It's Foster's For Growth, Mate

Over the past decade, the plain-spoken president and CEO of Australia's $5.2 billion Foster's Group, E.T. (Ted) Kunkel, has been a force in the global alcoholic-beverage scene. The New Zealand-born Kunkel began his career in 1968 at Carlton & United Breweries (now Foster's CUB unit) as an assistant brewer and moved to senior posts at Canada's Carling O'Keefe Breweries and Molson Breweries before returning to Foster's in 1992 as president and CEO. At the time, the brewer was floundering under a mountain of debt accumulated during the 1980s, but 59-year-old Kunkel quickly went to work. He shed $5 billion in assets to strengthen Foster's balance sheet, revved up Foster's Lager as an engine of international growth, and deepened the brewer's involvement in the faster-growing wine business -- just when Australian wines were winning unprecedented international credibility. Kunkel's crowning achievement, though, was the October, 2000, acquisition of the 124-year-old California winemaker Beringer Wine Estates for $2.8 billion. He quickly melded Beringer with Foster's existing wine division, Meldara Blass, to form Beringer Blass Wine Estates, which has a huge footprint in the fast-growing "new world" wine market that has so successfully challenged the established European vintners. On the beer front, Foster's has fared well lately in its home market, with brands like Victoria Bitter, Carlton Draught, and Crown Lager harvesting the biggest part of the industry's growth, outpacing rival Lion Nathan. Internationally, Foster's Group has ridden Foster's Lager to growth in more than 150 countries, tying the brand identity to bold Outback imagery and Formula One auto-racing sponsorships. In both beer and wine, Kunkel has sought to grow at the premium end of the business, a strategy that has allowed Foster's Group to maintain its strong performance even in an uncertain environment. During a recent U.S. visit to talk to analysts and investors, Kunkel stopped by BusinessWeek's New York offices to chat about Foster's prospects with Marketing editor Gerry Khermouch. Following are edited excerpts from the discussion: Q: There's been ample speculation about when, if ever, you'll step down from the company. You've built a strong team, with several executives viewed as having the potential to run Foster's. So how will you decide when it's the right time to step down? A: Look, I'm solidly in the chair. There's no short-term changes contemplated at Foster's. But the board clearly believes that an orderly changeover is exactly the right thing to plan. And the changes to our senior management lineup at the end of last year [gave] a number of our people...opportunities to show their wares. I'm sure that at the appropriate time the board will make their choice. Boards always have the ability to look outside as well as inside. But I'm not privy to what their choice will be. Q: Is there any overriding objective you really want to try to achieve before you think of moving on? A: If I look at the company today in terms of its absolute positioning in premium brands globally, compared to where we came from in the early '90s, you'd have to say that we've reached a position -- particularly with our premiums, our financial strength, and our critical mass -- where another sort of large transaction is not imperative any more. We have scale in beer and in wine. We can grow very well organically. At the end of the day I think every CEO has to look at the company and ask: Is it in better shape when he leaves it than when he came into it? And are you leaving behind the people that can do the job? Are you leaving more doors ajar that the next leader can take the company through? I'm [confident in my answers to those questions.] Q: Southcorp has experienced considerable disarray this year, prompting speculation that you or a global rival -- Allied Domecq has been mentioned -- might be tempted to make a run at acquiring it. Is that an opportunity you are considering? A: The bulk of our acquisitions have been aimed primarily at increasing the returns of the business, because that's the only true measure of shareholder value. We've been able to do them in small bites -- anything up to A$100 million [about $60 million]. Not only that, I've actually filled strategic needs as well -- [for instance] Castello di Gabbiano, filling a gap that we had [for Tuscan wines]. So we've been very strategically targeted as well in our bolt-on acquisitions. You ask about Southcorp. First of all, I think in any large acquisition, you have to decide whether it's strategically right for you, then is it financially right for your shareholders? I've had no indication whatsoever from the board of Southcorp that they're considering anything other than appointing a new chief executive and getting on with life. Q: One distinction I often hear is that you've managed to play at the middle tier and high end in wine, while Southcorp has been a little more at margin risk because they've played a little further down the scale. So it would seem not to make strategic sense for you to get involved with Southcorp. A: Our premium position certainly didn't happen by accident. We've been semi-immune from the sort of wholesale discounting that you've seen. I'm not saying for a moment that we're totally immune to it. But it's a matter of your brand power, maintaining your brand equity, and your brand equity maintaining margins. Q: How do you see the outlook for wine? A: The question that demands an answer is: Have you lost your confidence in premium wine? And the answer is clearly no. People have got the idea that [the market] is sort of imploding. I think the business has actually stood up pretty well [despite the current macroeconomic situation]. Q: My sense is that the market at times has penalized Foster's Group shares for mixing wine and beer rather than being a pure play one way or the other. Has that been a source of frustration to you? A: Well, the market is the market now. And I've been speaking to the market for over a week. It just seems to be a crisis of confidence. It's almost too hard to look two or three years out when two or three months is the horizon. We had a very deliberate strategy when we got into wine that we would use the cash flow for beer. We actually took the cash flow from beer and put together an accelerated entry into the premium-wine business that arguably has given us the No. 1 or No. 2 position in the world. That wine business -- I can't stress enough how this differentiates us from our peers -- is actually cash-producing, so we've ended up with a business today that's generating greater than $1 billion, over half of that in operating cash. That's a tremendously strong company. And I think those fundamentals will be recognized. What they probably question more in this market is the pieces hanging on the side: Do you really need your pubs business, your property business? Those are always the sort of strategic questions that any company should ask itself. We always do that, but the answer right now is that we think we've got the best mix currently for cash and returns and growth in this particular marketplace. Q: On the beer side, you seem to have fared well against rival Lion Nathan with your move into the premium tier -- what we in the U.S. call superpremium. What are the components of that strategy? A: We never let our costs increase at inflation. When you've got $1.1 billion of cost, if you can save a little bit on the inflation, that's fine. And if [revenues] can keep pace with inflation, you're getting a little bit of a break there. Then you add this phenomenon that has been happening in Australia where people are drinking up, moving away from a pub and club culture to [more upscale] seaside restaurants and bars. [People at] those venues are much more likely to drink a premium beer. Our normalized share in Australia is 55%. But our share of the premium segment -- which is growing strongly at about 10% a year -- is probably somewhere between 65% and 70%. And so you get a lovely skew as that grows. Q: Foster's Lager is almost a negligible part of your domestic beer portfolio, yet it has been a powerhouse of global growth for you. What's that brand's role? A: We sell as much Foster's outside of Australia as we sell of every brand inside Australia -- 100 million cases in each part. But [you have to] do the research and choose the brand that will service you. We had a real conundrum in the early days, because our large brand in Australia was actually Victoria Bitter. But a bitter in Britain is a black beer, so we couldn't take it to Britian and have any credibility. [But research showed that we'd have a good chance with] Foster's Lager, and that's why in the last 30 years we've grown Foster's into one of the most successful international beer brands in the world. If you have a look at Foster's International today, which is responsible for the Foster's brand -- basically all the brewing assets outside of Australia, including the stewardship of the Foster's brand around the world -- they have very little capital employed and make $30 million-odd a year in royalties, which has been growing at double digits. So the return on that virtual business is extremely, extremely high. Q: What about flavored alcoholic beverages? Brands like Smirnoff Ice certainly have been a phenomenon, though they may have peaked by now. You have Sub Zero and spirits brands that could be used for other entries. How do you participate adequately in this segment without overcommitting to what could be a fad? A: We bought a company [last May] called BCB Beverages that gave us a low-cost production capability for the ready-to-drink businesses in Australia, which is where we wanted to be a part of that segment. I can't see us being a part of it outside Australia. We didn't particularly want to [enter the segment at all,] but it was defensive as far as we were concerned, in terms of whether it was going to chew up the beer market. So we're into that market at the level that we feel we need to be