|Canandaigua Wine Sours|
|Fool's Take...One Fool's Opinion||
Canandaigua Wine guided analysts' expectations downward today, the second time that they've done so this year. We've compiled conference call synopses and an insightful Take from MF Debit for your reading pleasure -- enjoy!
FOOL TAKE---ONE FOOL'S OPINION*
(FOOL EQUITY RESEARCH)
UNION CITY, Ca., Sept 6, 1996 /FOOLWIRE/ --- CANANDAIGUA WINE CO. (NASDAQ: WINEA & WINEB) left a bitter taste in shareholders' mouths as it first hit a new 52-week low yesterday, closing down $7/8 to $22 on fairly normal volume, then followed that with a late-night press release slashing current fiscal year and Q2 earnings estimates in half. The party continued on a downward trend today with the stock getting squished another $5 a share to close at $17.
Canandaigua is a family-business success story that was started in 1945 by chairman Marvin Sands (who, with his family, still owns more than 60% of the company). On the strength of a dessert wine -- Richard's Wild Irish Rose (named after his son, Canandaigua's current president Richard Sands) -- the company slowly expanded by buying small wineries.
In the early 1990s, the company realized it had built a significant distribution network that could handle more volume and went on an acquisition spree that included Guild Wineries & Distillers (Cook's champagne), Barton Beers (Highland Mist and Kentucky Gentleman, among others), Vintners Int'l (Paul Masson and Taylor wines), Almaden/Inglenook wines, and 12 spirits brands from United Distillers Glenmore (UDG).
Today the company is a giant in national and regional alcoholic beverage brands. It is the 2nd largest supplier of wines (after Gallo), the 3rd largest importer of beers (beer brands owned by Canandaigua include the craft brand Point and imports St. Pauli Girl, Corona, and Tsingtao), and the 4th largest supplier of distilled spirits in the United States (with the #1 mezcal brand, Monte Alban, and the #2 tequila brand, Montezuma).
According to last night's press release, instead of earnings per share in the $2.30-$2.50 range for FY 1997, which ends next February 28th, the company now only expects earnings to come in between $1.10-$1.40 per share. They also revised their Q2 numbers, which they will report in mid-October, downward -- analyst estimates for Q2 currently stand at $0.60 per share and the company expects actual earnings per share for Q2 to be somewhere between $0.20-$0.30. On top of that, this is the second time this year that the company has revised estimates downward. In the quarterly conference call held at the end of April, the company cut FY 1997 estimates from $2.80 to the $2.30-$2.50 range. The stock has been on a downhill slide since last November.
So, how did all this happen? Well, the company is blaming their latest disappointment on their wine division, which was also blamed for the April revision, and was a cautionary note in the July Q1 call when the company highlighted the fact that unit volume was flat and it was the first time they have not seen a dramatic increase in their varietal wine category. In the July call, they viewed the situation as temporary, mainly due to slowed growth at retail as a result of industry-wide price increases and higher-than-expected grape costs which impacted margins. In the latest revision, they cited higher than expected product costs, lower than expected production efficiencies, and lower than expected net sales for wine products. The company held a conference call for stock analysts this morning to explain the situation. (Note: a synopsis of the call is included in this collection. Or, you can listen to a taped replay of this morning's call by dialing 1-800-759-8643 and entering the passcode: 1234 when prompted).
The wine business is very difficult to model because it has some unique uncertainties associated with it. Canandaigua has also made the number-crunching a little bit difficult by changing their fiscal year-end earlier this year. For them, FY 1996 was a six-month "transition period" from August 31, 1995 to February 29, 1996. The transition period almost has to be thrown out for comparisons because it involved costs and expenses that had a large negative impact on earnings. Not only was it a 6-month fiscal year, it also included a large acquisition (with associated charges) which they had to jump-start with advertising and other related expenses that were not covered by product sales for the acquired brands. They also experienced higher-than-expected grape prices and the fiscal year change affected the timing of cost recognition and expenses.
If you're still with me, it gets more complicated. The wine business in general is a little tricky to figure out. Canandaigua uses a last-in, first-out (LIFO) method of accounting whereby at the beginning of a fiscal year (in March) they estimate what grape prices for the Fall harvest will be and also what inventory positions, overhead rates, and other material costs of inventory will add up to by the end of the year. They then apply those costs throughout the year by making a LIFO adjustment to their first-in, first-out (FIFO) profits.
Where they often get into trouble is with the uncertainty of predicting Fall grape harvest prices in March. If the grape prices are higher than they estimate, they either have to hope that they have achieved better-than-expected margins on their other product sales throughout the year, or they have to make up the losses by increasing wine prices next year. The grapes they buy in the Fall do not generate offsetting income until the following Spring and Summer. And, on top of that, the Winter quarter during the Christmas and New Years holiday season is typically their strongest selling period -- so missing that Fall number means a full year before another strong selling season, since prices in the industry are generally adjusted in the first calendar quarter of the year, after the holidays.
In Canandaigua's case, they were hit with higher than expected grape prices last Fall and it looks like the same will be true this Fall. They actually did expect grape prices to remain high this Fall and also expected that the strong performance in their spirits and import beer divisions, plus an increase in their LIFO adjustment earlier this year would offset that.
What they didn't expect, that seemed to make the difference here, were the production efficiency problems and the continued soft sales performance of their wine products. To give a little background on the production problems, last year Canandaigua made the decision to consolidate their wine production to utilize the capacity of a huge facility (Mission Bell) in Madera California that they acquired with the Almaden/Inglenook purchase. When they brought their wine facilities together (Almaden, Inglenook, Paul Masson, and Taylor brands), there were many more stock keeping units (SKUs) and many more components that had to come together at the right time.
There were also many more SKUs in the warehouse that had to be stocked to make sure that they had inventory to ship to their customers. During the beginning of the process (the material requirements planning portion) they have had organizational and system failures in getting the right materials in the right place at the right time, which means that the bottling line has to stop. At the other end, they have had difficulties in their distribution requirement planning which means that they don't have the right inventory, given their customers' orders and the warehouse can get plugged to the point where there is no place to put the goods, so the bottling lines again have to stop. Also, with regard to the run length, sometimes instead of running a line for 3 days, they have to run it on 1 SKU for four hours, switch to another SKU and run that, so downtime is greater than planned. The real complication in production efficiencies as they pulled the Almaden/Masson/Inglenook/Taylor facilities together is a result of doubling SKUs which geometrically complicates things, and their systems and organization were not prepared to deal with that.
The company believes that this problem is fixable, but could take 12-24 months before the full benefits trickle down to their bottom line numbers. Despite the problems with the wine division, there are still a lot of things that are working well at Canandaigua. First of all, even with the estimate cuts, they will still be profitable. And, they still believe their earnings on a FIFO basis (before interest, taxes, depreciation and amortization) will be in the $130-$145 million range compared to last year's $115 million -- that is still above-average growth for their industry and will represent a 13-26% increase over last year. Even within the wine segment, their varietal wines are doing well and performing better than the industry average. They are only underperforming the market for their White Zinfandel and non-varietal products. The one caveat here is that the White Zinfandels do make up a big percentage of their varietal wine product line as well (Chardonnays, Merlots, and Cabernet Sauvignons make up the remainder of the varietal line), so that's not the best one to be underperforming.
The UDG spirits brands they picked up during their FY 1996 transition period and their imported beer business are both still showing better-than-expected performance, too. These products command higher margins than the branded and varietal wine products. So, the mix skew could still help them, and, even if it doesn't, those are two very strong profitable divisions that represented good acquisition decisions for the company. As they grow, they will serve to lessen the impact of the volatile wine market and the company should come back very strong when it fixes the problems with the wine division. In fact, the full benefits of the re-engineering efforts would mean that the company will recapture $17 million of operating inefficiencies, improve their volume trend and recapture profit associated with their volume trends in the wine business, produce additional synergies and operating efficiencies above and beyond the $17 million, and lower the capital employed in the wine business to significantly increase return on invested capital. Pretty cool, huh?
A lot of the other problems they are facing in the wine division are cyclical and will improve too. Canandaigua's slowing sales due to their price increases earlier this year is something that is impacting the whole wine industry, not just Canandaigua. Their competitors are facing the same problem. Their chief competitor, Gallo, increased prices on the low end of their product portfolio, in response to higher 1995 grape prices, equal to the increases Canandaigua made. Canandaigua had bigger increases in their varietal products on a dollar basis, because they were well below competitors' pricing because of special introductory pricing they did on the new value varietal products. So, while it was larger in terms of dollars, it was just a gap-closing increase rather than one that exceeded the retail prices of competitive products.
The grape prices cycle higher for a two to three year period and then tend to go down because growers, responding to increased demand, plant more grapes. These cycles are fairly predictable because when you plant vineyards it takes 4 years for a partial crop to begin to bear fruit and 6 years for the vineyard to be fully productive. When you graft vineyards it takes 3 years for a partial crop and 4 years for almost complete productivity. So, barring any unforeseen natural disasters or adverse weather and vineyards being taken offline, when the supply increases due to the planting, the prices trend back down again. So, over the long term, the grape cost problem will correct itself too.
Investors who have held or purchased the stock since the high last November have already seen their shares plummet from $53 per share to $17 as of today. With the huge stake insiders still hold in this company, a share repurchase program they intend to complete, new strong management in place to fix the 1/3 of their strong businesses that needs a little more help to mesh the workings of all their acquisitions in the wine category together, I think I would hang on to see what kind of progress they have to report in their October quarterly report.
The company emphasized that these problems are fixable and do seem to just represent a situation where they will still report good growth, just maybe not the blockbuster growth they have reported for the past 5 years. Once the problems are ironed out, they will be very well positioned to resume the blockbuster growth mode investors were used to. With today's closing price sitting at 10 times trailing earnings, that puts the stock price in line with the industry average multiple. The company has the strong calendar Q4 selling season just ahead and some time before that to get some of their efficiency programs in place. The other things Canandaigua has going for it are product line breadth and depth, great brand strength in hot segments like imported beers, and their track record of achieving double-industry-average growth.
* A Fool Take represents the opinion of one Fool and in no way should be taken as the opinion of either the Motley Fool, Inc., the company in question or representative of anyone or anything else other than that specific Fool's thoughts.
(FOOL CONFERENCE CALL SYNOPSIS)*
By Debora Tidwell (MF Debit)
Canandaigua Wine Company, Inc. (NASDAQ: WINEA & WINEB)
UNION CITY, Ca., September 6, 1996/FOOLWIRE/ --- Canandaigua Wine held a conference call with analysts this morning to discuss the press release they issued last night revising earnings estimates downward for Q2 and FY 1997 (their current fiscal year which ends February 28, 1997).
The change in their forecasted results reflect the poor performance of their wine division, despite strong performance by both their beer and spirits divisions. While their re-forecast to $1.10-$1.40 per share is disappointing versus last year's 12-month income of $1.92 (exclusive of non-recurring and one-time items), the company's cash flow is strong. The company's cash flow as measured by FIFO EBITDA has improved significantly over the last 12 months and is expected to continue to improve for the full fiscal year.
DETAILS ON THE CHANGES IN ANNUAL EPS ESTIMATES
They are tracking back in their explanation in the press release to their forecast they made at the end of last year for earnings per share, LIFO, to be $2.30-$2.50. From that point forward, to today, their estimated LIFO adjustment to costs had increased $10.5 million after the first quarter and they did not re-forecast. They now believe that they may need to increase that estimate up to another $6-7 million.
So, all told from their original forecast, their estimated LIFO adjustments is increasing by approximately up to $17 million. Their operating inefficiencies that are included in their re-forecast, versus their original forecast, are pretty close to the same range as the LIFO adjustment -- pretty close to $17 million. The $17 million is the increase in LIFO from the original $2.30-$2.50 forecast.
That $2.30-$2.50 forecast included approximately a $13 million LIFO adjustment. So, from that original forecast, their estimated LIFO adjustment could go up by as much as $17 million and they have had almost that much in unexpected operating inefficiencies, $17 million.
The third area they mentioned is wine division sales. Their wine division sales which are primarily volume related -- they have actually had more price increases and better price increases than they had anticipated -- their volume deficits versus their plans less better pricing is in or near the $10 million range. These figures would add up to more than the increment they have decreased the forecast by. The reason is that their spirits and beer businesses have been performing beyond their original forecast and have made up the difference.
So, to translate in terms of EPS estimates, $17 million is $0.51 per share, so doubled is $1.02, and $10 million is $0.30 per share. So that's $1.32 and they forecasted down $1.15 per share from the $2.30-$2.50 numbers. The difference between $1.32 and $1.15 is the beer and spirits over-performance.
OVERVIEW OF WINE DIVISION DIFFICULTIES
The performance issues are localized in one of Canandaigua's 3 businesses -- the wine business. Both their beer and spirits businesses are performing well. Their beer business has performed well beyond expectations with regards to both sales and profits. Within their spirits business, the integration of the UDG acquisition has proceeded in-line with their plan. UDG sales transfers since a year ago are positive for the quarter and their basic spirits business, without UDG, is steady.
As discussed in their press release, their wine division performance will be negatively impacted by higher than expected costs related to the 1996 grape harvest. This impacts wine division performance primarily through the LIFO adjustment to costs. In July, following their first quarter, they discussed the fact that their estimated LIFO adjustment increased from approximately $13 million to $23.5 million as a result of higher costs. They had hoped they would be able to offset these higher costs through cost reductions and other revenue opportunities. Unfortunately, they found unanticipated operating inefficiencies instead of improvements in this area, and volume shortfalls occurred versus their plans.
In addition, as they proceeded into the harvest and began to crush grapes, pricing for grapes is definitely higher than expected as demand has exceeded supply. Reduced tonnage to adjust their inventories will result in additional higher overheads associated with this harvest. They expect, therefore, that they might have additional LIFO costs above and beyond the re-estimated $23.5 million discussed in July by year end and have included such hich higher costs in their estimates to be conservative.
Furthermore, they experienced higher than anticipated wine division production costs. While to-date management has slightly improved bottling and warehouse operating efficiencies, they have not, by any means, achieved near the results they expected or should have achieved in this area. The problems are correctable and are being addressed by their management. Additional production inefficiencies were found as management, in their re-engineering process, explored and identified root causes of their problems.
The other element of their worse-than-expected performance results from lower than expected wine division net sales. While they planned for small increases in sales, they are seeing a decrease versus last year. Consumer response to industry-wide price increases across all categories of table wine has resulted in a reduction of growth trends within each category. As an example, varietals had been growing at approximately 13% a year ago, prior to prices increasing. As prices have increased, varietal growth has dipped as low as 4% for the 4-week period ending July 5th. The pattern for individual varietals like Chardonnay which had been growing a year ago at over 20% and dipped to a low point of 8% during July is very similar. They are seeing this across other varietals like Cabernet Sauvignon or Merlot. Canandaigua's varietal position, prior to the introduction especially of their new "value" varietals has been and continues to be heavily dependent on White Zinfandel. White Zinfandel volume for the industry, prior to the industry-wide price increases, had been growing at approximately 6%. In July, White Zinfandel growth rates reversed to -2% -- that is, they are actually seeing declines in the marketplace in White Zinfandel on an industry-wide basis. While Canandaigua has been outperforming the industry in key varietals like Chardonnay, Cabernet Sauvignon, and Merlot, they are underperforming in their White Zinfandel sales.
That identifies the primary sources of their poor wine division performance. As they have indicated LIFO and, to some extent, their wine sales patterns result from a high degree of volatility and unpredictability in the grape markets. Eventually they believe grape prices will stabilize as demand is tempered by higher prices in the marketplace. Simultaneously, new plantings are coming into bearing and increasing the supply. The net result should be that grape prices will retreat at some point. It has been the historical trend after a period of sharply rising prices for grapes. Unfortunately, at the peak of a grape cycle, especially when there are two short crops in a row and all segments of the grape market are peaking at the same time, it is very difficult to predict what prices will be during the harvest and, to some extent, next year.
WHAT THEY'RE DOING TO HELP THE SALES VOLUME ISSUE FOR THE WINE DIVISION
The non-varietal market has shown a similar tendency, moving from about a 4% industry-wide growth rate down to 1% as prices have increased slowly. Canandaigua has been underperforming in this category and believe that they are addressing the situation.
To address the volume situation they have put together a cross-functional team to focus on the area where they are having these volume shortfalls which are in the Almaden, Paul Masson, Inglenook, and Taylor products. While the industry is seeing less increases, they are still seeing increases. So, Canandaigua should be able to, if they are performing in-line with the industry, see increases in their business -- as long as the industry stays at what was discussed in terms of July numbers.
Canandaigua is underperforming in their non-varietal business and in their White Zinfandel business. They believe that this has occurred as a result of two factors. First, they split or separated the pricing of White Zinfandel and non-varietals to a greater extent than they had before and, as a result, in the marketplace at retail where in the past they had White Zinfandel and non-varietals being promoted together which makes for a very attractive promotion, they are no longer getting that type of activity. So they need to bring the pricing of the two closer together, especially on promotion so that the stores will stack non-varietals and White Zinfandels together. That would help both pieces of business, non-varietals and White Zinfandel.
Also, they believe in certain markets, in localized situations while competition on non-varietals increased their prices to the same extent Canandaigua did, they may have crossed price points that either produced short-term consumer resistance or long-term consumer resistance -- they don't know which and they are trying to explore that and potentially, in those markets, look to bringing their pricing on non-varietals to those resistance points to pick up volume and pick up their trends.
The net results, in the opinion of the Almaden/Masson/Inglenook/Taylor management team, if they made all the adjustments, their net pricing (pricing less promotion) would be worse than it is today, but their volume would go up and their volume trends would be at industry levels and at the bottom line that would put them in the same position they are forecasting at the moment. So, they are looking to make those adjustments, but are not forecasting for the remainder of the year that they will have a bottom-line impact. They will just put Canandaigua in a position to maintain their market share and hopefully increase their market share through their over-performance in the other categories (Chardonnay, Merlot, and the other varietals).
WHAT THEY ARE DOING TO FIX THE PRODUCTION INEFFICIENCIES IN THE WINE DIVISION
They are addressing their production inefficiencies through a number of short-term and long-term measures. They are implementing new management information systems to better measure and control their operations. They have new leadership in place at the Mission Bell facility. They have new financial management within the wine division and the wine division management team is addressing the root causes of the production inefficiencies through cross-functional task forces that are looking to improve efficiencies and solve problems on a short-term basis. In the longer term, their re-engineering efforts are focused on their work processing systems and organization necessary to run the wine business in an optimal fashion in terms of cost efficiencies and revenue generation. They believe that their re-engineering efforts will, in fact, put them in a position to address th eneeds of their distributors, retailers and consumer and drive their wine business forward in the future.
They don't anticipate taking any significant restructuring charge as the re-engineering is not focused on a major workforce reduction and/or closing of facilities. Their revised forecast does take into consideration certain one-time only or non-recurring costs associated with the re-engineering and its implementation, but not necessarily a formal restructuring charge.
Their re-engineering efforts are nearing their final design phase and they are preparing to announce their changed work processes, systems, and organization necessary to support work processes and systems to their own internal organization very shortly. Until that point in time, they are not in a position to really discuss the details of this re-engineering effort with the financial community. After they have made the internal announcements, they will gladly discuss the details and hope that the financial community will see that they are planning on making dramatic changes that should address the issues they talked about previously and understand how their re-engineered organization and work processes will enhance accountability and lead to improved results.
The $17 million production inefficiencies number seems very large because the wine business is a very production-intensive business, so it is large. Also the company doesn't want to characterize that $17 million operating inefficiencies number as a non-recurring charge because they think that might be overly simplistic. They do believe and hope that over the course of time they can improve their operating efficiencies and eliminate those inefficiencies. It's not rocket science. It is, unfortunately, going to take a different organization, different operating information systems and different work processes to accomplish. They feel that they have put the right people in place to manage their Mission Bell facility -- their very large facility in Madera California -- and that is where the problem is.
They feel that their re-engineering design addresses the work processes and the organization so that they can have the necessary integrated organization and work processes to address the more complicated problems. At Mission Bell they have hired a new plant manager with a very strong production background (at PepsiCo's Frito-Lay division). In their opinion, PepsiCo/Frito-Lay has one of the best management training programs in the country and one of the strongest production management training experiences and programs in the country. So, they are hopeful that this will help. They have also taken their best bottling expertise within the company and moved them out to the Mission Bell facility to address the bottling and warehouse inefficiencies. With the existing West Coast team they have changed their warehouse management. They are using consultants and have also added overhead by putting on additional capacity in that they put more bottling back at their Monterey facility and have increased their Madera warehouse space by leasing warehouse to make sure that, as they enter the holiday season, if they continue to not improve efficiencies, they will still have product for customers. They do not want to be, no matter what the cost is, in the position of shorting customers. Eventually, when they get things worked out, they can re-engineer and reduce overhead by undoing those temporary measures.
The bottom line in terms of what the specific problems were at the Mission Bell facility -- the speeds at which their bottling lines operate are not operating as they have in the past or as they should. Nothing is wrong with the machines. Efficiencies like that are very complicated issues. When they brought their wine facilities together, there were many more SKUs and many more components that had to come together at the right time. There were also many more SKUs in the warehouse that had to be stocked to make sure that they had inventory to ship to their customers. At the beginning of the process (the material requirements planning portion) they have had organizational and system failures in getting the right materials in the right place at the right time, which means that the bottling line has to stop. At the other end, they have had difficulties in their distribution requirement planning which means that they don't have the right inventory, given their customers' orders and the warehouse can get plugged to the point where there is no place to put the goods, so the bottling lines again have to stop. Also, with regard to the run length, sometimes instead of running a line for 3 days, they have to run it on 1 SKU for four hours, switch to another SKU and run that, so downtime is greater than planned. The real complication in production efficiencies as they pulled the Almaden/Masson/Inglenook/Taylor facilities together is a result of doubling SKUs which geometrically complicates things, and their systems and organization were not prepared to deal with that.
The full benefits of the re-engineering efforts would be recapturing the $17 million of operating inefficiencies, improving their volume trend and recapturing profit associated with their volume trends in the wine business, producing additional synergies and operating efficiencies above and beyond the $17 million, and lowering the capital employed in the wine business to significantly increase return on invested capital. That is the full benefit of re-engineering.
OTHER ACTIONS AND ISSUES
They also brought in a new CFO for the wine division. They didn't replace their wine division controller, they just brought in a much stronger person who has had experience in consumer products goods companies and other manufacturing companies. How rapidly this person has learned the business and gotten his hands around the production issues -- the accounting portions of the production issues and the operating accounting issues -- has been tremendous. They believe this will go a long way to help them address the situation -- having this level of strength within the CFO in their wine division.
The company was asked whether the internal issues of operating efficiencies and warehouse efficiencies would have, on their own, had a substantial impact on the performance of the wine business if the environmental factors related to the grape crop had not gone against them. The company responded that if they had not had the external influence of grape price increases, they still would have had significant internal disruption or poor performance below expected levels due to their operating inefficiencies -- the two are unrelated.
The company ended by asking the analysts to please remember that it is only one of their three businesses that they are experiencing problems in and that their beer and spirits businesses are performing very well. And, they are making improvements in the wine division, although much more slowly than planned or than they would have expected.
The company was asked to give an update on the status on the company's view toward its stock repurchase plan. The company responded that it is the company's intention to complete its stock repurchase plan and they will, over the course of time, be doing exactly that. They refused to give any more details on where they currently are in terms of the plan other than to restate the progress reported with the last quarterly earnings. They indicated that they would give another update on progress in their regular quarterly call in October.
* A Fool conference call synopsis represents an effort to highlight the salient points of a conference call and should not be taken as an authoritative accounting or transcription of the entire event. Note: Statements made by a company other than historical information may constitute forward-looking statements for which the company can claim protection under the Safe Harbor Act. Please consult the company's filings with the SEC for information on risk factors which might cause actual results to differ materially from the information contained in these forward-looking statements.
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