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batbeer2
batbeer2
Articles (58)  | Author's Website |

Value Idea Contest: Crimson Wine Group

Crimson Wine trades at a significant discount to book while its land and inventory have a fair value far in excess of book. Earnings are temporarily depressed

December 09, 2018 | About:

Instantaneous production of wine from water is fairly unusual. Only one winemaker in recorded history succeeded and people are still talking about it 2000 years after the fact.

Given time though, there is nothing miraculous about turning water into wine. Find some suitable land and plant some grape vines. Water and prune the vines regularly and in a few years you start harvesting grapes. At the winery the grapes are crushed and the juice is fermented and bottled. Depending on the variety of the grapes and the fermentation process, it takes a few months to a few years to end up with wine that people are willing to pay for. In short, patience is a valuable ingredient.

Compared to the craft of winemaking, the art of accounting is a relatively new invention. Accountants are taught that assets get worth less over time. Generally Accepted Accounting Practices dictate that patience is a liability. For this reason, professional accountants will solemnly sign a document declaring that wine stored in the cellar of a winery is worth no more and probably less than the price of the juice used to make it. Interestingly, many accountants will happily pay $50 for an old bottle of fermented grape juice. Now that is a miracle and perhaps an investment opportunity.

Valuation

First, let’s see what we get when we purchase shares of Crimson Wine (OTCPK:CWGL). Along with a significant amount of cash, bonds and some debt, the two most significant items on Crimson’s balance sheet are:

  1. Inventory.
  2. Property and equipment.

That inventory is in fact wine and it is carried at cost. Given that Crimson generates 50% gross margins (100% percent markup), the fair market value of that inventory is at least $150 million. Another way to think of this is that Crimson ships about 350,000 cases of wine (that’s 4.2 million bottles) annually and reports revenue of $65 million. That’s $15.50 of revenue per bottle. Meanwhile the accountants value the company's inventory of 12 million bottles at $6.25 per bottle.

Just to check for sanity, a quick online search for a bottle of 2016 vintage Seghesio Zinfandel comes in at $17. Seghesio is Crimson’s largest winery. Older bottles sell for more.

The second major item on Crimson’s balance sheet is PP&E. This represents the land it owns and the facilities it has built and operates. The land itself is carried at a book value of $46 million. Dividing that number by the 1 000 acres Crimson owns, works out to a per-acre book value of $46,000. Meanwhile, vineyards in Napa sell for roughly $300,000 an acre.

While not all Crimson’s land is in Napa, the company does own 160 acres in Napa’s prime Stags Leap district. At $300,000 an acre that land alone is worth $48 million. Valuing the 313 acres of the Seghesio Vineyard in Sonoma at $100 000 an acre and Crimson’s remaining 500 acres at $50,000 works out to a fair market value of Crimson’s land of roughly $100 million.

The value of a vineyard is of course tied to the price of the fruit it produces. In Napa Valley, an acre of Cabernet Sauvignon vines will produce roughly three tons of grapes. At $7,000 per ton that’s revenue of $21,000. The annual cash cost of farming is roughly $3,000 an acre leaving $18,000 of per-acre cash flow. A fair value of $300,000 for Napa Valley land works out to a 6% yield. At that same yield, Zinfandel grapes in Sonoma County need to sell for $3,000 per ton to support a per-acre value of $100,000. The price of Californian vineyards may be high but not irrationally so.

Just to check for sanity, in 2017 E&J Gallo acquired 600 acres of vineyard in Napa at $300,000 an acre. Half of this land is planted with Cabernet Sauvignon, the most expensive grape variety. This property was long thought unsuitable for grape farming but was developed by the Krupp brothers relatively recently. At Pine Ridge all the land is planted with Cabernet Sauvignon making $300,000 a conservative estimate of the per-acre market value of the Pine Ridge land.

There are other indications that the fair market value of Crimson’s land is higher than the reported book value. An article in Wine Spectator indicated Leucadia received offers upwards of $150 million for Pine Ridge in 2000. At the time that was 3x the book value of the business. More recently, Crimson sold a non-strategic vineyard for $1.8 million in 2013, booking a pre-tax gain of $700,000. In 2014, the company sold an unplanted plot in Washington for $3.9 million booking a pre-tax gain of $1.8 million. This makes sense given that land prices have risen over time while most of the land Crimson owns was acquired more than a decade ago.

Adjusting the value of Crimson’s inventory up to $150 million and similarly adjusting the reported value of its land up to $100 million works out to a per-share liquidation value of $14 for the company.

So that's what we are getting but what are we paying? Interestingly, Crimson’s shares do not trade at a premium to book. They trade at a discount. Reported per-share book value is $9 and Crimson’s shares trade at $7.90. This probably explains why insiders are buying shares and the company itself is buying back and retiring shares.

Business and history

Crimson Wine Group is in the business of producing and selling wines that retail for over $16 per 750 ml bottle. Wine is sold directly to consumers as well as through wholesale distributors. The company is headquartered in Napa, California and owns six wineries:

  • Archery Summit (Willamette Valley, Oregon).
  • Chamisal Vineyards (Edna Valley, California).
  • Pine Ridge Vineyards (Stag’s Leap District, California).
  • Double Canyon (Horse Heaven Hills, Washington).
  • Seven Hills (Walla Walla Valley, Washington).
  • Seghesio (Dry Creek Valley, California).

Each winery has its own specialty with Archery Summit specializing in Pinot Noir and Chamisal Vineyards producing Burgundy-type wines. Pine Ridge and Double Canyon have Cabernet Sauvignon, Seven Hills has Merlot and Seghesio is known for its Zinfandel.

Crimson became publicly traded in 2013 when it was spun out from Leucadia National (Trades, Portfolio). When Leucadia and Jefferies merged, Jefferies’ management believed Crimson was not worth more than book value. Leucadia’s management (Ian Cumming and Joseph Steinberg) disagreed, causing Leucadia to spin out Crimson prior to Jefferies’ acquisition of Leucadia’s remaining assets.

Leucadia had been acquiring vineyards since 1991 when it acquired a stake in Pine Ridge Winery. At the time, Pine Ridge had an empty cave and no land and was operated by its founder Gary Andrus. It did have a facility with a production capacity of 15,000 cases using grapes sourced from nearby vineyards.

By the turn of the century, Pine Ridge was growing grapes on land it had acquired and had expanded production capacity to 75,000 cases, equal to its current capacity. Andrus and his wife Nancy wished to sell out their interest and the company was put up for sale. Leucadia reported that offers were inadequate and in 2001 acquired the remaining 10% interest from the founder.

Crimson started Archery Summit from scratch in 1993. Archery Summit owns 106 acres, and controls through leasing arrangements an additional 17 acres of estate vineyards in the Willamette Valley of Oregon. Approximately 98 acres are currently planted.

Double Canyon vineyard land was acquired in 2005 and 2006 and is located in the Horse Heaven Hills of Washington’s Columbia Valley. Last year, Double Canyon completed construction of a wine production facility in West Richland, Washington, with an initial production capacity of 50,000 cases. Double Canyon owns 185 acres of vineyards in the Horse Heaven Hills appellation in Washington, of which 107 acres are currently planted.

Chamisal Vineyards was acquired in 2008 and has been conducting operations since 1973. Chamisal owns 99 acres of vineyards in the Edna Valley of California, of which 86 acres are currently planted.

Seghesio Family Vineyards was acquired in 2011 and has been conducting operations since 1895. This vineyard consists of 313 acres in Sonoma County.

Seven Hills Winery, which has been conducting operations since 1988, was acquired in 2016 and is located in Walla Walla, Washington.

Financial strength

Crimson’s balance sheet shows $28 million worth of cash and bonds and $23 million worth of debt. Current assets alone are 2.5x total liabilities. That’s a strong balance sheet for any company, especially one that has been profitable in every year as a publicly traded company.

By comparison, publicly traded competitor Scheid Vineyards carries an amount of debt that is roughly equal to current assets. Willamette Valley is another publicly traded winery. That company too has a strong balance sheet with current assets at 3x liabilities.

Management

The names Steinberg and Cumming are well known to value investing aficionados. The pair had a phenomenal record of value creation through patient investing. Warren Buffett (Trades, Portfolio) held them in high regard and was happy to do business with them on various occasions. One of their last deals before winding up Leucadia was setting up a joint venture together with Berkshire called Berkadia. Berkadia is still compounding value at very high rates of return. Alas, Cumming passed away earlier this year. His place as a director of Crimson has been taken by his son, John.

Cumming and Steinberg were aggressive and patient at the same time, buying assets at deeply discounted prices and owning those assets for decades. They would make bolt-on acquisitions along the way. Market participants would invariably agree that Leucadia’s assets were worth more than their stated book value but would consider the stock “dead money” because it was always unclear if how and when Steinberg and Cumming would monetize the assets. Lacking a catalyst, Leucadia’s stock often traded at a discount to liquidation value. Once in a decade or so they would announce a sale of some assets in some tax-efficient manner, distributing the proceeeds to shareholders.

Outlook

Once again, market participants wonder how and when Crimson’s assets will be monetized and so the stock trades at a discount to liquidation value. For the patient investor though, this is not dead money. The company does not simply carry a lot of inventory, it carries an increasing amount of inventory. Since 2013, days inventory is up from 550 to 850.

In five years the company has produced but not sold almost one years' worth of wine. The company now has three years of production stored in its cellars. It is worth noting that Willamette operates with two years worth of inventory and Scheid has one year. Financially speaking, Crimson has deferred $65 million worth of revenue in five years. Each year, in addition to the wine it shipped, the company reserved an extra $13 million worth of wine for its cellars.

Should management decide to simply maintain production and inventory at current levels, this should boost per-share reported earnings by at least 50 cents. That’s a significant increase for a company reporting per-share earnings of 24 cents.

This increased earnings rate at constant inventory does not account for the possibility that the wine Crimson has held in reserve has become worth more. This is a distinct possibility. A quick search on wine-searcher.com reveals that Pine Ridge Cabernet sauvignon retails at $45 dollars per bottle for the 2015 vintage and $90 for the 2010 vintage. At least for the Cabernet Sauvignon variety, each additional year that the wine is allowed to age increases its market value by roughly 15%. A similar pattern emerges for Seghesio Family Zinfandel for the 2011 to 2016 vintages.

Another indicator that this isn't dead money is the fact that per-share book value has been growing steadily. It is important to note that current assets as a fraction of book have been growing more rapidly. The quality of the book value is getting better. Put differently, the per-share book value is increasing slowly but intrinsic value is increasing faster. If that continues to be the case, investors don’t need and shouldn’t want an exit strategy.

Specific risk

Wildfires: Napa, Sonoma and surrounding counties in Northern California suffer from wildfires. So far the wineries have not been impacted. Of course, Crimson has a diversified portfolio of Wineries spread along the coast. This mitigates the risk somewhat. Investors worried about this might want to consider Willamette Valley. That company is similar to Crimson in but operates in Oregon.

Market risk: Crimson has been proposed as a value investment ever since it became publicly traded. The stock has languished and may continue to languish for many years.

Plant disease: Grape vines can suffer from disease forcing the farmer to uproot and replant the vineyard. Again, Crimson has a diversified portfolio of vineyards in different states and of different varieties. This does mitigate the risk somewhat.

Water shortage: Grapes need water to grow and California has a shortage. While on one hand it is a risk, it is also a barrier to entry.

Disclusure

This is not a recommendation to buy or sell anything. This is an expression of my views about Crimson Wine Group with an intent of engaging in intelligent discussion about the company and its stock. At the time of writing, I held no position in any of the stocks mentioned.

Read more

https://vineyardandwinerysales.com/blog/napa-sonoma-wine-grape-prices/ - grape prices

https://extension.umd.edu/sites/extension.umd.edu/files/_docs/programs/viticulture/2018%20GRAPE%20Enterprise%20Budgets.pdf - farming costs

https://static1.squarespace.com/static/556a1744e4b07ec484fcae64/t/58bccea6ebbd1ad2e8e4a0f9/1488768679704/CWGL2.pdf - MBA / LBO types pitching Crimson

https://www.valuewalk.com/2016/04/leucadia-national-letters-1978-2015/ - Leucadia archive thanks to valuewalk

https://vinous.com/articles/book-excerpt-appellation-napa-valley-stags-leap-district-jul-2017 - How Stags Leap AVA came to be

https://www.glwas.com/2017/8070/ - Long Cabernet Sauvignon.

http://www.stockspinoffs.com/2014/09/23/crimson-wines-steinberg-tells-shareholders-will-get-rich-together-slowly/ - Different method same conclusion a while ago. With commentary by Steinberg.

About the author:

batbeer2
I define intrinsic value as the price I would gladly pay to own the business outright. With current management in place. For most stocks, that value is 0. I can be reached at batbeer AT hotmail DOT com.

Visit batbeer2's Website


Rating: 5.0/5 (8 votes)

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Comments

Nicola Guida
Nicola Guida - 7 months ago    Report SPAM

Thanks batbeer2, a very interesting article!

batbeer2
Batbeer2 premium member - 7 months ago

My pleasure.

ChuksBuccs
ChuksBuccs premium member - 7 months ago

Batbeer2,

Thanks for sharing, great read!

Not sure if you saw the article this week in the WSJ regarding Harvard Endowments' acquisiton of California vineyards due to their location relative to natural water reserves (https://www.wsj.com/articles/harvard-quietly-amasses-california-vineyardsand-the-water-underneath-1544456396?mod=hp_lead_pos5).

Just curious if you came across any docs in your diligence that supported a similar theme with Crimson's wineries, i.e. more value due to location relative to water?

Best,

Nick

bmayerle1
Bmayerle1 - 7 months ago    Report SPAM

Great article. One thing I learned from years in the wine business is that the conditions that produce quality grapes in California cannot be easily replicated. Climate, soil, proximity to the ocean and daily temperature fluctuations all combine to produce grapes suitable for winemaking. In fact, a large part of the wine-business is simply growing the grapes and selling to major producers like E&J Gallo, Constellation Brands, etc. It's noteworthy that similar conditions exist in the same latitudinal zones of the southern hemisphere as well. The viticulture is only one half of wine-making, but it does present an important barrier to entry (no wine grapes growing in the otherwise fertile Mid-West USA). On an aside, the technology now being employed by even relatively small wineries in CA is producing wines of outstanding quality and consistency. Thanks for the in-depth look at Crimson.

batbeer2
Batbeer2 premium member - 7 months ago

Hi ChuksBuccs,

Yes, another reader brough that article to my attention.

No, other than the typical discussion of water supply being constrained and Crimson claiming to be doing their best to be effeicient with water I have not seen anything to make me believe Crimson has a particular advantage in any of its vineyards when it comes to water supply. The wells in Napa (Pine Ridge) and Sonoma (Seghesio) are well documented though. If I have time I could check out the depth/capacity of those wells relative to the surrounding vineyards.

But here's my thinking on the matter. E &J Gallo will sometimes point to the fact that its wine is cheaper than bottled water. Given that it takes roughly 500 tons of water to make one ton of wine, that does not make sense. At least not in California. Taking 500 tons of scarce Califiornia water to make a ton of wine and exporting that wine from California at a price below the cost of plain bottled water is not rational.

As water becomes more of an issue, the farming industry in Califirnia moves up or out. In the past, sugar beets were displaced by grapes, and going forward, you will find high-end vineyards where you previously had bulk wine producers. Of course if all of Califoria turns into Death Valley then that's a problem.

As for diligence... any help from someone around there who could take on the heavy burden of checking out those vineyards, counting the barrels, tasting the Zinfandel and sharing their findings.... would be much appreciated.

batbeer2
Batbeer2 premium member - 7 months ago

Hi Bmayerle1,

Yes. The land/microclimate is unique. While I couldn't tell a Cabernet Sauvignon from a Pinot Noir myself, I can see how grapes grown in Napa's Oakville or Stag's Leap districts have some unique qualities.

Thanks for the kind words.

Low Tide Investments
Low Tide Investments premium member - 6 months ago

Hi Batbeer, this seems like a very similar situation to SVIN. Have you taken a look at that at all? I recently came across your article when doing a comparisson of the two.

batbeer2
Batbeer2 premium member - 6 months ago

Hi Albanese121,

Yes, I have looked at Scheid and Willamette. I think they're interesting too.

Crimson is my pick because the inventory is a relatively large fraction of value. Yes, there's a lot of uncertainty in valueing that inventory but (to me at least) it is easier than valueing land. With Scheid I believe the vast majority of the value is in the land.

In short, with Scheid I would be relying more on my ability to value the land and I don't think I have an edge in that area. Punching wine-searcher.com into my webbrowser....that I can do :-)

Also, Crimson's management has a longer track record. Especially with Willamette, I wonder how good management is at capital allocation. Off the top of my head Willamette has some prefs eating some of the cash flow ahead of the ordinary shares. I don't have a problem with prefs per se but management can do funny things with them if the incentives are misaligned. We shall have to be patient to see how they manage that aspect and how it works out for minority shareholders.

Just some thoughts.

stephenbaker
Stephenbaker - 3 months ago    Report SPAM

Hi Batbeer,

A look the balance sheet shows that while inventory is rising, cash and short term investments are falling by a near equal amount. I'm not sure what is the point of sitting on inventory unless the company believes it can be sold for far more in the future. The company does not seem to make a lot considering the high margins - looks like somewhat of a value trap. The wine business is getting more competetive by the year; what do you believe will trigger an unlocking of value?

batbeer2
Batbeer2 premium member - 3 months ago

Hi Stephenbaker,

You raise a number of good points. I'll try to address them one by one.

>> what do you believe will trigger an unlocking of value?

That's the toughest one for me. I don't remember ever getting a catalyst right so bear that in mind. Sometimes the business develops along the lines of some scenario I contemplated but then the stock price does exactly what I wasn't expecting. Having said that, here's my best shot.

Until 2023, CWGL is somewhat restricted in a change of ownership because of certain tax assets (NOLs). Cumming and Steinberg always managed Leucadia to maximize the value of any NOLs. Conversely, the company might ramp up earnings (increase inventory turnover) in 2021 & 2022 ahead of a possible sale in 2023. I saw Leucadia do that very often (almost invariably). In short, the only hard catalyst I see is 3 years away. One could argue this is in fact the opposite of a catalyst.

>> A look the balance sheet shows that while inventory is rising, cash and short term investments are falling by a near equal amount. I'm not sure what is the point of sitting on inventory unless the company believes it can be sold for far more in the future.

Indeed, this only makes sense if you believe the inventory gets worth more as it ages. So then management prefers to hold inventory earning say 15% as opposed to cash earning less than 2%. If however, you don't believe that inventory gets worth more over time, then it is very bad. Rising inventory is a textbook example of an accounting red flag. My variant perception is that in this particular case, the higher inventory is a good thing. If I'm wrong on this, I will look especially foolish, knowingly going against value-investing best practices.

>> looks like somewhat of a value trap.

Frankly, I agree. Then again, I can't remember ever investing in something that wasn't considered a value trap. I get nervous if they're not. This is not meant to be snide; I'm serious. A few did indeed crash and burn but on the whole, it has generated satisfactory results. I recently did an analysis of my returns and to my surprise I found I get a percentage point or two just from shorts paying me to borrow shares I own. That's not the case with Crimson though. That's not a popular short.

Hope some of this makes sense. Thanks for poking holes in my thesis, I like that.

stephenbaker
Stephenbaker - 3 months ago    Report SPAM

Hi Batbeer,

The company produces white wines and red wines. White wines do not get better with age; in fact after a few years they go bad. Reds can age well but I don't believe the reason why inventory is rising is to attract better prices later. Rather, it is my understanding that because the wine business is so competitive today, companies like Crimson are having a hard time selling their wines. Case in point; today's youth are indeed drinking wine but they prefer cheaper brands, i.e. "bulk juice".

batbeer2
Batbeer2 premium member - 3 months ago

Fair enough. I have no hard data to (dis)prove that.

We'll have to find someone in California to go check the cellars, taste the wine and see if anyone is buying. I'm an ocean and a continent away. What's worse, I couldn't tell the difference between a pinot noir and a cabernet sauvignon. Zinfandel... that I might be able to correctly identify. And yes, that variety doesn't age as well as cabernet.

I do know that if I was going to cheat investors I wouldn't go about it this way. Everything is there to see and taste and all the prices easily checked. At least for someone on the sunny side of the globe ;-)

In a couple of years we'll know.

stephenbaker
Stephenbaker - 3 months ago    Report SPAM

I don't think it is an issue of cheating investors; rather a reflection of the business itself. The wine business is made up of a lot of quirky, artist-like characters. They take so much pride in their product and sometimes profitability suffers, or at least comes second. The larger CA wineries (Gallo, Mondavi, etc...) run their operations more like a business but even they have divisions that care more about the nuances of their wines than they seem to care about how much profit is being generated. Despite all that, the company does seem cheap on an asset-value basis, though one has to wonder how long and how high real estate prices for Napa real estate can continue to rise (I believe reality will set in sooner or later and prices will readjust downward quite abruptly). It is, however interesting to note that the company's CEO continues to buy small quantities of stock on a regular basis and the company is slowly repurchasing its shares at these prices.

cwgl
Cwgl - 2 months ago    Report SPAM

@at all

CWGL looks not good! Any Thoughts? Thanks!

batbeer2
Batbeer2 premium member - 2 months ago

Hi Cwgl, thanks for chiming in.

You'll have to be a bit more precise about what you mean by "CWGL looks not good" before I can address what you're worried about.

Two facts:

  • Per-share book value is higher.
  • Per-share price is lower.

For the seller of this stock, that is a bad thing. For the buyer, it's good so you get to decide whether it is good or bad. Having said that, I would have hoped and expected Crimson to generate a much greater profit in the last quarter of 2018. They didn't. Instead, they sold more bulk wine and raw grapes relative to 2017. As a result, margins were lower (on higher revenue) than I was expecting.

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