Annual Report 2015

Overview

This was a challenging year for your Company both strategically and operationally. The leaking of our preliminary discussion with Spirit caused significant disruption from a managerial and market perspective. For a period of time we were inhibited from providing shareholders with visibility of performance and there was ill-informed speculation on strategic intent. For the avoidance of doubt, management remain entirely focussed on a long term strategy of strong brand-geographic combinations providing a robust foundation for participation in international cider growth. The parameters for assessing any prospective acquisition remain unchanged as we look to cover cost of capital in the medium term. All capital deployment will be assessed on this basis.

Operationally our core trading segments of Ireland and Scotland delivered operating profit growth despite challenging trading conditions particularly in the second half of the year. However, our C&C Brands business and our US business performed well behind expectations.

In the US, the cider category continues its stellar growth, and with a settled high quality distributor network we had hoped to at last properly participate in this dynamic market. The optimism proved illusionary as new entrants crowded the category and put pressure on shelf space and consumer choice. We continue to invest in the long term in the US increasing both sales and marketing investment. The new cidery in Middlebury is now fully operational providing an authentic home for our hand crafted cider and our innovation now accounts for over 30% of Woodchuck brand volumes.

In our C&C Brands business the trading environment became more challenging and new entrant investment supported further market fragmentation. You will recollect that we had previously increased our sales and marketing resource to give greater focus to the niche and speciality sub-categories. Regrettably, against tough market conditions, this was a mistake and the linked cost structure inhibited our ability to react to the changing market. We addressed this issue in the final quarter and adjusted our infrastructure costs to better reflect our share of the cider profit pool.

The Great Britain (GB) cider market remains the biggest in the world and London continues to be at the centre of brand credibility. It is important for the Group that we meaningfully participate in the GB market and that the Magners brand remains at the heart of our long term thinking. With growth in Europe, the US, and Asia for the Magners brand, management will continue to pursue operational and strategic initiatives to reinforce our GB prospects.

Against this backdrop, we delivered an operating profit of €115 million which was an €11.7 million reduction on the previous year. The reduction in operating profit is largely due to the performance of our C&C Brands and US businesses. The Group has also undertaken an independent valuation of fixed assets and an impairment review of intangible assets. This has resulted in a one-off non-cash impairment of €150 million in respect of US intangible assets, which reflects current performance and future growth projections. Our cash conversion improved with a 61% conversion of EBITDA pre exceptional costs compared to 52% in the previous year. Given our continued strong balance sheet and cash generation, and in the absence of non-organic opportunities, we commenced share buy back activity in the year, repurchasing 2.6% of the issued share capital for a cash cost of €30 million at an average price of €3.29 per share. This highlights our commitment to capital deployment in pursuit of shareholder return.

The Group’s long term strategy of strong domestic brand geographic combinations providing the platform to participate in international cider growth remains unchanged. During the year we have continued to integrate the wholesale business of Gleeson and Wallaces Express in Ireland and Scotland respectively, to create brand led wholesale platforms. These integration programmes encompass all facets of the business and require considerable management focus to deliver. In the medium term, the integrated brand led wholesale platforms will protect our strong brands and provide long term revenue growth opportunities.

The Group’s long term strategy of strong domestic brand geographic combinations providing the platform to participate in international cider growth remains unchanged.

Review by Operating Segment

Ireland

From a macro perspective, key economic measurements appear to be improving in Ireland. The country is emerging from the headwinds 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, although the long alcoholics drinks (LAD) category in the Republic of Ireland on-trade, grew by 1%, the cider category declined by 4%, partly due to the impact of an exceptionally strong summer in the previous year comparative. These trading conditions impacted the performance of the Bulmers brand relative to the previous year.

The Group launched Clonmel 1650, an authentic premium Irish lager during the year. The brand has made a promising start in both Northern Ireland and the Republic of Ireland with distribution levels in line with expectations. We are delighted that Clonmel 1650 won a gold medal at the recent International Brewing Awards. The adjudication panel for these awards is drawn from brewers and cider-makers and winning this award is a ringing endorsement of both Clonmel 1650’s brand quality and the new craft brewery at Clonmel where the liquid is brewed.

Over the past 12 months, we have continued the integration of the Gleeson business. The Gleeson business allows C&C to provide customers with a multi-beverage portfolio encompassing Bulmers, Tennent’s, Finches soft drinks, Tipperary water, as well as our owned wines and spirits brands and agency brands. There have been a number of changes to the customer base, as some brand owners have chosen to use alternative distributors for competitive reasons and the Group have secured new distribution agreements. During the year we have ceased distribution of the Bavaria and Coors brands in Ireland but have entered a new distribution agreement with AB InBev to distribute the premium global Corona brand in the Republic of Ireland. We look forward to working with AB InBev to drive future success for both parties.

Ultimately, the ambition for our Irish business is to be the pre-eminent brand led 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. 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.

Scotland

C&C’s second domestic pillar is the Scottish business. During the year the Group completed the acquisition of the Wallaces Express wholesale business and the business now trades as Wallaces TCB. The underpinning strategy of transitioning to a brand led wholesale model is to provide greater earnings and cashflow sustainability and provide the platform for modest revenue and earnings growth in largely ex-growth geographies. This strategic logic applies to Scotland and Ireland.

Economically, Scotland is participating in the wider UK recovery with GDP growth, reduced unemployment and improved consumer confidence. The introduction of new “drink drive” legislation in December 2014 appears to have had a short term impact on consumption, although we expect trading patterns to normalise over time. The Group views Scotland as an attractive geography critical to the overall success of the Group.

The Tennent’s brand remains very much at the heart of the brand led wholesale model in Scotland. We continue to innovate around the Tennent’s brand with line extensions of Black T and Lemon T successfully launched in the year. In recent years, the strength of our brands in Scotland combined with our customer access have allowed us to successfully introduce new brands such as Caledonia Best and Heverlee, a premium imported lager proposition from Leuven, Belgium. These brands have continued to progress in the current year with Caledonia Best volume growth of 3.6%. Heverlee has grown on-trade distribution by 3% while volume has increased by an impressive 116%.

During the year, we continued to invest behind our brands with sponsorship of Glasgow Celtic Football Club (Magners), T in the Park, and Scottish Rugby (Caledonia Best) and Magners Summer Nights.

Magners is our largest brand in the GB market and is our leading international cider brand and has strong consumer awareness – we will continue to invest behind it.

The Drygate Brewing Company, a craft brewing and bar restaurant facility adjacent to the Wellpark brewery opened during the year. This is a joint venture with Williams Bros Brewing Company, a leading family craft brewer, and facilitates access to the growing craft category. The facility is operated independently of Wallaces TCB management.

Following the acquisition of Wallaces Express, we have invested significant effort in the integration of TCB and Wallaces Express. Customer service is at the core of our integration plans and our objective is to have a single multi-beverage customer interaction in place for summer 2015. The scale of integration and management focus required to deliver successfully, should not be underestimated. Effectively we are combining two different business models into one platform and this involves major reorganisation and change to people, processes and systems in all areas of the business.

The TCB Wallaces platform will enable the 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 non-exclusive 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 around 86% 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 modest growth over the next few years.

C&C Brands

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

Distribution 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. During the year competition between off-trade retailers has been intense leading to aggressive retail pricing on cider. This retailer dynamic is compounded by the four global brewers fighting for share of distribution in the GB market. Over the years beer has become commoditised in the off-trade channel and we have experienced a similar trend in the cider category with pressure on brand owner operating margins.

The GB cider market was broadly flat in the financial year in volume terms (Nielsen/CGA). The on and off-trade experienced similar trends. In the on-trade volumes grew 1%, with apple down 1% and pear down by 17%, whilst flavoured ciders grew by 15%. In the off-trade volumes were flat with growth in flavoured ciders of 30%, offsetting decline in apple and pear of 3% and 29% respectively.

In recent years, the retail pricing environment and the number of major cider launches have impacted C&C Brands’ position. The Magners brand has suffered volume erosion and pricing pressure. Against this backdrop, the business model and resulting fixed cost structure was no longer sustainable. The Group has therefore taken action to transition to a lower cost operating model. A new unified sales and marketing structure is already in place and we expect distribution savings from the second half of the year.

Magners is our largest cider brand in the GB market and is our leading international cider brand and has strong consumer awareness – we will continue to invest behind it.

Over the past 12 months there has been mixed progress on Shepton Mallet brands. K Cider, our premium strong cider, has had a challenging year with market pressures and local legislative changes impacting volume performance. Local heritage brands such as Blackthorn and Natch have experienced a stabilisation in performance while the newly launched premium Chaplin & Cork’s offerings have won numerous awards and exhibit promising distribution growth.

We do not see the competitive environment in England & Wales improving in the short to medium term, and have taken action to transform our cost base to underpin operating margins and enable us to be competitive. We will continue to focus investment on pockets of the territory where sustainable value is clear and we can develop a profitable business, leveraging our cider and beer assets. Equally we will continue to evaluate strategic long term options to step change our participation in England & Wales.

North America

The cider category has grown by 54% in the year (IRI data) and now represents 1% of the LAD category. By contrast in the long established cider markets of GB and Republic of Ireland, cider is 16% and 13% of the LAD category. General consensus among industry experts is that the cider category will continue to enjoy dynamic growth for the foreseeable future.

During the financial year, we have suffered in volume and financial terms due to disruption from new entrants into the category. Our Woodchuck volume depletions declined 15% year on year. However, the Group continues to view the US cider category as attractive and retains belief that we can participate in category growth. This drives our long term approach to investment. During the year, we opened the new cidery in Middlebury, Vermont, having invested $34.5 million. The new cidery is an outstanding facility and cements our position as a founder of American cider and affirms our commitment to authentic craft cider making and investment in the future. We have maintained our track record for innovation launching new products such as Hopsation and Gumption during the year and have refreshed the Woodchuck brand image with new packaging and a new marketing campaign in the summer. These investments coupled with a more stable competitive landscape show some positive signs with month on month market share of Woodchuck, in the key off-trade channel, beginning to stabilise in recent months.

The new cidery is an outstanding facility and cements our position as a founder of American cider and affirms our commitment to authentic craft cider making and investment in the future.

The Magners brand has benefited from a stable distributor platform with growth of 2% during the year while Blackthorn has experienced growth of 29% in the year with positive trends in distribution and rate of sale. The Hornsby’s brand has continued to decline in the US although we have seen some success in markets outwith the US.

Despite the disappointing performance in the year, the Group’s investment thesis remains valid in terms of cider internationalisation, and we believe that in time with continued investment, we will participate in US cider category growth.

Export

In volume terms, our key export markets outside North America are Spain, Italy and Australia. The business relies on strong distributor relationships and management of these relationships. We have limited exposure to areas of political instability and uncertainty.

In Australia, we had a year of transition between distributors which impacted shipments to the market. We now have a solid distributor platform and relationship with Bacardi Lion and had a strong finish to the year, so we are confident on prospects for this market as we enter the new financial year.

During the year, in volume terms the Magners brand grew internationally (excluding Australia) by 17%, with 14% growth in Europe and 35% growth in rest of the world.

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 57%.

We also continue to grow in Asia, albeit from a small base, with positive volume momentum in Malaysia, Taiwan, and Thailand.

Looking forward, the Group sees further organic growth opportunities for our Export business in Europe, Asia and potentially Africa for both cider and beer assets. As an example, by 2030, Asia is projected to have 66% of the world’s middle class population and currently 4 of the top 10 growth markets for beer are located in the region. As a consequence, we will increase investment, resource and executive management focus in these territories.

Strategy

Ireland and Scotland provide the bedrock for the 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 for moderate earnings growth in these territories, which are ultimately ex-growth in terms of the alcoholic drinks sector. Winning in these geographies requires local knowledge, superiority in customer service and strong brands. Both our Ireland and Scotland businesses display these characteristics.

For now, GB 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 and promising premium craft innovation. We will focus on actions to maximise 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 GB and Republic of Ireland is 16% and 13% respectively. This compares with just over 1% in the US despite spectacular category growth in recent years. 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 US is likely to be the global cider market with the greatest potential in scale terms. We have invested significant shareholder capital in the US 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 1.1x at the year-end. The Group finished the year with a net debt position of €158 million, after absorbing a €30 million share repurchase programme.

Our balance sheet remains conservatively geared providing scope for future investment focused on long term value creation or return of value to shareholders.

Free cashflow conversion in the year was 61% of EBITDA (excluding cash outflow from exceptional items) which was a 9 ppts improvement on the previous year. Ultimately, the Group’s balance sheet and cash generation profile provide flexibility to invest in bolt-on acquisitions and capital projects with attractive returns, as well as consider options for return of value to shareholders.

People

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 than 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.

The Island of Ireland business is 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. Brian Calder previously manager and owner of Wallaces Express has assumed full responsibility for the Scottish business. This is entirely consistent with our vision to establish a brand led wholesale model delivering outstanding customer service. Brian has had four decades in the Scottish drinks industry and is a hugely respected figure in the trade.

Andrea Pozzi has taken on leadership of the C&C Brands business. Andrea will combine leadership of the new C&C Brands team with his existing Europe, Middle East & Africa responsibilities.

In the US, Dan Rowell leads the local management team closely supported by our International Director, Joris Brams. We bolstered the local US board with the addition of Christian McMahan as a non-executive director. Christian has extensive marketing experience in the beverage sector and in social media and will support the local US marketing team.

Billy Mason is the Operations Director with responsibility for manufacturing and logistics.

There continues to be significant coverage on 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. Bonus arrangements for managers and employees focus on local 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.

Corporate responsibility

Corporate Responsibility (CSR) is an important part of our business and something that the Group takes very seriously. Shareholders should be proud of the lead we are taking on many industry initiatives and of the work we are doing with our communities. I am personally very proud of the work undertaken by employees to ensure that we nurture our environment and the communities in which we operate.

The Group has delivered a great deal across a broad range of CSR initiatives. During the last year the Group achieved an energy reduction target of 11%. This was ahead of our targets and we did not stop there. The Group also invested another €1 million in energy-saving initiatives in Scotland to reduce further our CO2 emissions and energy consumption. The Group also worked hard to protect our precious environment including helping apple growers in Somerset protect against a repeat of last year’s damaging floods. The environment 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.

The Group focuses its CSR efforts on activities that strengthen our relationships with our customers and communities. Our work with the Scottish Government and with Best Bar None is directly helping to improve the quality of the night time economy in Scotland. Additionally, the Group is working with the Scottish, Irish and Northern Irish governments on the implementation of minimum unit pricing, which we believe will be an important step in improving the relationship some people have with alcohol.

Our Tennent’s Training Academy continues to go from strength to strength with more courses across a wider spectrum of skills being offered at more locations resulting in over 16,000 people having now undergone training at the Academy. This is a major asset to the hospitality industry and one of which we are extremely proud.

Our Tennent’s Training Academy continues to go from strength to strength with more courses across a wider spectrum of skills being offered at more locations resulting in over 16,000 people having now undergone training at the Academy.

We have also introduced initiatives that will bring the community closer to our business. The new craft breweries in Clonmel and Glasgow enable access to new groups of consumers for different occasions and our Visitor Centre in Glasgow is now in full operation as a leading tourist attraction.

We are also proud of our links to charities, big and small. Over the last year we have worked with the Irish Society for the Protection of Cruelty to Children, One Water offering clean water to the developing world and countless small charities including Friends of Chernobyl Children in Northern Ireland and the St Andrews Hospice in Scotland.

Our goal is to improve the lives of our communities and the quality of the environments in which we operate and during the last twelve months we have strengthened our position in both of these areas.

Outlook

Despite the challenging financial performance in the current year we believe we continue to take actions in the best interests of long term shareholder value. Brand led wholesale models in core businesses 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 on long term value creation or return of value to shareholders.

We are intensely proud of our brands and quality is at the heart of our brand ethos. As mentioned previously we have won awards this year for Clonmel 1650 lager and Chaplin and Cork’s cider range. We have also won international brewing awards for Tennent’s Gluten Free 1885 beer and the Woodchuck range in the US. This demonstrates the pride our cider makers and brewers have in developing new brands and our passion for quality in the production of our brand portfolio.

C&C are also extremely focussed on how we market our brands. We cannot compete directly with the global brewers in terms of headline marketing investment and therefore need to be smart with our investment choices. We invest heavily in social media and selectively use local sponsorship platforms which give the greatest activation potential. To bring this to life, a key KPI for the US business is ‘likes’ for the Woodchuck Facebook page and we supported Scottish rugby through our Caledonia Best sponsorship at recent international matches. Despite lower volume than expectation during the year, we maintained levels of marketing investment and have an upweighted investment plan in place for FY2016. This will protect the key brands in core businesses and promote brand growth internationally.

It is important to note that we are not just focussed on our own brands. We are now in the 5th year of a non-exclusive distribution agreement with AB InBev in Scotland and Northern Ireland. As previously mentioned we have recently been awarded the distribution contract for the global premium brand Corona in the Republic of Ireland. This is vindication of our capability to work successfully in long term partnership with third party brand owners, alongside our own portfolio.

Stephen Glancey

Group Chief Executive Officer