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									Wine Manufacturing
        Industry Vitals

        KordaMentha Research Unit
                   Publication 707

                        April 2007
Industry Vitals
April 2007

                  Wine Industry

                  Sector: Wine Manufacturing in Australia

                  •   The profitability of wineries (large listed to small boutique) has
                      trended down over the last four years predominantly due to:
                      −    over-supply of cool and warm climate fruit;
                      −    increased competition and heavy discounting both
                           domestically and internationally; and
                      −    consolidation of the Australian retail sector;
                      −    a strengthening AUD.
                  •   As always there are exceptions to the rule as demonstrated by the
                      growth in Yellow Tail underpinned by significant US sales growth,
                      albeit at single digit growth in recent years.
                  •   New market development, brand repositioning and the accelerated
                      depletion of surplus inventory (due to drought, hail and frost as
                      discussed below) may indicate the bottom of the industry cycle has
                      been reached.
                  •   In an increasingly crowded retail market, market access is a critical
                      issue. Supermarket dominance will require brand owners to adopt
                      and evolve sophisticated marketing techniques in order to survive.
                  •   Medium size producers (revenue $5 million to $20 million) are most
                      at risk of being “lost in the middle”. They have suffered from the
                      tendency for large retailers to deal with large suppliers and are
                      unable to clear their volumes through cellar-door sales. It is likely
                      that ongoing distribution consolidation will drive future mergers
                      between medium sized operators.
                  •   Whilst barriers to entry are high and increasing, the outlook for
                      existing players is highly dependant upon the industry’s ability to
                      manage the supply-demand equation through non-price mechanisms.
                  •   Due to extreme seasonal weather conditions the current vintage is
                      expected to be approximately 30% lower than the 2006 vintage, with
                      the 2008 vintage forecast to be approximately 20% lower than 2006.
                      Consequently the estimated 530 million litres of unallocated
                      inventory on hand is forecast to be materially reduced, if not
                      exhausted, by FY09.
Industry Vitals
                                                            •   Anecdotal evidence indicates that some large producers are “buying
                                                                up” contracts for varietals such as sauvignon blanc and buying back-
                                                                vintage bulk wine.

Profit and Loss Analysis                                    Revenue

Indicative Revenue & Expenses per Case
                                                            •   Revenue per case is a key performance indicator. The ratio varies
                                                                significantly as wineries increase in size due to sales mix. As an
Revenue                                           $89.05        indicator, revenue ranges from $172 per case (small boutique) to
     Gross Margin                                 $36.66        $73 per case for the larger producers
     Profit                                       -$3.71
     Advertising                                   $3.69    •   Whilst price adjustments have historically been the primary method
     Overheads                                     $9.64
                                                                of resolving supply and demand in equilibrium, going forward
     Packaging                                    $16.16
                                                                additional adjustment factors may come into play to mitigate price
Source:   Annual Financial Benchmarking Survey 2006,
          Winemakers’ Federation of Australia.                  sensitivity:
          Based on revenue of $5 million to $10 million

                                                                −    Replacing bulk red wine imports into Australia;
                                                                −    Replacing multipurpose wine grapes with specialist wine
                                                                −    Managed reduction in the yields of overcropped vineyards;
                                                                −    Rationalisation of high cost poorly managed vineyards from
                                                                     the market.

                                                            Cost Structure

Cost Structure
                                                            •   A significant portion of overheads are fixed. As wineries grow they
                                                                achieve economies of scale. Scale savings are generally achieved
Revenue                                           100.0%        when revenue exceeds $5 million.
Less Cost of Goods Sold:
     Grapes                                        11.6%
                                                            •   Large scale production results in reduced marginal production costs.
     Bulk wine                                      3.7%        Small scale wineries under 250 tonne crush capacity are relatively
     Barrel amortisation                            3.0%
                                                                cost inefficient.
     Packaging                                      9.5%
     Labour                                         9.6%    •   Labour costs are declining due to increasing investment in modern
     Overhead                                       3.8%
     Other                                         17.6%
Total Cost of Goods Sold
Gross Margin
                                                            •   Wine companies who sell branded products tend to spend between
Gross Margin (range)                        34.6 - 49.7%        five to ten percent of annual revenue on marketing, but the average
     Sales and Marketing                           10.7%        for the industry as a whole is around four percent.
     General and Admin                             23.7%
EBIT (range)                                  4% - 15.9%    •   Bottling and packaging costs range from $19 to $27 per case
EBT (range)                                  -7.0 - 11.5%
                                                                (declining as volumes increase).
Source:   Annual Financial Benchmarking Survey 2006,
          Winemakers’ Federation of Australia.              •   Smaller wineries tend to own the majority of their grapes whereas
          Based on revenue of $5 million to $10 million
                                                                the larger wineries generally only own strategic vineyards and source
                                                                the majority of their grapes via contract growers. The cost of grapes
                                                                per tonne for larger wineries can be half the cost of smaller

                                                                                                                              Page 3
Industry Vitals
                                                             •   Contracted fruit prices have tended to be “out of the money” but due
                                                                 to recent environmental conditions are moving toward weighted
                                                                 district average price.
                                                             •   The Australian model of large scale low cost irrigated farming
                                                                 techniques continues to attract interest from Asia and the US.

                                                             Medium Sized Producers – “lost in the middle”

                                                             •   Enterprise size plays an increasingly important part in the ability to
                                                                 compete. Recent profit figures (EBIT) for large multinational wine
                                                                 producers are around 14% - 18% of revenue, while medium sized
                                                                 producers are returning around 4% - 7%.
                                                             •   The size of an enterprise partly determines access to markets and
                                                                 distribution channels.
                                                             •   Medium sized wineries have suffered from consolidation of the
                                                                 Australian liquor retailing industry, exposure to “out of the money”
                                                                 grower contract, and the tendency for larger retailers to increasingly
                                                                 deal with large suppliers at the expense of smaller suppliers.
                                                             •   Smaller wineries sell a significant proportion of output through
                                                                 cellar-door sales, mail orders and website/online. This direct to retail
                                                                 strategy avoids the burden of distributor costs.
                                                             •   In light of diminished profit margins a number of medium sized
                                                                 wineries have sought to outsource production to specialised high
                                                                 volume contact producers to achieve economies of scale and realise
                                                                 assets to retire senior debt.
                                                             •   Wholesale distribution channels are an important channel to market,
                                                                 particularly for medium to large enterprises.

                                                             Market Access/Brand Management

Market Segmentation Matrix
                                                             •   In an increasingly crowded retail market, market access is a critical
Status             Convenience         Destination
                     Off     On      Off     On
                 Premise Premise Premise Premise             $          Icon                    Price: $50                 Indicative brands:

Icon                                                                                            Volume market share: 1%    Penfolds Grange
                                                                                                                           Henscke Hill of Grace
Ultra Premium
Super Premium
                                                                                                Price: $15-$50             Indicative brands:
                                                                                                Volume market share: 5%    Wolf Blass Grey Labels
                   Coles/Safeway     Specialty Stores                      Ultra-
                                                                           Ultra-                                          Orlando St Hugo
Source:   KPMG
                                                                                                Price: $10-$15             Indicative brands:
                                                                                                Volume market share: 10%   Penfolds Koonunga Hill
Convenience - Volume brands at the lower price.                                    Super-
Destination - All brand owners except those where offer is
                                                                                   Super-                                  Jamieson’s Run

              exclusively mainstream.                                              premium
                                                                                                Price: $5-$10              Indicative brands:
                                                                                                Volume market share: 34%   Jacobs Creek
                                                                                                                           Banrock Station

                                                                                                                              Price: $5
                                                                                                                              Volume market share: 50%



                                                                                                                                                         Page 4
Industry Vitals
                   •   Supermarket dominance requires brand owners to adopt
                       sophisticated marketing techniques in order to survive:
                       −      Access to scan data (AC Nielsen);
                       −      National account management capabilities; and
                       −      Supply chain management and order fulfilment capability.
                   •   Small and medium sized players between 0.1 million to 3 million
                       cases, with no defined market niche, are most at risk.


                   •   Wine Equalisation Tax (“WET”) (29%) is a value-based tax levied
                       on the value of the goods at the last wholesale sale. Results in a 2%
                       to 3% increase in the price of a bottle of wine.
                   •   Legislation recently passed contained a number of changes to WET:
                       −      A new Commonwealth producer rebate which replaces the
                              cellar door rebate scheme;
                       −      A repayment of export credits on wine that is subsequently
                              returned to Australia for sale; and
                       −      Inclusion of bottling and packaging costs in the tax base
                              where wine is purchased in bulk for retail sale.
                   •   Under federal rebate arrangements (effective from 1 October 2004)
                       producers are entitled to a rebate of 29% of the wholesale value of
                       domestic sales. The maximum rebate is $500,000 each year for wine
                       producers’ sales of up to $1,700,000.

Cash Flow Issues   Capex/Fixed Assets
                   •   Vines - Generally three to five years to full production
                   •   Oak barrels – A 225 litre French oak baroque costs approximately
                       $1,400 and depreciates over three to four years.
                   •   Other capex includes storage tanks and vineyard netting. There is a
                       tendency towards asset finance arrangements to ease the cash flow
                       burden of significant capex.

                   Seasonality/Cash Flow
                   Where processors use owned fruit in production, most costs of
                   production are incurred during vintage, between Feb and June as
                   demonstrated in the table below.

                                                                                      Page 5
Industry Vitals

                                                                                             Fermented                     Transferred to Oak                        Filtered / Bottled

                                                      Seasonal Funding
                                                                                                             Tank Fermentation            Transferred to Oak          Aged in Oak

                                                                                                                                                    General                    General
                                                                          Thinning      Harvesting and Production            Pruning               Maintenance   Vine work      Maint.

                                                                           Jan                                                    Jul                                            Dec

                                                                                     Seasonal funding Requirement                      White             Red             Vineyard

                                                     Where processors acquire fruit for production, the key periods during
                                                     which funding is required are:
                                                     •                   During the vintage period from February to April; and
                                                     •                   May, June and September of the vintage year representing the
                                                                         standard payment terms of grape supply agreements.

Balance Sheet Issues                                 Inventory Management
                                                     •                   Current ratio – Wineries producing white varietals generally have a
                                                                         high current ratio (typically 184% to 322%) as a result of high levels
                                                                         of current inventories (and current receivables) due to the shorter
                                                                         cellaring periods of whites.
                                                     •                   Ideal stock-to-sales ratio is 1.50 – 1.75.
                                                     •                   Each market sector has its own stock requirements:
                                                                         −       Lowest stock-to-sales ratio – Basic; and
                                                                         −       Highest stock-to-sales ratio – Icon.
                                                     •                   The impact of the shifts in the market mix has been towards sectors
                                                                         with longer stock-holding periods, increasing the industry’s average
                                                                         stock-to-sales ratio.
                                                     •                   Benchmark stock turn:
                                                                         −       Non vintage whites                              9 to 15 months; and
                                                                         −       Non vintage reds                                24 to 30 months.
                                                     •                   Quality and capacity of storage facilities – is it appropriate to cater
                                                                         for forecast volume and the planned production?
Oversupply Matrix                                    •                   For producers performing contract supply services, inventory value
                                 Warm      Cooler                        needs to be pegged to their fruit reimbursement price. For producers
                                Inland    Climate
Market Share                     85%        15%                          performing contract processing services, inventory should not be
Share of Winegrape production   60%         40%                          carried on the balance sheet.
Oversupply                        No         Yes
Price Pressures                   Yes        (Yes)   •                   Inventory carrying values of producers processing cooler climate
Margin Pressures                  (Yes)      Yes
                                                                         fruit may need to be reviewed in light of current oversupply issues
Source:   AWBC February 2007
                                                                         facing that market segment.
                                                                                                                                                                                          Page 6
Industry Vitals
                  •   AASB - 141 Agriculture:
                      −    AASB 141 requires the carrying value of vines to be
                           measured at fair value less estimated point of sale costs
                           except where fair value cannot be measured. In determining
                           the FV certain assumptions have to be made about the yields
                           and market prices of grapes in future vintages, the cost of
                           running the vineyard and the quality of the grapes grown.
                           Generally an independent valuation is required; and
                      −    The amendments to the AASB’s have eliminated a large
                           degree of the subjectivity associated with the previous
                           standards in relation to inventory valuation.

                  Debt to Equity

                  •   The smaller wineries generally have a higher debt to equity level as a
                      result of limited access to equity. Fixed assets are generally debt

                  Valuation – Land Under Vine

                  •   The value of land under vine can vary significantly. Key
                      considerations include soil conditions, yields, operational costs, age
                      and varietals of plantings, rate of new plantings, water supply,
                      disease and geographic location.

                  Brand Names/Trademarks

                  •   Quality of label – Market perception/brand awareness is critical.
                  •   Awards received – From where and for what?
                  •   Are these items allowed to be recognised in the balance sheet?
                      Generally only acquired intangibles may be recognised at cost.
                      Internally generated Brand Names/Trademarks should not be
                      capitalised and the expenditure charged against profits in the year in
                      which the expenditure is incurred.
                  •   These intangibles must be tested for impairment where indicators of
                      impairment exist to ensure carrying value does not exceed the
                      recoverable amount.
                  •   Expenditure in developing, maintaining or enhancing these
                      intangibles should be written off in the income statement in the year
                      in which it is incurred.

                                                                                    Page 7
Industry Vitals
                  Environmental/Climatic Risk/Disease Management

                  •   Production is affected by supply of grapes, which is impacted by
                      weather, soil conditions and disease.


                  •   Water usage varies considerably, depending upon weather
                      conditions, operational efficiency and age of the vines (high in initial
                      years and lower thereafter).
                  •   Consider availability of water (dams/water rights).

                  Climatic Risk

                  •   Fire – Risk is enhanced due to drought conditions (King Valley and
                      Grampians). The Yarra Valley 2007 vintage has experienced smoke
                      taint in red varietals as a result of recent fires.
                  •   Weather – Drought conditions in Australia/Frosts in New Zealand
                  •   Frost/hail/wind/storm damage – Is insurance in place?
                  •   Bird damage – Is netting required? Capex requirements?

                  Disease Management

                  •   Is the company doing enough/too much/anything at all?
                  •   Control – Spraying, farm management.
                  •   Prevention – Phylloxera resistant root stock/sufficient infrastructure
                      and management strategies in the event of an outbreak
                      (Yarra Valley).

                  Exit Strategy Considerations

                  •   Consider impact of third party leased equipment – particularly
                      storage tanks and barrels.
                  •   Potential ROT on bulk wine, bottles, barrels, etc.
                  •   Lien claims for storage/distribution agents. Consider liens available
                      for contract suppliers or contract processors.
                  •   Impact on key contracts, grape purchasing, bulk wine sales,
                      distribution, contract crushing, etc.

Other             Regulation
                  •   Subject to food standards legislation.
                  •   Australian Wine and Brandy Corporation (AWBC) is a
                      Commonwealth statutory corporation that regulates and promotes the
                      Australian wine industry.

                                                                                     Page 8
Industry Vitals
                  •   The Australian Wine Export Council (AWEC) issues export licences
                      (required when exports exceed 100 litres to any destination) and
                      export quality inspections.
                  •   The Commonwealth Department of Agriculture, Fisheries and
                      Forestry (AFFA) collects levies on wine exports which are
                      forwarded to the AWBC for export promotion purposes:
                      −    0.20% on the first $10 million of FOB export sales;
                      −    0.10% on the next $40 million of FOB export sales; and
                      −    0.05% on remaining FOB export sales.

                  Barriers to Entry – High and Increasing

                  •   Capital requirement – Generally significant even for small
                  •   Foreign competition – Overseas large scale operations increasingly a
                  •   Premium grapes – Access is a diminishing problem as production
                      expands although the availability of quality and experienced wine
                      makers has become limited.
                  •   Brand establishment – High cost to establish and maintain in a
                      competitive market but imperative given consumers typically choose
                      a brand that they are familiar with.
                  •   Distribution channels – “Any Australian winegrape producer without
                      a secure purchase contract or any Australian wine producer who is
                      not already in the market with a well established brand by now, will
                      not succeed in the next 10 years.” (Bruce Kemp, Global Wine Advice,
                      Sept 2000)

                  US/AUS Free Trade Agreement

                  •   The FTA is expected to have little immediate impact on Australian
                      wine companies as tariff adjustments are to be phased in over
                      15 years.
                  •   The immediate challenges from the US are not quotas and tariffs but
                      competition from “extreme value” Californian producers

                  Non-Forestry Managed Investments Schemes

                  •   The federal government’s announcement that they will strip tax
                      concessions for all non-forestry related managed investment schemes
                      means investors will have to apply directly to the Federal
                      Government from 1 July in order to be able to claim tax concessions.
                      The ATO is currently preparing a Draft Taxation Ruling setting out
                      the position.
                  •   The tax incentives were originally offered to encourage investment
                      in the plantation timber industry and rapidly spread into other
                      industries, including the wine industry.

                                                                                   Page 9
Industry Vitals
Australian Industry                                              Industry Snapshot/Outlook
                                              1996     2006
                                                                 •   Due to saturation by producers in the Australian wine manufacturing
Area Under Vine ('000ha)                       63          169
Winegrape Crush ('000tns)                     883     1,981
                                                                     market in the recent years, the wine industry now faces a lack of
Production ('mill lts)                        620     1,434          retail opportunity.
Consumption ('mill lts)                       459     1,180
Exports ('A$M)                                129     2,758      •   Moderate industry growth will be driven by the export market.
Imports ('A$M)                                 60          234
                                                                 •   The medium-term outlook remains good for large-scale efficient
Source:    ABS
                                                                     producers who carefully target their markets. Medium-sized
                                                                     producers are likely to struggle as larger producers market more
                                                                 •   The global wine making industry is likely to mature by the end of the
                                                                     decade, at which point it will become increasingly difficult for
                                                                     Australian producers to grow revenue.
                                                                 •   Australian wine exports continued to grow in 2006 and accounted for
                                                                     over half of the industry’s output.

    Imp o r t s and Exp o r t s as a % o f T ur no ver
                                                                                          Australian Wine Exports FY06
                                                                                           Other 20%
                                                                                                                  UK 34%
                                                                                     Germany 2%
          FY02       FY03        FY04        FY05     FY06
                                                                                      Canada 9%

  Import s as %of Turnover        Exports as %of Turnover                                  NZ 4%
Source:    IBIS

                                                                                                       USA 31%
                                                                     Source:   ABS

                                                                 •   Exports to the US have increased significantly in recent years (up
                                                                     from 12% 1996), as demonstrated by the success of Yellow Tail’s
                                                                     strategy, and it is anticipated that this trend will continue in the short
                  I nd ust r y T ur no ver
                                                                 •   The large Australian wineries have a competitive advantage over
5,300                                                12.00%
5,200                                                10.00%          their international rivals stemming from professional management,
                                                     6.00%           local industry rationalisation, and cheap supply of grapes due to
5,000                                                4.00%
4,900                                                2.00%           access to land, water and capital.
                                                     -4.00%      •   The relatively low cost of land for Australian producers and
          FY02     FY03 FY04 FY05            FY06
                                                                     specialist large scale farming techniques has led to international
                                                                     attention focusing on Australian vineyards, as demonstrated by
          Current Prices ($)            Real Growt h (%)
Source:    IBIS
                                                                     recent market activity:
                                                                           −         Purchase of Evans and Tate winery with 18,00 tonne
                                                                                     crush, by The Wine Group from the US; and
                                                                           −         Purchase of Tandou winery with 30,000 tonne crush by a
                                                                                     large Indian company.

                                                                                                                                     Page 10
Industry Vitals
                                                                 •   Competition is increasing in export markets as wine producers in
                                                                     other countries become more reliant on export markets. Increased
                    T ur no ver Gr o w t h                           competition will come from both non-European countries and
 5,400                                                    15%        countries around the Mediterranean where EU subsidies have been
 5,200                                                    10%
                                                                     used to revamp vineyards. In addition, excess capacity and surplus
 5,000                                                               fruit will develop in traditional wine-making countries while
 4,800                                                    -5%
                                                                     production in countries such as Chile and Bulgaria will expand and
Source:   IBIS
 4,600                                                    -10%       South Africa will re-emerge as an exporter.
          FY02      FY04        FY06    FY08       FY10
                                                                 •   Asia represents an export destination with long-term prospects for
                 Turnover ($)                Growth %
                                                                     Australian wine producers due to the potential for increases in per
Source:    IBIS
                                                                     capita consumption and the region’s proximity to Australian

Further Resources
                                                                 •   Australian Bureau of Statistics
                                                                     −    Email:
                                                                 •   Australian Wines & Brandy Corporation
                                                                     −    Email:
                                                                 •   Australian Bureau of Agriculture and Resource Economics
                                                                 •   Winemakers Federation of Australia
                                                                     −    Email:
                                                                     −    The Australian Wine Industry Statistical Yearbook
                                                                     −    Annual Financial Benchmarking Survey

                                                                                                                                 Page 11
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Roundups and Industry Vitals.

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Industry Vitals provide a snapshot of key issues relating to selected industries.

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