|Shares Out. (in M):||63||P/E||0||0|
|Market Cap (in $M):||85||P/FCF||0||0|
|Net Debt (in $M):||-5||EBIT||0||0|
|TEV (in $M):||80||TEV/EBIT||0||0|
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Please note that given the relatively small market cap (~US$85mn), this idea is only actionable for PA/small funds.
The evolution of the modern Australian Whisky Industry
The birth of the modern Australian whisky industry is also very much the birth of Lark Distillery. It all started back in 1989, when Bill Lark was on a fishing trip with his father-in-law in the Tasmanian highlands. Whilst enjoying a dram, Bill looked at the barley fields, the peat bogs and soft flowing water of the Clyde River and remarked “I wonder why there isn’t anyone making malt whisky in Tasmania?”
After looking at acquiring a distillation license, Bill fell afoul of an antiquated colonial-era law introduced in 1838, which outlawed the distilling of small batch spirits. The wife of the Tasmanian Governor at the time, Lady Jane Franklin apparently said “I would prefer barley be fed to pigs than it be used to turn the men into swine” and thus killed the embryonic Tasmanian whiskey industry in the crib for the next 150 years.
However after finding some sympathetic members of parliament who enjoyed the odd dram, Bill Lark managed to successfully overturn the law and in 1992 began in his quest to make world-class single malt whisky in Tasmania. Whilst the whisky was made in the Scottish style, Bill tinkered around to account for Tasmania’s diurnal climate and found using smaller barrels worked best with the quicker aging process. Also, Lark’s whisky used a brewing barley provided by the famed Tasmanian beer brewer, Cascade Brewery, that resulted in a fat, oily malt and distinct flavor profile.
Other producers soon joined Bill Lark, including Nant, Hellyers Road, Old Kempton, Overeem and Sullivans Cove and there was a collegiate atmosphere amongst the distillers, given they were all small batch producers, attempting to share best practice to account for Tasmania’s unique distilling conditions.
However whisky was not a particularly popular drink in Australia at the time, and the distillers struggled to achieve mainland sales. Nevertheless, several of the distillers started to win prestigious awards in worldwide whisky competitions, such as the World Whiskies Awards and International Wine and Spirits and the reputation of the whisky being produced in Tasmania grew amongst the whisky cognoscenti. The majority of the small batch output was exported overseas, with the remainder held in cellar doors. The industry also received high praise from legendary whisky critic, Jim Murray, who noted in his 2013 World Whisky Bible “something majestic is happening here … I now have no option but to start thumbing through an atlas and flight timetable and get over there pronto.” In the years since, several of the Tasmanian distillers including Lark, Nant, Sullivans Cove and Hellyers Road have achieved ‘liquid gold’ designation (above 94 points).
The real seminal moment for the industry came in 2014, when Sullivan’s Cove was voted ‘The World’s Best Single Malt’ in the world at the World Whisky Awards in London - the first single malt outside of Scotland and Japan to win the highly coveted award. This accelerated press coverage and global demand for Tasmanian Whisky and really put them on the map.
Source: Company presentation
The social proof from overseas experts finally saw an increase in domestic interest for Tasmanian whiskey, and there has been a large increase in domestic tourism to experience the Tasmanian Whiskey Trail (The Tasmanian Whisky Trail | The Stories, the Love and the Passion (taswhiskytrail.com)).
Lark’s Corporate History
Lark’s history as a publicly-listed company began when ASX-listed Australian Whiskey Holdings (AWH), completed a full buy-out of privately-held Lark Distillery Co in 2018, having progressively increased its ownership stake in the preceding three-four years. In recognizing Tasmania’s burgeoning reputation in malt whisky, AWH was set up in 2014 in order to consolidate and commercialize what was (and still is to a large extent), a cottage, artisanal industry.
Whilst AWH made a number of investments in Australian Whiskey distilleries and barrels, its two major investments were its ownership stakes in Lark Distillery Co (which also owned the well-regarded Overeem Whisky, as well as Forty Spotted Gin), as well as Nant Distillery, which also had an excellent reputation amongst Whisky experts.
Under AWH ownership, Lark and Nant made some major investments in terms of investment in laying barrels and capital investment to increase distilling production. However, given the time lag between laying down barrels to maturation (typically between five-eight years) and the previously capital constrained nature of the distilleries, the actual earnings power of AWH immediately after these acquisitions was initially quite low, given little maturation of stock available for sale.
The company also went through a boardroom tussle in 2019, with major shareholder Bruce Neill successfully deposing the incumbent BOD/management, bringing on Geoff Bainbridge (ex Fosters MD Spirits, co-founder Grill’d) and David Dearie (ex Treasury Wines) on board as CEO and Chairman, respectively.
Under the new management, a number of moves were made including a $5mn debt raising in early 2020 to shore up the balance sheet around the time covid hit, and $8.85mn equity issuance $1.10 per share in September 2020, primarily to increase production of spirit for future sales. They also renamed the company from ‘Australian Whisky Holdings’ to ‘Lark Distilling Co’, whilst selling the Overeem brand back to its original owners, and allowing them to focus on their core brands – Lark, Nant and Forty Spotted Gin (my focus is on the whisky production as the gin business is not germane to the thesis).
This was part of management’s newly unveiled ‘Brands and Barrels’ strategy. The company rename was to reflect Lark as the company’s hero brand, with CEO Geoff Bainbridge‘s goal to turn the Lark Brand into the Penfolds of Australian whisky. Penfolds is one of Australia’s oldest and most distinguished wine labels, with the Grange Hermitage label vintage one of Australia’s most valuable wines. However Penfolds leverages its heritage to also sell large volumes of more reasonably priced wine. Lark is in the early stages of attempting something similar and is also looking to introduce a more reasonably priced whisky (~AUD$100 price range) via its new column still (currently codenamed AX8).
Management is also continuing to look to increase whisky under maturation inventory, and is currently producing almost 6,000 litres per week. Whisky under maturation is currently at 818k litres (Dec 31 2020), with a goal to get to 1.5mn litres under maturation by the end of June 2022. (The goal clearly implied a massive step-up in production from current production levels (which are already +50% from just one year ago), with a lot of the incremental production related to production of lower-cost column still AX8, which is still in ramp up mode).
Key Investment Strengths
Lark’s Brand Heritage and growing recognition:
· Bill Lark is considered the godfather of the Australian whisky industry, given his role in overturning the distilling laws and having consulted the majority of distillers that currently operate in Tasmania. He remains a brand ambassador for the company to this day and Lark has the oldest history amongst all producers, being Tasmania’s first craft whisky. He is also one of the few people outside of Scotland to be in the Whisky Hall of Fame.
· Outside of all the critical acclaim, recognition in Australia of Lark’s brand continues to grow. Visiting the Cellar Door and Distillery is one of the highest rated activities on things to do in Hobart according to Tripadvisor, with rave reviews.
· Lark’s whiskys perennially win awards in some of the most prestigious awards show. The most notable recent distinction was Lark being nominated for the 2020 IWSC Worldwide Whiskey Producer of the Year – one of only four nominations.
Source: Company website
Business is inflecting / recent insider buying:
· Lark’s operating results for H1 2021, demonstrate the kind of torque that is available to Lark’s future results, as production and ramp up become more consistent. They were able to reap the fruits of AWH’s investment from years prior, resulting in a large increase in whisky maturing that was available for sale. Net sales and gross profit increased by 70+% to~$6mn, and almost all the incremental gross profit hit the bottom line, demonstrating the inherent operating leverage of the business model and also allowing the company to declare its maiden profit.
· Current whisky inventories and maturation schedule suggest this increase should be a ‘new normal’ for Lark’s revenues over the next few years, whilst there should be a further massive ramp up again in four-five years time, as progressively increasing production levels are reflected in maturing stock available for sale. Based on current annual production of ~300,000 litres at NSV of $139 per litre, this would imply annual revenues of over A$40mn from 2025. Management has also noted the A$139 is already conservative to what has historically been achieved and should further benefit from Lark bringing distribution in-house. This also doesn’t include outsourced production ramp-up of AX8 and the potential real option that may provide to future sales levels should it be successful.
· CEO Geoff Bainbridge has been aggressively purchasing shares on-market, even after the capital raise in Sept 2020. He is currently a substantial holder, with over 5% ownership of shares, having accumulated the majority of his holding in the past nine months.
· We also note the attractiveness of incremental barrel unit economic, resulting in a circa 50% 5yr IRR (7.5x MOI) from when the whisky is stored to maturation.
Source: Company presentation
· Lark currently trades at EV/Revenues of 7.6x and EV/Gross Profit of 13.8x, on annualized H1 2021 results.
· Post 2025, based on current 300,000 litres of annual production (and not counting planned AX8 production), revenues should be between $40mn+, assuming production remains consistent and demand levels remain similar, implying forward. EV/Revs and EV/Gross profits of 2.6x and 4.2x respectively. I would expect incremental margins to be quite high (as demonstrated by ~100% incremental gross profit, hitting bottom line in h1 2020). Even assuming a 50% incremental margin, this would put 2025 earnings around A$9mn, which at a 20-25x multiple would result in a market cap of $180-225mn in five years time, or ~100% upside (~15% IRR).
· However, if production were to materially increase from current levels (likely if management are successful in their objectives) and/or Lark end up becoming successful in introducing a lower priced whisky, we would expect the potential earnings and exit multiple to be much higher.
· We also note that in terms of downside protection the quite literal liquid balance sheet that Lark possesses. The company currently has over 800,000 litres of whisky under maturation at an NSR of $113mn, with that number growing rapidly based on management’s target of over 1.5mn litres under maturation by FY22.
Future ramp in matured stock available for sale
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