It's interesting how as I've invested I've picked up knowledge of certain industries. I've never set out to study a specific industry, but as a number of cheap names cluster in industries I start to become familiar them. Wine and winemaking is an industry I never expected to be familiar with, but did after making a few investments in the industry, such as Corticeira Amorim, and Treasury Wine Estates.
Scheid Vineyards (SVIN) is an interesting company, their vineyards cover over 70 miles near Monterrey California, yet only 2% of their grapes are bottled and sold under their own brand. Adding to the intrigue the company's top six customers accounted for 53% of their sales. What's going on here?
When most people think of a winery they think of a quant little estate with a nice wine tasting room and row upon row of grapes. The grapes are harvested on site, then crushed, fermented and turned into wine, which is sold in the store and through distributors. The reality is a bit more complicated. There are indeed wineries that conduct business like this, but they are the exception rather than the rule. Most wine is grown and processed on wineries like Scheid, and then shipped as bulk grapes to customers who then ferment, filter and bottle the wine with their own label.
I first encountered this when I visited a local winery as part of a company event a few years ago. The winery had a few rows of vines up front for nothing more than show. We received a tour of the winery and the proprietor told us that it's far cheaper to buy grape stock verses cultivating a vineyard and harvesting grapes.
Think of it this way, wine making is really two components, an agricultural component, and the actual winemaking process (fermenting, filtering, testing, bottling). Kurt Gollnick, Scheid's COO explains the company like this: "This is a production winery in Monterrey County, not a ridge-top winery in Napa Valley planning to make money on wine-tasting events." The company is more of an agricultural company than a winery.
The company's facilities are relatively new, they were featured in an article in Practical Winery & Vineyard, an industry publication in 2007. (link here)
The company's stock is unlisted, I picked up my tracker share earlier this year and contacted the company for an annual report. The first item I want to highlight is their revenue breakdown. The following graphic shows that Scheid generates most of their revenue from bulk grape sales, actual wine sales are a much smaller component of revenue.
For the years I have seen reports for the company lost money in 2011 and 2012, and then in 2013 swung to a large gain. Here is a small summary snapshot I put together:
Earning $9.13 a share is significant given their most recent share price of $24.23. Not all of the company's recent earnings can be attributed to continuing operations, the company reported a $5.7m gain on a $7.5m sale of a 238 acre vineyard.
Backing out the one time gain lowers operating income to $4.5m or $5.17 per share. The company's operating cash flow was $4.08m which tracks nicely with their adjusted income, meaning this company is trading with a P/E of 4.68.
Stocks at low earnings multiples are interesting, but as I discussed in some previous posts earning power can change rapidly, whereas assets change slowly. What does Scheid's balance sheet look like?
The company unsurprisingly has a large inventory, accounts receivable, and property, plant and equipment balance. Most of the company's assets consist of those three items, which is expected for an agricultural company.
An important determinant to the value of a company's equity is the condition of their property, and equipment. As noted above the company's facilities are state of the art as of a few years ago. The company is also willing to monetize their real estate holdings, selling 20 acres in 2011, and 238 acres in 2012.
The company plans on spending $3m over the next year to develop a 240 acre vineyard, and an additional $3m on winemaking equipment.
None of the book value discussion would matter if the stock weren't cheap, fortunately it is, trading at 53% of book value. Considering the company's book value is possibly understated this might be cheaper than it initially appears.
The company isn't without risk, they do have a substantial debt load. The debt was my biggest concern when considering an investment, I was worried that in a down year the company might have trouble making interest payments forcing them to declare bankruptcy or liquidate assets.
The company has $50m worth of long term debt, with most of it coming due in 2015. The company is paying 3.06% on their debt, which is held by Rabobank, a bank known for winery lending. Interest was covered 3.8 times this past year.
I was asking myself two questions as I looked at Scheid, the first was whether their assets had any value, and secondly whether I thought the earnings were sustainable?
Besides the information I dug up on the company's facilities I reached out to someone I know in the wine industry in California. He claimed that most likely the company's assets are understated due to the strength of the winery real estate market, which Scheid is apparently taking advantage of by selling acreage.
The second question is a little more difficult to answer without a larger earning history. I'm encouraged that the company's earnings improvement was due to a drop in the cost of goods sold. I don't know what's driving the change in COGS, but it could be efficiency gains from pushing through larger volumes at their facility. The company's facilities were built to handle twice the volume they were doing in 2007, which means that fixed costs could initially be high until volumes improve and the costs are spread more evenly.
If the company is able to maintain the $4m in earnings then they have the potential to fall into a category of stocks I love to purchase, two pillar stocks. These are stocks where the company's earning power capitalized at 10x is equal to their book value. When this occurs there are two variables supporting a book value valuation.
Regardless, the discount to book, and earnings were too good for me to pass up, I took a position in Scheid when I read their latest annual report. The stock has run up 32% since I purchased, but even at these prices it's still attractive.
Disclosure: Long Scheid