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The City

Published:  18 January, 2007

All companies aspire to a strong balance sheet. It is a sign of corporate health and a strong incentive for investors to buy the shares.

So when companies improve their borrowing position or reduce other potential liabilities to improve their finances, it is a reason for increasing confidence. It is also a reason for rivals to look over their shoulders, because the financial strength of a strong balance sheet makes mounting a takeover bid easier, especially if the predator is hoping to make a part payment with its own shares.

In most cases, however, reducing borrowing is simply prudent business. Take Wolverhampton & Dudley, the growing regional brewer and pub operator. It is increasing its own firepower by refinancing 1.05 billion of debt. It is following the growing industry practice of securitising some 70% of its pubs against future cash flow from them. This will raise between 530 million and 805 million. In addition, Wolves is putting in place a new bank facility of 250 million.

The facilities will not be put in place until interest rates are favourable - most commentators believe they are on the way down - but whenever they become available, Wolves will be financially stronger. Already this year it has taken over Jennings Brothers, the Cumbria-based brewer and pubs group, and although the group says it will pay down some loans and redeem some debenture stocks, reducing its annual interest bill in the process, it has made no secret that it remains acquisitive if the right opportunity arises.

The same can be said of Diageo. Its balance sheet has just become that bit much stronger because it has shed any potential liability for underwriting loans to Burger King when the fast food empire was sold in 2002. Burger King's refinancing of its debt means that Diageo will be repaid about 150 million, while it also loses the requirement to guarantee a further $850 million in credit. The likelihood of Burger King ever calling on that guarantee was minimal, but its removal strengthens Diageo's finances in the eyes of the credit markets.

Diageo already has an A' credit rating and is generating very strong cash flows, so in some senses an extra 150 million in its coffers is small change. But it will soon have to pay Pernod Ricard some 310 million for Montana and there is growing speculation that Paul Walsh would like to make further wine acquisitions should the right opportunities occur. A stronger balance sheet will make a move that bit easier to finance. At the same time, Diageo has pledged to generate extra shareholder value by continuing its share buyback programme.

Analysts will be looking for clues to Diageo's strategy when it announces its annual results at the beginning of September.