Green shoots trimmed by WET conditions

After more than a decade of oversupply, winemakers are disappointed that tax issues might hurt an industry recovery.

There was barely a ripple in the market last month when one of Western Australia’s biggest wineries decided to shut down most of its production capacity in order to revise its strategy.

First revealed by Business News, 3 Oceans Wine Company’s move, which it blames on changing conditions in its key market of China, follows a troubled history for the company that launched in the late 1990s as Palandri Wine Group on the back of a flood of tax-effective investment money.

It raised more than $100 million before going bust in 2007. The business was taken over by interests associated with Chinese businessman Ma Xibo.

With its links to China, and representing around 10 per cent of the state’s wine exports mainly to that previously buoyant market, it seemed odd that the eighth-biggest WA winery could face such problems.

Historic numbers provided by the Wines of Western Australia seem to reflect the trajectory of companies such as 3 Oceans, and intimate that such concerns are far from fanciful.

The huge rise in WA production, which started in the 1990s and peaked in 2004, at the end of the tax scheme investment splurge, was followed by a massive rise in exports to markets such as the UK and the US. As those markets crashed due to global oversupply, the rising Australian dollar and the GFC, production eased dramatically (even though China picked up some of the slack).

Now, if history is repeating, China appears to have peaked, just as 3 Oceans’ experience suggests. With exports falling to a 12-year low in 2014-15, the past performance of WA’s wine sector would suggest production is heading south, too, likely to dip below 2002-03 levels once the figures are made available.

Anecdotal evidence suggests this drop in production has occurred, helping to end the glut that damaged many less volume-driven wineries.

An example was another major producer with an investment scheme background, Watershed Premium Wines. In its 2014-15 annual report, Watershed said it had mothballed almost 42 hectares of its 187.5ha of vineyards, as well as selling 37.5ha to Margaret River neighbour Vasse Felix for $3.3 million to clear $2 million in debt.

However, Watershed managing director Geoff Barrett believes the company’s move as part of a cost-cutting exercise has proved, in part, ill-timed. He said Watershed could easily have sold the production from those dormant vineyards and may well have to buy more land in the next 12-18 months.

Innovation

It is possible forecasting China’s demand as a wine market by looking at recent data may be premature. On the back of a falling Australian dollar and some good connections, key players say there’s plenty of demand both there, and in other markets.

In fact, Mr Barrett said Watershed was seeking to take control of another Margaret River wine business’s production through a strategic alliance, which, cumulatively, will represent the biggest volume in this significant wine region.

Many in the sector are engaged in such innovation in order to find niches that are profitable in an otherwise competitive marketplace.

For Watershed, one area proving fruitful is the cruise ship business, with the winery teaming up with operators to not only supply wines but also have staff join voyages to provide education sessions.

Perhaps the most entrepreneurial of the bigger WA wine groups is Ferngrove Vineyards, which, through the investment of its Chinese owner Xingfa Ma, has 60 retail own-branded outlets in China.

It is therefore unsurprising that Ferngrove CEO Anthony Wilkes is bullish on China.

Mr Wilkes said there had been a two-year blip in China sales but exports were rising again strongly by early 2016.

“The government austerity measures launched at the end of 2012 have left a lingering impact on the high-end Chinese wine market, while the middle-to-lower end market and younger wine drinking population have revealed their true potential,” Mr Wilkes told Business News.

“Demands for high-end products still exist, but the market has changed and you need to understand the market with good on-the-ground intelligence and adapt your offering accordingly.”

Tax dispute

Closer to home, the biggest issue for winemakers is a planned tightening of the Wine Equalisation Tax, which came into effect in 2000 to negate the impact of the introduction of the GST, a tax that has not changed despite much political conjecture.

Margaret River Wine Association president Stuart Watson, who is also chief winemaker at second-generation family-owned Woodlands Wines, is clearly angered by the changes to the WET outlined in the recent federal government budget.

Mr Watson said WA wineries would be disproportionally affected by the changes due to their size and the way they conducted their business.

For many WA wineries, a $210,000 reduction in rebate from $500,000 represents a direct and significant hit to net profit, as they are big enough to get the full current rebate but small enough that it remains a sizeable part of their earnings.

Mr Watson said the original $290,000 rebate would be about $490,000 if indexation applied, so the current $500,000 amount was about right for an industry that operates in a way that wins praise from economic pundits.

“Wine is tough,” he said.

“It is agriculture, manufacturing and sales and marketing all wrapped up into one.

“We are a high value-adding and innovative industry.

“(Malcolm) Turnbull talks about that but this will stop any type of innovation.”

Great Southern Wine Producers Association chairman Andrew Hoadley, winemaker at La Violetta Wines in Denmark, said while the industry acknowledged that reform due to rorts was necessary, the changes were damaging legitimate businesses, both in terms of rebate reduction and eliminating rebates for wine businesses that contract out their winemaking.

“Unfortunately the changes announced in the federal budget will take money from the pockets of medium-sized producers and force many small producers out of business unless they decide to build or lease their own winery,” Mr Hoadley said.

“WA will be hit much harder by this because our industry, like Tasmania’s, is heavily weighted toward high-value fine wine rather than bulk production.

“We need reforms that will encourage investment in vineyard improvement, tourism and export development, rather than encouraging the building of more small wineries.

“That’s the last place we want to be putting our capital, in infrastructure that is used for two or three months of the year.

“Clearly enough winery space already exists to meet current production requirements, so why build more?”

Family matters

Multi-generation family businesses represent some of the biggest winemakers in WA. Names like Burch Family Wines (Howard Park, Madfish), Calneggia Family Vineyards (Rosabrook, Bunkers), Fogarty Wine Group (Millbrook, Deep Woods, Lake’s Folly, Smithbrook), Leeuwin Estate, and Voyager Estate are prominent in the top echelon.

Some of these players are more circumspect about the impact of WET changes, but are also bemused by federal government efforts to end rorting by penalising all legitimate wine operations.

Calneggia Family Vineyards founder Mike Calneggia is cynical about the government’s position.

“They say they are going to crack down on people rorting it,” Mr Calneggia said.

“They have those powers now but the tax office doesn’t police it, they don’t have the expertise.”

Mr Calneggia said the additional $250 million the government’s WET change was expected to raise meant wineries would be forced to increase prices.

“If wineries want to maintain margins, someone has to pay for it, it is going to be the consumers,” he said.

Rising prices will undoubtedly affect the balance between supply and demand, just as the Australian glut was coming to an end.

“We have to hope export markets keep growing and it (new oversupply) will be diverted away,” Mr Calneggia said.

Voyager Estate managing director Alexandra Burt is equally concerned about the WET changes hitting all producers indiscriminately.

“It is penalising valid and invalid recipients, rather than targeting invalid recipients first,” Ms Burt said.

But she believes the bigger issue in the wine industry is the lack of profitability in the sector, with the family-owned nature of the smaller wineries, often subsidised by off-farm incomes such as professional salaries, resulting in loss-making enterprises flooding the market with product when. In most other sectors, they would not have survived.

“Decisions around strategy are often made around the kitchen table rather than the boardroom table,” Ms Burt told Business News.

“It is predominantly a family thing and it is really hard to make that decision to let it go.

“People hang on in spite of what looks like a tidal wave of evidence to do otherwise.”

Ms Burt said this proliferation of players with a survivalist mentality had resulted in a market cluttered by brands. In 10 years, she said, the number of stockkeeping units – an inventory term which in wine represents a multiple of brands and the different grape varieties or blends on offer – had risen to by 50 per cent to 30,000.

“For the consumer the choice of wines that is available today is mindboggling,” Ms Burt said.

“There is no category in any industry I can think of that comes close.”