Falling dollar and drought could end Australian wines' price advantage

SYDNEY: Australian winemakers, riding 10 consecutive years of rising export sales, may lose their price advantage on the world market as the Australian dollar trades near a 23-year high and a record drought pushes up the cost of grapes.

Foster's and McGuigan Simeon Wines, the top two publicly traded winemakers in the country, are faced with either cutting profit margins to keep brands competitive or raising prices and risking a decline in their 10 percent share of global wine exports, according to Matt Hoult, an analyst at ABN AMRO Asset Management in Sydney.

"Consumers globally will turn to other makers as Australian wine becomes less competitive," Hoult said. "Right now Australian wine is straight-out noncompetitive. This will weigh on their shares for some time."

Shares in Foster's, the second-largest winemaker in the world after Constellation Brands, have fallen 7.2 percent so far this year. McGuigan stock is down by half this year.

Just 2 of the 14 analysts tracked by Bloomberg who cover the industry have buy recommendations on Foster's, while 11 rate it a hold and ones rate it sell. McGuigan has four buy ratings, one hold and one sell.

 Foster's and McGuigan, which generate almost half their sales overseas, deal with an Australian currency that has gained about 11 percent against the U.S. dollar in the past three and a half months. It now trades at 87.99 U.S. cents.

The falling dollar and rising euro also stand to hurt exporters in France, Italy and Spain, the three biggest wine-producing nations, while benefiting U.S. wineries.

But vintners in Australia, the world's fourth-largest wine producer, are also being squeezed by the most severe drought in the country in a century.

The cost of grapes from the 2007 harvest rose 5 percent from the previous year, according to Australian Wine & Brandy, a government body that regulates the industry. Average prices per bottle rose 2 percent in 2007, the largest increase in eight years and the first since 2003.

Australia exports 53 percent of its wine production, the second-highest proportion of output among the top 12 producers in the world after Chile, according the Australian Bureau of Statistics. France exports 33 percent of its wine, Italy and Spain about 29 percent and the United States 16 percent.

"The cycle is working against them at a time when there are a lot of stocks out there that don't have the cycle working against them," said Atul Lele at White Funds Management in Sydney, whose holdings include shares of Foster's. "Any move we make in our Foster's stake from here will be downward."

The 2008 harvest may be as low as 800,000 tons, about 43 percent less than the 2007 harvest of 1.4 million tons, according to the Winemakers' Federation of Australia.

As Foster's has to buy about half the grapes it uses to make Australian wine, the higher prices and increased scarcity will lead to higher costs and may even force the company to import supplies, Lele said.

Foster's began its wine expansion in 1996 as it sought to limit the impact of stalling beer sales by paying 482 million dollars for Mildara Blass. In 2001, it moved into California with the purchase of Beringer Wine Estates for 2 billion dollars, and in 2005 it paid 3.2 billion dollars for Southcorp, the maker of Lindemans, Rosemount and Penfolds Grange.

It is the profitability of the Australian beer industry, which has wider margins than rivals in Europe and North America, that keeps Hoult, of ABN AMRO, invested in Lion Nathan, the No. 2 brewer in Australia after Foster's, while avoiding other Australian winemakers.

With less than 10 percent of sales from wine, compared with 55 percent at Foster's and 100 percent for McGuigan, Lion Nathan's earnings risk from wine is limited, he said.

"If I could get Lion without their wine business, I would be very happy," Hoult said.