It is a daunting task to make estimates or inferences as regards the cost and profitability of wine grape farming.
|1. INTRODUCTION AND REVIEW
Farming enterprises differ in respect of the products they produce, the mix of red and white grapes, cultivar composition, production levels and quality obtained, producers’ expectations regarding a realistic return for their efforts, prices paid by buyers, etc.
In recent years VinPro has conducted financial analyses in the various wine regions in order to determine the financial situation in which primary wine producers – in other words the producer who produces grapes for the wine industry – are likely to find themselves. This review, known as Production Plan, which has been conducted in conjunction with Winetech since last year, aims furthermore to provide an economic support service to producers and industry organisations, to increase the level of knowledge of financial management, and to determine industry averages and norms to be used in certain industry decisions.
During the 2005 review it was found that the total (201) number of participating producers realised an alarmingly low nett farming income (NFI) and that said profit margin had decreased by more than 50% since the previous vintage. From last year’s (2006 vintage) analyses it seems, however, that the decrease in the industry average NFI continues and that it is now in all probability starting to take on critical dimensions. This, judging from the 2006 review which was conducted among 227 producers who represent approximately 18% of the total South African wine industry surface, in all 9 VinPro wine regions.
The assumption may be made that the majority of the participants have above-average managerial capabilities, follow scientific farming practices and are considered in many instances to be leading farmers in the various districts. In view of the aforegoing, as well as the fact that the size of the units that were evaluated is much bigger than the average (economies of scale undoubtedly resulted in a lower cost and capital structure), one can and should accept that profit margins are unlikely to increase if a bigger number of producers in the SA wine industry had to participate in the review.
2. BACKGROUND TO THE CALCULATIONS
2.1. Cost of grape production / cost structure
In the production of grapes there are basically 3 important motivations that have a significant impact on profitability, viz:
- Cost per hectare
- Yield per hectare
- Cost per ton
- Although it is generally accepted that the cost per hectare remains more or less the same, there will definitely be differences among vineyards – everything depends on the desired viticultural practices and requirements, as well as the product and price point for which production should take place, i.e. market oriented grape and wine production. Large differences also occur among different geographic areas or districts in the industry i.r.o. the factors that influence total cost, the most prominent of which are certainly labour cost and yield per hectare.
The cost involved in the production of grapes – excluding the entrepreneur’s remuneration, cost of land and interest – consists of the following components:
- Cash expenditure / Annual running costs
- Provision for replacement / Capital maintenance
- Cash expenditure / Annual running costs
All cash expenses incurred in the year under review.
Provision for replacement / Capital maintenance
In the course of the production process machinery and implements are required, in addition to that which is bought annually for the production process. In due course of time tractors, equipment and other implements are no longer fit to be used. Even vineyards and buildings deteriorate and have to be replaced. The “deterioration” and “exhaustion” of these items form part of the cost of the production process.
Taking into account the fact that the purchase value of an item has to be recovered during its lifetime, as well as the vicissitude of inflation, sufficient provision has to be made for this. By using the principle ‘provision for replacement’, a larger amount is recovered than in the case of ‘depreciation’. This addresses the issue of rectilinear depreciation to a certain extent and ensures that the going concern is maintained.
In the calculation of provision for replacement items are written off against replacement value:
- Buildings – 60 years
- Vineyards – 20 years
- Movables / means of production – 5-15 years
3. THE RESULTS
3.1. Production cost
The industry average cash expenditure and total expenditure per hectare, except for Malmesbury, amounted to R15,599 and R21,332 respectively for the 2006 vintage. Variations of between R19,416/ha and R27,009/ha occurred among the said districts, while the industry average total expenditure amounted to R1,391 per ton. It varied from R646/ton for the Orange River to R3,700/ton in Stellenbosch.
Total labour cost amounts to 44% of the average annual cash expenditure, while fuel, cost of water (including electricity) and direct costs amount to a further 7%, 9% and 15% respectively… altogether 75% of the total cash expenditure.
3.2. Profit (NFI)
Once the cost structure has been calculated, it is important to determine the production structure and profitability of participants.
In the calculation of the profitability of wine grapes two approaches may be taken, viz.
- The profitability of a specific production year
- The profitability of a specific vintage.
The results and findings in this report refer to the profitability of a specific vintage. The income that the crop will possibly realise is consequently partly estimated / expected income, but the actual cost of application regarding the particular vintage is in fact calculated. Experience has taught that the estimates of producers and cellars are sufficiently accurate. The advantage of earlier processing, using an estimated income, is that the results of the analyses may be applied to planning and budgeting for the new production year.
Time value of money and delayed payments to producers are certainly some of the most important factors that are creating serious cash flow problems in the current economic climate. It is impossible to calculate the impact thereof in this review, seeing that all participants receive their income at different stages.
To determine the production structure the total surface planted to vines is considered, also age distribution, expected payment per ton, production per hectare and the expected income per hectare.
Profit or NFI is calculated as the difference between the total income and total production cost, i.e.: PROFIT (NFI) = TOTAL INCOME – TOTAL EXPENDITURE (Before interest / cost of land, tax and entrepreneur’s remuneration.)
From the above it was obvious that the average NFI decreased by more than 50% from the 2004 to the 2005 vintage. This was due mainly to a sharp decrease in red wine prices, the more horizontal movement of white wine prices, smaller crops in certain districts, as well as the fact that the total costs increased.
Although the 2006 analyses indicated some improvement i.r.o. NFI in certain districts, mainly due to larger crops / higher yield per hectare and the fact that said areas had a bigger percentage of white wine grapes, the average NFI for the industry continued to show a decrease.
With the 2004 analyses the average annual cash expenditure and total expenditure amounted to 46% and 61% respectively of the total income. This ratio deteriorated to such an extent that it amounted to 58% and 79% respectively according to the 2006 analyses. As a guideline for economically sustainable production, the average gross income and NFI should have realised R34,032 and R12,700 per hectare respectively. (Including interest / cost of land and entrepreneur’s remuneration.) None of the districts evaluated last year managed to come near these figures.
As in all industries the wine industry and primary producer are also subject to increasing input costs, fluctuating climatological conditions as well as price fluctuations. Income does not increase at the same rate, however, and since the 2004 vintage the total income per hectare has in fact decreased. These circumstances naturally cause producers to find their cash flow under severe pressure and their profitability being constantly eroded. Profit margins, if any, make insufficient provision to meet exceptional capital obligations.
It will not be possible to meet additional obligations such as land tax, increased minimum wages, ongoing increases i.r.o. fuel prices, water levies, the effect of steep increases in excise tax, etc. and it is without any doubt clear that ‘smaller’ farming units will be the most severely affected. The smaller the unit, the more expensive the cost and capital structure, with the accompanying negative impact on the profitability of that business, if there is no compensation by obtaining high prices for the grapes.
With thanks to First National Bank, Nedbank, Standard Bank, Land Bank and ABSA for financial support.