This is the second of our extended series on the New Zealand wine industry based on the Deloitte 2012 industry benchmarking survey.
By Tim Burnside and Paul Munro*
This year we have altered the first and second category’s cut-off from $1.0m to $1.25m due to a natural split occurring in the participant’s revenue at this level.
The 2012 survey results indicate that profitability generally increases with size ranging from a loss of 5.5% for the smallest category to a profit of 11.1% for the largest category, with the $10m-$20m category jumping well ahead of the curve with profits representing 17.0% of revenue, as shown in the table below.
Given that this marks Deloitte’s seventh survey we are able to map the trend in profit / (loss) before tax for each category in order to identify any emerging trends. Each category’s profitability and trend is discussed separately below.
• This category has been the most volatile in profitability over the past three years jumping between lowest and highest recorded profit / (loss) before tax. The movement from 2011 to 2012 is a result of a change in mix of survey participants, but in general the volatility can be expected to a certain degree for this category as small dollar changes can have large impacts in percentage terms if the underlying dollar revenue is low.
• One participant in this category generates all its revenue through contract wine making and therefore lowers the average percentage of case sales to total revenue. Excluding this participant lifts case sales to 74.9% and drops contract winemaking revenue to 0%. In relation to other categories, the largest contributor to the category’s loss making position is its high cost of goods sold (“COGS”)
• General and administration costs decreases in percentage terms as size increases as anticipated with economies of scale. However, the high general and admin costs have been counteracted somewhat by cutting back on selling costs (the lowest of all categories), giving an operating profit (EBITDA) of 6.6%.
• This category made a notable improvement this year, turning profitable after being loss making for many consecutive years and achieving its highest level of profitability since inception of the wine survey at 6.5% profit before tax.
• The revenue mix of this category is more in line with the three larger categories than the $0-$1.25m category but still has slightly less case and bulk wine sales and slightly more grape and contract wine making sales. This mix produces a gross margin that is slightly higher than the $5m-$10m and the $10m-$20m categories but it still falls below that of the $20m+ category.
• The relatively high overhead costs for this category causes it to drop short in terms of profitability of its larger counterparts. This is fuelled by relatively high depreciation and amortisation costs, which erodes the majority of the operating profit for this category.
• The $5m-$10m category consistently returns solid levels of profitability varying between 7% and 9% in profit before tax over the history of the survey.
• 86.9% of revenue is generated from case sales and 6.5% from bulk wine sales. In comparison to the smaller and larger categories either side, the $5m-$10m category’s overhead costs falls in the middle yielding an operating profit of 17.5%. This category’s profit levels are aided by having the lowest depreciation and amortisation, reflecting lower plant and equipment levels than other categories. $10m-$20m category
• This category recorded the largest average profitability of all five categories at 17.0%, returning to its historical levels prior to a dip in 2010.
• With a similar sales mix and gross margin to the $5m-$10m category, this category achieves its high profit levels by recording the lowest overhead and interest costs in comparison to all other categories. The interest expense at 1.9% is much lower than other categories, that have recorded over 5% in this survey, reflecting a lower reliance on debt funding.
• The largest category remains profitable at 11.1%, a slight decrease however from 2011 at 14.0%. The main drivers for the reduction in profitability are a change in the mix of case sales to bulk wine sales. Last year reported case sales of 87.0% and bulk wine of 8.2% compares to 85.6% and 10.9% respectively this year. The higher proportion of bulk wine sales this year appears to be yielding a slightly lower margin at 48.5% (2011: 51.3%); however this category still records the highest margin of all categories. This result is influenced by one participant in the category that has a heavy focus on bulk wine. Removing this participant pushes the average case sales up to 89.4%, bulk wine down to 6.9% and gross margin up to 50.6%.
• The relatively high gross margin allows a focus on selling costs (highest of all the categories at 21.8%) and it also records the lowest general and admin costs (at 5.3%) demonstrating economies of scale.
• Case volumes tend to be exponentially higher for the larger categories. A general increase in volumes is observed across the same set of survey participants over the past year. It is considered that a reduction in bulk wine inventory and the lower volume vintage may have contributed to a greater focus on case sales.
Revenue per case
• The price range has had a narrowing trend since 2007 and is roughly in line with last years’.
• With the $10m-$20m category continuing to record the lowest revenue per case ($88.75) and the $5m-$10m category recording the highest ($113.31), there is no clear trend in revenue per case between the five categories. Interestingly, the highly profitable $10m-$20m category records substantially lower revenue per case than the other categories, which range from $100.68 to $113.31. This lower revenue per case is not easily explainable with the data available, however it is consistent with last year’s survey. Despite this however it does appear to be a bit of an anomaly as it is generally expected that the larger brands offer the lower price points.
Gross margin per case
• The historical trend in gross margin per case has remained relatively flat. The three larger categories are generally consistent with last year’s survey results with the $1.25m-$5m category recording an increase and the $0m-$1.25m category recording a drop. The $20m+ category records the highest gross margin per case at $59.97 (57% margin).
Selling expenses per case
• The $0m-$1.25m and $10m-$20m categories have recorded the lowest selling expenses per case at $10.67 and $9.88 respectively to rationalise costs in line with their relatively lower sale prices per case.
• The $20m+ category is continues to be at the other extreme, maintaining a large focus on marketing and sales at $26.98 per case.
Overhead expenses per case
• The trend across the five categories demonstrates the benefits of economies of scale with overhead expenses per case decreasing as size increases. The $0m-$1.25m category spends $11.34 per case and the $20m+ category spends $2.93 per case on overheads.
Packaging cost per case
• Packaging cost per case also generally decreases as the winery size increases with the exception of the $0m-$1.25m category which ranks in the middle of the size categories.
Profit / (loss) per case
• As with overall profit / (loss) before tax, the $0m-$1.25m category is the most volatile and is the only category that is making a loss this year of $9.73 per case. The $1.25m-$5m and $10m-$20m categories have both recorded improvements over the past year, with the other two categories remaining relatively flat.
• The $10m-$20m category is the most profitable at $17.96 per case despite its relatively low revenue per case, proving that their high volume low price strategy undertaken over the history of the survey works.
• The current ratio is calculated as current assets divided by current liabilities. If the current ratio is above 200% ($2 current assets for every $1 of current liability) then the company is considered to have good short term financial liquidity (depending on the proportion of current assets held in inventory).
• The current ratio recorded (including inventory) is well above the 200% threshold for all categories. However, the liquidity of inventory should also be taken into account.
• When recalculating the ratio using more liquid assets (excluding inventory and other current assets) not one of the categories make the 200% threshold, with the $0-$1.25m and the $10m-$20m categories falling below 100% which indicates potential short term liquidity risks. The proportions of liquid assets to liabilities can be observed in the current assets and liabilities graph by comparing the total current liabilities to the first two bars of liquid current assets.
• The debt to equity ratio is a common lending covenant, with lenders typically requiring more equity than debt – that is a ratio of less than 100%. This year’s results range from 24.8% for the $10m-$20m category to 82.1% for the $20m+ category. All but the $20m+ category have ratios below 50%, which is a notable reduction in debt levels in comparison to last year’s survey results. It appears that the expected pressure that lenders would be exerting on wineries to reduce debt levels is starting to materialise.
• The debt to total tangible assets ratio has also decreased for the majority of the categories, with ratios ranging from 22.7% to 56.5%. This implies that the wineries surveyed have sufficient tangible asset levels to cover their debt if it was to be settled today. However, when considering this one needs to remember that while debt levels are relatively easy to determine accurately the book value of certain tangible assets that are based on historical cost may not reflect a fair current market value. Land values predominantly seem to be valuation based, but building, vineyard and inventory values should be considered with some discretion. Given current market conditions, if the realisable values of tangible assets are lower than their book values, there will be less assets to cover debt and higher ratios will be observed.
Interest cover ratio
• Interest cover is calculated as earnings before interest and tax (“EBIT”) divided by the interest expense. This reflects the ability of the business to meet interest obligations. This is a standard measure in banking covenants, typically requiring a level of more than 200% to 300% to be maintained (i.e. EBIT covers interest costs 2 to 3 times).
• This year the two larger categories cover their interest more than 3 times, the $5m-$10m and $1.25m-$5m categories fall in the 2 times to 3 times range, and the smallest category falls well short with EBIT only covering 20.6% of the interest expense.
• Implied interest rates have been calculated by taking the interest expense divided by the total interest bearing debt. The range calculated this year spanned from 5.9% to 7.8% which is in line with implied rates in last year’s survey and appears to be reasonable given current market rates.
Inventory turnover ratio
• Inventory turnover is calculated as the COGS divided by the closing inventory figure in the balance sheet. This measure indicates the number of times that inventory has been turned over in the year. An inventory turnover figure of less than 100% indicates increasing inventory levels. Wineries would be expected to have inventory turnover below 100% during periods of increased production as some of the wine produced will be held in inventory for ageing.
• The three smaller categories record ratios below 100% indicating that they are accumulating a portion of their stock. The larger two categories had inventory turnover of more than 140% in the last year which indicates that opening inventory levels have been sold down.
Profit before tax to equity ratio
• This ratio is calculated by dividing the profit before tax by the value of equity and represents the return on the owner’s investment. It is considered that an acceptable level of return to a winery investor would easily exceed 15% to ensure they are adequately compensated for risk.
• The four larger categories record returns on investment ranging from 3.7% to 13.4% with the largest two recording at the upper end and the middle two at the lower end of the range. The $0m-$1.25m category does not record a positive return on investment given its overall loss making position.
Paul Munro is a partner in the Christchurch office of Deloitte. You can contact Paul here ». Tim Burnside is an associate director at Deloitte.