Tuesday, June 5, 2007

Investing in Argentina - Wineries

I have been doing some research lately in the wine industry and here are some of my findings.
1 - The wines and vineyards market is in very high demand in Argentina and it is no small feat to find an operating winery/vineyard with "Brand" and presence in the foreign market for sale. It is possible nevertheless to find vineyards with wineries that need some work (refurbishing) or vineyards without wineries and then invest in the winery.
Adapting a winery to elaborate premium wines can cost close to U$2/lt, thats is to say between U$100,000 and U$150,000 based on your production requirements of 50,000 to 100,000 bottles per year. In addition, you need to add that cost of the Oak Barrels which depending on origin can cost between U$900 and U$1200 for a 225 lt barrel (U$4.5 to U$5.5 per lt). If you would want to park (age) the wine for 2 years, you would need 670 barrels = 600k to 800k, which would be outrageous. This is only done by those who have an established brand in the premium market. If you start from scratch, you have to go slower and sell part of the wine with less aging through a "second brand". Besides there are ways to add the oak flavour without the need for the oak barrel. All this to say that with a little bit of "know how" there is no need to have in advance a fully operating winery and it is possible to start in the business with a smaller investment.
2 - The size you a lot small investors are looking for (50,000 to 100,000 bottles/year) is a bit small and works only for operations that produce premium wines U$10 per bottle in the local market and U$4 FOB export market).
3 - Well located vineyards (Zone 1 = Agrelo, Perdiel, Lujan de Cuyo, Tupungato) and planted with high quality vines are priced anywhere between U$35,000 and U$50,000 per ha. In San Rafael (you want to start becoming familiar with the different regions) vines planted in areas of good soil and with anti ice pellets net installed are around U$25,000 per ha. If the goal is to produce premium wines, specially if it
includes champagne (sparkling wines) and white wines, San Rafael is an interesting alternative. If the portfolio of products will be focused on super premium red wines, specially Malbec, you need to stay in Zone 1.
4 - For wineries adapted to make premium wines the price is between U$1 - U$3 per ltr of capacity, depending on installed equipment. Large and old wineries, set up for regular (non premium) wines are priced much lower but they also require a lot of (expensive) investment.
5 - With a good vineyard, operated to produce quality wines, the yield is about 9000 to 9500 bottles of premium wine per ha. So in order to reach the goal of 100,000 bottles as per your requirements you do not need a large establishment. 15 - 20 has ought to do it. We need to add to this the cost of the winery.

The business in wines today is to produce premium (vs regular or intermediate) wines. Based on all the above info, find below the opportunities i have been able to find, to wit:
- A vineyard in Tupungato, 80 ha total, 60 ha planted 5 to 6o years ago (Cabernet, Merlot, and some Malbec), drip and furrow irrigation system, U$33,000/ha.
- A vineyard in Tupungato, 294 ha all planted, U$43,000 ha.
- 60 /120 ha in Alto Agrelo (excellent for Malbec, next to well know wineries Septima and Ruca Melen), at U$14000 / U$16000 ha. no plants and with wells and irrigation systems in place.
- A winery looking for equity partners, but not sure you are interested in equity investment instead of acquisition.

As per my experience, the most difficult task is to adequate the initial requirements of most small investments to the reality of the local wine and real estate market (one is inexorably affected by the other one) and to the logic and time frames of this business activity and the business cycle. I think that if you
believe that the project is feasible (given your own assessment), even if you might not start with a turn key project there is still a lot of opportunity because there are many properties available.

Sunday, April 1, 2007

Cattle Industry update

Even though the ban has indeed been partially lifted, there are still 4 or 5 other measure the government took during the last 12 months that continue to keep the prices depressed about 40% for cattle that is not being exported (our case).
From March 06 until now mainly 5 measures where taken by the government that went in direct detriment of our investments: raised export duties by 10% and remove a subsidy (reimbursement) of 5%, exports ban, imposed a minimum slaughtering weight of 280 kilos that then was changed to 300 kilos (i will come back to this later because it was very impactful) and finally they simply intervened the spot market with a list of maximum prices. Last but not least the price of corn (thanks to ethanol, bad
weather in the Midwest of the US and who knows what else) increased exponentially
(corn was the main input). all this happened in the span of just 6 months. In an industry where you need time to plan, where the minimum fattening time is at least three months if intensive and 8 -12 months if extensive (which is the stage where your cattle was at the time of the measures) the way these events took place makes it impossible to predict said events which would have allowed an investor to have enough timely information to make decisions.

The slaughtering weight limit changed the business model almost completely. the whole model was based in fattening cattle up to about 260 kilos. The market for this category called "bolita (little ball)" which was between 240 and 260 kilos approx was eliminated overnight with the strike of a (presidential) pen. This meant that the feedlot model (intensive corral corn fattening) which is based in a "conversion rate formula" suddenly was no longer possible because that conversion rate (of 8 kilos of corn per each kilo of beef gained) is only profitable up to around 260 (+-) kilos. beyond that the animals start eating more corn to produce the same kilo of beef but the costs of the extra corn eats away the margins. So all the plans now had to be rewritten and figure out a way to make the best out of this situation. The operators (Ganadera Mallin y Piedra) then decided to take all the animals to the
open range for extensive breeding which takes at least eight months but can last for up to 3 years depending on the age of the cattle but it needs no feed except for the grass. In the meantime the prices in the market have collapsed and the expensive (now sunk) costs that were incurred to feed them (corn and concentrate and the like) can not be recuperated at these price level. While all this was happening and while
everybody involved in the industry was hoping that this was the last intervening measure, new measures would come into play and would make things worse. Should operators have informed investors while all this was happening? probably, but nobody expected this to unfold like this and so fast.

So what happens now? it appears the storm has passed and now its time to rebuild. A couple of weeks ago the Agriculture Minister was sacked (due to the conflict between the government and the producers) This is the first good news in almost a year and a sign that there is political will to change the situation, may be because it is election year and they don't wont the farmers against them?. There have been attempts to re-establish the talks and they announced some measures that if and when
implemented they should have some positive impact in the cattle industry. Said measures have to do with increasing subsidies and reducing intervention in the Liniers spot market (price controls and such) but have not addressed neither the export ban issue nor the high retentions (export duty) just yet, which means that we have to wait an see how much will this changes really impact on the prices. For now they are still very depressed and there have been very little change. not enough to justify selling anything yet. It could take a year before prices accommodate again. But it is also true that these whole ordeal has been a disincentive for a lot of farmers and those who could have switched from cattle to grain, which in the long term should mean lower supply of beef and higher prices.

In my opinion there has been no negligence from the part of the operators but rather a very unexpected and unusual set of measures (war like) from the government against a sector of the economy that has (unfortunately) a high impact on inflation. The whole industry has seen their profitability gone this year due to this very adverse conjuncture.

I nevertheless agree and empathize with investors opinion with regards to this entire ordeal. I am not going to repeat in this report the plethora of attacks the Industry has had to endure in the last 12 months because i have gone in great detail in previous reports about it and at this point i think you are fully aware of the complexities of this entire industry wide situation (operative words are: industry wide). This is not a problem exclusive to one investment in particular.

The life cycle of cattle growing is at least 3 years (from the moment they are born) if you want to eat young steer and can go up to 5 years if what you are selling are cows. This means that the cattle can still remain in the farm for quite some time before it needs to be sold.

Before these set of events cattle fattening was indeed a great opportunity and nobody in his right mind could have ever predicted that the government would start a war against it. This is to say that investments have been lost. it will just require a bit of time and patience to get it back.

For now it appears investors will have to wait a few months before the cattle can be sold at least at close to break even prices.

Thursday, February 15, 2007

Cattle Industry lock-out

A few weeks ago the cattle industry finished an unprecedented 9 day "lock out" and second strike of the year - the first one was last July-, due to the disorientation and preoccupation - caused by the continued official interventions in the cattle industry -, that has suffered in the last few months, the exports ban, a depreciation as consequence of the ban of 35-40% in the price of the kilo vivo, reduction of the slaughtering weight, and maximum prices imposed by the interior commerce minister, Guillermo Moreno, in the (supposedly free) spot market (Mercado de Liniers). In short, the market is intervened.

The paradox is that what would have been a blessing in any other industry or market, the fact that raising international prices would result in higher prices (and profits) for the local breeders, ended up being a curse. What happened was that the government understood that the export boom in beef was responsible for pushing inflation higher, due to the high weight of beef in the Consumer Price Index CPI, and decided to clamp down on inflation by implementing anti market measures against the cattle industry such as the elimination of the 5% reimbursement of the export duties, the increase of export duties from 5 to 15%, the exports ban, etc...

Here is a chronological table describing in detail the interventionist policies implemented by the government in the last few months and which resulted in loss of profits and the impossibility to operate under normal and predictable circumstances in the Argentine cattle market and which had a direct impact in the returns of our investments. I put next to the event the approximate effect in the industry returns, from said measures.

Reimbursements and Export Duties:

- 21/12/05 The then minister of finance, Roberto Lavagna, imposes the minimum slaughtering weight at 260kilos and 10 days later he suspends the 5% reimbursements n export duties. Impact on industry profits = -5%
- 18/01/06 The government decides to increase beef export duties from 5 to 15%. Impact on industry profits = -10% due to the fact that this increased duty meant a disincentive to export and therefor increase supply in the local market pushing prices down.


- 08/03/06 The government imposes a ban on beef exports to stop the increase on beef prices and their effect on inflation. Impact on industry profits due to oversupply in the local market = -20%

Do not buy beef!

- 14/03/06 Kirchner asks the Argentine people not to buy any more beef unless prices go down, Impact on industry profits = 0% nil. Argentines consume beef just as much or even more than before.
- 27/03/06 First rural demonstration, in Salliquelo. Days later another one takes place in Trenque Lauquen.
- 06/04/06 Government agrees with producers, slaughterhouses and meet packers on reduced prices for 11 popular cuts.

Meet Moreno:

- 13/04/06 Gulliermo Moreno, Interior Commerce secretary starts implementing control measures to curb the price increases. Imposes maximum prices below producers break even. Impact on industry profits = -5%

- 26/05/06 Government starts freeing up the ban to export beef. impact on industry profits = +5%

The first strike:

- 12/07/07 CRA announces the first rural strike against Kirchner's administration.
- 17/11/06 The government intervenes the beef market again and new maximum prices list are imposed. Impact on industry profits = -5%

In short, the battery of interventionists policies imposed by this government have cost the producers (and us) a loss of profitability between 30 and 40%. Just to have an idea, in todays Argentina to produce 555 kilos per hectare , the costs are U$440. With this scheme, which yields a net income of U$416.3 , there is a negative return of U$23.8 per hectare. When producers obtain negative returns that means the operators can not cover their fix or infrastructure costs. These costs are however
inevitable if they expect to continue with the enterprise. This means they operate at a loss until the prices increase enough to justify start selling cattle again. Selling before this level would mean the loss of capital and hence the investments. This is why most operators have tried not to sell any cattle and the reason why most investments have been paralyzed.