Andrew Peller: Want Some Dividends With Your Wine?

Ladies, this one's for you

Legendary investor Peter Lynch once told investors they should invest in what they know, legitimately believing the average investor could enjoy an edge over the professionals by picking and choosing stocks that produced items or provided a service that delighted them.

Many serious investors will scoff at Lynch’s advice, saying an excellent product is just one part of a much bigger puzzle. They’re right, of course. So I’ve taken the famous Lynch-ism and changed it around a little bit. I want to invest in what I know, but it’s only a starting point for further research.

I’ve taken it to heart, owning the company that provides me with internet (Quebecor), supplies service for my cell phone (Telus), generates my power (Capital Power), serves my food (Boston Pizza), where I shop (Canadian Tire, Choice Properties), holds my mortgage (Royal Bank) and probably a dozen more examples I won’t bother listing.

I don’t know much about wine — I can’t stand the stuff — but I’m guessing there are quite a few readers who know a great deal about the product. It’s the perfect buy-what-you-know product for many of you — especially the ladies, because hot damn do you like wine — which is why I wanted to cover it. Plus, as you’ll see, the stock is ridiculously cheap.

Let’s take a closer look at Canada’s wine leader, Andrew Peller (TSX:ADW.A)(TSX:ADW.B), a company with a rich and storied history, although it has stumbled pretty significantly as of late.

The skinny

Want a quick peek at what I think of Andrew Peller without reading the rest of this? Check out my brand-new one-pager report.

Andrew Peller stepped onto Pier 21 in Halifax in 1927 with just $5 in his hand and a dream in his heart. The Hungarian immigrant was eager to seize the opportunity before him.

He quickly settled in Kitchener, taking a job at a local brewery which was flourishing after Ontario repealed its Temperance Act in 1927. After establishing himself with his strong engineering and mechanical abilities, he sent for his wife and young son to join him in Canada. Soon he took another job at a brewery in Toronto before finally starting his own brewery in Hamilton.

Peller’s brewery was an instant success, eventually drawing the attention of a local investor who purchased the business at an attractive premium. He then started several forgettable businesses — with varying degrees of success — before uprooting his family yet again and heading west to try his hand at the wine business.

At age 58, Peller bought a farm, planted some vines, and got a license to build and operate a winery just east of Vancouver. Operations grew from there, with the company acquiring assets near Calgary, in Nova Scotia, and, finally, cracking the Ontario market in 1970. Andrew was succeeded as CEO by his son Joe in 1966 and Joe’s son John in 1995. John changed the name of the company from Andres Wines to Andrew Peller in 2005 to celebrate his grandfather’s accomplishments and his timeless vision.

These days, Andrew Peller has grown into Canada’s largest publicly-traded wine producer with nine award-winning wineries in B.C. and Ontario, as well as extensive marketing and distribution operations. It has since expanded into at home wine making kits, other alcoholic beverages, and tourism experiences at its wineries. Prominent brands include Peller Family Vineyards, Copper Moon, Black Cellar, and XOXO on the premium side, and Hochtaler and Domaine D’Or on the value side. It also owns more than 100 independent retail locations in Ontario.

Despite COVID-19 hitting the rest of the alcohol sector pretty hard, Andrew Peller appeared to be holding its own throughout the first part of the pandemic. Sales actually increased in fiscal 2021 — which ended March 31st, 2021 — to $393M, up 3% compared to 2020. A one-time sale of some land in B.C. also boosted the bottom line. But 2022’s top line came in much lighter than expected, falling some 5% to $374M. We’ve at least seen a slight recovery in 2023 thus far, with sales in first nine months of the company’s fiscal year increasing by 3.2%.

The bigger issue has been declining profits. After gross margins peaked at 43.9% of sales in 2020 they’ve been falling ever since, hitting a low of 37.2% in fiscal 2022. The company was largely unable to cut any operating expenses to make up for the lower margins, leading to a big decline in the bottom line. Profits sank from $0.53 per share in 2020 to $0.29 in 2022. 2023 looks to be even worse, with profits through the first three quarters of the year falling to $0.16.

Management was quick to point out the decline in profits was caused by external issues, namely inflation hitting input costs, closure of winery tours because of the pandemic, and supply disruptions. Elevated shipping costs didn’t help either.

Another issue plaguing the company today is overall weakness in the wine market in Canada. Although wine sales have held up much better than beer sales, management disclosed wine sales in Canada were down approximately 3% in Canada over the last year and growth in total wine consumption was somewhat anemic at 1% per year over the last three years.

In other words, it looks like the wine business is basically flat — at best — in Canada right now. Although that is being offset somewhat by price increases.

The opportunity

Andrew Peller shares are interesting today because there’s some significant upside if management can turn the business around.

I’m not sure many of you realize just how much this stock has cratered in the last few years. I sure didn’t know. Here’s a chart of the class A shares, the much more liquid of the two series of shares.

Is it just me or does that chart kinda look like a giant middle finger?

The stock has gone from $18 to just over $4 in five years. Yikes.

One thing I like to do in situations like this is take a look at the business when the stock peaked and compare it to today. Andrew Peller has actually increased sales by approximately 3% since the stock peaked, but profits have fallen off a cliff. Full-year profits in fiscal 2018 were $0.69 per share. The company should earn around $0.20 per share this year.

However, there are some indications the turnaround could be beginning. The company posted gross margins of 40.3% in its most recent quarter. The last time it cracked above 40% was six quarters ago, and gross margin in the same period the year before was 35.1%. Inflation is rapidly coming under control and shipping costs have declined as well. And summer 2023 is shaping up to be an excellent one for travel overall, which should help the winery tour part of the biz.

The company is also telling investors to expect better things going forward. In the most recent conference call, CEO John Peller told investors the company has projected EBITDA to return to 2019/2020 levels in the next couple of years. Based on previous profitability in those two periods — combined with a modest reduction in shares — that translates into profits of between $0.50 and $0.55 per share, or approximately 8-9x earnings based on today’s depressed price.

Andrew Peller shares traded for a 25x multiple when the stock peaked in 2018. A 15x multiple on $0.50 in profits — which I think is a reasonable valuation — gives us a price target of $7.50, or upside of approximately 70%. Not bad.

The wine market in Canada

Your author was a long-term holder of Molson Coors shares before recently exiting the position at a fresh 52-week high. I took a small loss on the position before dividends.

Although Molson Coors has had a nice bump in the short-term — thanks, Bud Light boycott, which has temporarily moved consumers over to Molson Coors brands — I sold because the beer market in North America continues to look bleak. Volumes have consistently been falling in both Canada and the United States for years now, despite steady population growth. These declines have been offset by acquiring smaller, higher-growth craft beer brands and by increasing prices, meaning legacy sales are even worse than overall headlines.

In other words, the beer business in North America is a slowly melting ice cube. I’m okay with that in certain situations — like Cogeco, which remains a cash cow and has relatively high switching costs — but beer (or wine) is a more bleak story. It’s really easy to switch brands.

On the demographic side, both beer and wine are suffering from the same big issue. Young people just aren’t that interested in drinking.

A fascinating report from Wine Intelligence spoke more about this:

In fact, from the same report, the overall wine market in Canada has shrunk since 2017 and is forecast to remain about the same in the next five years despite heavy immigration. How is the largest wine producer in the country supposed to goose its business in that environment? I want stocks with growth potential, not ones in an overall declining market.

Dividends and buybacks

Despite shares trading at a 10-year low and management telling investors the company’s balance sheet is strong, Andrew Peller seems somewhat reluctant to repurchase shares. Total shares outstanding have declined by about a million shares since 2019, falling from 44.2M to 43.2M. That’s a decline of approximately 2% — or 0.5% a year. It’s a start, but it’s not much.

The company also has authorization to repurchase up to 1M of its class A shares, but hadn’t repurchased any as February 8th, when it reported its Q3 results. This analyst questions why the company isn’t repurchasing more shares at a 10-year low, but I think I have the answer already. The balance sheet simply isn’t that good, and the company doesn’t want to tack on more debt. After all, long-term debt has more than doubled since 2020 and interest rates are up substantially since then.

Things are much better on the dividend front. Andrew Peller has paid consistently rising dividends over the last decade, increasing the annual payout from $0.15 per share in 2013 to $0.25 per share today. The current yield is 5.6%.

As it stands today, the dividend isn’t sustainable. I project the company will earn around $0.20 per share in 2023, growing modestly to about $0.25 per share in fiscal 2024. I should note analyst coverage on this name is pretty much nonexistent, so take any forward earnings expectations with a grain of salt.

If the company can recover and we see earnings shoot higher over the next year or two, the dividend is fine. If earnings don’t head higher, watch out. The dividend could easily be cut in 2024 or 2025.

The bottom line

As part of my research for this post, I talked to a few people I know about their wine consumption, and they almost all told me the same thing. It’s down, and they’re trying to drink less of it. Even when they’re socializing.

Combine that with an overall market that looks to be ‘meh’ at best, shrinking consumption among young people, a crowded industry with plenty of competition from imported wines, and an individual stock in the middle of a turnaround, and I don’t think there’s going to be any wine in my portfolio.

However, this is one I could very easily get wrong. There’s plenty of upside if management can turn things around. And Andrew Peller is the king of the sector in Canada, meaning if I was going to bet on a recovery in wine, I’d do it with Andrew Peller stock. Good things tend to happen if you buy the leader.

Overall though, the low valuation and really nice dividend yield aren’t enough to get me excited about this one. Some of you looking for turnarounds may like this one, but it’s not for me.

Author has no position Andrew Peller. Nothing written above constitutes financial advice. Consult a qualified financial advisor before making any investment decisions.