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Low Tide Investments
Low Tide Investments
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Value Idea Contest: Scheid Vineyards Inc.

A micro-cap company trading for less than liquidation value with an upside catalyst

February 11, 2019 | About:

Scheid Vineyards Inc. (OTCPK:SVIN)

Price: $84

Shares outstanding: 883,086

Market cap: $74.2 million

Cash: $1.7 million

Interest-bearing debt: $106.3 million

Enterprise value: $178.8 million

Thesis

Scheid Vineyards Inc. is an illiquid micro-cap company that recently “saw the light” by starting to report financials to the public again in March 2018. The current market price does not reflect the full value of the properties it owns nor the value of the future prospects of the business. This is a classic Mohnish Pabrai (Trades, Portfolio) “heads I win, tails I don’t lose much” situation, in that the property the company owns provides downside protection, and the future shift in revenue mix will generate significant upside due to increased margins.

History

Scheid Vineyards is a vertically integrated winery that grows its own grapes, mashes them and turns them into premium wine under several different brands. It began as a grape growing operation in Monterey County, California, in 1972. Its business originally focused on establishing long-term contracts with wineries to provide them grapes. In the 1990s and aughts, its strategy changed to producing and selling bulk wine. It has since pivoted to its business of today, selling bulk wine and its own brands.

Operations

Most of its revenue is derived from bulk wine sales and cased wine sales. "Bulk wine" refers to the sale of wine via large containers, usually for other wine brands to bottle, market and sell. The bulk wine segment is extremely competitive. The sale of bulk wine leads to low gross margins due to the decreased price at which it sells the wine. "Cased wine" refers to its own brands. Cased sales are able to obtain a much higher price per gallon. 

Scheid Family Wines has several brands of wine: Scheid Vineyards, District 7, Metz Road, Stokes’ Ghost, GIFFT and VDR. Its vision is simple: “By 2025, Scheid Family Wines will become one of the most recognized wine producers in quality, innovation and sustainability in the world,” according to its website.

Transformation

Its strategy is to transition from a seller of bulk wine to a seller of its own brands. This will lead to significantly more revenue with little increase in overall costs simply from selling the volume of wine produced from bulk sales as case sales. Additional costs will arise due to bottling, distribution and marketing, but its margins should increase significantly due to the higher price at which it will be able to sell wine by the gallon. To put things in perspective, Scheid has a 2 million case capacity, but sold only 517,000 cases last year.

The majority of the volume of wine produced right now is sold as bulk wine. The company will simply be selling all the wine that it already produces under its own brands, rather than to other wineries. Cased wine sales have exploded, from only 151,000 cases in 2015 to the 517,000 in 2018. It is highly likely that Scheid will eventually derive the bulk of its revenue from cased wine sales, which will improve profits significantly.

Management has made drastic transformations to the business in the past. For instance, they successfully transitioned from selling grapes to selling bulk wine, which is arguably much harder than their current plan. What will make this transformation easier is the quality of the company's product. The premium-priced wine brands that Scheid produces carry an average weighting of 3.91 on Vivino, which falls between the website's classification of “Good Stuff” and “Very Rare Stuff.”

Further, the board and management are extremely incentivized to make this transformation successful due to their personal stakes in the company. Al Scheid (chairman and founder), Scott Scheid (president and CEO) and Heidi Scheid (executive vice president) collectively own 41.5% of the entire company, making it highly likely that they will achieve their goals in the future.

Balance sheet

One area of concern is the company's significant amount of debt. It recently took out $100 million in debt backed by the value of its properties. It carries 2.74x more debt than equity. It has an extremely low interest coverage ratio and is highly levered compared to other wineries.

But, the amount of debt in its capital structure speaks more to the value of its properties than anything else. Modigliani and Miller would probably agree that taking out debt on valuable properties is an effective way to finance a company, as the weighted average cost of capital is relatively cheap. By taking out this new debt, they effectively refinanced their old debt that was held by Rabobank. A significant amount was due within the next few years. Under the new debt terms, $3.84 million is due in 2023 and $70 million is due in 2033. This gives Scheid plenty of time to transition from a bulk wine seller to a cased wine seller.

Valuation

Scheid currently trades below liquidation value. If it were to sell all its land, make improvements, collect its receivables, and sell all of its inventory, shareholders would receive more in a liquidating dividend than they can currently pay for the company in the market. But Scheid is not likely to close its doors, as it is just beginning to see success selling its own brands. Therefore, investors will do best to look at the liquidation value as the floor price Scheid should trade at and use another method to value it as a going concern.

Below the tax appraisal of the property owned is used in order to remain conservative. The value of the property is likely higher than the value appraised for tax purposes.

Item

Value

Tax Appraisal of Property Owned

$ 111,868,733.00

Cash

$ 1,761,000.00

Receivables

$ 16,187,000.00

Inventory

$ 60,133,000.00

Improvements to Leased Land

$ 23,000,000.00

Total Assets

$ 212,949,733.00

Less: Total Liabilities

$ 124,935,000.00

Liquidation Value

$ 88,014,733.00

S/O

883,086.00

LV/Share

$ 99.67

Price

$ 84.00

Margin of Safety

18.65%

The upside valuation is dependent on Scheid successfully implementing its transition from a bulk wine seller to a cased wine seller. If it can do this, it should earn around $12.50 per share. We expect them to achieve this before the year 2025. Using a multiple of 15x and assuming it completes this transformation in 2025 represents a return of 14.32% per year.

However, this return may be conservative, as it may be able to complete this transition sooner than 2025. It may also generate larger-than-projected revenue due to the continued upward trend of direct-to-consumer sales, which demand a higher price per gallon of wine produced. The 15x multiple may also be conservative, as the average 10-year earnings multiple for Willamette Valley Vineyards Inc. (NASDAQ:WVVI), another vertically integrated wine producer, has been 20.90.

Seeing how Scheid’s strategy plays out in the future will be interesting. We are long the company due to the extremely limited downside and high upside potential.

Disclosure: Author is long Scheid Vineyards. We have no plans to initiate a position in the other securities mentioned within this article.

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About the author:

Low Tide Investments
Read more at www.lowtideinvestments.com and follow us on twitter @lowtideinvest

Visit Low Tide Investments's Website


Rating: 3.0/5 (2 votes)

Voters:

Comments

batbeer2
Batbeer2 premium member - 1 month ago

Thanks for an interesting idea.

You say: >> Its strategy is to transition from a seller of bulk wine to a seller of its own brands.

Scheid carries less than 1 year worth of inventory ($50m worth of inventory, $60m worth of revenue). That's consistent with their current strategy of selling wine in bulk. The distributor buys Scheid's wine within months after it has been produced and takes care of bottling and marketing.

It seems Scheid main product is Pinot Noir. Pinot Noir is best consumed 3-5 years after production and yet Scheid sells its product immediately after it has been produced. The distributors let it age for a few years while Scheid uses the cash it has collected to maintain the vineyards and grow, harvest and ferment the grapes for the next year.

So much like a bank, the distributor pays Scheid cold cash in advance and takes the inventory as "collateral" for that loan. The good news is that Scheid does not pay any interest on the loan. It also never comes due. The bad news is that as the wine gets worth more in the 3 years before it is sold, that excess value accrues to the distributor. And that's the margin Scheid want a piece of.

But if Scheid is going to transition to a company that sells direct to consumers, they need to retain roughly 3 years worth of inventory. Another way to put it is that current Scheid gets paid within months but "new Scheid" is paid three years after the wine has been produced.

3 years of inventory is 3x$50m of cold cash. Yes, Scheid will collect eventually but in the meantime, someone has to pay the bills. Also, if there's a bad year then that's the end of your operation. In the final analysis, a vineyard is a farm. The classic risk for a farm is that the farmer gets wiped out if there are a couple of bad harvests (drought/locusts/fire) and he can't pay the interest on the loans.

In short, where is Scheid going to get the $100m - $150m worth of cash to finance this transition? That is more than the company is currently worth! Yes, they could do a gradual transition funded from retained earnings but that would take decades.

Low Tide Investments
Low Tide Investments premium member - 1 month ago

Hi Batbeer.

Thanks for the read and the very thoughtful comment. I appreciate your insights on this industry, as I really enjoyed reading your article on Crimson Wine Group.

Are you under the assumption that most of Scheid's revenue is currently derived from bulk?

batbeer2
Batbeer2 premium member - 1 month ago

>> Are you under the assumption that most of Scheid's revenue is currently derived from bulk?

Yes.

Am I missing something?

Low Tide Investments
Low Tide Investments premium member - 1 month ago

47.2% of sales came from cased goods sales in 2018, while 31.8% came from bulk wine. The other 21% came from grape sales, winery processing and storage revenues, direct sales revenues, and vineyard management services. Only 19.9% of sales came from cased goods in 2015, while 51.3% came from bulk wine over that same period. Bulk wine does not represent a significant portion of Scheid’s revenue stream. However, it does represent a large portion of Scheid’s inventory.

The reason the days inventory on hand is still low relative to CWGL and WVVI is because cased wine only accounts for ~24% of total inventory. The other ~76% of inventory is turned over more often throughout the year. If we look back to 2005 and 2004, where bulk wine represented 84% and 78% of total inventory, respectively, we can see that the average days inventory on hand was roughly 114 days. (24% x 1,095 days for cased wine) + (76% x 114 days for bulk wine) = 349 days inventory on hand (roughly 60 days off their current DIOH).

The costs of producing the wine are essentially the same as they relate to accounting for the inventory, though bottling and aging are costs incurred with cased wine.

Since 2015, growth in bulk inventory has been relatively flat (~2.3% per year). Over that same period, Cased wine inventory has grown 36.9% per year, mostly due to a large investment in 2018. Assuming that their main product is pinot noir, which is best consumed 3-5 years after production (thanks for this info btw), the large increase in cased wine inventory seen in 2018 should translate into significant revenue growth in 2021 – 2023.

As they invest more in cased wine inventory, the days inventory on hand should increase because cased wine as a percentage of inventory will be greater.

In summation, I don’t see them having a liquidity problem by shifting away from selling/producing bulk wine because it doesn’t represent a significant portion of their revenues right now. Due to their large investment in cased wine inventory in 2018, bulk wine should make up an even smaller amount of revenue in the upcoming years. Days inventory on hand will grow in the upcoming years as they continue to invest more in cased wine inventories.

batbeer2
Batbeer2 premium member - 1 month ago

Interesting, thanks!

I'll have to dig into the sec filings to get a more precise idea of the volumes and margins involved. One would expect there is a significant margin differential between cased goods and bulk. If not, then that raises other questions about their strategy.

The thing I'd be most interested in is how volumes and margins and volumes break out across "direct to consumer" versus "to distributor". I don't expect that the mere act of putting it in a bottle before selling it to your distributor will take your gross margin from 30% to 60% (in the case of Scheid, back to 60%).

If and when I've had time to do the homework I hope to continue this discussion here.

Please leave your comment:


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