We hope our shareholding will result in KWV developing a stronger vision of its participation in the liquor industry going forward” – HCI Directors

Investment company HCI has two main objectives for wine and spirits producer KWV. One is to improve its performance and value. The other is to use the company as a platform for growth in the liquor industry.

The appointment last week of HCI senior executive André van der Veen as acting CE of KWV can be seen as an early step towards achieving these aims. The previous CE, Thys Loubser, resigned with immediate effect. Loubser, who joined KWV as CE in January 2007, previously ran AECI’s speciality fibres business, which produces materials for the textiles sector. Van der Veen has a financial background.

KWV chairman Marcel Golding, who is also executive chairman of HCI, was reluctant to comment as the company is in a closed period before its year-end results. He says, however, that it “needs to knuckle down and get back to basics”. As shareholder of reference, HCI has taken stock of the business and concluded it requires a “whole range of restructuring” to improve returns. More announcements will follow.

KWV is not listed on the JSE, but its shares are traded in the over-the-counter market. It has 3538 registered shareholders and, on its last traded price of R10,50, its market capitalisation is R720m. It is a 93-year-old company with a rich history as an exporter of SA wines. It owns heritage assets and quality brands, but its profitability and growth have been weak.

Among its assets are a valuable art collection and extensive property, including a lavish head office. Golding says it’s too early to say whether it will be necessary to sell assets. However, it seems the real issues for management will be cultural and operational.

HCI became the largest shareholder in February this year when it acquired a 33,9% stake, for R274,1m, from Zeder, the PSG Group’s investment company in the food and beverages sectors. In May, three HCI executives, Golding, CE Johnny Copelyn and Van der Veen, joined the KWV board.

When HCI reported results for the year to March, it held 34,9% in KWV and said it had obtained permission from the competition authorities to take control. Given the accompanying comment, it’s little surprise the investment company has appointed an HCI manager to run KWV.

“The business has not been performing well and we hope our entry into its shareholding will result in it developing a stronger vision of its participation in the liquor industry going forward,” the HCI directors said. “We believe it is in any event a good base for HCI to grow into that industry and are very excited at the prospect of facilitating this.”

In an interview with the FM last month, Copelyn said HCI saw the liquor industry as an attractive area for growth, as the sector tended to be stable and cash generative. “We see KWV as a good entry point, with size and depth,” he said. “When you buy a company like KWV, it comes with responsibilities. We’d like to build KWV.”

Other shareholders have expressed frustration with KWV’s performance in recent years. When Zeder reported year-end results, chairman Jannie Mouton said that, though KWV was asset rich, its performance was “disappointing”, with the interim results to December 31 2010 implying a return on equity of about 1%.

Chris Logan, a shareholder and chief investment officer of Opportune Investments, says the company needs to improve its transparency, change its culture and lift its operational performance. The latter will require cutting the cost base or sharply increasing efficiencies.

Comparisons with Distell underline the scope for improvement (see table). Distell has a much higher operating margin, partly because its costs are lower. KWV has cut its costs and reduced its staff in recent years. At its June 2010 year-end, it employed 363 people, down from 455 a year earlier. Nonetheless, its operating expenses last year accounted for 35,8% of sales, compared with Distell’s 20,7%. Its annual sales per employee were just over R2m; Distell’s were R2,6m.

The comparisons may be a bit unfair. Distell, a Remgro company, has done particularly well since it was formed out of the merger of Distillers and Stellenbosch Farmers Winery a decade ago. KWV, an agricultural co-operative until 1997, was restricted from entering the domestic market until 2004.

Distell derives 72% of its sales from the domestic market and has a broader product range, including ciders and ready-to-drink beverages. KWV made 49% of its 2010 sales locally and has small domestic market shares, at about 2% for wines and 5% for brandies.

The companies differ, but it could equally be argued that KWV has been slow to change to a profit culture and use the power of its brands.

“Consumer banding is at the heart of everything we do,” Distell says in its annual report. KWV could find it difficult to justify that claim.

Logan expects the 2010 year-end results will again be weak. But patient investors might be rewarded. A successful restructuring may take some time but should produce better returns and a rising NAV and share price. HCI has a good record with turnarounds and nurturing businesses.

Source: Financial Mail – Andrew McNulty