Shares: Bitter looks sweet: Industry changes make regional brewers attractive

DRAUGHT bitter is re-emerging as a fashionable drink, which is good news for regional brewers. It is also becoming increasingly clear that the better- run regional operators are well placed to exploit the new rules promoting greater competition to increase their profitability.

At the same time, further changes in the rules of the fairly heavily regulated beer industry and the decreasing influence of the old family shareholders could lead to a wave of restructuring and corporate activity before the end of the decade.

The investment arm of Lazard, the merchant bank, has been persuaded by the attractions of shares in the smaller brewers. On 29 September, it is launching a trust to invest in the sector. The offer, which plans to close in late October, is targeting pounds 50m but hoping for more. Shares are offered at 100p, with a life of 10 years and one free warrant to subscribe for a further share at 100p with every five shares purchased.

In effect, the proposed trust is a replacement for the old Whitbread Investment Company, which proved a brilliant investment over the years with its collection of stakes in brewing companies. The fund is to be managed by Billy Whitbread, a member of the brewing family who managed the Whitbread Investment arm for a number of years with considerable success. The timing looks good, and the shares are likely to prove an attractive investment; especially given prospects that some institutions will exchange individual brewery shareholdings for shares in the trust.

A Lazard spokesman cited a string of reasons for being bullish on regional brewers' shares. Most important are the boom in cask-conditioned ales, where sales volumes are growing by 5 per cent a year, and the spectacular growth in pub food sales. Cask-conditioned ales are perceived as a higher-priced, premium product that is lifting profit margins. Balance sheets are typically rock solid, with hefty property backing. Management is strong, with some of the old family companies bringing in experienced people from the giant brewers.

There have also been some drastic strategic moves. One regional group, Boddington, at 267p, sold its brewery and beer brands to Whitbread. This had two effects. Boddington is developing as a successful leisure group with 70 per cent of profits coming from beer retailing and hotels. Meanwhile, Whitbread's massive distribution has made Boddingtons arguably the most valuable beer brand in the country.

A classic example of a regional brewer undergoing dramatic change while still staying true to its roots is Salisbury- based Gibbs Mew. The big change came in 1992, when the group bought a fast-growing drinks distribution business, UK-D, for a mixture of cash and shares. This fitted nicely with an existing distribution operation but, more importantly, it diluted the Gibbs family stake below 50 per cent and brought in the Hedderson family, both as shareholders and into key management positions.

Most recently, the group has made a quantum leap with the purchase of the Centric business, virtually trebling its tied estate of pubs. This gives new outlets for the distribution operation and long-term potential for greatly expanded sales of Gibbs Mew's booming cask- conditioned ales.

The profits impact could be dramatic, since 1991/92 pre-tax profits have climbed from pounds 620,000 to more than pounds 3m, with analysts looking for pounds 4.65m to March 1995 and nearly pounds 7m the following year. On those figures, earnings per share would reach 35.2p in the latter year, dropping the p/e to less than 12 at 420p.

Another brewer that has turned the new regulatory environment to its advantage is Staffordshire-based Marston, Thompson & Evershed at 307p. Some five years ago, when David Gordon arrived as group managing director, the company decided to rationalise its brands, many of which were designed to create an impression of variety in its tied pub estate. It now makes just five brands led by Pedigree and a low calorie bottled beer called Low C. Distribution beyond the group's tied estate of 900 pubs came from reciprocal agreements with national brewers.

Another great success has been food. In five years, sales of pub meals have gone from pounds 400,000 to pounds 17m. Over the last five years, sales and profits have grown by 80 and 56 per cent respectively to pounds 143m and pounds 23.3m. Further progress is expected this year and next - to more than pounds 25m and pounds 28m - to drop the p/e to 13.5, which looks excellent value.

Last but not least is the amazingly successful Manchester-based Joseph Holt at pounds 37.13. The shares have the reputation of being almost impossible to buy but are a classic for tucking under the bed. The group operates from 110 high-volume pubs within a 20-mile radius of its brewery. Pub food is a new growth area, and recently the group has been more aggressive in adding pubs. The shares are the ultimate one-way bet - they even went up in the 1987 crash. Forecasts of profits going from pounds 8m to pounds 8.7m and then pounds 9.5m would drop the p/e to 17.6, which is not dear for Holt.