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Significant investments and currency fluctuations were chiefly to blame for a problematic 2003 at Baltic Beverage Holdings, one of the most important jewels in both the Carlsberg and S&N crowns. But, as Olly Wehring discovered, margin pressure and the structural concerns continue to cast a shadow into 2004.

The Russian beer market has been one of the industry's biggest success stories of the last 10 years. With an area covering 10 time zones and holding almost 150 million people, the collapse of the Soviet Union in 1991 preceded a boom time for brewers. Baltic Beverages Holding, a joint venture between Denmark's Carlsberg and the UK's Scottish & Newcastle, has been at the forefront of this success story. And yet last week's year-end figures were described by the company itself as "not the best", as margins in the sector continue to be squeezed. And though BBH has remained confident, analysts have begun to wonder whether the Great Bear is heading for long-term hibernation or merely dozing, in need of nothing more than gentle prodding to wake it up.

In 2002, Russia was the fifth-largest beer market in the world, and second after China in terms of absolute volume growth over the seven previous years. Beer consumption in the country has increased by an average of 20% year-on-year since 1996. Looking forward, in retail sales the beer market is expected to grow to $10 billion in 2010, up from US$6.9 billion in 2003. With such scope for expansion, the acceptance by BBH that 2003 was a tough year will no doubt cause some concern.

To an extent the company, like so many this year, was undone by factors outside its control, in particular currency rates. In terms of euros, net sales for the year to 31 December 2003 fell by 6% to €1.16 billion, but in dollars, net sales rose by 13% to US$1.3 billion. EBITDA for the year fell by 14% in euros to €352m, but in dollars was up by 4% to US$400m.

Speaking to just-drinks last week, BBH's corporate affairs director Mervi Heinaro said: "2003 was not the best year we've had for profit. The Russian rouble depreciated by 17% against the Euro last year."

BBH also made some significant investments in the business over 2003, which increased costs. "We made a huge investment in two new breweries and distribution networks, which were necessary investments for our future," Heinaro said.

But while Ulla Mouritsen, equity analyst at Jyske Bank in Denmark, accepts that volume growth was higher than expected and turnover for the year was just about what she'd expected, she said: "There was significant pressure on margins, however. This was due to high growth in the PET segment - both prices and margins are lower than for glass - and the new sales and distribution investment for Baltika. BBH said all year that there would be pressure on margins in 2003, and it also says this will be the case in 2004."

On top of the margin pressures, Baltika, BBH's main brewing concern in Russia, also saw its share of the total market fall by 1.5% last year, with most of the losses coming in the mid-price segment. Baltika started to restructure its sales system last year, introducing clear rules for its distributors and reducing their quantities. This consequently had a negative impact on volume sales. Added to this was increased competition in the higher-margined canned beer segment, where Baltika suffered a substantial loss of market share, from its previous high of 39% in 2002 to 28% in 2003.

All that said, the company still seems well placed for 2004.

"They have such a strong position in the market, with a very clear strategy and some good ideas," says Mouritsen. "Going forward, they will benefit from last year's investments. Whilst I don't expect them to capture as much as 2% more market share next year, BBH should continue to grow steadily." Mouritsen feels, however, that margins may still not perform as well as the company hopes. "There will be some higher marketing spending going forward, and this will put pressure on margins," she adds.

Potential, she pointed out, lay at the higher end of the beer market. "The Russian market won't expand as quickly as it has done - the days of 15% a year are over - but it is still not a mature market," she says. "The premium segment is where the growth will come, and also where higher margins can be made." BBH is positioning itself well in this segment, with Carlsberg and Tuborg already brewed in Russia, and Kronenbourg 1664 and Foster's heading east later this year.

Krivoshapko agrees. "I believe Baltika has very good potential for market growth," he says. "The company intends to double its advertising budget in 2004, which should help." There will probably be reasonably strong top-line growth, he believes, though he also sounds a warning on margins, which may now hit the added problem of increased malt prices, thanks to the scorching summer last year.

Split loyalties

The longer-term health of BBH may be more difficult to predict however, and, the curious situation of two major west European competitors teaming up to take on Russia's brewers, continues to split opinion.

The company line is that the status quo is working well. "We get this question all the time," says Heinaro. "Having two owners is, for BBH, business as usual and it's the way it's always been."

But Krivoshapko sees things differently. "It's not a 'going concern' partnership," he says. "I think maybe they will split the business in the future. Each brewer would like to push its own products through BBH."

There are also questions related to the company's operational structure. In a recent research note, Krivoshapko wrote: "There are no synergies within the largest beer holding in Russia, BBH, as all of its breweries act independently."

At the moment, BBH's regional brands act in direct competition with its strategy of pushing the Baltika brand nationally, a situation Krivoshapko calls "ridiculous". Consolidation of the BBH network into what the research note calls "one discrete organisation", would create a clear leader with 33% volume share. It is a move that could add real benefits for the company, allowing it to take full advantage of what still represents one of the most attractive growth rates of any international beer market.

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