Why Beringer, Canandaigua Aren't Popping Corks Over Fed's Next Move

When the Federal Reserve meets this week, there'll be some well-gnawed fingernails in the executive suites of American wineries, some of which have gorged themselves on easy, low-interest credit to pump up their earnings.

Put yourself in their position: Imagine filling out a credit application and confessing that interest charges from existing debt were eating up close to one-third of operating income. Now imagine the howls of laughter that accompany the rejection slip. Some nerve!

But that's precisely the situation facing Beringer Wine Estates (BERW) and Canandaigua Brands (CBRNA).

Beringer, for example, blew 33% of its operating income on interest payments during the quarter ended March 31. According to the latest 10-Q, it booked $5.8 million in interest charges against $17.3 million in operating income.

Most of Beringer's interest goes to pay the debt incurred when Texas-Pacific Group did a leveraged buyout in 1996, acquiring the operation from Nestle and taking it public in 1997. As of March 31, Beringer had $224 million in long-term debt, giving it a long-term debt-to-equity ratio of 152%. That's makes it about 50% more leveraged than the average beverage company and more than twice as leveraged as the typical company in the S&P 500. While debt is down from 1997, when Beringer had a staggering $315 million in long-term debt, it's still enough to clobber earnings.

Now, no one thinks Beringer's debt levels come anywhere close to endangering the company's ongoing operations. And the leverage has helped to boost results -- revenue in the quarter ended March 31 rose 21% from the year-earlier period to $93.2 million. Beringer's 10-Q said the increase reflected both a 16% increase in volume and a 4% rise in per-unit revenue. But it is equally clear that the heavier debt burden increases the risk that Beringer's earnings could get pummeled in a bad year.

By contrast, the Robert Mondavi Winery (MOND) -- which is usually compared with Beringer -- has a long-term debt-to-equity ratio of just 87%. Their 10-Q for the quarter lists interest expense of $3.9 million, or only about 24% of operating income of $16.5 million.

By contrast, the management of Brown-Forman (BF.B) won't be giving the Fed's decision a second thought, thanks to a minuscule long-term debt-to-equity ratio of just 5%. For the three months ended Jan. 31, interest expense totaled a mere $3.3 million, just 4.3% of the company's $75.8 million in operating income for that quarter.

But way out in western New York, the story is likely to be a lot more ragged at Canandaigua Brands, the only major publicly traded wine-related company with a heavier debt load than Beringer. Thanks in large part to an acquisition binge that Drinks & Diversions wrote about in early May, these big spenders have a long-term debt-to-equity ratio of 190%, reflecting $832 million in long-term debt as of Feb. 28. The acquisitions caused Standard & Poor's to downgrade Canandaigua's debt to negative from stable, which can only increase its borrowing costs down the road. Canandaigua's 10-K shows interest payments of $41.4 million, or 28% of operating income of $145.9 million.

These debt levels may explain why some Greenspan-sensitive investors have shied away from the more heavily leveraged wine companies, Beringer and Canandaigua. And while there are many who think that Brown-Forman has too little debt, thus holding down returns, critics of this Kentucky company's conservative management should look at the unvarnished, un-tricked-out numbers: Of the industry's largest companies, it boasts the highest return on equity, at 22.2%

Drinks & Diversions wrote about Brown-Forman's smooth recipe for success last fall, and the current data only reinforce the wisdom of the company's conservative style. And while Brown-Forman's Southern gentleman's approach to business may draw sneers from the industry's fast-talking dealmakers, it's pretty clear that a conservative balance sheet will be a valuable ally in the uncertain rate environment ahead.

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