Simeon's volume strategy

With the wine industry generally growing at a couple of percentage points faster than GDP, one would think that Simeon's share price would be looking fairly good. But since January 1998 the stock has declined an alarming 22% annually, as against an 8% annual gain for the All Ordinaries Index. That's after a period between 1994 and 1998 when they outperformed the All Ords by around 3.5 times.

A lot of this is down to perceptions. Simeon is a bulk producer and most of the wine that it makes goes to companies such as Southcorp or Orlando-Wyndham, a French-owned outfit that is Simeon's largest shareholder, with 13% of the capital, who put their own labels on before the wine reaches the bottle shops. This is a lower margin business and, since branding means a great deal in the wine game, it's not surprising that the market currently accords Simeon a multiple on EBITA (earnings before interest, tax and goodwill amortisation) of only nine, versus 15 for the typical listed wine company. Not helping was gearing as at 30 June 2000 of 64%, a figure a bit high if you're a bulk supplier of any commodity.

Fundamental health

Yet another reason for the lower rating is that 1999/2000 saw a pullback in earnings - net profit after tax dropped 9% to $15.3m, in spite of a 17% rise in sales to $117.7m. However that disguises what we believe is the fundamental health of Simeon's business. During the year the company's wineries processed a record 147,900 tonnes of grapes, which should have made for an earnings increase were it not for the poor performance of the company's 2,200 hectares of vineyards, which had a bad 2000 vintage.

The vineyards don't worry us too much – they were only about 25% of EBIT in 2000, with that proportion declining every year. On the other hand we're rather excited by the performance of the wineries. For a start, these expect to increase grape throughput by 19% in 2000/2001.

The perception by industry watchers is that margins are low, and at the mercy of a squeeze by customers. Simeon begs to differ. Simeon sells 80% of its wine under long-term contracts which have up to 15 years duration. Often the buyers have committed themselves to increased offtake of wine each year. Simeon concedes that margins are low, but at least they're fixed, and with economies of scale on the supply side and guaranteed increased volumes on the demand side Simeon's prospects in bulk wine are reasonably secure.

Of course, that hasn't stopped Simeon trying its hand at direct international sales, where margins are fatter, via its owns sales force in the UK. Also, recognising that its lack of branding was causing it to miss out on the worldwide boom in branded premium wines, Simeon last year laid out $27.5m to buy Chateau Yaldara Wines, a Barossa Valley winemaker producing 500,000 cases of branded product annually.

At the present, with both volumes and margins in the plain old bulk wine business set to grow in this year, driven by sales of inexpensive table wine to large overseas supermarkets, our forecast 2000/2001 results make the shares look reasonably cheap. However, timing in this game is important. Simeon earns most of its profit in the second half, so until that time comes round it's better to HOLD.