In vino, value?

Few industries caused more trouble for investors over the past decade than wine, which is one reason why there are so few stock exchange entry points today despite evidence that a dollar-led recovery has started in the wine business.

Apart from Treasury Wine Estates (TWE), the spin-off from Foster’s Brewing, and Australian Vintage (AVG), the vehicle for McGuigan and a number of other South Australian wine brands, there is no other wine company of substance on the ASX.

Lack of choice is one reason to treat the early signs of a wine revival with caution, another is the risk associated with any form of agricultural investment with droughts, floods, fires and crop disease a few of the issues which keep winemakers awake at night – and that’s before getting to competition for retail shelf space.

But, offsetting those negatives are three factors combining to breathe fresh life into a business which should have performed better if not for damage caused to export markets by the high value of the Australian dollar over the past few years and a truly spectacular marketing mistake made by the local industry.

Causes for optimism

The dollar, as every investor knows, has retreated significantly with some seasoned wine professionals, such a Casella Wines managing director, John Casella, forecasting that an exchange rate of US90c will restore Australia wine’s competitive position in the U.S.

While the dollar drop is important in helping exporters (and hindering importers) there are the other factors adding to confidence in a sustainable wine sector recovery. They are good growing seasons which have seen a 10% increase in grape production and a shift away from promoting Australian wine as “cheap and cheerful” to a try and capture a bigger share of the premium wine market with its higher profit margins.

A decade ago, when the dollar was valued at less than US60c, a flood of cheap Australian wine hit the shelves in Britain, Europe and the U.S. where it competed in a category best known by the nickname of one US winery: “two buck chuck”, which isn’t as awful as it sounds because the name came from Charles Shaw Wines, a super-cheap wine producer.

Unfortunately for Australian wine exporters they mistook volume for value and found themselves in a cut-price, cut-throat, pricing trap which made profits hard to earn during a period of low exchange rates, and impossible when the dollar rose.

Listed wine stocks

This time around the Australian wine industry is aiming to chase quality rather than volume which should be good news for wine producers and investors, if they can find a way into the industry which boils down to three possibilities; Treasury Wine Estates, Australian Vintage or through a new wine float which enterprising investment banks will be working on now.

Waiting for a new float is not an option, neither is exposure to wine via a supplier to the industry, which leaves either TWE or AVG, both of which have enjoyed a share price recovery over the past 12-months as early-bird speculators take positions ahead of a potential profit recovery.

Of the two stocks TWE is by far the biggest with a market capitalisation of $3.83 billion, some 60-times more than AVG’s $63.6 million.

However, of interest to investors, both companies are profitable, both are dividend payers and while a comparison between a micro-cap in AVG and TWE, which ranks as the 63^rd most valuable company listed on the ASX is a meaningless exercise, there are common factors driving both companies.

AVG, in its latest crop report (vintage) and trading update, noted a sharply higher grape crush (153,000 tonnes this year v 120,000 tonnes last year), high grape quality and with a profit forecast to be in line with last year when $7.1 million was earned from $228 million in revenue with a 2.6c dividend paid.

If that forecast holds then at a current share price of 48c AVG shares are on a dividend yield of around 5.4%, which is high by the standards of bigger companies and probably reflects the risk profile in wine production.

TWE, which owns some of Australia’s best-known wine labels such as Penfolds, Rosemount and Seppelt, is generating a less attractive dividend yield of 2.2% but that’s largely a result of a sharply higher share price.

Since January, TWE shares have risen by 26% a function of the overall wine sector recovery, TWE’s unique status as the sole big listed wine company to survive which narrows investor choice, and persistent takeover speculation which is a function of international interest in Australian agribusiness. 

Once the ugly duckling of a failed experiment which tried to combine combining a beer business with a wine business TWE now looks to be a company with a share price that has probably moved ahead of its profits.

The price rise from $4.70 at the start of the year to recent trades around $5.93 makes it one of the better performers on the ASX, well ahead of the more popular bank sector.

Can it continue? Perhaps, but unlikely with most analysts concerned that the stock has got ahead of itself, even though profit for the current year is expected to show a reasonable increase to $175 million (versus estimate of $135 million for the year which ended on June 30), with the dividend expected to rise from 13c this year a share to 17c.

The consensus view of TWE is sell which is ironic given the consensus view of the wine sector is buy – if you can find a way in.