LESSONS ABOUT VINEYARD ESTATE INVESTMENTS

It is a great pleasure to walk through the valley and fields of a vineyard on a weekend trip into the Saint-Emilion, Bordeaux or Burgundy region in France, or into the region of Tuscany, Veneto and Piedmont in Italy, or the region of Rioja in Spain. There is something catching when you see the landscape, the terrain, the direct contact with nature, the historical architecture, and of course having good food accompanied by fabulous fine wine.

Owning a vineyard is an enjoyable and pleasant property pursued by wealthy people seeking an international elite status but not necessarily a very rewarding investment decision if the valuation is not correctly assessed.

In this series of articles, I focus my analysis on the economics and financial aspects of investing in vineyards and winemaking business. This is the result of my experience evaluating property deals during 2021.

A vineyard is a land (permanent assets) with buildings and facilities (fixed assets) in place used for a mix of purposes such as personal use (a countryside house), agricultural activity, and economic activity such as wine production and hospitality business.

In real estate, the land is a permanent asset (with unlimited duration), but its value is not perpetually constant, and neither will increase over time. Indeed, its value will be driven by supply-demand factors, and this means, the willingness to pay for a property and the readiness to sell at those levels.

There are multiple factors behind this attractiveness of the land which include, without pretending to be exhaustive, some general factors and intrinsic features. The general aspects include things like the limited availability, the accessibility via road, the existence of public services and utilities, the socio-demographic composition of the community, and environmental and regulatory conditions. There are other intrinsic factors which include the terrain, any attractions like access to rivers, lakes or wood, and the use of the land and property for economic activities, for instance, for agricultural use, industrial process or leisure and hospitality business like hotels and tourism.

Those investors I spoke with who acquired vineyards estate in the past for the pleasure and reward of owning a luxury property said they are not generating any added value, and, in some cases, they are draining their money to maintain those assets. I do not classify this decision as an investment but a pure discretionary consumption.

The purpose of an investment is to put your money to work with the aim of building wealth for you and your future generations. Investment objectives are always different in any person, with some individuals looking for a yield and income generation, others looking for long term capital growth, and in some other cases, people are looking to match future liabilities or just simply to build an income replacement when decide to retire. Regardless of your objective, any investment should provide a superior return to the unit of risk taken on the decision. Evaluating an investment decision in a vineyard estate under those principles requires a thorough economic assessment and a clear plan.

What investors fail to grasp is that investing in vineyard estate assets could potentially deliver uncorrelated risk-adjusted return and superior yield if the purpose is in owning the land and building, not only for the pleasure of having a place to visit and staying with friends and relatives but for the purpose of operating mix of an agriculture business with processing activities and some leisure and hospitality aspects. But managing a vineyard, like any other business, requires passion, dedication, a real love for producing exceptional wines, and talented people sharing the same values.

But it is important to understand your numbers well before entering a transaction because a huge portion of the superior return tends to be heavily impacted by the purchase price, the price of the land per acre or hectares, the productivity of the land, and the quality of the wine produced.

For example, last year I evaluate multiple vineyard properties in Italy with asking prices in the range of €800k per hectare to €1,500k per hectare (this is for properties with a total hectare in the range of 12 to 60 hectares). Why so much difference between lands in Italy? Some properties were in the region referred to as CR? and prices because of the fine wine produced in the region, but it is important to understand the actual cultivated land and the kind of grapes cultivated within the property. Some properties contain beautiful, well-maintained buildings, some of them with a main mansion or palace and 10+ empty rooms, but when it comes to the cultivated land, some of them produce 40 to 50% of the total land plot.

I pay attention to the cultivated land, the grape production and recent harvesting seasons because the winemaking business is a free cash flow business model. The viticulture and winemaking business require relative small recurring capital expenses but generate long term operational cash flow on the back of the productivity of a well-maintained vineyard with a life span that could exceed the 100 years of production. This means that owning a vineyard should generate dividend distribution to the shareholders.

The only caveat on the wine business model is the working capital management and the typical cash conversion cycle associated with the winemaking process. The wine business is by definition an inventory-rich business. Every year after the harvesting of the grape, the grapes Mosto pass through a long process of fermentation, filtration, stabilization, and ageing in multiple types of barrels. It is fascinating to visit the cellars where the wine is produced. Once the winemaker decides the wine is ready to market, then it comes to the bottling and labelling process, marketing and sells.

Every year the winemaker decides whether the wine is ready to be brought to the market and releases inventories held for many years. Some of the best wines with certification of origin (like DOG and DOCG) require minimum ageing of three to pass the technical and tasting analysis. For instance, a Barolo wine in Italy will require three years of ageing, the Brunello di Montalcino requires five years while Bordeaux tends to improve with long maturity. This means that your vineyard business requires good financial plans to manage the shortfall of cash during the year.

Another aspect of the wine business is logistics and distribution channels to reach international markets. If you are a large wine company, you would have a stronger gross margin (typically around 40%), giving you room to have your own marketing and distribution effort and maximize the net selling price. For small family-owned vineyards, this is not possible due to a lack of economies of scale. Those businesses rely on third-party distributors who will take a large chunk of the retail price with a large share of gross margin with a huge implication on the gross margin and the ability to generate significant unleveraged cash flow.

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What happens, in the end, is that the working capital needs (financed with short-term debt), the small scale of production, and the large distribution margins, leave the business with a small gross margin (~20%) and a tight Ebitda margin (~10%).

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The good news is that there are strategies to improve the fundamental economics of the wine business through the consolidation of multiple vineyards. This is an M&A strategy focused on building a balanced portfolio of wine brands that generate significant economies of scale to justify having their own distribution channels and maximize the ex-cellar netback price.

I hope you enjoy this article. Please, leave me your comments and feedback so I can incorporate them into the following articles.

Thank you very much.

Jhoan Cordoba