This is not investment advice. Do your research before taking a position in any of the securities mentioned in the post below.
Chances are you probably know of Lark Distillery ($LRK). Whether it is the quality of their Tasmanian whisky, the meteoric rise of their share price in 2021 or the controversies with their former CEO they have made plenty of noise for a $210m company.
Lark, whose revenue is still largely tied up in the namesake whisky brand, also owns a few labels such as Shene, Nant, Overeem and Forty spotted Gin. It also has been quite opportunistic at raising funds at market highs (>$5 SP) to do M&A; even if those Pontville/Shene acquisitions were not necessarily at cheap multiples.
Understanding their value proposition
Whilst today’s article focuses more on their financials, I would encourage anyone interested in the company to listen to the podcast Bainbridge here -> https://www.youtube.com/watch?v=ad_qkq-wSAo.
Despite Bainbridge no longer being with Lark, he shows some compelling reasons why they have been so successful:
Branding for luxury alcohol is not just about the liquor; the whole experience needs to be luxurious (e.g. their largest demographic is now 25-35yo and >50% is female - and their superior branding has helped them grab this)
Adjusting their sales model increased their GM%. This was done by having 23% of sales Direct to Consumer and 40% through Hospitality. Even at a higher prices their volumes didn’t fall!
Operationally, they have done some good M&A to ensure they have the capacity for more whisky
Overview of Whisky players
According to Allied Research, the whisky market is going to grow at a CAGR of 4.9% from 2019 (to $86.4bn of sales by 2027). However, understandably it was the Asia Pacific which is still under-represented by whisky producers and generally larger ticket whisky's are growing at a larger rate (e.g. Lark assumes c.9% growth)
Market share figures are a bit dated, but the general split is Diageo (36%), Pernod Ricard (19%), William Grant & Sons (7%), Bacardi (6%), Beam Suntory (3% share) and the rest is split up between Constellation Brands, Brown–Forman, Asahi, La Martiniquaise and Loch Lomond Distillers.
At a micro level for Lark, none of this market share data matters, but the key point is that:
The big spirits manufacturers dominate all of the distribution channels and so the obvious scenario is that Lark is swallowed up by a major
Generally, these businesses trade on a 20-25x EV/EBITDA whilst international beer brands trade on 10-13x EV/EBITDA
Depending upon leverage, they generally generate c.15% ROE (noting Diageo is more levered)
Observations of Working capital
On Lark specifically, they have quite good reporting around the liquidation value of the inventory
From an accounting point of view, the carrying value of the whisky in maturation is 8-10x lower than what it can be sold at maturation (e.g. $200m of whisky is carried at $20m) so there is no incentive to sell a partly matured product if you have a long term view. Being specific, their rough value of whisky/litre is:
Year 2 = $50/L
Year 3 = $90/L
Year 4 = $135/L
Year 5 = $175/L
Year 6 = and $216/L
For Lark it is best to assume a maturation period of 5-6 years. However, recently there has been a big push to extend that conversion cycle out 12-24 months for a finite amount of their stock
Putting the whisky for 12-24months in shiraz cask barrel, Japanese Mizunara barrel or Para Port barrel and classing it as “Limited Release” whisky means a 50% higher price tag
Given the growth in Lark production and these limited release barrels; their receivables cycle is closer to 7-9yrs; not 6yrs because their production volumes are growing so heavily
To my mind, Lark has managed its business well from a long-term perspective by focusing on total maturation. However but their cash burn is higher due to the constant growth in whisky under maturation & the increased agedness of their whisky. For example - The limited release program (>7yrs old whisky) is 52% of total sales vs. 7% three years ago.
I also think their stock valuation is heavily pinned to an exit value ($216/L) and whilst there is nothing to suggest their margins are under pressure; it is worth understanding that discounting would materially impact their liquidated value.
Conclusion
Moat: The maturation process means that whisky businesses have much better moats than beer businesses and whilst the cash drag is annoying; it means Lark's business has a better LT outlook than others
Investors: Greencape/Perennial/Mirrabrooka invested in Lark at much lower prices and whilst it is more appealing at $2.8 than $5 highs; it is still expensive on traditional earnings multiples
LT sensible, ST tough; Lark moved to a premium product that needs a longer, not shorter, cash runway (1-2yrs more) as well as ramping up their overall production volumes. I think their ability to 'price engineer' better sales prices beyond $216/L by sales in hospitality & DTC has a cap on it in the immediate term
Even with $55m in the bank, CF matters now: Going into a weaker capital market, Lark which on a simple multiples basis (e.g. EV/EBITDA) is expensive is very likely to be punished by the market unless it shortens its cash flow (e.g. increases Gin sales) or slows investment marginally
Overall I think Lark is well run business (and I the moat, however) however I still consider it expensive. For example; if you assume
fairly steady sales price; given it is already quite toppy
overlay for unsold stock in 2023/4
33% overhead and 55% gross margin
Note - for simplicity D&A, interest and other income were excluded. However, they are not material drivers
Even if you assume a fairly straightforward ramp-up in sales; it is not unrealistic for Lark to be highly profitable by 2024/25. The issue is that Lark is yet to face significant ASP pressure and today's valuation assumes a straightforward path to profitability (i.e. a small margin of safety)
With c.$30m of cash consumption to be required in the next 12months, I think it best to wait and see how Lark deploys its current $50m of cash holdings and/or if it needs to pivot away from M&A and Limited Release sales to better conserve cash flow and sell its large supply of whisky in maturation.
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