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Interview with Group Chief Executive, Mr Louis A Farrugia 4/27/2006

CEO Louis Farrugia explains the difficulties Farsons has had to face in 2005 but is confident that the Farsons Group will return to a healthy profit in a short time through measures it has taken and by re-engineering its workforce and investing heavily in its operations.  He concludes by stating that the Farsons Group is in the process of reinventing itself and this will bring increased profitability for the Group.

1.      Results published yesterday reveal that last year was a difficult one for Farsons Group. Can you explain why?

It was a year that was characterised by radical changes in the market place that have had a significant impact on the performance of our beverage businesses across the Group.

It was also a year that saw further losses in certain subsidiary companies.

As already announced with the publication of our half yearly results the Group is taking immediate action to address these realities through a heavy investment programme and by re-engineering its workforce and work practices to ensure that we are well equipped for this changing scenario.

On the macro level, a difficult economic climate has prevailed during the past year. There have been increases in the prices of utilities and fuel which have increased our costs throughout our Group’s activities as well as having a dampening effect on consumer spending. Tourism to Malta during 2005 was relatively flat in numbers of arrivals whilst at the same time, this important industry has a changing profile with a reduced length of stay per tourist. These adverse economic factors were further fuelled by the fact that in 2005 Malta experienced lower than average temperatures, hence depressing the demand for beverages.

The changes in the market place have resulted in new realities that need to be addressed. In 2005 we have seen a new flood of imports largely due to the advent of parallel traders who trade in all brands and challenge the traditional importer/principal relationships.  This is a new reality that has taken root in 2005. We have also experienced illegal imports of beverages which have not been levied with the official excise duties and have entered Malta’s market through unorthodox methods. Our industry has made its representations to the authorities and we sincerely hope that government’s measure announced in the last budget to introduce bandarolls on importation of each bottle will go some way to reduce these illegal operations.

In the scenario described above the control of costs becomes even more crucial and corrective action is being taken to reduce operational costs wherever possible.

2.      These were the second, successive, annual results showing a deteriorating performance. Last year you said in your press release that: "We are however confident that the strategies adopted to face the challenges are the right ones and the steps taken by management will give the required returns in the years ahead." Does that mean you were surprised by the outcome this year?

Yes we stand by what we said.  We are in an industry that was heavily protected for decades.  The changes we have had to face are probably more radical than many other industries.  Yet one year after full liberalization we are slowly winning this battle with the strategies outlined in this interview.

3.      What action has your Group taken to address the issues?

We have a promise of sale of the Galleria Complex and so taken a once only impairment charge of Lm542,000 on this investment.

We have downsized the operation of Guido Vella to arrest the heavy losses we have made and re-dimensioned its role within the Farsons Group.

We have initiated a cost cutting exercise by launching an early retirement scheme which has reduced our workforce and has resulted in a once only charge on this year’s accounts of Lm200,000.  Besides this we have targeted another Lm200,000 of cost savings in administrative expenses for this year.

We have released some surplus property for sale which will result in increased funds for the important investment programme now underway.  Interest rate costs have been reduced and so have our bank borrowings despite our heavy investment programme.

4.      In the interim results for the period ended July 31 you reported that the board of directors is continuing to address the issues relating to the loss-making companies - Guido Vella Ltd, Vita Sana and Galleria - and believes that its strategies will be successful in the short to medium term. Can you elaborate on these strategies? What, realistically, are the prospects for these companies to turnaround in the short to medium term? Specifically, does Farsons intend to sell Galleria and is it in talks for such a sale?

As stated already we have downsized Guido Vella significantly to a bottle shop rather than a fully fledged wholesaler.

We have a promise of sale agreement for the sale of the Galleria Complex which will mean that we have halted any further losses in this subsidiary.  This sale will be concluded in early 2007.

Vita Sana is on the way to profits and I am confident will be a profit earner within the next 24 months.

5.      Do the results just announced have an impact on your investment programme including the new brew house, soft drinks packaging hall and distribution centre?

No we are moving forward with our plans but obviously taking the necessary steps to reduce costs whenever we can and increase our revenue stream throughout our businesses.

The Group has reasonable cash flows given the high depreciation and amortisation charges of nearly Lm2,500,000 annually.

6.      Is the investment programme announced last year proceeding according to plan?

Yes very much so.  The new soft drinks building is ready and we are now in the process of buying the machinery.  Besides the site for the new Logistics Centre has been cleared and excavated ready for building and we have just awarded the building work for new premises.  In total these two projects will cost Lm11,000,000 and we are confident that we will finish on schedule (December 2007) and within budget.

7.      How are the Unions reacting to your strategy of change in work practices – does your drive for greater efficiency entail some job losses? Will these results have an impact on your workforce numbers or on conditions of work?

One of the major costs the Group faces is its wage bill.  The need to address its size is a fundamental part of our re-engineering process.  We have announced an early retirement scheme to our employees.  The targeted number of possible retirees have accepted to voluntarily retire and as they leave they will not be replaced. 

The GWU and UHM are proving to be very mature interlocutors on this issue as they have fully understood the implications of the challenges facing the Group.  With the full collaboration of the Unions work practices and manning levels are being amended to result in higher efficiencies and outputs. 

It is accepted that the jobs and excellent employment conditions prevailing within the Group can only be preserved and improved if all employees are willing to adapt to the changes in work practices required.  Extensive training and retraining programmes are part of this effort to maintain a competitive edge.

8.      Demand for the group's beverage products is suffering due to lower economic activity in the tourism sector and cooler summers. Are you modifying your product range to address changing consumer needs and tastes?

Our leadership of the beverage market requires that we remain innovative and stay in close proximity to market trends at both international and local level.

Major trends are creating significant challenges for all industry players but they also create opportunities. Harnessing these chances to seek growth, particularly, in areas where we have a seasoned management expertise ready to seize the moment, is critically essential.

To take just one such trend, the worldwide phenomenon of weight consciousness, and the concerns that have come to surface in all nutritional and educational spheres, has a direct influence on our business. At Farsons we have understood the implication of such movements, and met the challenge by for example, the extension of our bottled water business to every price level of the market, and the development of fruit flavoured water products like San Michel Fruitwaves.

We have in fact been increasingly innovative this past year and we are more than firmly convinced that this is the key to our sustainability and growth potential. We have intensified our efforts within a New Product Development programme and focused our commitment to create new products to meet changing consumer preferences and so retain the all important competitive edge.  We are launching a number of new products in the coming weeks.

9.      Farsons has been facing stronger competition from the importation of beers and spirits, although the accounts have shown healthy figures by the imports section. Do you see a threat from the importation of soft drinks with full liberalisation due in 2008?

When this liberalisation takes place it is expected that the market will shift from soft drinks in returnable glass bottles to soft drinks in one way PET bottles. This investment is ensuring that the company is well prepared to face this expected change in the market place.

10.      To a large degree the Group is still dependent on the local market. What are the prospects for export markets?

We are continuing with our efforts to seek overseas markets for our brands. Italy is once more expected to take centre stage for our beers as in the later part of last year new importers were appointed in the southern area of the country. Worth noting is the debut of the Cisk XS Extra Strong Lager which was received with great enthusiasm by pub patrons in Italy We intend to further pursue the export markets potential with renewed vigour and have strengthened our team with the recruitment of a new International Business Manager to seek new revenue sources from external markets.

11.      Several of the subsidiaries have been underperforming for some time. What, realistically, are the prospects for these to turnaround in the short to medium term?

In the beverage importation sector new challenges have had to be addressed. Both Wands Ltd and Anthony Caruana & Sons Ltd have faced strong competition from cross border trading on leading spirits brands, which has been fuelled by the high level of excise duty imposed on spirits in Malta when compared to neighbouring countries like Italy. In the wine sector the liberalised market has resulted in a large increase in the number of importers and in the variety of wines imported, particularly at the lower end of the market.

The rules of the game in the Cash and Carry wholesale business in Malta have changed dramatically since our acquisition of Guido Vella Ltd.  A new but increasingly common practice is that of new wholesale trade players directly parallel importing international brands.  As already explained we have now downsized this operation.

In the Food Imports sector, notwithstanding the growing competitive pressures within the food sector as a whole, Quintano Foods Limited has continued with its positive performance. This year was its first full year of operation within the Group following its purchase in April 2004 and it has continued to perform in line with our predictions. It is clear that this business has consolidated and successfully managed to optimise on the synergies and opportunities of collaboration offered by the group. Today this company is our fastest growing company within the Group and has established itself as a valid contributor both in terms of revenue generation and profitability.

During the year the product portfolio has been further enhanced with new products as for example the Tropicana fruit juice line. Given the positive outlook of this business, management is committed towards further strengthening the represented product portfolio.

In the sector of dispense water bottles, our subsidiary Eco Pure Preminum Water Company Ltd, which sells 19 litre water bottles for dispense from coolers supplied by the company, has delivered a satisfactory profit despite ever growing competitive pressures. There is a limit to growth within the Malta market which is why we have ventured into the Italian market and set up our own subsidiary Vita Sana srl based in Treviso, Italy.

We have committed considerable resources to ensure a better performance from our Italian dispense water operation Results to date have not yet registered a profit but we expect to reach break even within the next 18 months and our investment will result in a satisfactory return shortly after this.

In the food franchising segment, during the year under review, Food Chain (Holdings) Limited has had to face various challenges resulting from both external and internal factors. The electricity surcharge has dealt a double blow in this area. The surcharge has not only dampened consumer demand but hurt its cost base. This company does not benefit from the capping system the government introduced for industry and hotels which has limited the cost increases to reasonable levels.

Pizza Hut has increased its exposure in the market place.  The St Julians outlet is being refurbished on the same specs as Bugibba, and this outlet too will move away from the fast food idea and align itself with the casual dining concept.

Burger King has experienced some negative sales trends but we are encouraged that the Sliema outlet has experienced a turn around during the year. This year saw the 10th Anniversary of Burger King in Malta and various marketing initiatives were carried out to mark this event.

KFC started the year very positively.  This turnaround has however been dampened with the arrival on the international scene of Avian Flu which resulted in a sudden drop in sales of poultry products.

T.G.I. Friday's also experienced some challenges during the year but a new menu layout and further controls on cost of sales went some way in addressing these challenges. 

12.      Product quality has always been a Group priority. How would you say your products compare to foreign ones?

Our focus on our two key ‘own’ brands Cisk and Kinnie, has not wavered and it is a matter of great pride for us that Cisk was awarded the silver medal for the category of best bottled lager in the International Lager Competition category Class 1 of the Brewing Industry International Awards 2005 held at the Drinktech Fair in Munich in October 2005. 

This competition, held once every four years, is known as the ‘Oscars of the Brewing Industry’ and our award is indeed very prestigious given the high quality of the hundreds of beer brands from all over the world that took part in the competition.

Kinnie continues to arouse interest from overseas visitors and we believe that it has serious potential for export.  We are working hard on this opportunity.

13.      Has the recent move into property management yielded satisfactory results or is this seen as part of a more long-term strategy?  

The Group is giving more focus to its property portfolio. The need to earn a good return on the considerable value has been declared as a priority objective by the Board of Directors.

In line with this, Trident Developments Limited last year disposed of some of its property at a good return and has continued to strive to maximize its rental return on its property portfolio. The company is continuing to plan how to maximise its return for the benefit of all shareholders. In the next five years a sizeable amount of land and property will be released by the Group for the benefit of starting new income streams.

14.      To what extent will the new logistics centre impact on your operational efficiency?

The distribution of Farsons products today is done through six depots spread across the island resulting in a significant amount of double handling of our products. Excavation work on the site of a new centralised distribution centre started in the last quarter of 2005 and the whole project is scheduled to be completed in December 2007.

This new centre will cover an area of circa 12,700 sq meters and will centralise all the Group’s beverages distribution. It will also incorporate within it new stores for Wands Ltd and Anthony Caruana Ltd. It will result in a more efficient, leaner operation that will give a better product to the consumer and a more efficient service to our clients and in so doing will free the depots spread across Malta and the Wands site.

The Board has approved a strategy whereby these sites will be prepared so as to be put on the market once they are vacated. These sites total in excess of 25,000 sq meters of land and include some prime locations. The revenue derived from the sale of these plots of land will be used to part fund the investment program.

The third and final phase of the investment plan is the construction of a new brew house. This is planned to take place in 2009-2010.

15.      How do you plan to utilise the property that will eventually be available for re-use?

The new investment program will not only result in the vacating of the depots and Wands site mentioned earlier. It will also release a substantial area of prime real estate used by the current operation along Mriehel Road.

An area of circa 22,000 sq meters stretching for half a kilometre along this road which is currently valued in our books at cost will become available for the Group to utilise in the best possible way. This could include a business park complemented with a large area for retail outlets whilst retaining valid current architectural structures.

16.      What are your expectations for the Group’s future profitability?

As I stated at the beginning this has been without doubt a difficult year for the Group. These difficulties however have not discouraged us but have renewed us with enthusiasm to face the challenges ahead. The market place has changed and we are changing so as to ensure that we are able to address these new realities and rise to the test as we always did in the past.

Through our investment program, by re-engineering our workforce and work practices and by exploiting our real estate portfolio we are confident that we will return to a healthy profitability within a very short period of time.   We are in fact reinventing the Group’s activities and this will allow us to improve our profitability and adjust our core businesses to suit market trends.