value and opportunity

A very persistent commentator asked me about my opinion on Australian Vintage, an Australian Wine producer. In between, Nate from Oddball covered the stock and seemed to like it as an asset play .

Optically, the company looks dirt cheap (Bloomberg):

P/E 7
P/B 0,3
P/S 0,3
Dividend yield 10,5%

When I look at such “cheap” companies, I start reading the only annual report and concentrate only on problems. I tend to avoid company presentations as they usually only show the positive stuff. A 30 minutes “speed” read of the 2013 annual report shows already some issues:

– goodwill, brand values and DTAs make up ~100 mn AUD of the book value plus another 50 mn AUD or so for biological assets and water rights
– the 2013 profit includes a significant “one-off” reserve release. without that, 2013 profit would have been some 40% lower or the P/E well into “double digits”
– the company carries significant debt and lease obligations, overall around 240 mn AUD in the 2013 annual report
– the directors salary is at ~ 3 mn AUD a significant portion of the profit
– on the other hand, directors own only insignificant amounts of shares (AUD amount of shares ~20% of total annual salary)
– operating cashflow has been negative in 2013, so the dividend has not been “earned”
– Depreciation is around 7 mn AUD per year, investments only 4-5 mn in 2012, 2013. This looks like “underinvestment”.
– most “hard” assets (inventory, property etc.) are pledged for the loans
– all subsidiaries are explicitly guaranteed by the Holdco, so all loans are fully recourse against any asset
– bank loan covenants exist, but are not clearly reported:

The Group is also subject to bank covenants with its primary financier as follows:
– Equity must be above $210 million.
– Gross profit and earnings before interest and tax must exceed pre-defined levels

– the bank loan facilites mature in 2015 and will have to be renegotiated
– there are “related party dealings” with companies of the CEO (purchase of grapes etc.)

In October / November 2013, they did a massive capital increase (42 mn AUD) in order to pay back debt. Some might argue this is a good thing, but paying large dividends and in parallel doing large capital increases is a very bad sign and very bad capital management (among others, they had to pay around 5% fees on the raised capital).

One observation with regard to the capital increase proespectus: On page 35 they show that the capital increase will increase earnings per share due to lower interest rate expenses. However they use a pretty obvious “trick” here: they use an “average amount” of outstanding shares, not the relevant final amount of shares. With the full amount of shares (232 mn) instead of the “average”, the capital increase would of course be “dilutive”.

The first 6 months of fiscal 2014 looked better on the bottom line, but again includes a big reserve release. Operationally, the first 6 months of 2014 were a lot worse than the year before, especially the US turned from an operating profit to a loss.

Some additional thoughts:

– As an Australian asset play, the Australian Dollar plays a big role. As a non Australian investor, I might have a operational upside if the AUD goes lower, but asset value as a EUR investor will be lower as well
– the UK supermarkets who are the major non Australian clients, are under a lot of preassure themselves. They will squeeze their suppliers as hard as they can and will demand lower prices if the AUD becomes weaker
– return on assets is very low. If the 10 Year treasuries yield 3.7% and Return on assets is far below that than the value of the assets ist most likely overstated by a large margin
– moving “upscale” is not easy. This needs even more capital (oak barrels, longer ageing = higher inventory etc.) and time.
– from the main brand “McGuigan”, you can buy in Germany only the Shiraz which is currently on sale (4,95 EUR vs. 5,99 EUR) and a “Sparkling Shiraz” at 12,95 EUR. To upgrade from that level will be hard…..
– finally, the Australian wine industry seems to be one of the clearest victims of climate change. Water will become much more expensive and many grapes might not grow so well in the future. This could for instance seveely reduce the value both, of the land and teh biological assets. This study for instance shows that Australie is hit hardest globally. If this will realize, everything, land, machinery and “Biological assets” would loose most of their value.

Overall I think the main issue is that the interests of the Management and shareholders are not really aligned in this case. Especially the CEO, whose max target bonus has by the way doubled for next year, seems to be far more interested in his salary than the shares and it looks like that the majority of his own investments seem to be outside the listed companies. Combined with the relatively risky financial profile, this is clearly a “deep value” case with a significant risk especially close to the 2015 maturity of the loans.

Opposite to Nate, I can see a lot of things that could go wrong here and either trigger another massive capital increase or even a bankruptcy. As I do not know a lot about the Australian Wine industry either, I think I would pass on this investment as it is extremely difficult for me to handicap the probabilities and would therefore be a quite “risky turn around gamble”. As I don’t have any experience with Australian liquidation rules, I would also be really careful to expect meaningful recovery rates for shareholders in case of a bankruptcy / restructuring. If for instance the loans would get into the hand of aggressive “vultures” like Oaktree, I would bet that stated book values would not be worth a lot.

However for “deep value” specialists, this could be interesting if they are able to estimate the “survival probability” to a certain extent.

A side note: “Moving up the value chain” in wine usually means oak barrels. So despite the much higher valuation, I still think that Tonnelerie Francois Freres is the better (and safer) long term investment in the wine industry.