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A Technical Guide for Wine Producers
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VinPro survey: The cost of grape production and producer profitability
Gert van Wyk, VinPro Agricultural Economist
INTRODUCTION
In 2008, as over the past four years, VinPro conducted financial analyses in the various South African wine districts in order to calculate the production, capital and cost structure, as well as the profitability of primary wine producers. The survey, better known as the Production Plan, is executed in collaboration with Winetech and with the financial support of the National Agricultural Marketing Council, Absa, Nedbank and Standard Bank.
At the core of the survey lies the determination of average production cost guidelines for each wine district in the wine industry, but it further serves to provide producers and industry organisations with an agricultural economic support service for certain negotiations and decision making.
The content of this report refers mainly to industry average results and the evaluations are not cultivar or block specific - wine grapes are evaluated in totality as a branch of the industry. The majority of the 220 farming enterprises that participated in the 2008 survey are diversified into other agricultural activities, they benefit from economies of scale and are predominantly producers with very good to above-average managerial ability. The test sample represents ±18% of the total wine grape surface and ±20% of the total 2008 grape harvest respectively.
For the 2008 production year the industry average cost related to the production of wine grapes consisted of approximately 70% annual cash expenditure (running cost) and 30% capital maintenance (provision for replacement). Since the 2004 production year, total industry average production costs have increased by 24% to R23 578 per ha.
It was obvious that over the past five years annual cash expenditure increased by only 17% to R16 702 per ha for the 2008 production year. Since 2007 cost increases have been only 4% - inflation for the same period was more than 7%. This can be partly ascribed to very good cost management, but undoubtedly also to cash flow pressure, the direct impact of which was that some producers simply cut costs to the bone - in many instances to their detriment.
Capital maintenance (provision for replacement) i.r.o. the running concern has increased by 44% since 2004. Considerable increases i.r.o. vineyard replacement, especially the cost of soil preparation, trellis and irrigation systems, the purchase price of production means, as well as increases in building costs, are said to be some of the most important reasons for this state of affairs. Producers have greater control over the management of their cash expenses than over the cost of capital maintenance.
Figure 1:
Costs i.r.o. short term practices, i.e. pruning, fertilisation, pest and disease control, weed control, canopy management, harvesting costs, mechanisation and irrigation were responsible for approximately 75% of the total cash expenditure. The remainder of the cash expenses were constituted of repair, maintenance and upkeep of vineyards, means of production (loose assets) and fixed improvements, as well as licenses, insurance, land and municipal taxes and administration cost (see Figure 2).
Figure 2:
Production costs differ between districts in the wine industry (see Figure 3), as well as for each farming enterprise. Undoubtedly differences exist i.r.o. the cost of different blocks or cultivars, because producers align vineyard practices to specific price points - provided the price point offers sufficient motivation. This not being the case, producers follow a strategy of average production instead with no significant cost differences between blocks.
Over the past five years producers, supported by viticultural advice, have made a concerted effort to produce at the lowest possible cost, with optimal production and quality, for specific price points.
From Figure 3 it is also clear that although the production cost i.r.o. each wine district differs per hectare, the difference per ton is even more significant. For the 2008 production year it ranged between the two extremes of R790/ton (Orange River) and R3 951/ton (Stellenbosch). The biggest contributing factor was production (ton/ha).
Figure 3: (click to open table)
Although producers are already staggering under input costs, an increase of 20% has been predicted for the 2009 production year. This is mainly driven by extraordinarily high increases i.r.o. prices of fertilisers, insecticides and pesticides, herbicides, fuel, electricity, etc. In the course of 2008 tariffs for electricity increased by almost 30% and for a large part of the year producers suffered as a result of high fuel prices, while international prices i.r.o. certain nitrogen-related products increased by 160%. Prices of certain phosphate, potassium and sulphur-related products increased by more than 300%. These increases had an effect on the South African wine industry with the cost of fertilisers increasing locally from 60% to more than 300%. Chemicals to control oidium and downy mildew increased by between 20% and 300%.
With regard to the cellar there were considerable increases i.r.o. electricity, bottling and packaging, chemicals, cleaning and filtration material, financing costs, etc, which have undoubtedly impacted on producer income.
PROFITABILITY
In the calculation of the profitability of wine grape production, two approaches are possible, viz:
The results and findings in this report refer to the profitability of a specific harvest.
Time value of money and deferred payments to producers are undoubtedly some of the main factors causing serious cash flow problems in the current economic climate. It is impossible to calculate the impact thereof in this survey, since participants realise their income at different stages.
Profit, in other words Net Farming Income (NFI), is calculated as the difference between the total income and total production cost, i.e.:
PROFIT (NFI) = TOTAL INCOME - TOTAL EXPENDITURE (Before interest, tax and entrepreneur’s remuneration).
The industry average NFI over the past five years i.r.o. the participants was calculated as shown in Figures 4 & 5.
Figure 4: (click to open table)
Figure 5:
As a guideline for economically sustainable production, the average producer income and NFI for the 2008 harvest year should have realised R39 478 and R15 900 per hectare respectively.
NEGATIVE CHANGES I.R.O. PRODUCERS’ FINANCIAL POSITION SINCE 2004
The past five years’ poor grape and wine prices, as well as high production costs, undoubtedly created an income problem for primary wine producers.
Farming enterprises’ total debt burden and payback ability deteriorated and increases in interest rates were the order of the day.
It is a fact that many producers are no longer able to replace old and non-profitable vineyards. They are also unable to replace production means such as tractors, vehicles and implements. Their capital structure thus becomes increasingly dated. This is unquestionably the most important place where they try to save, but in the medium- to long-term it may impact negatively on them, as well as on the industry. Vineyards that are currently not even able to service cash expenses are uprooted and in many instances not replaced with vines.
According to the latest report regarding the area under vines by the SA Wine Industry Information and Systems (Sawis), it is also clear that more vineyards were uprooted than planted in 2006 and 2007. The total area under vines is also decreasing and a cause for concern is the fact that since 2005 the industry has been unable to replace 5% of existing vineyards (20 years serve as guideline for their economic lifespan) (see Figure 6). This trend was expected to last throughout 2008 and in all likelihood through 2009 - especially since there will be insufficient plant material to reverse the situation, according to Nico Spreeth, CEO of Vititec. More than 40% of the industry’s total white grape surface is older than 15 years.
Figure 6:
As in all other industries, the wine industry is also uncertain about the impact of the weak economic situation internationally and locally. Although wine exports for 2008 showed strong growth, the questions remain whether it is sustainable - will the necessary raw material be available - and how much of it will indeed be economically sustainable in future?
According to the latest Sawis production and market estimates, it seems that the industry has managed to wipe out red wine surpluses quicker than expected. All indications are that the industry has moved to optimal, or even lower, stock levels for both white and red wine.
In 2008, the industry experienced good growth in exports (thanks to a weaker Rand, strong brands, etc) and there are positive signs of increasing prices.
It appears furthermore, that interest rates have stabilised to the extent that further decreases might even be expected in the course of 2009.
Fuel prices started to decrease sharply towards the end of 2008 (thanks to a decrease in the price of crude oil) which can only bring very welcome respite, especially combined with potential decreases in prices i.r.o. fertilisers and certain other input costs as from January 2009.
At last things are looking up with strong indications that an upswing is on the cards. At least for now enterprising producers have more opportunities to achieve success again.
With thanks to Standard Bank, Nedbank and Absa for financial support.
SUMMARY
From the analysis of the 2008 harvest it was found that the wine industry’s average production costs have increased by 24% over the past five years to R23 578 per ha. At the same time income and net farming income per hectare dropped by 6% and 52% respectively, which has undoubtedly caused financial problems for primary wine producers. Despite the current high pressure from input costs, a further increase of 20% is expected during the 2009 harvest year. This is primarily driven by exceptionally high price increases for fertiliser, pesticides, herbicides, fuel and electricity. Overall, prospects are more positive with strong indications of an imminent upswing and there are more opportunities for enterprising producers to achieve success once again, as was the case over the past five years.
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