1. Introduction.

1.1 Brief company overview

Established in 1922 and with its headquarters in Nairobi- Kenya, East African Breweries Ltd. (EABL) is a
leading branded alcohol manufacturing company in the East African region engaged in the marketing,
brewing and selling of alcoholic and non- alcoholic drinks as well as the manufacturing of glass containers.
Majority owned by Diageo, it consists of a number of subsidiaries.1

1.2. Research rationale.

Compared to their counterparts in the developed world, little research has been carried out on organizations
that operate in African countries as these are seen as lacking the management capacity or financial resources
either to compete with larger organizations in the developed world or to interest international investors.

However the events of the last two years, which have seen investors lose millions of dollars in their
investments due to the collapse of the international financial markets, have increased the need for
international investors to diversify their portfolios into regions hitherto considered unimportant. By carrying
out a critical business and financial evaluation of the performance of a typical large African organization, this
report attempts to highlight the missed opportunities that may remain untapped in emerging markets.

With annual revenues of KES 21 billion (US$ 285 million), KES 26 billion (US$ 367 million) and KES 32

1
The subsidiaries include Kenya Breweries Ltd., Uganda Breweries Ltd., Kenya Maltings, UDV Kenya and Central
Glass Industries. The company also holds a 20% stake in Tanzania Breweries Ltd. (EABL, 2008a p.85)

-1- © 2009 PK Mwangi Global Consulting

billion (US$ 479 million)2 in FY06, FY07 and FY08 respectively and an adherence to international
accounting and audit standards i.e. IFRSs and ISAs respectively, this
company3 may represent a well managed company with growing profitability and investment potential. This
report attempts to establish this by analyzing its business and financial performance over a three year period.
To assist in the analysis of EABL’s performance the average exchange rate prevalent in the three years under
study are as follows:

Table 1: Foreign exchange rates.

Average annual exchange rate
Calendar Year US Dollars (USD) Kenya Shillings (KES)
2006 1 73.73870
2007 1 70.80733
2008 1 66.83044

Source: Oanda (2009)

1.3. Research objective and question.

This research delves into both the business and financial performance of EABL with an aim to identify the
major business elements that are key to its performance. It goes further to look at how these business factors
have impacted on the financial performance of the company.

It is difficult to separate the financial performance of a company from its wider business environment and
hence the business and financial performance of a company are closely interlinked. Decisions made at the
corporate and/ or business level impact directly on company’s financial performance. Where corporate
strategy aims to grow the company through acquisition of competitor firms, this will have a direct impact on
profitability and profitability indicators. Increased sales in new markets will lead to bigger profits and
margins where costs are well managed.

1.4. Research approach.

Drawing primarily on secondary sources of information (accounting books, annual reports, academic
journals, newspaper articles, etc) this research sought to analyze both quantitative data and qualitative

2
These figures are converted from KES to USD based on average exchange rates for the relevant years as shown in
Table 1.
3
Although EABL is a group of companies, it has been referred to as a company throughout this report for ease of
reference.

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information with a view to using this to critically evaluate the performance of a real life organization- EABL.
Quantitative data was drawn mainly from the company’s financial statements while the qualitative
information was drawn primarily from academic and practitioner journals.

The business models and accounting techniques were applied to gathered qualitative and quantitative
information and used to evaluate and critically analyze the company, identifying areas of strengths and
weaknesses. (ACCA 2009).

In addition, limited data on key business and financial variables was collected on the company’s key
competitors as well as industry-wide statistics in order to benchmark the performance of EABL against these
other factors. This offered, in addition to the inter-temporal analysis of the company, a further avenue of
analysis thereby enabling a more comprehensive business and financial analysis of company performance.

Section One is an introduction to the research project providing a brief company overview as well as briefly
explaining the research rationale, objectives and research approach. Section Two explains in more detail the
research methodology undertaken and also the limitations associated with this research methodology. It also
identifies and describes the business models and accounting techniques used in the research project. Section
Three looks at the sources of data, presents the data collected and looks at the limitations in gathering the
data. Section Four applies the business models and accounting techniques to the company environment and
on the basis of this goes on to evaluate and critically analyze EABL’s business and financial performance
over a three year period. Section Five then presents conclusions reached on the basis of the research
undertaken as well as providing a number of recommendations.

[OMMITTED]

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4.2. Financial performance analysis
4.2.1. Ratio analysis

Table 7: Financial ratios of EABL for the period FY06 to FY08.

Ratio Analysis

% change 2006 % change 2007 % change 2008

Profitability
Percentage increase in sales revenue 8.97 23.74 25.58
Return on capital employed (ROCE) 0.64 31.28 5.10 32.87 14.55 37.66
Return on equity (ROE) 4.10 45.28 15.35 52.23 13.34 59.20
Net asset turnover -1.18 1.02 10.72 1.13 17.93 1.33
Gross profit margin -7.37 62.23 -11.43 55.12 -2.97 53.48
Operating profit margin -2.88 37.94 -3.49 36.62 -8.52 33.50

Financial stability.
Equity to assets ratio -2.67 57.12 -18.88 46.34 0.67 46.65
Debt to equity ratio (gearing ratio) 0.00 0.00 0.00
Current ratio 2.91 3.23 -31.76 2.21 -10.39 1.98
Liquidity (quick) ratio -1.17 2.29 -32.60 1.54 -15.25 1.31

Management efficiency.
Closing inventory holding period -3.22 187.12 -8.62 170.99 -16.19 143.31
Trade receivables collection period -1.46 41.13 51.85 62.46 -26.03 46.20
Trade payables payment period -9.22 190.31 20.26 228.87 -13.44 198.11

Investment
Debt-holder Interest cover 0.00 0.00 0.00
Interest yield 0.00 0.00 0.00

Shareholder Market share price as at 30 June -7.02 139.00 10.79 154.00 29.22 199.00
Dividend per share 30.93 4.91 49.49 7.34 9.67 8.05
Dividend cover 1.44 -12.96 1.26 -6.40 1.18
Dividend yield 40.82 3.53 34.93 4.77 -15.13 4.05
Earnings per share (EPS) 13.10 6.82 13.78 7.76 23.07 9.55
Price earnings ratio (P/E ratio) -17.79 20.38 -2.63 19.85 5.00 20.84
Net asset value per share 18.34 133.71 1.25 135.39 -17.91 111.15
Total Shareholder Return (TSR) -3.74 -529.83 16.07 114.34 34.45

Source: EABL, 2005; EABL, 2006a; EABL, 2007a; EABL, 2008a

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 Profitability

Figure 7: EABL profitability indicators between FY06 and FY08.

35000
32486

30000

25871
25000

KES 20907
Millions
20000
Net sales value

15000
12,316
10,884 Operating
10,636
9,474 profit
10000 8,577
7,933
Profit before
tax
5000

0
2006 2007 2008

Year
Source: EABL, 2007b p. 28

Both ROCE and ROE rose year-on-year between FY06 and FY08 due to heavy capital investments4 that
have yielded increased productivity. The year-on-year increase in sales revenue and ROCE with increased
capital investments and upward revaluations of PPE suggests that revenue has increased proportionately
higher than the increased capital investments and revaluations – an indication of better capacity utilization
and productivity.

Despite a bonus issue in FY085, ROE continued to rise showing an increasing return to a larger shareholder
base. However gross profit margins fell between FY06 and FY08 due to cost of sales increasing
proportionately more than the increase in sales revenue. Cost of sales was driven up by increasing
productions costs caused by a shortage of barley, rising fuel costs and constant power outages. (EABL,
2007b p. 28)

Operating profit margin also declined in the period. A combination of rising marketing expenses6 and

4
Capital expenditure on state-of-the-art equipment grew during this period from KES 2 billion to just over KES 3 billion
(see Figure 14)
5
Assuming post-tax profits remained constant, an increase in the number of shares on issue would lead to a fall in
ROE. That ROE in the three years has continued to rise is an indication of an increasing return for each share in issue
i.e. the growth in post-tax profits has outpaced the growth in equity capital.
6
These rose by 27%, 19% and 37% in FY06, FY07 and FY08 respectively. (see Appendix)

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distribution costs7 (due to increased activity in newer markets) contributed to this decline. (Gosman, 2009 p.
46)
Net asset turnover8 rose in line with sales revenue and ROCE indicating EABL’s efficiency in the use of its
net assets in line with increasing ROCE.EABL has no finance leases but rather makes rental payments on
leased PPE. These costs, as a percentage of the value of the related PPE, may be less than the ROCE figures
thereby contributing to the rising ROCE9.

Financial stability.
EABL’s equity to assets ratio dropped in FY06 and FY07 but remained stable in FY08. The drop showed a
decrease in the importance of equity to the financing of total assets. However the company has had nil
gearing throughout the same period following a policy of zero borrowing.

The company’s current ratio dropped in FY07 and FY08. The relatively high ratios, however, reveal
excessive cover of current liabilities. The falling current ratios were in line with falling inventory periods in
FY07 and FY08 while payables payment period rose, albeit falling marginally in FY08. The relatively high
current ratios are also indicative of a large cash base which has helped service increased capital expenditure.
The company’s liquidity ratios also fell in FY06 to FY08. These still represent high levels of cover in line
with company policy of minimal borrowings.

However the trend has been declining current and liquidity ratios due to increasing deferred income tax
liabilities. This led to additional tax charges of KES 222 million and KES 217 million10 in FY07 and FY08
respectively.

Management efficiency.
Inventory holding period decreased in FY06 to FY08. This was down to the increase in cost of sales
outpacing that of closing inventory. Despite increasing productivity and sales, closing inventory continued to
rise, an indication of the company’s need to maintain high inventory levels to accommodate expansion into
newer markets.

Both trade receivables collection period and trade payables payment period decreased in FY06 and FY08 but

7
Fuel costs alone increased by 82% in the 12 months leading to FY-end 2008 (EABL, 2008b p.8)
8
This measures the amount of sales made by the company per KES 1 invested in net assets. A turnover of more than
1 time reflects a more than proportionate return to investment and hence efficiency in the use of PPE.
9
A further indication of EABL’s superior ROCE is the fact that PPE is held at current values (note the existence of a
revaluation surplus account) meaning that were PPE to held at historical cost, ROCE figures would show an even
more impressive return.
10
This is because total deferred tax liabilities on the balance sheet rose from KES 1.8 billion to KES 2 billion between
FY06 and FY07 and from KES 2 billion to KES 2.3 billion between FY07 and FY08. (see Table 3)

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increased in FY07. The relatively short receivables collection periods and long payables payment periods are
evidence not only of the company’s effective credit control but also of the weak bargaining positions of both
buyers and suppliers. The strength of the company’s credit control is also evidenced by the larger number of
receivables in the 0-30 days receivables band as opposed to those in the 31- 120 days band (see Appendix).

Despite a rise in sales volumes throughout the period, receivables and receivables collection period dropped
in FY08 due possibly to better credit control. It would be a cause of concern had sales volumes dropped in
line with decreasing receivables as this would have indicated falling demand or capacity inefficiencies given
that capital expenditure in FY08 alone was up 5%. That this was not the case is evidenced by a 14% increase
in ROCE in FY08.

Investor activity.

DPS and dividend cover.

Figure 8: EPS and DPS values between FY04 and FY08.

10
9.55

9
8.05
8 7.76
7.34
7 6.82

6.03
KES 6

5 4.89 4.91
EPS

4 3.75
DPS
3 2.89

0
2004 2005 2006 2007 2008

Year
Source: EABL, 2008a p.5

DPS has grown year-on-year showing a healthy dividend policy by the company. This has helped improve
the company’s share price performance These dividend payouts have been made out of current year profits
and hence future profitability is not endangered by paying out current dividends from prior year earnings.
Dividend cover fell in FY07 and FY08 due to increases in dividend payments outstripping those in post-tax

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profits11.
Earnings per share (EPS)

EPS grew during the period in line with increases in post-tax profits. Despite a bonus issue in FY08 (which
should have seen a fall in EPS due to an increase in the number of shares on issue), EPS continued to climb-
a clear indication of the growing profitability of the company.
Price-earnings ratio.

The PE ratio has remained fairly stable falling marginally in FY07 and then rising marginally in FY08. PE
ratio marginally fell in FY07 as the rise in EPS narrowly outpaced the rise in EABL’s share price. This
pattern was reversed in FY08.The slower growth in EPS in FY08 was down to the bonus issue which saw an
increase in the number of shares in issue.

This relatively stable PE ratio shows that investors are fairly confident in the company’s future performance.

Net asset value (NAV) per share.

NAV per share relates to the book value of a company’s share. EABL’s NAV per share rose marginally in
FY07 and then dipped substantially in FY08 falling by 18%. The initial rise was due to the increase in net
assets in FY07 while equity capital remained constant. However, following the bonus issue in FY08, NAV
per share fell substantially.

Differences between NAV per share and EABL’s market share price indicate that EABL shares are selling at
a premium. This is in line with the high PE ratios averaging 20 times for the three year period. (Pontiff and
Schall, 1998, p. 142)

4.2.2. Benchmarking EABL .

EABL outperforms its major competitor- SABMiller in all profitability and financial stability ratios. (see
Appendix)12. Both ROCE and operating profit margin are much higher than the respective SABMiller
figures- an indication of better capacity utilization and cost management13.

11
While dividend payments grew by 28% and 25% in FY07 and FY08 respectively, post-tax profits grew by 17% and
22% for the same periods. (EABL, 2007b p. 31; EABL, 2008 p. 42)
12
A word of caution here is that the figures for SABMiller are derived from its worldwide operations while those of
EABL are based solely on its East African operations. However SABMiller prepares no financial statements for its
African operations and the financial statements prepared on the basis of its global operations provide the best avenue
for comparison. These ratios can be assumed to be broadly similar for its East African operations.
13
It may well be that EABL operates in a fast growing market indicated by the higher net asset turnover figures. The
contribution to turnover by each unit of PPE is higher than at SABMiller which may be operating in near saturated
markets.

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 Although EABL has a much superior cover of its current liabilities, both companies have either nil or low
gearing and hence face little danger to their going concern status. EABL’s longer payables collection periods
indicates its superior bargaining position against suppliers in the region while SABMiller may not enjoy such
luxury in global markets where competition is stiffer.

SABMiller’s shorter receivables collection period may also be indicative of its need for quicker working
capital movements to finance its debt obligations. However, SABMiller has a superior dividend cover due to
its lower payout ratio14 while both companies enjoy high PE ratios and hence continued investor confidence
in their future performances.

4.2.3. Segment Analysis.

Segmental analysis of EABL in the region involved exploring the different rates of profitability and different
opportunities for growth presented by each geographic segment15. (FTC Ltd., 2005 p.193)

Profitability
Figure 9: Contribution to operating profit by geographic segment.

10,000 9,690

9,000
8,387
8,000
6,957 Kenya
KES 7,000
Millions
6,000
Uganda
5,000

4,000

3,000 Tanzani
a
2,000
1,087 1,194
976
1,000

0
2006 2007 2008
Year

Source: EABL, 2007 p. 59; EABL, 2008 p. 73

14
These stood at 45% and 43% for FY07 and FY08 respectively. (SABMiller, 2007 p.1; SABMiller, 2008 p.1)
15
Segment information is presented on the basis of the group’s geographical segments, which is the primary format
based on the countries of operations. No distinguishable business segments exist (EABL, 2007a p. 57-8)

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 Figure 10: Contribution to net profit by geographic segment.

8,000
7,566

7,000

6,032
KES 6,000 Kenya
millions
4,990
5,000
Uganda
4,000

3,000 Tanzania

2,000

1,000 763 762 735 810 808

657

0
2006 2007 2008

Year

Source: EABL, 2007 p. 59; EABL, 2008 p. 73

Kenya has provided the greatest contribution to both group operating profit and net profit during the three
year period averaging 89% for operating profit and 80% for net profit respectively (see Appendix).

Kenyan operations showed a higher percentage increase in revenue in FY08 than the Uganda operations but a
lesser percentage increase in revenue in FY07. In line with higher operating profits and net profits, the Kenya
operations showed superior operating profit margins and net profit margins. This reveals better PPE
(capacity) utilization at the Kenya plants. This may be due to the higher capital investment in the Kenya
operations as opposed to the Uganda operations16. This is evidenced by the increase in depreciation charge in
FY08 in the Kenyan operations which rose from KES 588 million to KES I billion, up 84%.

EABL has a minority stake in the Tanzania operations and hence profit margins here are nil except for
EABL’s share of associate profits.

16
2005 saw a KES 600 million investment in a brew house in Kenya which led to a 35% improvement in energy usage
as well as a further KES 425 million investment in a keg-line. (EABL, 2005, p. 22)

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Growth
Figure 11: Volume growth rates by geographic segment.

30
27 27 27 27

25

20
20
18 18
%
Kenya
15
Uganda
Tanzania

10

5
5
2

0
2006 2007 2008

Year

Source: EABL, 2007b; EABL, 2008b

Despite its low contribution to overall sales and profits, the Tanzania operations have seen tremendous
growth in FY07 and FY08 at 27% and 18% respectively. This is down to EABL increased focus on
improving its market share here.

- 11 - © 2009 PK Mwangi Global Consulting

Figure 12: Sales revenue growth rates by geographic segment.

35
31
29
30

25 Kenya
25

20 Uganda
% 16

15
Tanzania
10

0
2007 2008
Year

Source: EABL, 2007b; EABL, 2008b

Fig. 13: Segment share of group volume and units exported (FY08).

80
71
70

60 Share of group
volume (%)
50

40

Exported units
30 (millions)

20 18

10 5.7 6
1.4 0.5
0
Kenya Uganda Tanzania
Country

Source: EABL, 2008b p. 17-18

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4.2.4. Finance risk analysis

Table 8: Finance risk analysis matrix.

EABL RISK ANALYSIS

On a scale of 1 to 5
1 - very low risk
2 - low risk
3 - moderate risk
4 - high risk
5 - very high risk

Rating assigned Weight assigned(%) Weighed Value of Factor(%)

Financial risk factors

liquidity risk 1 30% 0.3

foreign exchange risk 4 10% 0.4
interest rate risk 3 20% 0.6
contagion risk 4 10% 0.4
credit risk 2 20% 0.4
falling equity prices 4 10% 0.4
Total weights 100% 2.5 Financial risk factor

Liquidity risk has received the highest weight assigned (30%) due to its implications on the
company’s going concern status. Loan default could lead to liquidation and a cessation of
business.

Interest rate risk also received a high weight (20%) due to the impact a hike in interest rates
would have on a business’ ability to raise finance17. Credit risk also received a high weighting
(20%) due to the implications of counter-party risk where business parties are unable to meet
their contractual obligations18.

Foreign exchange risk, contagion risk and the risk of falling equity prices have received
weightings of 10% due to their relatively lower impact. Foreign exchange risk is a factor
where a company has substantial offshore trading. Contagion risk and falling equity prices are

17
Where a business has borrowed close to its limits and is struggling to meet its lender obligations, a minor hike in
interest rates may have grave implications for its going concern status. Conversely, for a company with substantial
term deposits as opposed to borrowings, a decline in interest rates will mean a fall in interest income. (EABL, 2008 p.
71-2)
18
On the supply side this has an impact on the ability of the company to continue in operation unless alternative supply
sourcing is identified. On the demand side, inability of receivables to make payments impacts on cash flow and
possibly the going concern status.

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particularly relevant in recessionary periods. (Crouhy et al., 2000 p. 72)

However, despite their lower weightings foreign exchange risk19, contagion risk and the risk of
falling equity prices all received high risk ratings due to the specific impact they have on
EABL’s profitability. EABL’s heavy dependence on equity funding also means that contagion
risk and consequent falling equity prices directly impact the company’s ability to raise equity
finance20.

On the other hand, however, liquidity risk and interest rate risk received low to moderate risk
ratings due to the company’s strong cash and nil gearing positions. There is no risk of loan
default by the company and although a hike in interest rates would have little impact on the
company’s financial position, a fall in interest rates would affect interest income due to
EABL’s substantial term deposits. Credit risk received a low risk rating due to the company’s
strict vetting of its trade partners.

4.2.5. Capital investment.

Figure 14: EABL capital expenditure between FY02 and FY08.

Source: EABL (2008b p.11)

A high proportion of net cash generated from operations is paid out as dividends, exceeding that used in the

19
Transactional foreign exchange losses totalled KES 72 million in FY07 and KES 53 million in FY08. (see Appendix )
20
Falling equity prices mean that a rights issue would raise less funding than otherwise since investors would be
reluctant to invest where equity prices are on the decline.

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purchase of PPE21. Although this sends a positive message to investors and has a positive impact on EABL
shares, this high payout ratio seems unjustifiable in a market where competition is increasing.

In FY06 massive asset disposals worth KES 289 million were made. Profits of KES 106 million were
received from these disposals suggesting that these assets were sold well before they had exhausted their
economic useful lives. This is further evidenced by the relatively high proportion of carrying amount relative
to cost showing that PPE is not near the end of its economic useful life22. Thus replacement of PPE is
motivated by other factors other than an aging of existing assets. One plausible reason is a desire to boost
productivity to stay ahead in an increasingly competitive environment. (Mautz and Angell, 2009 p. 16-17)

4.2.6. Investor relations.

4.2.6.1. Business valuation.

The PE method can be used here to give a business valuation of EABL. Based on this

method the value of a company is given as:

Value of company = total earnings ×PE ratio.

EABL’s total earnings (PAT) as at 30 June 2008 were KES 9,184 million (see Table 2)

The PE ratio at this date was 16.13 (see Table 7)

Value of EABL as at 30 June 2008 was KES 9,184 million × 16.13

= KES 148 billion

(FTC Kaplan Ltd., 2007 pg. 509-24)

21
In FY08, for example, of the net cash from operations of KES 9.3 billion, KES 3 billion was used for capital
expenditure while a massive KES 7.7 billion was paid out to shareholders.
22
As at June 30th 2008, the proportion of the carrying amount of PPE to its cost was 65%. (EABL, 2008 p. 79)

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 4.2.6.2. Share price performance.

Figure 15: Share price chart for the period October 2006 to October 2009.

Source: myStocks! (2009)

EABL’s share price held relatively steady in FY06 and FY07 in line with stable profits. In October 2007
following the bonus issue the share price registered about a 20% rise before falling again to its pre-bonus
issue price.

The share price however peaked in June 2008 in line with a record DPS of KES 8.05 and a record payout of
84%23. This and the year-on-year increase in DPS have helped fuel its relatively strong stock performance.

23
EABL’s high payout is evidenced in Figure 8 by dividing the annual DPS values with respective the EPS values.

- 16 - © 2009 PK Mwangi Global Consulting