THE FOLLOWING ARTICLE was sighted in Gaetjens Langley’s Valuer & Broker newsletter (December 2013, edition 10).
A consolidating retail market. Gloomy export statistics. A continuing oversupply of bulk wine. Supermarket labels growing at the expense of private brands. When the banking sector has better horses to put its money on – property, food production, information technology – what makes them stay with wine?
NAB agribusiness South Australian wine specialist Stephen Stegmeyer believes the wine industry has always been about understanding the cycle, being nimble to expected and unexpected changes, taking advantage of opportunities when they arise and patience.
“We’re dealing with an industry which is exposed to agricultural risks, many of which cannot be mitigated, along with domestic and international competition that for a number of years has benefited the consumer and not the producer,” he said.
“Unlike other agricultural commodities such as wheat, wool and meat, which are staple items, wine is generally considered a luxury item.
“Wine is a consumer driven product with many alternatives and the cost of production and holding is significant.
“There are few industries which produce a product held for 18 months to two years before sale.
“The wine industry is unique and as bankers it is vital that we have a clear understanding of the market in which our clients operate, the business cycle and the need for patience.
“It is not an industry you can support in the good times and then reduce your exposure in the difficult times.”
NAB’s philosophy is they are in “partnership” with its clients and provide support when they need it most.
Stegmeyer believes the current state of the wine industry, at least from his perspective as a banker dealing with South Australian wineries, is emerging from its darkest days.
“Wineries are capital intensive, cash hungry and generally have an extended cash cycle. A winery’s ability to generate sufficient cash is our primary focus,” Stegmeyer explained.
“The cash cycle varies between operations – for bulk wine operators the cash cycle, from the crushing of grapes to receipt of payment ranges between 180 to 400 days however for premium branded operations which are predominantly red varieties, the cycle is around 750 days on a per vintage basis.
“Bulk wine operators’ cash cycle is extremely good although margins are lower.
“Branded operations are focused on brand value and reputation and generally you would expect improved margins that are required to cover higher holding costs.
“During the period 2009 to 2011 we found that inventory levels for branded operations had increased and that inventory days on hand had grown to around 1,000 days.
“Wineries were overstocked as export markets had deteriorated and there was an element of unsaleable or poor quality wine within their inventory.
“This was a very difficult period for branded operations as they were unable to unlock cash from their inventory and subsequently additional funding was required by these operations.”
Stegmeyer said the reasons for the difficulties are well documented – the effect of the GFC on international demand for Australian wine, coupled with the high Australian dollar and the sharp increase in supermarket dominance of the liquor retail sector.
But the turnaround is just about here he believes, and much of that can be attributed to wine operations managing their position, identifying new market opportunities and cost control.
“I think a lot of Australia’s wine operations have done an exceptional job,” he said.
“We are seeing inventory days back to around 500, positive cash flows and healthier balance sheets than we were seeing in 2009 and 2010.
“There are instances where branded operations are now short on inventory to meet
demand and they are having to fill requirements from the bulk wine market.
“I really admire the way our clients have managed this difficult period – the true position of a relationship is exposed during difficult or challenging times.
“Throughout this period we encouraged open and honest conversations with a “tell it as it is” approach with our clients – we couldn’t help if we didn’t know.”
Stegmeyer said for banks there was no one strategy which appeared to be more successful than another.
It depended on a number of factors including whether they were a bulk or branded operation, which region they operated in, were they domestic or export focused and which price points they were targeting.
“Bulk wine operations which supplied domestic markets had varying results,” Stegmeyer said.
“They were largely driven by fruit/wine quality and volumes and that was largely driven by seasonal conditions.
“Whilst the majority of wine was moved there were instances where lower quality wine was very difficult to sell.
“The 2011 vintage was the most difficult.”
Branded operations that were traditionally focused on export markets had also found trading conditions difficult.
Exchange rate pressure, a drop in consumer spending and uncertainty around distributors’ ability to sell wine and remain financially viable all threatened producers.
“We noticed a number of branded operations withdraw from export markets and focus on domestic markets,” he said.
“The domestic market itself was highly competitive and there is no doubt that consumers benefited as they were able to purchase quality wine at lower prices.
“With high domestic competition, margins did reduce back to the producer however producers were able to reduce inventory that had built up over the prior periods.”
The reduction in inventory has been welcomed by NAB, as it has unlocked valuable cash.
“In any wine related transaction the main consideration is the ability to generate cash,” he said.
“It is important to understand that cash generation is not purely assessed to establish or insist on an amortisation program as it may not be the most appropriate use of cash if there are growth opportunities that provide a better return on capital/investment.
“Our view is that security via land, buildings and inventory provides a strong secondary exit but a strong security position without cashflow is not a reason to lend.
“There are many that simply assess the performance of a wine operation on a Profit & Loss Statement.
“However, we have found that any profit is generally held in inventory or debtors and not freely available – cash is the key focus.”
Stephen said there has been a focus for wine operations to reduce their inventory and improve their cash flow between 2010 and 2012.
Many reduced their debt burden because it was the most appropriate use of cash in the short term.
However, there are a number of operations looking for strategic acquisitions and having a lower debt position has provided them with confidence.
“This is a long term industry and we have seen a number of successful and astute operations seize opportunities to purchase vineyards, winery properties and brands at historically low prices,” Stegmeyer added.
“These buying opportunities are rarely presented and for those who have purchased these assets over the last couple of years, they will gain significant future benefit.”
IS A GOOD BRAND AN ASSET?
Stegmeyer believes it is very difficult to place a specific value on a brand.
He said there are external firms which will provide a value on a brand.
“There are thousands of brands within the market and it can be quite confusing as some are virtual brands and others are backed by winery and vineyard assets,” he added.
“Creating a brand is not difficult – what is difficult is creating a compelling reason for a consumer to buy your brand instead of another brand.
“The value of a brand is largely determined by a story, market acceptance, demand, repeat business, quality, consistency and margin.
“A good story is undeniably important – you just have to see the impact the First Families of Wine are having here and overseas.
“But we also know that brand strength can change quickly – for example with the retirement of a brand champion or distressed sale.”
Stegmeyer said brand was also increasingly influenced by region, given the move by more wineries towards acknowledging provenance and terrior and away from the generic Australian styles of the early 1990s.
“The Barossa seems to have really leapt ahead of other Australian regions in terms of land values, grape returns and wine prices,” Stegmeyer said.
“It didn’t fall as far as other regions during the downturn and values are now being restored quite quickly.
“We have seen significant interest from international investors in the Barossa more than other South Australian regions.”
While there has been increased interest in the Barossa, he expects there will be a time when opportunities will be harder to find.
“When this happens we expect that other regions such as McLaren Vale, Clare and the Adelaide Hills will attract added attention or interest, and this willresult in higher prices.”
He believes the next five years will be very positive for wineries and viticultural enterprises in favourable regions who have well researched and documented business plans and positive cash flow strategies.
“The last few years have been extremely difficult for our wine producing clients and while most have been through difficult times in the past they had not been presented with so many challenges at the one time.
“Their ability to navigate through the period by managing inventory, identifying new markets, reducing costs, maintaining relationships and identifying acquisitions has been remarkable.
“For many this will be a remembered as a defining period and they will benefit greatly in the long term. ”