Allied's wine thirst may bring headache

ALLIED Domecq is falling further behind Diageo. In the past two weeks, the world's leading spirits company has sped ahead of Allied, selling Burger King for £1.5bn, strengthening its US distribution system and launching another version of its successful Smirnoff-branded alcopops.

With each manoeuvre, Allied's price-to-earnings discount to Diageo has widened - it now stands at about one-third. The group, led by Philip Bowman, trades at about 10 times Morgan Stanley's estimated 2003 earnings per share to Diageo's 15 times.

By almost every measure, the discount seems deserved. Diageo holds the top brand in seven of the world's 11 major spirits categories and is the clear leader in the fast-growing ready-to-drink segment. Diageo's return on invested capital is 50% higher.

All of this is made possible by Diageo's US distribution network, which dwarfs that of Allied. There is no easy way for Allied to narrow the gap. Building world-class spirits brands takes years. Allied's response may be to do a deal, as its listing in the US - where some potential merger candidates are located - might suggest. Here again, investors have concerns. Allied has splurged on assets in the wine business, but these have proved costly for shareholders and are some four years away from meeting their cost of capital.

As for merger partners, both Brown-Forman and Fortune Brands are linked with others in distribution arrangements that would be complicated to break. That leaves the potential for another wine acquisition - and shareholders are still enduring a hangover from Allied's last such binge.

Bad debt is a hot topic as bank shares ride high

BARCLAYS and Lloyds TSB have caused a stir with jumps in provisions for bad debts. But this has yet to dent the price of bank shares. The banks have escaped the worst of the market meltdown. Despite the failure of big borrowers such as Marconi and NTL, their loan books have remained relatively sound.

Low interest rates have enabled consumers both to splurge and keep debts current. The banks index has fallen by 15% this year against 22% for the Footsie.

Banks have also benefited from a belief among investors that they have become cleverer about managing risk. This is based upon changes banks made to their lending practices during the long upswing. It has never been stress-tested in a downturn. That may soon change. True, the British environment remains largely benign, and Lloyds TSB and Barclays blamed their provisions largely on adventures in Argentina.

But consumer spending has started to lag, with both the volume of retail sales and shop prices falling in June. In the US, where this trend is more advanced, the share prices of consumer lenders have collapsed. It is feared that a consumer slowdown could tip the US back into recession.

Banks have traditionally traded at a discount to the broader market to reflect the risk of a bad debt explosion now and then. It is hard to understand why bank stocks would continue to outperform at a time when the risks of such an explosion have increased.

Ebner shock

MARTIN Ebner, the celebrated Swiss investor, has surrendered control over his investment funds, causing shock and amazement among investors. But it is not so hard to see how it happened.

Ebner built his reputation and his fund during the long upturn when credit was easy and stock prices were seemingly on a one-way escalator. So it doubtless seemed a good idea to borrow to buy long-term holdings of shares and to guarantee to redeem selling investors. But Ebner only acquired a small number of big holdings in companies, leaving him somewhat exposed should share prices fall. He is not the first hero of the bull market to exhibit feet of clay in today's trickier markets. He won't be the last.