Tonnellerie François Frères: transitioning towards a more acyclical business but maybe at the cost of lower margins

A french hidden champion in barrels

A family business since 1910

TFF’s history begins in 1910 with Joseph François, then his son Robert took over in 1917. Jean (father of the current CEO) started working in the family company at the end of the 50’s. Jean is at the helm of the  company at the beginning of the 70’s and develops the export business. Jérome François (the current CEO and Jean’s son) joins the company in 1989. From there on, external growth takes place.

It is always interesting to study a company whose motto is “Time is on our side”. TFF builds barrels which is sells directly (thus it keeps the margin) to its clients. They are autonomous in the oak sourcing which is decisive as their sourcing is secured and there inventories are quoted at the acquisition price in the balance sheet.

To build a barrel you need good quality oak which requires adequate aging (an additional barrier to entry), quantity and secured sourcing. This requires sourcing, and cutting the oak in the right dimensions. Then it needs to be aged and then it can be worked upon by a TFF employee who will be exchanging with the wine producer to build a barrel so as to “build” and put forward the desired wine by the client.

Three business units: wine, scotch and bourbon with different dynamics

The wine BU has the highest margins as the offering is completely integrated and clients are high end, these two elements explain the higher margins. Indeed the cost of a new barrel is high and can only be afforded by high end wine producers. This has another advantage as these clients in their turn have a long term vision and oak barrels are an essential part of their product. Churn is low as wine producers need time to be convinced but once they are they are very loyal. The same can be said of Oeneo. They can be a strong volatility in sales which are dependent on the weather conditions which impact wine havest.

The scotch BU is a clear world leader albeit with a lower sales growth. It is capex light as scotch is aged in used barrels. There is no need for a production site. The business is essentially a maintenance and repair due to the aging time required for the scotch whiskey. Thus, no production sites are required and working capital is lower (not required to have oak inventories). Scotch market grows slowly but surely and is less affected by weather conditions.

Investing in the bourbon sector to reduce cyclicity to the whole business

The bourbon BU requires new barrels and thus it can be compared to the wine BU in the sense that production sites are required as well as oak inventories. What distinguishes it from the wine market  is that growth was and seems to be stronger ( 5% growth in sales per year) and is less affected by weather conditions (i.e raw materials harvest are much less impacted by swings in weather). Margins are lower as there is a higher competition and possibly that bourbon is not as high end as top notch wine.

Bourbon and wine need new barrels, which implies a production site and oak inventories. Cost synergies should kick in time. The bourbon market dynamic is good. As production increases, breakeven will be attained and the BU will be profitable as well as cash generative also helped by much lower capex.

Oak inventories and close relationship with clients

It can act as a hidden asset as inventories are at historical cost in the Balance sheet. Good quality oak is rare and would certainly be worth much more if sold at market price. But clearly TFF will not sell them on the market as it contributes to its completive advantage (sourcing) and margins. We could take it more as an additional element that reinforces the balance sheet.

Oak is paramount to the business as you need good quality and it needs to age (“Time is on our side”). There is a working capital entry barrier which cannot be easily replicated. If you want to set up a new cooperage more or less half of the investment is linked to buying oak inventory. Tonnellerie François Frères secured it’s sourcing by buying oak from the ONF (Office National des Forêts: French public organism which manages the French public forests) and also by having it’s own companies which secure sourcing. They are completely autonomous for French oak and nearly completely autonomous on most of the sourcing.

TFF have the most important stave inventory and they do not accelerate the drying of the wood.  

They are very close to their clients as they design in partnership the barrels with the wine producers. In others words they help to co-build the wine as the barrel has a unique importance in building the wine’s unique characteristics. This also explains why they are lots of different cooperage’s within TFF as each is in a specific geographic situation (The Tonnellerie Radoux acquisition enabled them to enter the Cognac region) which ensures proximity and can be specialized in a specific type of wine.

Employees who build barrels need to be trained 2 to three years and also contributes to the moat. Turnover appears quite high even though it is just under market level.

FCF generation could increase dramatically as bourbon capex is over and if there are fewer natural disasters impact wine harvest

The bourbon investments are now over and the know how seems to be now in place as there are no longer any provisions to put the sites up to the required level. FCF should increase (and has already increased in 2021) with much lower capex for the bourbon business, upstick in the bourbon business, solid scotch activity. The other lever will depend on wine production and thus on the climate as well as the absence of wildfires or other climate related issues.

No variable income at the top management level

The CEO and CFO do not have any variable income. The CEO has a fixed remuneration of 1 MEUR and even a bit more if we add remuneration coming from other positions within the company. It strikes me as a little high as the CEO is a member of the François Family which controls 70% of the company. This is not the case the level of the different business unit entities which are incentivized on the EBIT.

External growth to strengthen network and proximity with clients

One of its major acquisitions (Sogibois in 2000) was to increase their autonomy in oak sourcing. 

The other acquisitions are essentially made to ensure a strong proximity with clients, expertise in a certain type of market, a certain type of wine…

Here is a recap of their latest moves which illustrate the precedent point.

Snapshot of some entities: sales and net result seem to flatten out for some entities event though margins remain high

I will be honest I don’t know why the margins or sales seem to flatten out even if I take the 2019 numbers which a normal pre covid year. Nevertheless, some margins are really high and illustrate the high end positioning as well as the impact of the vertical integration.

Valuation

Capital allocation for TFF has been the following one: growth capex for the bourbon business, buying small cooperages to increase the network and a regular dividend.

2021 FCF saw a big boost thanks to the end of the capex investments for the launching of the bourbon business. As a reminder, Capex was respectively 36 MEUR and 44 MEUR in 2019 and 2020. Adding to that there wasn’t any major acquisition. With a 26,8 € share price the FCF yield stands at 6,9%. Once again 2021 was a special year and working capital was favorably impacted. So yes FCF was quite exceptional but it gives us a sense of the cash flow generation when capex is more normal. Our 10% threshold can be easily attained with the return of a normalized climate situation for the wine BU, a bourbon BU which will start to become profitable and normal capex after the big investment cycle to launch the bourbon business. You also get 1,3% dividend yield as TFF has always paid out a dividend. As time is also on our side, TFF seems interesting. At a personal level, I just think that we still have some time to become shareholders of the company once we see that the wine harvests are back at normal levels.

The investment case on TFF is linked to the absence of climatic issues as well as a picking up of the bourbon unit after the heavy investments. The company is solid but it appears that their move in the bourbon business with it’s higher secular growth and not impacted by climate will be a the cost of margins. Nevertheless the company is a leader and a top notch actor.

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Disclaimer: The above article constitutes the authors’ personal views and is for entertainment purposes only. It is not to be construed as financial advice in any shape or form. Please do your own research and seek your own advice from a qualified financial advisor. The authors may from time to time hold positions in the aforementioned stocks consistent with the views and opinions expressed in this article. Disclosure – we do not hold a position in TFF Group at the time of publishing this article (this is a disclosure and NOT A RECOMMENDATION).