Further pressure on producer profitability

Introduction

The average nett farming income (NFI) of the South African primary wine producer – i e the producer who produces grapes for the wine industry – may decrease by more than 50% since the 2004 vintage. This was the conclusion reached in the light of financial analyses conducted last year among 201 such producers in the nine VinPro wine districts. This VinPro survey, called Production Plan, will in future be conducted in conjunction with Winetech.

During the 2004 survey the interest earnings on capital earned by 131 participating producers in 7 districts were so low as to be alarming. Their average pre-taxable interest earnings for the year in question amounted to just 6,89% – relatively low compared to general interest returns from investments.

Meanwhile a study based on average NFI for the participating wine producers has proved to be a more practical approach, therefore the emphasis with regard to the interpretation of the results of this survey fell more on NFI, although the average interest earnings were also calculated and have now decreased to 3,62% in the case of irrigation units. For dryland units it was calculated separately at 4,68%.

“One may assume that the majority of the participants have above-average managerial ability, follow scientific farming practices and in many instances they are considered to be leading farmers in the various districts. In the light of the above, combined with the fact that the extent of the units evaluated is much larger than average (economy of scale undoubtedly resulted in a lower cost and capital structure), one may and should accept that this profit margin would scarcely increase if a bigger number of producers in the SA wine industry had to take part in the survey.

“The primary producer is without any doubt one of the most important links in the value chain of the wine industry, ‘for without a sustainable supply of quality raw material the most effective marketing strategy is useless’. As in all industries the wine industry and primary producer are also subject to increasing input costs, variable climatological conditions and price fluctuations. Income does not increase at the same tempo, however, and since the 2004 vintage the total income per hectare has decreased instead. This phenomenon obviously puts serious pressure on producers’ cash flow and their profitability is continuously eroded. Profit margins allow limited scope to meet foreign capital obligations and one wrong management decision may cause a farming enterprise to go under. It will be difficult to accommodate additional obligations such as land tax, increased minimum wages, ongoing increases in fuel prices, water levies, the impact of steep increases in excise duty, etc, and it is undoubtedly clear that ‘smaller’ farming units will be worst affected. The smaller the unit, the more expensive the cost and capital structure, with the result that it impacts negatively on the profitability of that business, unless this is compensated for by fetching higher prices for the grapes.”

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The Survey

The above-mentioned financial analyses, according to which participating wine grape producers were able to compare the results of their own enterprise with regard to production, capital and cost structures, as well as profitability, with the district averages, were calculated by means of study groups in the various wine districts. With regard to irrigation units, the participants’ average surface planted to wine grapes amounted to 73 ha, while the dryland units amounted to 193 ha.

Taking into account the above-mentioned districts and the fact that producers compare cost mainly based on hectares, it is of cardinal importance that cost structure, as well as the gross and nett income per hectare are calculated.

The Results

The average results, weighted according to the total surface planted to wine grapes in each district, are as follows:

Dryland units that were evaluated were limited mainly to the Perdeberg and Malmesbury areas. (Do not form part of the average with regard to the irrigation districts.)

The average NFI (total income minus total production cost) of the participants for the 2005 vintage will in all probability realise R5,781 / ha for irrigation units and R4,027 / ha for dryland units respectively, compared to R12,236 / ha and R8,178 / ha for the 2004 vintage.

Cost structure:

Total cost, excluding entrepreneur’s remuneration, consists of the following components:
Cash expenditure / Annual running costs
Provision for replacement / Capital maintenance

Cash expenditure / Annual running costs
All cash expenditure incurred in the year under review.

Provision for replacement / Capital maintenance
Vineyards, buildings and movables / means of production are ‘used up’ in the course of time and must therefore be replaced. Taking into account the fact that the purchase value of an item has to be recovered in its lifespan, as well as the volatile nature of inflation, sufficient provision must be made for this. By using the principle ‘provision for replacement’, a bigger amount is recovered than in the case of ‘depreciation’. To a certain extent this addresses the problem of straightforward depreciation in value and ensures that the business remains a running concern.

Provision for replacement writes off items at replacement value:
Buildings – 60 years
Vineyards – 20 years (were written off over 25 years up to and including 2004)
Movables / means of production – 5-15 years

According to the results of the study the total labour cost amounts to 44% of the annual cash expenditure, while fuel and water costs (including electricity) respectively amount to a further 7% and 9% … altogether 60% of the total cash expenditure.

In view of the steep decrease of approximately 31% in red wine prices since 2003 (643 cents per litre (bulk) to 441 cents per litre on average for January to October 2005 according to Sawis), the more horizontal movement of white wine prices during 2004 & 2005, as well as the fact that the total cost and other obligations are continuously increasing, the question arises for how long the producer will be able to absorb these phenomena and what he/she should do to survive this difficult period.

Complete production cost and target income guidelines are available for each district. Contact Gert van Wyk for more information on tel 023-347 2795.

Thanks to First National Bank, Standard Bank and Land Bank for financial support.

SUMMARY

The average nett farming income (NFI) for the South African primary wine producer – i.e. the producer who grows grapes for winemaking purposes – can decrease by more than 50% since the 2004 harvest according to financial analyses that were conducted during 2005 among 201 such producers in the nine VinPro districts. As in all industries, the wine industry and primary producer are also subject to increasing input cost, variable climatological conditions and price fluctuations. Income does not increase at the same rate, however, and in certain instances income has even decreased. These phenomena obviously put producers’ cash flow under serious pressure, thus eroding their profitability. Profit margins allow limited scope to meet foreign capital obligations and one wrong management decision may cause a farming enterprise to go under. It will be difficult to accommodate additional obligations such as land tax, increased minimum wages, ongoing increases in fuel prices, water levies, the impact of steep increases in excise duty, etc, and it is undoubtedly clear that ‘smaller’ farming units will be worst affected.

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