Investment opportunities in Western Australia’s wine industry

Contents

Investment highlights...............................................................................2Executive summary..................................................................................3Industry overview.....................................................................................6The market.............................................................................................11The proposal..........................................................................................14Case study: Ferngrove Wine Group.......................................................17Financial analysis...................................................................................19Other benefits for an investor.................................................................23Other important information...................................................................24Key risks and mitigants..........................................................................24How to progress.....................................................................................27Disclaimer..............................................................................................28

Investment highlights This document describes the business case to invest in fine wine production in Western Australia.

There are a number opportunities for investors, principally in joint ventures or equity partnerships with established successful grape and wine businesses. Capital investment will enable the businesses to grow to the next level of operation and profitability.

These businesses include:

growers of high quality grapes that make fine wines wineries and wine producers of high quality fine wines producers who are able to establish a niche brand, markets and/or methods of

distribution medium-sized wine producers with competitive costs and high quality

established and desired brands small high quality wine companies, including ‘icon’ wineries, mostly selling

direct to loyal customers companies able to create and/or capture unique market opportunities using

other growers and winemakers’ resources.

Projected returns to investors include:

The opportunity to be part of a wine industry with an established and growing reputation for its fine wine regions.

Capitalising on the growth in fine wine markets, domestically and internationally, and the booming tourism industry for fine wine, food and lifestyle experiences.

The opportunity to be part of the most profitable sector of the wine industry where returns are expected to grow over coming decades.

Other benefits to investors in Western Australia include:

dedicated supply chain for wine to both international and domestic target markets

access to production in climatically diverse regions within Western Australia for a range of wine varieties and wine styles to suit consumers in target markets

suitable grape growing land that is readily traded in Western Australia.

Executive summary Western Australia provides a range of opportunities to invest profitably in fine wine production for international and Australian domestic markets.

Western Australian is the pre-eminent fine wine producing state in Australia. Its fine wine regions are recognised as some of the best, most distinctive and diverse in the world.

The strategic investor would capitalise on the significant competitive advantages of the Western Australian wine industry which include:

ability to produce high quality grapes and world class fine wines excellence in viticulture and winemaking production of internationally renowned regional fine wines such Margaret

River Cabernet Sauvignon, Chardonnay and Sauvignon Blanc-Semillon, and Great Southern Shiraz and Riesling

strong domestic market distribution and direct sales networks freedom from major pests and diseases of grapevines a pristine, ‘clean and green’ growing environment.

Western Australia’s competitive advantage is strengthened by the climatically diverse regions which provide ideal growing environments for a range of high quality wine varieties, wine styles and blends.

Production is based predominantly on cool and maritime viticulture of the classic wine varieties such as Cabernet Sauvignon, Shiraz, Chardonnay, Sauvignon Blanc and Semillon. The nine wine growing regions in the South-West provide a choice of climates ideal for a range of newer varieties suited to high value niche markets and changing consumer tastes.

Newer varieties include Tempranillo and Vermentino from Spain; Sangiovese, Nebiollo, Barbera and Brucceta from Italy; Legrain from France; Gruner Veltliner from Australia; and Saparavi from Georgia.

Two major market opportunities stand out for growth in business returns and profitability over the next few decades:

growth in consumer demand for fine wine in national and international markets

growth in tourism, particularly in destinations which offer fine wine, food and lifestyle experiences.

Fine wine is the fastest growing and most profitable segment of the global wine market. The demand for fine wine at higher price points is growing in key Australian markets, including China, North America and emerging Asian markets.

The growth in tourism is having a positive impact on the demand for regional fine wines from Western Australia. Tourism Australia invests significant resources to promote wine, food and lifestyle to high-end international consumers searching for authentic experiences.

The success of Margaret River Gourmet Escape, an international fine food and wine event, indicates how Western Australia should continue to interact with its wine and food ambassadors. The wine industry and government continue to build on the fine wine, food and tourism-based economic development of southern Western Australia.

The Western Australian wine industry has many different business models with wide ranging opportunities for profitable investment. The supply chain is diverse, highly integrated and marked by a high level of engagement by industry participants.

After nearly two centuries of continuous winemaking and grape growing, the Western Australian industry has well-established regional brands, vineyards and winery infrastructure and community-based viticulture and wine services.

New investors would be able to partner with existing successful business to provide the capital needed to capture the growth opportunities in fine wine over coming decades. These businesses include:

growers of high quality grapes that make fine wines wineries and producers of high quality fine wines producers who are able to establish niche brands, markets and/or methods of

distribution medium-sized wine producers with competitive costs and high-quality

established and desired brands small high quality companies, including ‘icon’ wineries, selling mostly direct to

loyal customers companies able to create and/or capture unique market opportunities using

other growers and winemaker’s resources.

Areas where profitable investment could be made with a wine industry partner include:

increasing the scale of operations through integration, acquisition or consolidation to expand grape and wine production, shore up supply and gain better control of quality for fine wine production

upgrading production techniques and technology in vineyards and wineries to improve grape and wine quality and production efficiencies, for example berry sorting, winemaking facilities, tank storage and cool barrel storage

improving management systems improving access and better routes to international markets where investors

can bring local knowledge about their home and other markets, and the ability to build strong distribution and retail networks

vertical integration to enable better control of supply and quality from the vineyard through the winery to the market

diversification of wine products, for example, capacity to craft wine styles to consumers in target markets, expand the range of wine varieties by taking advantage of Western Australia’s diverse production regions

cellar doors, fine wine and food, and other facilities to capture the increase in tourism in the state’s South-West

development of new vineyards or restructuring of established vineyards to varieties in demand, elite clones and new varieties

innovation in grape production, winemaking, management systems and marketing.

Financial returns will vary with the size of the business, region, wine varieties and styles, and market channels. The financial scenarios described in this business case focus on the production of high quality grapes and fine wines of regional ‘flagship’ varieties by small and medium businesses.

Fine wine production has a gross margin per case (9 litres) of A$76 (48%) and A$43 (57%) for Cabernet Sauvignon and Chardonnay respectively for the China market, and A$43 (35%) and A$30 (34%) for the Australian domestic market.

Vertically integrated operations that grow grapes and make wine have potential to be more profitable than those concentrating on one aspect only.

Industry overview Wine in Western AustraliaWestern Australia is the pre-eminent fine wine producing state in Australia. Its wine regions are recognised as some of the best, most distinctive and diverse in the world.

Wine has been produced in Western Australian for 180 years. After being established in the Swan Valley in the 1830s, the industry grew steadily until the boom years of the 1970s, 80s and 90s when it expanded rapidly into the cooler Great Southern and South West regions.Table wine production began in the 1960s when it was recognised that premium table wines were in greater demand than the excellent fortified wines that had dominated production until then.

Wine quality in Western Australia has never been better. The maturing of vineyards, the pedigree of vignerons and winemakers, our ‘clean and green’ environment, the diversity of our regions and climates and the exceptional run of strong vintages in recent years have all combined to enhance Western Australia’s fine wine reputation.

Extraordinary international and domestic accolades for many of our regional fine wine brands are evidence the industry is focusing its energy correctly with the right varieties and clones in the right regions. This focus on regions will enable the Western Australian industry to reap the benefits of the expanding fine wine markets in the coming decade.

On an international scale, Western Australia’s 65 000 tonne wine grape crush is a drop in the ocean of global supply. Most production is high price point wine which remains profitable and competitive with long established distributors.

Innovation in grape and wine production, markets and managing businesses will benefit the industry in the long term. The evolving maturity of our vignerons and winemakers working to achieve excellence with new clones and the right varietal selection for the region and site will pay dividends over coming decades.

The projected growth in tourism in Australia will have a positive impact on the demand for regional fine wines from Western Australia. Tourism Australia invests significant resources to promote the wine, food and lifestyle of Australia to a world of high value consumers searching for authentic experiences. It will represent Australia as cosmopolitan society strongly connected to its food producers focusing on our unique expression of food and wine. The success of Margaret River Gourmet Escape, an international fine food and wine event, indicates how Western Australia will continue to interact with its wine and food ambassadors in the future.

Medium and large producers continue to expand export markets. These developing markets offer the best opportunities to grow production at sustainably profitable margins. The emerging markets in Asia and more specifically China offer the best

prospects from growth over the coming decades. Western Australia sends more than half of its exported wine to Asia and about a third of this into China.

Asia takes about 60% of Australian wine valued above A$10 per litre free-on-board (FOB), a category that is profitable and sustainable. As Asian middle classes continue to grow, so should their demand for premium products, including quality wines that cannot be produced in bulk.

The opportunities presented are significant and need to be realised through increased strategic investment in the industry.

Regional profilesWestern Australia’s competitive advantage is strengthened by the climatically diverse regions in which wine grapes are grown. There are nine climatically diverse regions (Margaret River, Great Southern, Pemberton, Manjimup, Geographe, Blackwood Valley, Peel, Perth Hills and Swan District) and six subregions (Mount Barker, Frankland, Denmark, Albany and Porongurup in the Great Southern; Swan Valley in Swan District).

Varieties suited to each region produce high quality wines with distinctive regional characters. This climatic diversity enables the production of a range of high quality wine varieties, blends and wine styles. The fine wine regions of Western Australia (Figure 1) such as Margaret River and the Great Southern are equivalent to world renowned wine regions such as Bordeaux, Napa and Barossa (Table 1) in terms of climate and wine quality.

Western Australian production is based predominantly on cool climate viticulture of premium wine varieties for the fine wine market. The main varieties are Cabernet Sauvignon, Shiraz, Chardonnay, Sauvignon Blanc and Semillon. The diversity of the wine regions of the South-West provide ideal climates for a range of newer varieties suited to high value niche markets and changing tastes of consumers. These include Tempranillo and Vermentino from Spain; Sangiovese, Nebiollo, Barbera, Brucceta from Italy; Legrain from France: Gruner Veltliner from Australia; and Saparavi from Georgia.

Western Australia is considered to have a boutique wine industry with mainly small to medium-sized wineries, a few large wineries and no major wineries. Wineries are grouped according to their crush capacity as micro (up to 100 tonne), small (100-750 tonne), medium (750-5000 tonne), large (5000-20 000 tonne) and major (more than 20 000 tonnes).

The wine industry is actively investing in emerging Asian markets such as China, Hong Kong, Japan and South Korea and repositioning itself as a supplier of high value wines in the domestic, USA, UK, and European markets. The industry is on track to more than double exports to A$100 million in the next three years. Its value is expected to increase from A$659 million in 2010 to A$790 million in 2015.

The wine industry’s mostly small privately- and family-owned businesses are dynamic, pro-active, value chain-focused, responsive to market signals and

adaptable to change. The industry has the potential to expand production of high quality grapes and wine.

Figure 1 Wine regions of Western Australia

Table 1 Western Australian wine region statistics

RegionVineyard

area(ha)

Heat degree days

(growing season)

Annual rainfall(mm)

Mean January/July temperature

(oC)

Western AustraliaMargaret River 5 960 1690 1177 20.4Great Southern 3 424 1467 798 19.0Pemberton 971 1497 1255 19.6Swan District 897 2340 865 24.1Geographe 869 1700 975 22.0Blackwood Valley 435 1578 856 20.7Manjimup 393 1492 1055 20.0Perth Hills 168 1770 1069 23.3Peel 108 2325 897 22-23Other famous regionsBordeaux (France) 115 000 1409 778 20.5Burgundy (France) 29 500 1189 750 19.6Barossa (South Australia) 10 356 1487 506 21.0

The South-West of Western Australia has a Mediterranean climate with wet winters and relatively dry summers. Average annual rainfall can vary considerably within some regions. For example, rainfall in the Great Southern ranges from 650 millimetres in Frankland to 1012 millimetres in Denmark (Sources: Wine Australia; ‘Viticulture & Environment’ by J Gladstones).

Grape and wine production

Western AustraliaWestern Australia produces about 5% of Australia’s wine. However, it is focused on the premium end of the market where it accounts for more than 20% of Australia’s top wines.

Western Australian grape and wine production peaked at nearly 88 000 tonnes and 56 million litres respectively in 2004 (Figure 2). Since 2010 grape production has stabilised at around 68 000 tonnes and wine at 45 million litres.

Figure 2 Western Australian grape and wine production from 1998 to 2012 (Source: Wine Australia)

Wine grape plantings are about 13 000ha. Around 70% of the vineyard area is in the Margaret River and Great Southern regions (Figure 3).

Figure 3 Proportions of total vineyard area in Western Australian wine regions (Source: DAFWA)

The Western Australian industry is complex and multi-layered with many different business models. It is dominated by small, mostly privately-owned and family-operated businesses comprising more than 500 grape growers, 400 wine producers and over 300 wineries.

The largest three wine businesses together produce nearly 40% of total wine production while the next five largest businesses account for about 15%. The major companies are Accolade Wines Holdings Australia, Fogarty Wines and Ferngrove Estate.

Other major producers include Vasse Felix, Burch Family Wines, Cape Mentelle, Leeuwin Estate and Plantagenet Wines. The wine production supply chain is diverse and highly integrated with a reasonably high level of engagement by participants. Distribution and marketing channels are diverse.

WorldAlthough the world-wide area under vines tends to be stable, it has decreased in recent years to about 7528 million hectares in 2012 (Figure 4). The reduction has mainly been in Europe due to vineyard removals and subsidised conversions in the face of falling prices and over-production.

Figure 4 World area planted to vines (‘000 hectares) 2000 to 2012 (Source: OIV)

Spain, France and Italy, the three countries with the largest plantings of vines, have reduced areas planted. In the southern hemisphere and USA new vine-plantings have continued at a moderate rate (0.3% increase in 2012 from previous year). European countries account for about 58% of the world’s vineyards.

World’s wine production increased during the 1970s but declined during the 1980s and 2000s. Wine production was expected to fall to 25 200 million litres in 2012, a decline of about 11% since 2000.

About 62% of wine comes from Europe, primarily France, Italy and Spain. In the ‘New World’ the USA, Argentina, Australia, South Africa and Chile predominate (see Figure 5).

Figure 5 The world’s major wine producers (Source: OIV)

Exports

WorldThree European countries, France, Spain and Italy, supplied 74.2% of global exports by value in 2009 (Table 2). Wine exports have been successful for Australia with exports doubling to A$1.8 billion in the decade to 2009.

Australia was the world’s fourth largest exporter in value terms in 2012 with 5.9% of global trade by value and 7.6% by volume. Other ‘New World’ producers such as Chile, South Africa and New Zealand have seen stronger growth in exports over the same period (Figure 6).

Table 2 Top world wine exporters in 2012

Country Value(A$ million)

Volume (Million litres)

France 10 109 1 499Italy 6 051 2 120Spain 3044 1 947Germany 1 256 396Portugal 913 339Australia 1 966 735Chile 1 805 752USA 1 390 401New Zealand 989 176Argentina 918 365South Africa 730 413Rest of the world 3 453 762World total 32 624 9 903Source: OIV

Figure 6 Top five wine exporting countries by value in US$ (Source: OIV and FAO)

Western AustraliaAustralian wine exports fell from A$53.2 million in 2006 to A$34.5 million in 2010, but bounced back to A$45.2 million in 2013.

China is now WA’s largest export market representing 35% of exports by value. Western Australian wines are exported to more than 60 countries. The top 10 destination countries by value are shown in Figure 7.

Figure 7 Value of WA wine exports by destination in 2013 as A$ million (Sources: ABS, Wine Australia)

The average free-on-board price of WA export wines in 2012/13 was A$6.48 per litre compared with A$2.61 per litre for the rest of Australia. The average price across WA’s top five export markets was A$7.29 per litre.

The marketGlobal wine trade was valued at more than A$32 billion in 2012. While production has declined slightly over the past four decades, the quantities traded have increased markedly.

Wine consumptionWorld consumption of wine increased to 24 300 million litres in 2012 (Table 3). After eight years of growth, consumption fell in 2008 and 2009 as a result of the world economic crisis. Consumption was expected to increase to 25 200 million litres in 2013. The European Union decreased its demand, which was partially compensated by increased demand from North America and Asia.

Countries that are historically large consumers and producers, such as France, Italy and Spain, have reduced consumption. The USA is becoming the largest market in terms of volume (2900 million litres in 2012). Wine consumption is rising sharply in Asia, particularly China (1780 million litres in 2012, up 67% since 2000).

Table 3 World wine consumption per capita in 2012

CountryTotal

consumption (Million litres)

Per capita consumption

(L/y)France 3 000 48USA 2 900 9Italy 2 300 37Germany 2 000 24China 1 800 1UK 1 300 20Russia 1 000 7Argentina 1 000 24Spain 900 20Australia 500 24Portugal 500 43Canada 400 -South Africa 400 -World total 24 300 -Source: OIV

Wine importsNorthern Europe and the USA are traditionally the largest net importers of wine. The UK and USA each represented about 11% of global imports by value in 2012 (Table

4). Imports into Asia have increased, particularly over the past two decades, reflecting growing populations with capacity to pay.

Japan, China, Hong Kong and Singapore are now among the global top 20 countries for wine imports. Despite its increasing local production Australia imports major quantities of wine worth A$604million in 2012.

The top 26 world importers of wine by value accounted for 93% of world imports in 2012 (Figure 8). North America, non-EU Europe and Asia showed the most dynamic growth.

Table 4 Top 29 world importers by value (A$ million) in 2012

Area Locations 2012 import value(A$ million)

European Union UK 5 127European Union Germany 3 112European Union Netherlands 1 070European Union Belgium 1 253European Union France 821European Union Sweden 703European Union Denmark 648European Union Italy 397European Union Austria 270European Union Ireland 321European Union Finland 240European Union Poland 233European Union Czech Republic 223European Union Lithuania 212European Union Total 14 695North America Switzerland 5 121North America Norway 2 002North America Russia 193North America Total 7 316Asia China 1 599Asia Japan 1 593Asia Hong Kong 1 049Asia Singapore 481Asia Total 4 721Rest of Europe Switzerland 1 205Rest of Europe Norway 414Rest of Europe Russia 1 063Rest of Europe Total 2 682Other major importers Australia 604Other major importers Brazil 305Rest of world Other importers 2 171Source: OIV

Figure 8 World wine imports by region based on value in 2012 (Source: International Organisation of Vine and Wine)

Price is indicator of qualityFine wine in this document is based on the Australian wine industry quality segmentation of grapes and wine developed by Winemaker’s Federation of Australia (Table 5). The five segments (A, B, C, D, E/F) are defined on price.

Table 5 Fine wine definition

Quality code

Wine quality segment1

Grape price(A$/t)

Domestic retail price

(A$/bottle)

Export FOB price(A$/L)

A Icon and ultra-premium >2000 >30 >10

B Super-premium 1501–1999 15-30 7.50–9.99

C Premium 601–1500 10-15 5.00–7.49

D Popular-premium 301–600 7-10 2.50–4.99

E/F Commercial <300 <7 <2.50Bulk wine is allocated to its own quality segment, under $1/L to E/F, over $1/L to D.1

Adopted from Lokshin, RabobankThe definition of fine wine includes the A and B grade quality segments which make up icon, ultra-premium and super-premium wines.

The proposal Foreign investment in the Australian wine industry has a long history. In recent years investors from China, the USA, France and other countries have successfully partnered with a range of wine businesses in several wine regions and states.

Examples include: Ferngrove Wines in Western Australia Gemtree Vineyard, Belvedere Wines, Yangarra Estate, Bleasdale,

Stonehaven Winery, Lane Vineyard and Loxton Cellars Winery in South Australia

Sunshine Creek Vineyard and vineyards in Coldstream in Victoria.

The types of investments have included joint ventures, partnerships, ownership of vineyards and wineries.

After a period struggling with the high Australian dollar and oversupply there is increasing confidence in the Australian wine industry. The time is right for investment in the Western Australian industry. Strategic investment is now needed to take advantage of two major opportunities for growth in business returns and profitability over the next few decades:

growth in consumer demand for fine wine in national and international markets

growth in tourism particularly in destinations which offer fine wine, food and lifestyle experiences.

Fine wine is the fastest growing and most profitable segment of the global wine market:

The demand for fine wine at higher price points is growing in key Australian markets, and the China, UK, North America and emerging Asian markets.

China is the fastest growing wine market in the world. The higher price point fine wine is the strongest category.

Wine consumers in the USA, one of the world’s largest wine markets, are turning to fine wines.

Fine wine price points are solid in other key international markets such as Scandinavia and Canada.

Wine Australia projects an undersupply of quality grapes for fine wine to meet future demand in these markets.

There has been a significant increase in the consumption of quality wines. From 2007 to 2012 wine selling above A$15 per bottle increased by A$268m (64%) in value terms.

The fine wine regions of Western Australia are perfectly placed for investors to take advantage of these opportunities.

Strategic investmentThe Western Australian wine industry has many different business models with wide ranging opportunities for profitable investment. The supply chain is diverse, highly integrated and marked by a high level of engagement by industry participants.

There are many opportunities for investors, including joint ventures or equity partnerships with successful grape and wine businesses. Buying land to develop new vineyards and/or wineries is another option. Because of current excess grape production and winemaking capacity the investor should seek further advice from industry experts before deciding. Western Australia is a relatively easy place to access land and expertise, and to develop a new business.

Strategic investments which combine the synergistic strengths of the investor and Western Australian wine businesses offer the best prospects for long-term future profitability and mutual benefits.

Capital is in short supply in the Western Australian wine industry and partnering with an investor is key to making wine businesses successful.

Strategic investment will enable Western Australian grape and wine businesses to focus on their strategic advantages:

ability to production high quality grapes and world class fine wines excellence in viticulture and winemaking production of ‘flagship’ regional fine wines such as Cabernet Sauvignon,

Chardonnay and Sauvignon Blanc-Semillon in Margaret River, and Shiraz and Riesling in the Great Southern

strong domestic market distribution and direct sales networks.

Strategic investment will enable the investor to: ensure supply of wine to their home market and expand into other markets develop styles and marketing programs more directly suited to demands of

individual markets provide routes to market with improved control of distribution and retail

exposure increase the international and consumer focus of the business introduce a level of discipline to where effort and resources are best spent develop brand awareness and reputation in Australian and international

markets develop new channels to markets such as USA.

A number of successful grape and wine businesses may be interested in partnering with an investor and include:

growers of high quality grapes that are used to make fine wines wineries and producers of high quality fine wines producers who are able to establish a niche brand, markets and/or method of

distribution medium-sized wine producers with competitive costs and high-quality

established and desired brands small high quality wine companies, including ‘icon’ wineries, selling mostly

direct to loyal customers companies able to create and/or capture unique market opportunities using

other growers and winemakers’ resources.

Areas for investment include:

increasing scale of operations through integration, acquisition or consolidation to expand grape and wine production, shore up supply and to gain better quality control for fine wine production

upgrading production techniques and technology in the vineyard and winery to improve grape and wine quality and production efficiencies, for example berry sorting, winemaking facilities, tank storage and cool barrel storage

improving management systems improving access and routes to international markets, where the international

investor can bring local knowledge about their home market and others and ability to build strong distribution and retail networks

vertical integration to enable better control of supply and quality from the vineyard through the winery to the market

diversification of wine product, for example, capacity to craft wine styles to consumers in target markets, and expand the range of varieties by taking advantage of Western Australia’s diverse production regions

cellar door, fine wine and food dining and other facilities to capture the increase in tourism in the state’s South-West

development of new vineyards or restructuring of established vineyards to wine varieties in demand, elite clones and new varieties

Innovation in grape production, winemaking, management systems and marketing.

Purchase of vineyards and winery properties

A number of vineyards and wineries are for sale in different wine regions of the South-West. Prices range from about A$750,000 to more than A$3 million for properties of less than 10 hectares to more than 60 hectares.

The price depends on the size of the vineyard and winery business, region, location within the region and wine varieties produced. Other factors that determine price are cost of the land, water supply, winery, cellar door, storage facilities, plant and machinery, and other improvements.

Winery assets normally include grape receival facilities, crusher and destemmer, chillers, fermentation tanks (refrigerated), maturation equipment (barrels, temperature controlled rooms), laboratory, bottling plant (optional, as may be contracted), cellar door/visitors area, and sales office.

It is a good time to invest in vineyards and wineries. Demand and prices for high-end wines are expected to increase in the short and medium term. The current purchase prices are significantly lower than the cost of setting up the vineyard and winery. Asian demand for wine is growing so investors can enter the market at a good time to supply future growth.

Wineries in Western Australia can be grouped according to their grape crush capacity as micro (up to 100 tonnes), small (100-750 tonnes), medium (750-5000 tonnes), large (5000-20 000 tonnes) and major (more than 20 000 tonnes). Western Australia mainly has small to medium-sized wineries, a few large wineries and no major wineries.

When deciding to purchase a vineyard or winery business the investor should: determine the wine varieties and wines styles they want to produce for their

target markets select the regions that can produce these wines determine the capacity required contact the appropriate government department, viticulture or wine advisors,

and real estate offices for assistance conduct due diligence by appointing an experienced viticulture or wine

advisor, and an accounting firm with wine industry knowledge. 

Case study: Ferngrove Wine GroupAnthony Wilkes, Managing Director/CEOFerngrove Wine Group, in Frankland River about 360 kilometres south of Perth in the Great Southern region, is one of the world’s most isolated, cool climate wine estates which was established in 1998.

In February 2011 Mr Xingfa Ma from Hangzhou took a controlling investment in Ferngrove Wines as he expanded his business interests to focus on a growing market opportunity for China’s rising middle class in food and wine.

After an initial investment of A$10 million, Mr Ma has increased his shareholding (via some shareholders choosing to exit) and injected additional capital (A$7 million) into the business to purchase new wine tanks, equipment, nearly A$1 million in solar power (to become the second largest solar-powered winery in Australia), and purchase two additional vineyards.

With a total of over 300 hectares of vines, Ferngrove is now one of the largest premium vineyard owners in Australia.

Ferngrove has been able to shore up its balance sheet, and enable the winemaking and viticultural team to take greater control over more of the fruit to focus even more on producing the best possible wine quality from the estate’s vineyards.

The sales and marketing team can now enter the marketplace with greater confidence knowing they have the backing of a ‘generational investor’ where patient capital is required to invest and build a global wine brand in an industry that needs considerable working capital, is highly competitive and moves with changes in market demands and agricultural influences from year to year.

The Hangzhou Ferngrove Food Company has opened more than 50 retail Ferngrove wine shops and employs over 100 sales people to build a distribution network throughout China which continues to grow.

Connecting a fine wine producer to this exciting market had previously proved challenging, but with local market intelligence, a drive to make sales and build distribution, and educating each other about the challenges and opportunities, has enabled Ferngrove to be well on the road to success in this exciting marketplace.

Proudly Australian-run with the benefits of international ownership, the Ferngrove story is one of deep respect for the land and the time and care involved in making outstanding wine which reflects where it comes from, but now able to access one of the most exciting growth markets in the world with confidence and knowledge of the market.

Capital is always in short supply in the wine industry and partnering with capital, but more importantly gaining market access or distribution is key to making a wine

business successful, particularly given our ability to produce world class, premium beverages in greater supply than our domestic market can consume.

Financial analysis The Western Australian wine industry has many different business models with a wide range of opportunities for profitable investment along the supply chain. The supply chain is diverse, highly integrated and marked by a high level of engagement by industry participants.

The financial information presented here focuses on the making of fine wines for the export (China) and Australian domestic markets (Tables 6a and 6b). The wine production costs and returns are compared for two ‘flagship’ wine varieties from the Margaret River Region, Cabernet Sauvignon (ultra-premium) and Chardonnay (super-premium). The wines are produced in a small winery (100-750 tonnes).

The gross margins reflect the returns from sales minus variable production costs. Profit is the gross margin less other costs such as sales and marketing, administration, interest payments, repairs, maintenance and capital depreciation.

Table 6a Export market costs and returns for China

ChinaCabernet Sauvignon(A$)

Chardonnay(A$)

Retail price per bottle1 44.71 (RMB 300) 29.81 (RMB 200)

Retail price per case2 536.51 357.68

Wholesale price per case3 320.99 213.99

Winery sale price per litre 17.36 11.22

Winery sales price per case4 156.29 101.02Production costs - -Grape cost per tonne 2500 1700

Extraction rate (litres per tonne) 700 600

Cost of juice per litre 3.57 2.83

Wine cost per litre 6.20 4.50

Wine cost per case5 55.80 40.50

Packaging cost per case 25.00 17.00

Total cost ex winery per case6 80.80 57.50Gross margin - -Winery gross margin per case7 75.49 43.42Winery gross margin 48.3% 56.92%

1 Retail price: Cabernet Sauvignon RMB 300 and Chardonnay RMB 200 per bottle2 Case: 12 of 750mL bottles, total 9 litres of wine3 Wholesale price: retail price less sales tax and retailer margin 4 Winery sales price: wholesale price less distributor/agents/importer commission, excise/duty/taxes, sea freight and Australian domestic freight5 Wine cost: cost of juice plus processing costs, oak costs, holding costs and wastage6 Total cost ex winery: wine cost plus packaging cost7 Winery gross margin: winery sales price minus total cost ex winery

Table 6b Domestic market returns in Australia

AustraliaCabernet

Sauvignon(A$)

Chardonnay(A$)

Retail price per bottle 35.00 25.00

Retail price per case 419.88 299.88

Wholesale price per case 207.13 147.93

Winery sale price per litre 13.77 9.74

Winery sales price per case 123.97 87.68Production costs - -Grape cost per tonne 2500 1700

Extraction rate (litres per tonne) 700 600

Cost of juice per litre 3.57 2.83

Wine cost per litre 6.20 4.50

Wine cost per case 55.80 40.50

Packaging cost per case 25.00 17.00

Total cost ex winery per case 80.80 57.50Gross margin - -Winery gross margin per case 43.17 30.18Winery gross margin 34.8% 34.40%

1 Retail price: Cabernet Sauvignon A$35.00 and Chardonnay A$25.00 per bottle3 Wholesale price: retail price less GST, retailer margin, wine equalisation tax (WET) 4 Winery sales price: wholesale price less distributor/agents commission, domestic freight5 Wine cost: cost of juice plus processing costs, oak costs, holding costs and wastage6 Total cost ex winery: wine cost plus packaging cost7 Winery gross margin: winery sales price minus total cost ex winery

Other investment options not considered in detail here include the establishment and development of new vineyard plantings, production of grapes from existing mature vineyards and establishment of new wineries. Information on these investment options is available on request.

The establishment cost of a new 40ha vineyard is about A$40 000 per hectare which includes development to commercial grape production in five years. This does not include the price of the land which varies considerably between regions.

The production costs and returns from an existing mature vineyard will be determined by the size, scale of operation, varieties grown, grape quality and region. Grape prices are a good indicator of quality and production costs. Table 6 provides an example of prices for high quality grapes from the Margaret River region. Further information on grape prices and production costs is available on request. The prices received for Western Australian wine are about 80% higher than those received by other parts of Australia (Figure 9).

Figure 9 FOB price of bottled wine from major wine producing Australian states (Source: GIS)

Western Australia specialises in premium quality bottled wine at significantly higher prices than most other exporting countries (Figure 10).

Figure 10 Export prices for wine from Western Australia and major wine exporting countries.

Export price is averaged over bottled and bulk wine. The Western Australian bottled wine price is shown separately. The bottled wine prices for other countries were not available (Sources: OIV, GTIS).

Other benefits for an investor There a number of additional benefits for an investor including: dedicated supply of wine to target markets, both international and domestic better control of quality and supply improved access and better routes to international markets improved control of distribution channels and market exposure increase the international and consumer focus of the business introduce a level of discipline to where effort and resources are best spent developing brand awareness and reputation in international and domestic

markets developing new channels to markets such as the USA access to production in a range of climatically diverse regions within Western

Australia for range of wine varieties and styles to suit consumers in target markets

benefit from synergies by focusing the strategic advantages of the Western Australian business and the investor

proximity to Asia and in the same or similar time zone established brands, wineries and vineyard infrastructure existing strong local distribution systems in independent retail outlets and from

premises Highly profitable direct sales through cellar door, emails and mailing lists.

Other important information It is extremely important that all applications for regulatory approvals are underpinned by a clear and concise intent to achieve full disclosure based on a properly developed project proposal. This is because regulators need full disclosure of all required information for quick and efficient processing of an application.

A comprehensive, integrated development application could be used to attain concurrent development approval from Local Government, the Department of Environment Regulation (DER), Department of Transport (DoT) and Department of Water (DoW). This could result in the time required for a total approval process of three to six months.

The Department of Agriculture and Food, Western Australia is skilled in assisting proponents to seek approvals and will work closely with proponents for the inception of the project.

The time period for all regulatory bodies to access a proponent’s application commences from the point at which they receive all the information required to make a decision in an appropriate format. This time period should not be confused with the point at which the proponent makes first contact with the regulators.

Proponents from overseas also need to comply with the requirements of the Australian Government’s Foreign Investment Review Board

Key risks and mitigantsThe key threats facing the wine industry in Western Australia are in the areas of biosecurity, concentration of retail power, imported wines, climate change and taxation burdens.

BiosecurityWestern Australia has a significant competitive advantage in biosecurity. The state has fewer pests and diseases than most other wine producing countries and regions of the world and is free from most major pests and diseases of grapevines. Industry and government recognise the need to be more diligent to maintain and advance this advantage.The main biosecurity threat is the introduction of exotic pests and diseases currently not present. These threats are managed by the state and national quarantine introduction and border protection services.

There is a National Viticulture Industry Biosecurity Plan which addresses the threat of exotic pest and diseases not present in Australia and a Regional Viticulture Industry Biosecurity Plan (Hortguard) which also addresses pest and diseases which are present in eastern Australia but not present in Western Australia. The industry is currently improving its surveillance and diagnostic systems for the early detection of incursions.

Western Australia is free of the following key pest and diseases of grapevines:

Common name Scientific nameInsectsGrapevine phylloxera Daktulsphaira vitifoliaeDiseasesPierce’s diseaseBlack rotDead arm disease

Xylella fastidiosaGuignardia bidwelliiPhomopsis sp.

VirusesFanleaf virusRed blotch virus

Grapevine fanleaf nepovirus

PhytoplasmaFlavescence dorée Flavescence dorée phytoplasma

Retail powerThe consolidation of national retail power in the hands of two major retail chains is considered a significant threat. Coles and Woolworths account for about 70% of all domestic sales. Private labels account for 16% of domestic sales. This is adversely affecting avenues to market for smaller producers.

These threats are being managed by industry and government at the national and state level. The Winemakers Federation of Australia is working with the national wine retailers and competition regulator on fairness, transparency and equity in the domestic wine market to create a domestic marketplace for industry where companies can grow share through quality, innovation and investment.

The Western Australian wine industry is working with the State Government to give producers greater access to direct sales to end consumers the most profitable marketing channel. The industry is implementing a Strategic Plan to boost the share of exports from 12 to 40% of production over the next 10 years thus reducing reliance on the domestic market.

ImportsThe volume of imported wine doubled from 2007 to 2012 from 8.9% to 15.7% of market share by volume and 16.3% to 18.6% by value. This includes the import of cheaper commodity wines as well as quality wines from South America.

The Western Australian wine industry is implementing two strategies to maintain and grow market share against imported wines:

maintain and improve the quality and competitive advantage of our fine wines market promotion programs to ensure Western Australian regional wines to

become the wines of first choice by Western Australian consumers.

Climate changeThe wine industry’s special dependence on unique regions is strongly related to climate. Western Australia’s nine wine producing regions and five subregions span cool to warm climate viticulture and high to low rainfall. Each region produces wine varieties, styles and blends with distinctive characters.

While temperatures are projected to increase and rainfall to decrease under a future climate the Western Australian wine industry is resilient to these changes. In the cool and maritime wine regions the late maturing classic wine varieties such as Cabernet Sauvignon, Shiraz, Merlot, Malbec and Cabernet Franc are expected to have more frequent high quality vintages.

Newer varieties such as Tempranillo, Sangiovese, Grenache, Zinfandel and Nebiollo will perform better and be adopted in more regions. Elite clones of existing varieties and new varieties are being introduced, researched and developed to improve wine quality and increase the industry resilience to climate change. Vineyard management practices to protect grape production and quality against the occurrence of heat waves and heat spikes during the growing season and efficient irrigation practices to reduce vineyard water use continue to be adopted and improved.

Land and water resourcesThe lack of availability of land with suitable soils and access to quality water supplies may restrict expansion opportunities in some regions or drive proponents to unsuitable sites with higher risks. Industry is working with government ensure access to limited natural resources, such as suitable land and water, and facilitate the adoption of practices that lead to sustainable use of natural resources.

TaxationWine tax arrangements have a significant impact on wine industry profitability and licence to operate in the community. WET (Wine Equalisation Tax) is a value based tax payable on the last wholesale sale. Effectively there is a 29% WET charged on the wine consumed in Australia (both domestic and imported). Export is exempted from WET. As WET is calculated on the value of wine, high value producers pay more. Wine produced in WA is of high value even at the production end, making it more costly at the wholesale level itself. When 30% of the wholesale value is added to the retail price, wine becomes more costly at the retail end.The Producer Rebate Scheme enables producers to claim back the WET charged. The maximum rebate an Australian producer can claim in a financial year is A$ 500 000. The rebate scheme helps Western Australia’s small winemakers to partially offset the disadvantage from WET.The Western Australian industry is working with the Winemakers’ Federation of Australia during the WET rebate review to ensure any changes do not diminish the profitability of the regional wine industry.

How to progress

Please contact the Mr John Ruprecht, Executive Director, Irrigated Agriculture and Diversification, at the Department of Agriculture and Food, Western Australia, on telephone +61 (0)8 9368 3405 or by emailing john.ruprecht@agric.wa.gov.au.

Services available from the Department of Agriculture and Food to assist investors in the agrifood sector include:

• providing detailed information on opportunities• assisting with pre-feasibility plans to assess opportunities• assisting an investor to seek the Government approvals required• supplying contacts such as project managers, joint venture partners,

financiers, immigration specialists, accountants etc• access to relevant research and development information• information and advice on Western Australian government natural resource

management and biosecurity legislation and regulations, and the responsibilities and obligations

• Information on Australian government quarantine and export regulation requirements.

DisclaimerThis business case provides indicative modelling on a fine wine supply chain for small to medium-sized grape and wine businesses in Western Australia.

The business case and any additional information or documents that the State of Western Australia through the Department of Agriculture and Food, Western Australia (DAFWA) may supply, are to be used only as preliminary and indicative information, to be considered and used by prospective investors in the Western Australian wine industry in conjunction with other information and appropriate financial, legal, industry and other expert advice tailored to their individual circumstances and intentions. Prospective investors should conduct (or engage appropriate professional advisers to conduct) their own analysis and due diligence on any proposed investments, including the process for obtaining approvals. No part of this business case or any additional information or documents that DAFWA may supply constitutes or should be relied on as financial, investment, legal or other advice.

The Chief Executive Officer of the Department of Agriculture and Food and the State of Western Australia accept no liability whatsoever by reason of negligence or otherwise arising from any use or release of material (which in this disclaimer includes this business case, any information in it or other part of it, and any other information, advice or material, oral or written, DAFWA may supply in relation to any aspect of the Western Australian wine industry, regulation of it or investment in it) or any error, inaccuracy or omission in the material. Although reasonable care is taken to make the material accurate, the Chief Executive Officer of the Department of Agriculture and Food and the State of Western Australia do not make any representations or warranties about its accuracy, reliability, completeness or suitability for any particular purpose.

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