Annual Report 2014

GROUP CHIEF EXECUTIVE OFFICER’S REVIEW

Overview

Looking back over the past financial year, it would be fair to summarise the period as one of consolidation and integration for the overall Group. Despite the inward focus and, at times, challenging nature of introducing new businesses into the organisation, we are very pleased with our financial performance for the year, having achieved operating profit of €126.7m. This represents profit growth of 10.6% compared with the prior year and another period of delivering on our market guidance.

In the current and previous financial years, we deployed a meaningful amount of shareholder capital to a number of acquisitions and investments. In the USA, we made our first significant international cider investment by acquiring Vermont Hard Cider Company (VHCC) for $305.0m (€230.9m). In Ireland, we paid €12.4m to acquire Gleeson group, the largest distributor of packaged long alcoholic drinks (LAD) to the Irish on-trade, and refinanced its debt of €47.9m. Finally, in Scotland, we took a 50% interest in Wallaces Express, the largest wine and spirits wholesaler in the country. Since the financial year-end we have increased our ownership in Wallaces Express to 100%. The VHCC investment provides us with the opportunity to participate in US cider category growth while the Irish and Scottish investments enable us to strengthen our domestic business model in the multi beverage space. These cash deployments are in line with the Group’s long-term strategy of creating strong domestic brand market combinations to enable it to participate in international cider growth. The efforts that have gone into integrating the Vermont and Gleeson acquisitions have been demanding on internal resources, whilst still trying to run the underlying business. However, we have made excellent progress in the period and in each market have strong foundations for creating long-term shareholder value.

Review by OPERATING Segment+-

Republic of Ireland

From a macro perspective, key economic measurements appear to be improving in Ireland. The country is gently re-emerging from the shadows of recession and austerity and we believe the future trajectory is broadly positive rather than negative, albeit there may well be periods of volatility along the way.

In this financial year, our Irish business has seen volume and revenue growth for the first time in seven years with the Bulmers brand outperforming the wider LAD market. The Irish business was undoubtedly helped by a summer period of sustained warm weather although we are also starting to see the benefits of our acquisition of the Gleeson group and the impact of broader customer access.

Over the past 12 months, we have undertaken an initiative to combine our existing Republic of Ireland business with the Gleeson group to produce a single Irish business. We have consolidated our sales, marketing and distribution functions, and have combined and relocated the back office and finance functions for the new business to Belfast. At the front end, C&C now has direct access to around 7,000 on-trade outlets in the island of Ireland, from a total population of just under 10,000, as well as the ability to service all off-trade multiple and off-trade convenience stores. This will allow C&C to provide customers with a multi-beverage portfolio encompassing Bulmers, Tennent’s, AB InBev brands (for which we have the distribution rights in the Republic and Northern Ireland), Finches soft drinks, Tipperary water, as well as our owned wines and spirits brands and agency brands. The construction of a craft brewery at Clonmel will also allow us to harness the growing demand for local, Irish craft beers.

Ultimately, the ambition for our Irish business is to be the pre-eminent bonded wholesaler in the island of Ireland with enhanced customer service and geographic coverage such that we become the drinks supplier of choice to the licensed on and off-trade. This evolution in our Irish business model from a mono-branded FMCG company to a multi-beverage drinks producer and wholesaler brings stability to our earnings and cash flows whilst also positioning our Irish business with the opportunity to deliver moderate growth in what is ultimately an ex-growth alcoholic drinks market. The island of Ireland delivers approximately half of the Group’s profit and most of this converts to cash, explaining why we see the Irish business as one of the two domestic pillars of the overall Group.

Tennent’s UK

C&C’s second domestic pillar is the Tennent’s business in Scotland which, with the investment in Wallaces Express, is moving in a similar strategic direction to the Irish business.

Economically, Scotland is outperforming the rest of Great Britain in terms of GDP growth, unemployment and consumer confidence. This makes Scotland an attractive market in which to trade and explains our continued investment behind the Tennent’s business. Investment in Scotland extends beyond Wallaces Express to include direct lending to the pub trade.

In the last 12 months, within the independent free trade our total beer volumes are up 13% and volumes of Magners are up 12%. This represents an outperformance versus the overall market. The strength of our brands in Scotland combined with our customer access have allowed us to successfully introduce new products such as Caledonia Best and Heverlee, a premium imported lager proposition from Leuven, Belgium. Caledonia Best grew by 37% over the past 12 months and it has quickly become Scotland’s third largest draught ale by volume from a standing start just over two years ago. Heverlee is now sold in 262 outlets throughout Scotland and Ireland with throughputs ahead of the market leading competitor.

During the year, we continued to invest behind our brands with sponsorship of Glasgow Celtic Football Club (Magners), Glasgow Rangers Football Club (Blackthorn), T-in-the-Park, Scottish Rugby (Caledonia Best) and Tennent’s Vital.

We will continue to develop and invest behind new brands and offerings. In particular, craft brewing in Scotland is in growth and we are investing over £1 million in Drygate Brewing Company, a craft brewing facility adjacent to Wellpark brewery. This will be a joint venture with Williams Bros Brewing Company, recognised as the leading family craft brewer in Scotland, and Drygate’s management team and will be operational in May 2014.

Over time and in line with our Irish business model, the post year-end acquisition of 100% ownership of Wallaces Express will enable C&C Group to offer a portfolio of drinks to on and off-trade customers including Tennent’s, Caledonia Best, Magners, Blackthorn, Heverlee, AB InBev brands for which we have the distribution rights as well as our owned wines and spirits brands and factored brands. In Scotland, there are approximately 10,000 pub licences and, as with Ireland, the independent free trade represents the majority of these licensees. This is a channel where we have dedicated significant financial and commercial resource because, plainly, it is an important part of the Scottish alcoholic drinks sector.

Our Scottish and Irish businesses deliver over three quarters of the Group’s earnings and cash. It is important that they are stable and well invested and we believe they are set-up for moderate revenue growth over the next few years.

Cider UK

Despite improving conditions in the UK and positive forward steps in terms of economic recovery, the beer and cider market continues to be extremely competitive.

Distribution in GB is highly consolidated with a small number of retail groups holding the majority of potential distribution points in the on and off-trade retail channels. This power of the retailers is compounded by the four global brewers fighting for share of distribution in one of the world’s most competitive beer and cider markets. Ultimately, this leads to commoditisation of brands at the distribution level.

The GB cider market was in slight growth in the financial year in both volume terms and value terms (Nielsen/CGA). The on and off-trade performed slightly differently. In the on-trade volumes were down by 2%, with standard draught cider making a partial comeback and pear down by 10%, whilst flavoured ciders grew by 19%. In the off-trade there was growth for flavoured ciders, which boosted year-on-year cider volumes by 5%.

Over the past two years, a number of major cider launches have impacted C&C’s position in GB. Ultimately, the Magners brand, having been the original ‘founder’ of premium over-ice cider ten years ago, remains in good health. The brand has been historically well invested relative to its peers and a fresh new TV campaign was launched in the spring of 2013. However, for reasons mentioned previously, whilst the brand’s distribution is broadly static, wholesale pricing is coming down.

Whilst Magners is our largest brand in the UK market, it has reached a point where the operating profit generated from Magners in other markets is higher than the operating profit generated from Magners in England and Wales, which accordingly has become much less relevant in terms of the Group’s total profit. That said, Magners is still our leading international cider brand and has strong awareness – we will continue to invest behind it.

When volumes and the top-line come under pressure, a company naturally focuses on its cost base. Consequently, we have right-sized our England and Wales business which now operates out of the Shepton Mallet cider mill in Somerset. Over the past 12 months, we established the Shepton Mallet Cider Mill division with a new management team and a collaborative sales and marketing set up with Green Light Brands. The division is focused on our craft, heritage English cider brands and in particular those from the West of England. Performance in the first year looks promising and is in line with internal expectations. Our Shepton Mallet business allows us to participate in niche areas of growth such as craft and speciality ciders and play in less competitive spaces such as premium strong cider with brands like K Cider. In addition we are making steady progress with Addlestones and the English craft portfolio and new product packaging development.

We will continue to focus on pockets of the market where sustainable value is clear and we can develop a profitable business, leveraging our English cider assets.

International

The International business unit has developed from being a business reporting losses five years ago, to a business generating €16.0 million operating profit over the last 12 months.

USA

During the financial year, our business in the USA has probably experienced the greatest disruption as a consequence of business integration.

The steps towards integration were staggered based on what was most critical to continue operating. At the start of the financial year, the Magners operation based in Boston was closed and all order capture and back office functions were transferred to Vermont. This allowed the team in Vermont to immediately service wholesaler needs and orders for all of C&C’s US brands. The second step involved re-organising the sales structure to accommodate the combined sales forces from VHCC and Magners USA. Concurrently, our American team was busy deciding on the optimum distribution footprint for the entire country. VHCC already had national distribution and long-standing relationships with wholesalers all over the country. In addition, Magners (and latterly Hornsby’s) had their own separate distribution footprint albeit less developed. In some instances, there was overlap and consistency. In others, it was concluded that having the entire C&C cider portfolio under one wholesaler’s roof would be optimum. There were 50 instances where we have instigated wholesaler consolidation over the past 12 months. For the avoidance of doubt, this does not mean 50 states; there can be multiple wholesalers in a specific state. We believe that this is almost entirely complete now and we can focus 100% of our efforts on selling and marketing again after 12 months of disruption. We are very pleased with the quality of our distribution network and the commitment and passion of our partners towards our brands. Indeed, c.$15 million was paid out by incoming distributors to their predecessors to gain the brand rights, confirming real interest in the brands.

Whilst these internal business issues invariably caused us disruption, it is fair to say that the competitive threat from other cider entrants has been the strongest the team in Vermont has seen throughout their history as a company. For 10 years, Woodchuck has pioneered American craft cider. Innovation and authenticity have been VHCC’s key strengths, allowing the Woodchuck brand to prosper at both a retailer and consumer level. However, over the past 18 months, a number of large beer players have recognised the attractiveness of the cider category and a number of new brands have been invented, created and launched.

The two combined factors of integration and competition resulted in a challenging year for our brands in the USA, in particular Woodchuck. According to the US Beer Institute, the total cider category grew by 67% in the 12 months to December 2013. In our financial year, Woodchuck, Magners and Hornsby’s declined by 1%, 17% and 40% respectively. Whilst we are pleased to see that the US cider category is gaining genuine traction and our investment thesis remains valid in terms of cider internationalisation, we are clearly disappointed by the fact that we are not growing with the market.

This is something we will focus on over the next 12 months with the major hurdles of business integration under our belt. We will focus on a number of commercial and business initiatives to try and reverse these trends. In particular, we will open a new cidery during the course of 2014 in our hometown of Middlebury in the state of Vermont. The new cidery cements our position as a founder of American cider and affirms our commitment to craft cider making and investment in the future.

I should also highlight the fantastic contribution that Bret Williams has made to VHCC. Ten years ago, Bret pulled together all the money he had and raised further funds from close family and friends. Bret bought VHCC when it was losing money and turned it into a major success story of the US alcoholic drinks industry. For the past 10 years, Dan Rowell has been working closely alongside Bret as the Vice President of Operations and CFO. In February, Bret stepped down from the day-to-day operations of VHCC as CEO and President. Bret will remain involved with the company and will sit on our local US board of directors, alongside Dan Rowell, who replaces Bret and will take the company to the next level. I would like to thank Bret for his contribution during our ownership and wish Dan all the best with his future role.

Other export markets

In volume terms, our key international markets outside the USA are Spain, Australia, Canada and France. The business relies on strong distributor relationships and management of these relationships. We have limited exposure to areas of political instability and uncertainty.

During the financial year, in volume terms the Magners brand grew internationally (excluding the USA) by 13%, driven by growth in Canada of 27% and Australia of 8%. In January 2014, we transitioned distributors from Suntory in Australia to Bacardi Lion. It was felt that a partner with a stronger portfolio and draught experience would be required to share in the recent growth of the cider category in Australia. It is too early to remark on the results of this change although we are very positive about the Bacardi Lion organisation and a sales force which is considerably larger than our previous distributor.

Although small in terms of scale, Asia is worth mentioning. In the financial year, total C&C branded volume grew by 108%. From no volume last year, India became the fifth largest export market for C&C, driven by K Cider, one of our English ciders.

In terms of beer, we are now exporting Tennent’s, Caledonia Best, Heverlee, Tennent’s Stout and Tennent’s Beer aged in Whisky Oak. In Italy, our largest beer market, we experienced growth versus last year of 12%. Beer will be an area of focus over the next 12 to 18 months as we look to market abroad the history and heritage of our Scottish beers and the Wellpark brewery.

Strategy+-

Ireland and Scotland should provide the bedrock for C&C Group both in terms of earnings and cash. We are able to utilise our brands and physical assets in these geographies to deliver stability to the rest of the Group as well as looking to moderate earnings growth in, what are ultimately, ex-growth alcoholic drinks markets. Winning in these geographies requires local knowledge, superiority in customer service and strong brands. Both Ireland and Scotland businesses display these characteristics.

For now, the United Kingdom is still the world’s largest cider market. We have a strong brand in Magners and in addition, a back catalogue of authentic cider brands within our Shepton Mallet cider business. We will continue to focus on maximising profit in, what has become, a highly commoditised and cluttered cider category. At the same time, C&C will play in niche areas of growth such as craft and speciality cider by taking advantage of our English cider heritage.

The overall pursuit of cider internationalisation remains at the heart of C&C’s strategy. Cider penetration of LAD in the UK and Ireland is 16% and 13% respectively. This compares with just under 1% in the USA (up from 0.3% 18 months ago). The evolution of the consumer palate across various global markets from savoury to sweet and the preference for natural, gluten free, local and authentic brands places C&C in a strong position to exploit international cider growth. The USA is likely to be the global cider market with the greatest potential in scale terms. We have invested significant shareholder capital in the USA and have strong brands and a high quality distributor network. Despite competitor disruption, in the medium to longer term, we believe we are well positioned strategically to optimise value.

Cash and balance sheet+-

Our balance sheet remains in robust health with a net debt to EBITDA ratio of less than 1.0x at the year-end. The Group finished the year with a net debt position of €145.2m, despite significant capital expenditure during the year on integration, the Vermont cidery and a craft brewery in Clonmel. This resulted in 52% of EBITDA (excluding cash outflow from exceptional items) converting to free cash which is below the long-term historical average for the Group. Next year, we would expect normal levels of cash conversion to resume. Ultimately, the Group’s balance sheet and cash generation profile provide flexibility to invest in bolt-on acquisitions and capital projects with attractive returns.

People+-

The expansion of the Group over the last twenty-four months has materially increased the number of people on our payroll. At C&C the model that we operate is that the Board allocates resources and assesses performance of the business divisions with the support of a head office of not more that 20 people, whilst each business division is equipped with the relevant people assets to ensure that we operate effectively in the market. Accordingly, each of our businesses has a local MD who has the associated capability to implement the agreed strategy and make day to day operational decisions for that business. In areas like procurement, planning and manufacturing, we seek to optimise our capability and run on a functional basis. Equally, our businesses quite often share back office administration resource, although this is always located in one of our operating markets.

With the acquisition in the USA, we have established a group of long-standing industry experts to enable Joris Brams and our local management team to tap into high quality local knowledge. It was previously noted that at the year-end Bret Williams stood down as managing director of VHCC but he will continue as a member of this group to make his expertise available to the new team. In addition, in place of Rob Hyman, who retired during the year, we are pleased that Bump Williams and Bill Burke (two industry veterans) have joined this group to further support our management team in the USA in the implementation of the C&C Board’s strategy for the USA.

The Irish business will be operated on a unitary basis with a management team headed by Tom McCusker. Tom has thirty years experience of the Irish drinks industry from his time at AB InBev and significant market as well as customer knowledge. At Magners GB, Paolo Mortarotti, who has replaced Tom, now adds the mainstream Magners and Gaymers portfolios to his responsibilities at Shepton Mallet Cider Mill.

With the full acquisition of Wallaces Express taking place post the year-end, we announced the retirement of John Gilligan later this year as MD of Tennent Caledonian. John is a 40 year veteran of the Scottish drinks industry and has made a huge contribution to the Tennent’s business over the last three years. John will work over the next six months with Brian Calder, the new MD to ensure smooth integration of Tennent’s with the Wallaces Express business. Brian was the owner and manager of Wallaces Express and like John has had four decades in the Scottish drinks industry and is a hugely respected figure in the trade.

Elsewhere we have moved Andrea Pozzi from his operational role to look after our European and African export business, mainly to exploit opportunities for our high quality exports from the British Isles. An additional benefit is that this will allow Joris Brams to focus predominantly on the USA over the next twelve months. Billy Mason has been appointed to replace Andrea in Operations and with thirty years’ experience behind him has a decent understanding of the nuts and bolts of this part of the business.

Much has been written recently around executive rewards. In C&C we believe that the main management incentive should be around equity and we have a bias towards schemes that involve investment from the relevant employee or manager. Management remain largely incentivised through equity and we have employee-wide schemes in Ireland and the UK with average participation levels of 50% and above of eligible employees. This year we have changed bonus arrangements for managers and employees to ensure more of a local focus behind objectives that are relevant for the creation of long-term sustainable shareholder value. All employees have the opportunity of participating in performance related bonus schemes. In the last financial year, the ratio of average executive Directors remuneration to that of the average employee remuneration was 19:1.

Corporate responsibility+-

Our Corporate Responsibility report details a broad range of initiatives across the company in support of the CSR agenda. We are proud of the work undertaken by all our employees in the local community and our ethos is to be local in all that we do. This year, with the support of the Board we have switched our cash investment from spending on industry lobbying groups to investing in the local community. I think shareholders should be proud of our achievements and activity on their behalf. One important area that we do not neglect is taxation. We seek to be efficient in ensuring that we optimally manage our tax affairs on behalf of all stakeholders. We do not like to pay tax unnecessarily but equally we are respectful of the markets that we operate in and the communities that rely on our tax contribution. Accordingly, we have a conservative tax structure and pay tax in all the national jurisdictions in accordance with local law.

Our goal is to improve the lives of our communities and the environments in which we operate. We focus on local initiatives and are increasing the resources we deploy in helping the areas in which we operate. This means we now support schemes such as Best Bar None, which will help our local night-time economy. We are also continuing to support the Scottish and Irish Governments in their plans for Minimum Unit Pricing, as part of an overall programme to promote responsible drinking.

Many members of our communities are benefiting from our actions. For example, in Scotland the Tennent’s Training Academy has now trained over 13,000 people on courses relating to the hospitality industry, equipping people with greater skills for the future. Our charitable activities have increased, our connection with Help for Heroes will see us raise money for that very deserving charity, as well as helping train ex-servicemen in hospitality industry skills at the Tennent’s Training Academy.

The environmental agenda is central to our business. We rely on high quality agricultural products and so our guardianship of the environment is also central to our business. Whether we are continuing our £1 million investment to support local cider apple growers in England or achieving zero waste to landfill in Clonmel or delivering any other of our environmental projects, we are always looking for opportunities to ensure the environment is safeguarded for future generations.

Outlook +-

The significant activity over the last financial year and since the year-end provides a strong foundation for the Group. Our recent developments in core markets should provide the financial stability to allow for continued investment in our growing international business. Our balance sheet remains conservatively geared providing scope for future investment focused as always on long term value creation.

Stephen Glancey
Group Chief Executive Officer