Should you invest in wine?

Foster’s former wine unit, Treasury Wine Estates, which still happens to be the world’s number two wine company with vineyards from Hunter Valley near Sydney to California’s Napa Valley, ended its first day on the stock exchange (9 May 2011) with a market value of AUD 2.18 billion (USD 2.32 billion), near the top end of brokers’ valuations.

But if the record of the wine industry is anything to go by, investors should proceed with some scepticism.

Both Foster’s and Constellation, which is the largest wine company worldwide, have suffered massive losses in their wine business.

Family-owned wine companies, on the other hand, have fared better and have maintained profitability and sales, which seems to suggest that wine is too unusual a business for publicly owned companies; that it cannot compete on the stock market.

Again and again, Australian commentators have pointed out that family-owned wine companies have different structures. Instead of having their strategies determined by shareholders, they work to the demands of land and seasons.

Wine, experts say to everybody who likes to listen, is an agricultural business exposed to vagaries such as unpredictable weather, foreign exchange rates and tax incentives for rival growers.

As the fate of Foster’s shows this is something that stock market-listed companies and investors have failed to understand.

To make another point. Stock market-listed companies have to answer to the growth imperative. Yet with wine, there is no clear line graph showing an increase in profits every year.

For example, Casella Wines, the company that owns the truly successful Yellow Tail wine brand, reported in January 2011 that in the year 2009/2010 it has had its profits reduced by 70 percent recently because the highly expensive Australian dollar affected its sales in the United Stares. The owner, John Casella, appears unfazed. He reportedly said that this does not really matter as long as the company maintains its U.S. market share.

Moreover, non-listed companies seem to be in a better position to deal with the wine industry’s strange accounting system. Wine companies tend to hold massive inventories of stock, wine that they cannot and will not sell. This has an impact on valuations and the bottom line and ties up working capital. As a rule of thumb, for every dollar of sales, there are two dollars of assets. That means that at best the return on investment can be as low as 2 percent, something for which any public company would be hammered.

Others nevertheless believe that wine companies can be successful in the stock market provided investors’ attitudes change and they bear in mind that the wine business is not a fast-moving consumer goods business; it’s driven more by agriculture than anything else.

Some analysts appear to have understood how the wine industry works. Merrill Lynch’s analyst David Errington recently warned that wine does not deliver good returns for investors.

He wrote that although wine is like any other consumable product in that it is produced and sold, it is still incredibly expensive to make (both in terms of operating costs and capital costs). More to the point, he argued, it appears to be nearly impossible to receive a price for wine as a finished product that offsets the production costs, the capital costs and the time taken to produce the wine.

“For reasons not clear to us, many investors and analysts choose to ignore these facts – although we suspect one day the investment market will shift suddenly – and rate wine as a severe discount industry rather than at a premium,” Mr Errington said.

Another fundamental difference between wine and other fast-moving consumer goods is scale. After spending so much on infrastructure and acquisitions, wine companies need to sell millions of cases. And therein lies the problem: the price of wine is created around its prestige and scarcity. Produce millions more cases of Château Lafite-Rothschild, hypothetically speaking, and it becomes a commodity and the price sinks.

There is no doubt though that the much-derided listed wine companies Foster’s and Constellation have done a lot of good too. They have created more awareness in the market about wine.

For the wine industry to be truly successful, it needs the listed companies to be successful. That they are not is partly an indication of the industry’s general difficulties.

That’s a warning investors contemplating buying into listed wine companies should heed.