Headquartered in Hobart, Tasmania, Lark Distilling Co Limited (ASX: LRK) is a high-end spirits maker. Lark is one of Australia’s leading whisky producers and their management is now at work to grow the product and brand both – domestically and internationally. Tassie is home to rich fields of barley, an abundance of pure soft water, highland peat bogs, and the perfect climate. This ensures that their spirits are of a very high grade and have the potential of not just having a sticky customer base domestically, but internationally as well. Lark produces Single Malt Whisky, Premium Vodka, Gin, and a Bush Liqueur, and they all are Kosher Certified.
Lark produces 3 ranges of whisky that have 3 price points:
- Lark Blend ($80 – $150)
- Lark Classic ($150 – $300)
- Lark Luxury (> $300)
With these product ranges, Lark is able to tap into the new world whisky market at different price points. The new world whisky market is a label that has been given to brands that do not originate from the top 5 whisky markets, that is, Scotland, Ireland, Canada, USA, and Japan.
Once the whisky is produced, Lark sells it in multiple channels – onsite and offsite, that is, at dine-in bars and restaurants and offsite stores such as retailers and ecommerce platforms. Historically, Lark had focussed on selling to distributors in order to minimize costs and the risks associated with selling directly to the consumer. However, with a management reshuffle, Lark has adopted the B2C and online retail approach to make the most out of the increase in demand for new world whisky.
New World Whisky Growth
The under penetration of new world whisky offers an opportunity for Lark and investors to enter this market before the wind starts blowing in the right direction. Lark caters to the premium end of the market and premium ends of whisky markets consists of consumers that are very sticky towards their whisky brands. This characteristic means that once Lark is able to sell their whisky labels in large quantities, most of their sales will be turned into sustainable recurring revenues from existing customers.
Lark’s positioning within the Australian market is still fairly low. However, their growth levels have spiked recently given the sales strategy their management has adopted. Research suggests that Lark have penetrated 0.3% of the Australian whisky market as of 2020, and by 2025, Lark would have increased their dominance to over 1%.
Expanding Litres Under Maturation
Aging is one of the most important components of whisky manufacturing. Whisky appreciates in value with age. Aging requires immense planning and forecasting in order to manage inventory and also meet the sales demand. Lark typically ages its whisky between 5 to 8 years. Litres under maturation during the recent half increased by 106,236 or 14.9% since 30 June 2020 with Lark now holding whisky inventories that at maturation would be valued at $113 million.
Whisky production will increase materially in H2 as the full impact of outsourcing takes effect and it is anticipated that at the end of FY21, Lark will be holding in excess of 1m litres of whisky under maturation.
Premium Product – Premium Price
Lark is a premium product with taste notes that will ensure a sticky customer base. This has its advantages. Due to this property, Lark can thus be treated as a luxury product that will be able to expand its prices by attaching premiums in the long-term. This is a competitive advantage all monopolies and luxury brands enjoy once their product comes off age. A price increase is very beneficial because even a 5% increase in premiums will translate into increased EBITDA margins and larger net profits.
Entry into China
If you plan on establishing yourself as a direct-to-consumer brand, China and the USA are the most essential markets for growth and sustainability. Entering the premium whisky market in the USA is a very tricky affair in the early stages of a company’s lifecycle because of how rigid and mature the consumers and the market is. China on the other hand is a lot more welcoming to premium labels. An emerging economy also allows Lark to impart themselves as a brand to Chinese consumers that are on the rise in terms of discretionary spending.
AX8 is Lark’s product that is in development to primarily enter offshore markets and specifically China. The maturation profile of AX8 is expected to be shorter than the average label that Lark produces, and it is expected to have a sweeter palate as well in order to effectively target the Chinese consumers. This strategy coincides with how Baiju became so popular in China – so much that it is now dubbed as the national drink of the country.
Forty Spotted Gin
As we mentioned earlier, Lark is not a one trick pony. In addition to whisky, they are also in the market for premium gin. The gin market in Australia offers an opportunity for sales in excess of a billion dollars. It is a very mature market among the high-class societies and a penetration here would translate into revenues and profits faster than the whisky market.
Distilling gin is also a lot less time consuming than whisky. It can reach the hands of a consumer within 7 days – making the entire product segment cost effective and a high margin business relative to whisky. Like whisky, the size of the Australian gin market is significant, and we do not require Lark to achieve high levels of penetration to meaningfully contribute to revenue. Therefore, in our terminal forecast year, we only forecast Lark attaining a penetration rate of ~1.2% of the Australian gin market.
Lark Distilling Co has been around for a while. However, the stock has started getting noticed off-late. This is because Lark revamped its management team, and they are now following a strategy to gain market share in the domestic whisky and gin markets by selling directly to end consumers and use online and offline retail channels more effectively. This strategy will also be carried forward into their planned entry to international markets.
The most noteworthy mentions in the board and management of Lark are:
- David Dearie – holds the position of Director and comes in with a lot of experience having held management positions as CEO of Treasury Wine Estates and Brown Forman Wine Group. In addition to the directorial role at Lark, David also runs his own consulting firm that specialises in brand management and strategic advice for clients specifically in the spirits and wine sectors.
- Geoff Bainbridge – Managing Director of Lark comes in with a host of experiences at Foster’s Group and Oakley as managing director. Geoff currently sits on the board of several Australian businesses in the food and beverage industry.
Lark is currently not yet profitable. Hence, they will need to raise funds either via equity or debt to keep going. The recent equity raise was in September 2020. Lark raised $8.85 million via an Institutional Placement Offer priced at $1.1 a share. The funds from the equity raise are being used to increase the inventory capacity of Lark so that the maturation quantities can be increased.
Whisky that originates from geographies other than Scotland, Ireland, Canada, USA, and Japan are known as New World Whisky, and this is where Lark operates. These whisky products use non-traditional distribution channels such as ecommerce and online retail and they are also benefited by a general lack of restrictions and regulations around the manufacturing process.
Whisky markets are often associated with an extremely stick user base as taste palate really dictates brand and product loyalty. The new world whisky markets are gathering momentum among the younger generations. Even though the alcohol consumption per capita has declined in Australia across all age groups, the sale of high-end whisky has increased. The growth in spirit sales by volume has grown by 2.7% CAGR from 2015 to 2019, while the retail sales value has grown by 5.2% CAGR over the same period. This shows that Australian consumers are preferring expensive spirits, while the growth in alcohol consumption has not kept up.
Much of this demand is coming from the rising demand for high-end cocktails and ready to drink alcoholic beverages that the young population is preferring. While restaurants and bars stayed shut during lockdowns, sales were reliant on – retail stores. Of the US$6.5bn online retail global spirits market, Australian whisky grew 104% in 2018-19. Lark’s e-commerce sales are also growing rapidly at an approximately five-fold increase year-on-year. Consumer preferences of Australians have also changed during this period. There has been a shift towards local products – and this theme is seen across several commodities and not just spirits.
Tassie is also home to the local whisky boom. There are over 20 distilleries operating in the state given the availability of raw materials and favourable climate for the manufacture of whiskey and gin. As we mentioned earlier in this report, Australian whiskey is leading the pack when it comes to new world whisky. This is due to the reputation we have of producing clean, premium spirits that can be trusted for consumption. Exports have thus increased, and whisky exports is the fastest growing among all spirits originating in Australia.
Whiskies need to stay in the barrel for 3-5 years. This prolongs the entire process of selling whiskies and realising revenues. Lark had a very positive half year FY2021. Gross revenues increased 95% to $7.5 million. Gross profit came in at $3.8 million – a 78% increase. Other operating expenses stood at over $3 million – taking the earnings before taxes (EBT) to just over $500k. This strong performance has been underpinned by:
- Strong Lark Sales Momentum: First Australian Whisky to Exceed $100K of Retail Sales in One Week in a Leading NKA
- Strong E-Commerce Growth (5x YOY) Driven by Lark Limited Release Programme
- Lark Christmas Cask Release II, 3 Month Campaign, 3,690 Units Sold Out, 7x YOY
- November – Record E-Commerce Sales @ $488k, Launched Rare Cask PARA50 (585 Units Sold Nov-Dec)
- December – Largest Revenue and Units Shipped Month in Company’s History
This strong performance is expected to continue as we expect Lark’s revenues to grow by 105% by the end of the current financial year. The strong performance in the first half has underpinned the expected growth that is to occur as we emerge out of the pandemic. Consumption of alcohol in onsite locations is expected to grow due as the pandemic is behind us. In the business of manufacturing, EBITDA margins are everything and the margins increase with scale. The new management has taken to reducing overhead costs since taking control of the business. Investment will continue to be made in sales and marketing. The margins as can be seen in the above chart is forecasted to increase as Lark is expected to increase prices in the long-term, bring new products into play that can fetch them higher margins, and of course economies of scale in the manufacturing of scale. Management has also made substantial strides in moderating costs per litre of whisky under maturation.
Lark will be looking to:
- Build a brand around their products because brand value is a very important factor in sustainable sales in the spirits industry.
- Launching products at different price points – catering to a wide customer base.
- Investing in inventory and barrelling more whisky today in order to increase sales volumes in the future.
- Relaunch Forty Spotted Gin successfully and add another revenue stream.
Net operating activity cash outflows were $1.99m for H1. Q1 operating outflows of $1.83m were the result of a build-up of costs which had been deferred as part of COVID-19 government support measures, mainly PAYG $356k and excise tax $788k. Operating activity outflows of $154k in Q2 were the result of an uplift in inflows received from customers due to higher product demand and sales volumes. The driving force behind the increase in receipts related to the strong performance of online and the hospitality venues.
Net investing activity cash outflows for H1 of $362k related to continued investment in the Cambridge production facility. Significant items included payment for the column still in Q1 $87k. A deposit for the Peat Smoker $64k, payment for 1000 litre IBCs $133k and $51k to finalise the column still project in Q2. Other outflows for PPE related to production infrastructure and improvements to the hospitality venues.
Net financing activity cash inflows for H1 of $8.20m was the result of the capital raise undertaken in Q1. Total funds received net of transaction costs was $8.4m and minor payments were made for truck and barrel finance. Net financing activity outflows were minimal for Q2. Minor payments of $85k related to truck and barrel finance repayments and lease liabilities. At the end of the half year period, Lark has $11.9 million in cash – a very strong cash position that should comfortably cover all expenses in the short-term.
The balance sheet of Lark is very strong. They hold just $5 million in debt. This takes the capital structure of lark to be funded by debt up to just 9.6%, and by equity for the remaining 90.4%. The below chart shows that Lark’s financial strength is immense in both the short and long-term.
- Consumer demand will always pose a risk to any B2C business model. In the manufacturing sector and in the spirits industry, consumer demand is everything. Changing preferences can quickly pose a risk to emerging companies.
- Holding on to inventory poses a challenge. For Lark, it is twofold – they have to successfully forecast their demand and plan years in ahead in order to manage their demand and supply curves.
- Trading pressures have intensified ever since the USA and China began their face-off. This has bled into every industry and affected Australian commodity producers as well. The rising geo-political risk has to be considered when making an investment case.
The enterprise value of Lark based on current market capitalisation is $136.66 million. Based on our forecasted projections seen earlier in this report and the enterprise value, below are the valuation multiples that Lark is trading on.
The high EV/EBITDA is FY2021 is due to Lark being projected to just break-even. Hence, it does not serve as an accurate measure when looking at how the market is pricing the stock. On a forward-looking P/E basis, Lark is very richly priced because of the potential earnings that are being instilled into the stock price.
Lark will have to invest in whisky production and barrelling today so that they can sell in 4 to 5 years later. Therefore, it will be continuous investments that have to be made that will determine how Lark will be priced by the market.
Lark is an emerging player in the new world whisky industry. They have a premium product and an experienced management to guide them to establish brand value. Lark has also increased investment in order to have more volumes of whisky coming out in 4-5 years’ time. We like the long-term potential that Lark brings to the table as they continue their quest to gain market share domestically. We recommend investors to “Watch” the stock and wait for an entry point at a lower level.