% market share at the end of 1996, while San Miguel's share declined to 79%. Asia Brewery has built a stronghold in financially poor but congested areas. It was the first to establish a brewery in Mindanao back in 1990 when no company was investing in that island. San Miguel's fall in market share is compounded by an industrywide drop in beer sales due to higher taxes, which the government began imposing in 1990. The more expensive the beer, the heavier the tax. To compensate, San Miguel raised the price of its Pale Pilsen from 9.50 pesos to 10.50 pesos on March 3, only to be forced to roll it back to 9 pesos in June as sales dropped 24%. So far, the effect of the price cut has been positive, but it may be only a temporary solution. Says John Zarate, analyst at Vickers Ballas Securities: "Future price increases cannot be exactly ruled out. The increase in volume is not enough to offset the expected decline in income as result of the price rollback."
Still, even with a slightly smaller share, San Miguel might have expected its beer sales generally to increase with population growth, about 2.3% per year, and rising per capita income, up about 12% annually since 1992. Indeed, SBC Warburg estimated this would translate into an additional 550,000 beer consumers per year. To be ready for them, the company undertook over the past five years a $2.2 billion expansion program, of which 65% was for the domestic beer business. That created substantial overcapacity-35% for beer alone in 1995-1996-pulling down profitability through higher depreciation and interest expenses. This year overcapacity is 60-70%. The additional beer drinkers may begin to materialize next year, but current economic conditions suggest that high overcapacity will continue to be a burden on profits.
From a 40% net profit increase in 1994, San Miguel's profit growth contracted to 10%, or 5.4 billion pesos, in 1995, before slipping to 5.2 billion pesos last year. This year, most analysts estimate net profit will dip another 20-25%, due in part to a 31% depreciation of the peso in the third quarter and higher interest rates, which are expected to squeeze margins and jack up costs of production.
"I already see higher costs filtering into the market," says de Larrazabal, who adds, however, that the higher cost in pesos of its $120 million in imports will be largely offset by softer prices in sugar and corn. "The biggest effect of the currency crisis will be on consumer demand," he says. Apart from the five breweries it owns in the Philippines, San Miguel operates seven others across Asia-three in mainland China and one each in Hongkong, Indonesia, Vietnam, and Nepal. It also owns glass and packaging facilities in China. Although it has been producing and marketing beer for the past 50 years in Hongkong, the company decided to push aggressively overseas only in 1990, and each of the other operations is still in build-up phase. International revenues, targeted to bring in 30% of total sales when overseas operations are fully onstream, now amount to only 12-13%, and that includes exports to the region and to the United States.
Analysts estimate that San Miguel could start breaking even by late 1999 and make a 550 million peso profit by 2000. But that may be overly optimistic. Losses from international beer hit 650 million pesos in 1996 and 480 million pesos in the first half of 1997 due to higher advertising and depreciation costs in connection with start-up operations in Indonesia. Analysts have forecast losses to total 1 billion to 1.4 billion pesos over the three years ending with 1999.
The company has also taken flak from some analysts on its other major international venture: the swap this year of its 70% stake in the largest Philippine bottler of Coke in return for a 25% stake in Australian bottler Coca-Cola Amatil, one of the largest bottlers outside the United States.
Alex Pomento, research head of Merrill Lynch Philippines, says that by selling Coke Philippines, San Miguel practically gave away its cash cow, which contributed 40% of the company's operating income. Unlike San Miguel's beer business, Coke Philippines, with a 75% market share, had managed to ride the wave of rising income, accelerating job growth, and an expanding middle class.
In terms of operations, the Philippine bottler bettered Amatil in almost all areas in 1996-eamings of $128 million versus $114 million, return on equity of 20% as against 8% over the last three years, and operating margins of 19.4%, compared with 8.6%.
But not everyone is negative on the Coke swap. Vickers's Zarate thinks the whole deal will be a "long-term positive" for San Miguel, expanding the geographical portfolio of its soft-drink business. Among Amatil's positives are a market capitalization of $5 billion and compounded annual growth rates of 22% in revenues and 16% in earnings, due to aggressive acquisitions. In the past four years, the Australian company has spent more than US$800 million for acquisitions and US$600 million to build a solid soft-drink infrastructure.
The long term is largely what the company is banking on in all its businesses-that and the prospect of lower capital expenditures beginning in 1998. Since major capacities have already been installed in the Philippines and overseas, capital spending is expected to decrease to about 5 billion pesos annually, freeing at least 13 billion pesos over the next two years to cut debt and reduce financing charges.
"It takes great faith to invest in San Miguel these days," says Anna Candelaria, an analyst at Eastern Securities in Manila.…
Questia, a part of Gale, Cengage Learning. www.questia.com
Publication information: Article title: Getting There. Contributors: Chavez, Gertrude - Author. Magazine title: Global Finance. Volume: 11. Issue: 11 Publication date: November 1997. Page number: 47+. © Global Finance Media Inc. Feb 2009. Provided by ProQuest LLC. All Rights Reserved.
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