Scottish & Newcastle's half-year results were respectable, if not outstanding, but many analysts remain unimpressed by the brewer's prospects. Olly Wehring met with the company's chief executive, Tony Froggatt, who is candid about S&N's problems but equally confident in its ability to solve them.

Earlier this month, S&N reported an 8% jump in half-year pre-tax profits to £316m (US$544.7m) on turnover up by 17% at £3,034m. Beer volumes increased by 4% to 25m hectolitres, while earnings per share rose by 9% to 25.9p. The results could hardly be seen as disastrous but it is clear that many analysts remain unconvinced.

While the company's performance in Russia, where S&N grew share with volumes increasing by over 12%, gave genuine cause for optimism, the news from the company's core UK market was less encouraging and arguably the principal cause of concern.

The UK beer market grew by only 1.5% during the period but Scottish Courage's volumes fell by 1% overall. Scottish Courage's top four brands (Foster's, Kronenbourg 1664, John Smith's, and Strongbow) outperformed the wider portfolio and grew volumes by 4%, led by Foster's, which grew by 8%, and Strongbow which grew by 10%.

"It hasn't been as exciting for us in the UK as we would have liked it to have been," Froggatt said. "The UK business had a tough time." Analysts have pointed to problems with S&N's distribution in the UK, a difficulty conceded by Froggatt himself. "We had a particular issue in terms of the supply chain," said Froggatt. "It was well publicised back in January and February. That has had a knock-on effect on our business."

Underlying beer profits in the UK, which fell by 13%, were hindered by delays in streamlining the company's distribution network, a performance which Froggatt feels was "not good enough." This disruption also saw S&N's volumes to the pub trade fall by 6%. Indeed, one analyst feels that the 'distribution hangover' will continue to affect the company next year.

"The main problem facing S&N in the UK is that it is losing market share," one analyst at a leading investment bank told just-drinks. "There are two reasons for this. Firstly, there are still distribution problems. Secondly, there has not been enough marketing effort behind its key brands. S&N's brands are still running behind Stella Artois. To make matters worse, the market environment generally in the UK has not been favourable. The shift from on-trade to off-trade has squashed margins for everyone."

So in the UK, Froggatt has his work cut out for him. On the supply chain issue, his dilemma is to make the necessary cost-saving efficiencies in the supply chain but not at such a pace that it causes further disruption to customers. While service levels have improved since early this year, Froggatt fears it will take up to three years to improve the distribution operation to reach industry-best levels.

Between £40m and £50m in cost reductions in Scottish Courage are planned which some believe could mean job losses and plant closures. The company would not be drawn further on this matter, but it seems inevitable. To catch, and hopefully overtake, Stella, S&N also proposes an increase in UK advertising next year by 15%. Plans are in place to correct the errors of the past. "We are, with a 27% market share, the biggest business in the UK and we should be doing better," said Froggatt.

One saving grace for S&N is that it is not solely reliant on the UK, as it would have been a few years ago. The company has built up assets abroad, particularly in France and Russia.

The company is particularly positive about Russia. Baltic Beverages Holdings, its joint venture with Carlsberg, is the market leader in Russia with 33% of a potentially huge beer market. Russia accounts for 25% of S&N's profits and volume terms are set to increase by between 5% and 7% with S&N continuing to increase its market share. S&N has announced plans to export Foster's and Kronenbourg to Russia from next year. "In terms of growth, Russia cannot be overstated," Froggatt told just-drinks.

In France, S&N needs to focus on the premium market, where Kronenbourg 1664 is up against market-leader Heineken. "That is our aim… to grow the premium side of our business," says Froggatt. As in the UK, increased marketing will be the approach in France.

Regarding any imminent acquisition plans, Froggatt is, unsurprisingly, wary though the company said it is in "advance negotiations" to acquire a 19.5% minority holding in Chongqing brewery in China. "Never say never, but I think we haven't fully exploited our own brands yet," Froggatt said. "We are looking primarily at driving our core businesses that we currently have."

Concentrating on and developing its core activities may be the sage strategy but it does not appear to promise S&N an easy time, with analysts predicting a tough year ahead for the brewer. "In the UK it is not a rosy picture for S&N," said one analyst. "The effects of the increased marketing investment won't be felt overnight. It'll take at least a couple of years for this to reap any rewards. It's not a good picture for next year in France either. Again, S&N is losing share. Although it is gaining in the premium brand market, they are under-represented in this sector, only really having Kronenbourg 1664. In the premium market S&N currently has around 20% share. Its main competitor, Heineken, is very effective with its marketing in France."

However, Russia continues to be a source of good news for the brewer, although some observers have said that its plan to sell Foster's and Kronenbourg in Russia carries some risks and it will be expensive to sell these brands across different jurisdictions. BBH is not expected to pay any share dividends until 2005, with earnings being ploughed into expanding the business.

While S&N seems to be playing down any acquisition aspirations of its own, it has been suggested that the company could itself become an acquisition target for a major international brewing combine, with SABMiller frequently touted as a possible suitor.

Froggatt naturally dismisses such speculation. "We're not concerned about what SAB or anybody else is doing," he said. Froggatt is clearly keen for S&N to be seen as a company taking affirmative action, including both increased marketing spend and restructuring, to tackle problems it concedes it has. But it does not want to give the impression that those problems are fundamentally undermining the company.

"Yes, there are issues in terms of the mature markets, particularly France and the UK," says Froggatt. "But in those markets we have very strong positions and we believe that there is value to be driven out of those businesses. Consumer confidence is not strong, particularly in Western Europe, so it's going to be a tough time ahead in 2004."

This does not appear to be an understatement if some analysts' forecasts are anything to go by. "S&N has the poorest prospects for profit growth of all the brewers we cover," one analyst said. So on this there is consensus. It is going to be tough. Just how tough it gets for S&N remains to be seen.