From an industry darling to drop out in the space of two years, the Australian winemaker Southcorp has few sympathisers left. David Robertson looks at the repercussions for this falling giant

Less than two years ago Southcorp was the most valuable wine company in the world but the company has taken a battering since then and the sparkling reputation of its managers is in danger of going flat.

The latest bit of bad news was a downgrade last week of 2002-03 earnings before interest, tax and amortization (EBITA). The 15% drop to A$287m is the third downgrade in a year following a profits warning last April and further reduction to A$335m tabled as recently as October.

Southcorp has also been forced to ditch a small-scale North American joint venture that produced the Seven Peaks brand, which will result in a A$29.3m writedown.

It has been a sad fall from grace for Southcorp. Before the A$1.5bn merger of Southcorp and Rosemount in early 2001, Southcorp's share price was around A$5.50 but optimism and confidence in the Rosemount management, which was installed at Southcorp, pushed the share price to A$8.30. It has been downhill ever since.

This time last year the share price was back around A$5.50 dropping to A$4.60 by the end of 2002. The BRL Hardy acquisition by Constellation Brands helped push the stock up to A$5.20 in mid January but the downgrade has since knocked the share price to just A$4.40.

More than A$2bn has been wiped from the company's value in a year and, more damaging in the long term, investors have lost confidence in the once lauded Rosemount management, and chief executive Keith Lambert in particular. So what has gone wrong?

When Lambert took over Southcorp he promised to hack back the sprawling empire cutting 1150 individual products out of the company's total of 2000. He has also axed 300 jobs in the last two years; all moves that have provided cost savings and kept investors happy. Unfortunately these savings have been swallowed by an aggressive expansion plan devised by Lambert to boost market share.

Part of this strategy was to concentrate on the core brands like Penfolds, Lindemans and Rosemount. This has paid dividends with a 21% increase in sales in these key brands in the first half of 2002-03. But this growth, driven by heavy discounting, has come at the expense of profits.

Perhaps the impact of this discounting would have been less severe if it had not coincided with a massive increase in supermarket retail power. In Australia, JP Morgan estimates that Coles and Woolworths, the big two with more than 75% market share, have boosted their liquor share from 29% to 42% in just 12 months.

In the UK, the supermarket wars have squeezed margins even further inflicting a double blow to the bottom line: margins have been cut by the retailers while Southcorp has fallen over itself to give them special deals at the same time. It is becoming clear that this was the wrong strategy at the wrong time.

Sources close to Bob Oatley, the former owner of Rosemount who now has 19% of Southcorp, have already indicated to the Sydney media that Oatley is unhappy about this discounting and it seems likely that Lambert will be reigned in.

Southcorp has also been hammered by a sudden glut in Australian red grapes, which is the product of years of unabated vine planting, although it looks like Southcorp may dodge oversupply costs in 2003 because of a severe drought this [Southern] summer.

Analysts have been fuming ever since early 2002 when it became clear they had over egged the Southcorp/Rosemount/Keith Lambert success story. Some blame Lambert for over promising and under delivering but it is just as fair to blame investors for their post-merger exuberance. But the third downgrade has really angered investors and Lambert could face an uncertain future if the situation does not improve (although this is unlikely to be before 2004).

Merrill Lynch has a "sell" recommendation on the stock and told clients that a 25 to 40% in margins in one year was not possible in a business that was being "competently managed".

"Whether the current management team has the capability to turn around a large and complex company must be in serious question - and surely answered within the next 12 months," the broker warned.

Many in the Australian wine industry will be rubbing their hands with glee at the fires being lit under Lambert's desk. He is often portrayed as a bully who has unnecessarily given the upper hand to the retailers by offering so many discounts; there is little sympathy for him among the smaller winemakers.

Few analysts have anything good to say about Southcorp or the management team either. The previously unimportant issue of Lambert being Oatley's son in law has been raised as a potential worry for independent shareholders. And some institutions are hoping that Oatley will take Southcorp private when the two-year moratorium on buying and selling his shares ends on February 25th.

Southcorp has cost a number of institutions a lot of money - and they blame bad management. If the situation does not improve they will start lobbying for a radical solution: privatisation or a sale. Either way they get rid of a problem stock, and its problematic management team.

But the real legacy of Southcorp's decline will be the power that the retailers have seized as a result of the company's strategies and this could contribute to hundreds of Australian winemakers going to the wall in the next couple of years.