By Scott Rochfort
Shares in Foster's Group have posted their biggest rise since April after one of the most outspoken critics of the beverage company's ill-fated $7 billion foray into the wine sector placed his first "buy'' recommendation on the stock since January 2005.
In a note to clients this morning, Merrill Lynch analyst David Errington upgraded his price target from $5.40 to $6.50 in his research note entitled: "Buy ... It's Time.''
Citing the tentative signs of turnaround in the global wine industry and the continued strong performance in Foster's beer business, Mr Errington said he believed the company was now "heavily undervalued''.
"Foster's beer business is expected to generate $1 billion in EBIT (earnings before tax and interest) in the next year or two, meaning it would be easy to value beer at an enterprise value of $12 billion - which is Foster's current total EV.''
"This implies that wine is valued at zero. And wine should generate around $350 million of cash in [2008-09] despite dreadful market conditions,'' Mr Errington said in his note.
Foster's shares rose 28 cents, or 5.7 per cent, to close at $5.24.
Mr Errington last "buy'' recommendation on the company was before its $3.1 billion acquisition of the wine maker Southcorp in 2005.
The Merrill Lynch analyst heavily criticised the group's foray into wine to the point that he was asked by Foster's former chief executive Trevor O'Hoy to take a two-year holiday at one analyst briefing.
But Mr Errington never took the vacation and O'Hoy resigned from the company before the two year's were up.
After O'Hoy's resignation, Foster's chairman David Crawford was quick to concede the group's experiment in transforming itself from a beer maker into a multi-beverage maker had been a costly mistake.
Following a review of the group's wine business, Foster's new chief executive Ian Johnston announced plans to structurally separate the wine and beer businesses early this year.
This has fuelled speculation that even if Foster's new management team fail, the company could become a takeover target.
Possible acquirers of the beer assets include Japanese beverage company Asahi, which recently purchased the Schweppes bottling operations in Australia, or Coca-Cola Amatil, which has been attempting to establish a position in the local beer market with its joint venture partner SABMiller.
In his latest note, Mr Errington appeared more confident in the new management of the company, who he said were "returning to basics'' and who were improving the efficiency of the business.
"Key to our optimism toward the future earnings growth of Foster's is our view that Foster's has a wonderful set of assets (both operating and brand names) that have been poorly managed in past years.''
"And other than needing to revitalise a couple of brands, we think Foster's physical assets require no capital expenditure.''
Mr Errington upgraded his profit forecasts for the company over the three years. He lifted his net profit forecast for 2008-09 by 3 per cent and 2010-11 forecast by 11.4 per cent to $1.04 billion.