Letter from Adelaide
Paul Evans: “The best achievement in my time is the level of understanding parliamentarians and media have of the industry and our challenges now compared to when I joined. Back then, many, including in the industry, simply didn’t understand the industry’s fundamental dynamics of supply and demand and how government regulation (such as wine tax) actually worked and impacted industry structure and profitability. Nor was there an informed appreciation of the deep impact on profitability from declining export performance given the stickiness of (over) supply.
“I can confidently say that out stakeholders now know far more about the industry and what must be done to aid recovery and growth, even if there is some ongoing dispute around how we should best go about it. That will stand the industry in good stead into the future no matter what. As a general comment, I think the industry is far more demand-side focused than when I joined and this should be welcomed. For example, no one argues that we need an export-led recovery and that industry has largely been gutted of investment capital and therefore we need government assistance to re-enter Old and New markets with a fighting chance against our heavily subsidised competitors.
“The level of understanding around wine tax has also improved. Almost everyone now agrees that the WET rebate needs reform and that current arrangements are unsustainable. As important, rebate reform could also provide a transformational amount of savings to fund the marketing boost we need. In other words, we can self-fund the category-level marketing we see as a key component of growing export demand.
“The biggest disappointment is that government has not acted on these proposals and we remain in policy limbo! The wine industry is the only sector of the economy with its own tax white paper process (WET Rebate Discussion Paper) outside the broader tax review process, which many other agricultural sectors can only dream about. We have also had the recent Senate inquiry, which again indicates we are making a lot of noise and are gaining attention. These examples and others are all welcomed but ultimately they are just processes. What we really need is more tangible outcomes and clear government decisions.
“While the exchange rate and FTAs are good, there will be a ceiling on how far and how long we can exploit the opportunities created by these macro-economic developments and they are likely to be cyclical. What we need is a structural shift in the demand for our products abroad and we simply need help to make this happen on the uneven playing field of the global market. We are willing to also pay for it ourselves through rebate reform and return the rest of the savings to government. I’m not entirely clear on what the hold-up is but industry has to remain united and not give government an inch of wriggle room.
“Finally, many in our industry don’t realise just how deeply entwined we are with government through a plethora of compulsory levies, wine-specific taxation arrangements, enforced technical and labelling requirements and a statutory authority that markets, funds research and regulates our product. We need to reduce the intensity of this relationship and a good start is WET rebate reform. Over the longer term, we need to put government as much at arm’s length as possible and be confident that we have a globally competitive product to survive and prosper in the global marketplace, even if some parts of the industry will need to adapt. In the meantime, paradoxically, we need government to partner with us to get that process underway. I hope government will use their greater insight into the industry to do just that over the coming months. They have promised to deliver before the next election and I hope my successor and industry holds them to strict account on this commitment.”
Onwards and upwards
Treasary Wine Estates (TWE) had a great first half and its share price continues to rise. Will it top $10 this year? Hard to predict, but the 12-month high has been $9.73 so it’s getting close. At the time of writing it has slipped back to $9.55, which is still very good, as the year low was $4.78.
Here’s an extract from a story in The Motley Fool Australia, by Ry Padarath, February 25:
“What exactly makes Treasury Wine Estates Ltd one of the best ways to tap into China?
“Rapid urbanisation and job creation has created a new boom in middle class spending. The Chinese consumer has the potential to be what the US consumer has been recently, a vital cog in world economic growth.
“That’s why companies that are exposed to this spending are well placed. Treasury Wine Estates has a number of brands that can fill the desire for wine in China, including the Wolf Blass and Wynns ranges.
“The challenge for Treasury in this market is converting a market that is traditionally more accustomed to white spirits and beer.
“Treasury Wine Estates has cleverly segmented its brand offering in China to ensure that its premium brand, Penfolds, can retail for up to $1000 for a good recent vintage.
“This has been done by limiting supply, which has the effect of increasing the perception of quality and prestige that attaches to the brand.
“The proof is in the margins, with Treasury’s Asian operations earning 30 per cent margins, which is double what it earns in its home market of Australia. However, any widespread economic stress in China will obviously affect the wealthy, and discretionary spending will likely fall in tandem, which could impact both sales and margins.
“All of the global beverage giants are vying for a piece of the Chinese market, but if Treasury can capture just a portion of the many billions of yuan currently spent on white spirits and beer, while retaining the premium status of its upmarket brand, it will be a growth stock for many years to come.”
Australian Vintage (AV) has also turned in a good first-half preformance, if one puts aside the cost of terminating the Del Rios vineyard lease, reported as $9.7 million after tax. This meant a loss of $6 million. That aside:
- Revenue was up 7 per cent to $129.8 million versus $121.7 million in the prior period
- Net profit after tax and before one-off items (Del Rios) was $3.6 million versus $2.0 million in the prior period
For years AV has been mired in debt. It’s good to see that debt dropped to $95.5 million from $104.3 million at the end of June 2015.
As the company crawls out of debt and increases sales and profit, the reasons given are the increase of branded sales, which are now 65 per cent of total sales (up from 39 per cent 10 years ago). The brands McGuigan, Tempus Two and Nepenthe increased by 26 per cent in the half.
From the report: “The biggest issue over the last ten years has been the onerous nature of most of our grape contracts and vineyard leases.
“With the recent termination of the Del Rios vineyard lease and the expiry of ‘above market’ third party grape contracts, we expect to make significant grape cost savings in the future. We still have some other ‘above market priced’ grape and lease contracts which will expire from 2021. For comparison, if AVL purchased the same volume of fruit and paid the 2015 average grape price, we would expect to save $10.5 million in 2017, $10.5 million in 2018 and $12.4 million in 2019 and beyond. This will significantly improve our future cash flow, reduce our inventory and enhance our already outstanding wine quality. Whilst the cash flow will improve immediately the accounting benefit will take some time.”
Has this proved that sale and leaseback of vineyards gives short-term cash injection but long-term problems? TKR wonders about the savings that AV expects. Grape prices are very low at the moment. They need to rise if the grape growing industry is to survive, and the savings that AV is expecting may be reduced or wiped out.
On a regional basis
The UK has been dominated by bulk sales, with plenty of wine shipped but not a great deal of profit for AV. One wonders how much footfall, hence sales and profit, AV wines generated for Tesco.