The Highest Return on Your Time Invested

Each year I get to write a State of the Industry report that's pretty well received in the wine business. Its even used as part of the curriculum in several U.S. Colleges and Universities which my mom thinks is really cool. She thinks I should be given an honorary PhD by one of the Universities but I haven't been able to donate enough money to a place of higher learning so as to receive that kind of recognition. Der Weinerschnitzel is considering offering me a fellowship, but thats still in early discussions.

Anyway ... this year we will be releasing the 2014 Annual Wine Industry Report in January. Before I can write the report, there's a lot of research that has to be done. That process starts with the Annual Wine Conditions Survey. The survey gets us very interesting observations such as the chart to the left that shows Millennials really don't move the needle on fine wine purchases, but Gen X'ers do. 

Or how about the one one at the top of this piece that showed the wineries themselves thought that they could take some small price increases during this past year. Of course that doesn't mean prices would increase because its just the additive opinion of over 450 wineries, and in fact we predicted price increases would be hard to come by in 2013, and they were. What it does tell you is the market participants intentions, and that has to be a factor in considering predictions. 

I would like to ask your winery to participate in the 2014 Wine Conditions Survey. It takes less than 10 minutes. The survey opened last Friday and was sent to 5,000 wineries throughout the US with very good initial participation thus far. There are just 15 survey questions, 4 of which are identifiers such as the region where you produce wine. The remaining 11 core survey questions are geared at understanding vintners' challenges in the present operating environment. We condense the results and those comments then return results, charts, and detail in a non-identifiable manner so winery owners and operators can get a better feeling for what your peers see.  To get a better sense of what you get for your participation, here is a link to what we delivered last year: [LINK]. 

Many of the AVA's encourage their memberships to participate since they receive their own gratis bench marking reports. You might see an email in the next few days from your own association so don't think we are spamming you. If you are on the mailing list, you will get one 'last chance reminder' from us and that's it. We never add people to mailing lists, and never use the survey as a tool for marketing.

 

While the survey is a Nationwide one, our East Coast brethren and sistern in the business haven't been quite as active as I'd like, so this year we are reaching out to some new AVA's particularly in NY and VA and hoping for a better sample from which we can deliver better regional bench marking. If you are able to help your AVA along those lines, we would appreciate it if you directed them my way.

The 2014 survey will be open through the end of business Friday, November 8th. If you would like to participate this year and receive the free results, you can do so by starting here: [LINK]

If you would like to permanently add your winery to the list for the survey and our State of the Industry publication that follows, please email me at rmcmillan@svb.com.

Feel free to offer any other thoughts you might have in the comments section which follows.

Grape Prices are Heading Lower.

Total Wine Sales Continue to Move Higher

About six weeks ago I was asked to speak about the economy, the environment for the US wine consumer, and the fine wine business. The meeting was part of a management retreat for a large wine company and included an acquaintance of mine who we will call "Deep Gullet." It included many of the distributor partners of the company as well so there was quite a wide perspective on the business. This wasn't a client of mine and never will be, but I took the invitation because I thought I might learn something from Deep Gullet and the other presenters. I did and came away with two important perspectives:

1. The small 2011 vintage was really difficult for fine wine distributors. Allocations were more the norm for their retail accounts because there just wasn't enough wine produced.
2. Attempting to increase bottle pricing - even in an allocated environment has been like pushing a wet string up the hill.

Overwhelmingly everyone believed 2012 was going to be a lot better from a supply perspective given the large and record harvest, so the allocation issue was probably temporary. The second issue however was about the consumer and that didn't seem to be going away. That got me wondering again about the popular press reports on supply shortages.

In the 2013 Annual State of the Wine Industry Report released in January of this year, I predicted that we were going to see a soft first half of the year economically, but an improved second half. You can read the report if you want to check my thinking. We predicted a 4th consecutive year of lower sales growth in fine wine; something between 4%-8%. It's still growth but growth has been slowing for some time. 

At this stage, we appear to be tracking well to the overall growth estimate but will have to wait to see sales results for Oct-Dec to see if we were correct in our annual prediction. After exchanging some G2 with Deep Gullet we discovered we were of the same belief: What is clear at this point is while wine consumption continues to increase in volume as seen in the lead chart, GDP is stalling and the middle class aren't able to fully participate. Yes .... Americans like wine and are drinking more in volume, but they aren't paying more in price to support winery production cost increases. The following chart is really descriptive of that point.
 

Source: Nielsen Beverage Group

My friend Danny Brager from Nielsen presented the chart to the right recently at a conference in which he was speaking. While all F&B categories are up 1.7% in price on average, wine is only up 0.20%. Consumers aren't accepting price increases for wine or spirits for that matter. The economy isn't supporting price growth and inflation seems to be well in check. I'll spare you the in-depth analysis of what's happening in the country that's holding back economic growth but here are some high-level bullets:

1. Housing has indeed recovered most of its value now which is a huge help to the middle class... should lead to a bit of a wealth effect and release pent up demand in sectors, and allow more movement between jobs in different regions. That should have helped support a better second half of the year as I'd thought, but now I have my doubts because of higher interest rates and Sequestration 2.
2. Youth unemployment rates are still very high in the main industrial countries of the world (Yes Virginia, the Millennials aren't reading the press about how they are driving growth in wine sales. They are a big cohort but have no income.)
3. Boomers are hitting retirement age. They drove the growth in wine since the middle 90's so that is a big accelerating headwind in the face of fine wine purchasing.
4. The wealth gap is widening. The wealthiest Americans have recovered their pre-crash wealth and are spending. The middle class while improving off the bottom, need real work to spend and while the unemployment rate continues to decline, the US labor force is shrinking. There are fewer people working than before even if the unemployment rate is falling.
5. The Fed announced last week they were postponing tapering. While the markets loved it, the reality is we are careening to another 'fiscal cliff' on funding and proving the S&P upgrade of the US credit rating earlier in the year might have been premature. What the announcement means is the economy isn't doing as well as the Fed would like and they are going to keep throwing economic crack at the market until they are a little more certain there is a recovery. In the meantime however, the long bond in the US has gone up dramatically since May and that means the middle class is less able to afford the houses to which they were aspiring. We see that in the sharp decline in new mortgages application rates.

Now move to grape and wine prices over the past 2 years. With most predicting a grape shortage by April/May of 2012, growers began to recover pricing that had been depressed since the recession started. Then we had the 4MM ton harvest of 2012 and the shortage - to the extent there was one, went away. Since non-bearing acres are so low and planting stagnated in the last decade - not even keeping up with vine replacement, most wineries looked through the heavy 2102 crop and still were willing to pay higher prices this year. With the the 2013 harvest now well under way, tanks are full and there is still a lot of bulk wine for sale. It looks like the harvest is coming in large once again. 

Prices Have been Dropping as Volume of Bulk Increased

So where does that leave us with grape prices? Add it up:

• Current 2012 Bulk Prices are flat to trending down
• The economy is not seeing the growth I'd hoped for in the back half of the year.
• Consumers haven't been willing to pay more for wine and based on the recovery sluggishness, I can't see them willing to pay more going into the holidays or even 2014 at this point.
• Producers have been paying more for grapes and getting their margins squeezed because the costs can't be passed on. 
• Supply isn't short for wine right now, and it looks like we'll have two back to back large harvests.

That leaves me and Deep Gullet to believe we won't see new grape contract price increases in 2014. Taking all the factors that impact price into consideration, the only question at this point is longer term supply. Are there enough acres planted? Should grape buyers look through the the large 2013 harvest again and view 2014 as likely short? If some of the higher tonnage of the past 2 years is a result of changed farming practices - and there is that possibility - we may not be as short, even in the long term as many have predicted. In the meanwhile while we ponder the balance of grape supply and demand, there are plantings taking place.

My conclusion is all things held equal, at the end of the 2013 harvest we should see downward pressure on grape pricing.

What do you think? Please share this piece in your favorite social media app, and log in to share your views with the community. The wine world wants to know what you think!

Wine Sales In the Last Half of 2013

The Best View of the Housing Bubble Pre-Crash

I recall giving a speech in August of 2008 to about 125 growers and winery owners. The speech was on the economy and I pulled up the slide above to demonstrate what I was seeing ahead of us. This was at a time just after Lehman Brothers collapsed where it had become apparent that we had crested a market high in housing and entering a bearish period. What the chart says in brief, is the historical average ratio of existing home price divided by median 4 family income is 2.8 times. That's what the red line is. With a ratio of 2.8 times, if a family made $100,000 a year, they could afford a $280,000 home. You can see what happened by late 2006 into 2007.

We are taught in school that in economics, measures have a tendency to revert to the mean. But talking heads everywhere were suggesting back then that what we were experiencing was a normal correction. Maybe, but the chart above along with some other indicators told me otherwise and I suggested we were about ready for a nasty correction and reversion back to the mean, and that correction was going to be huge and take years based on the slope of that line. 

If that weren't enough, I also suggested the growth rate in wine would fall to flat (zero percent) growth. I really thought there was a strong chance wine sales growth could go into negative territory for the first time in memory - but predicting that would get me permanently banned from the Economic Optimists Union so I fudged up a little on the forecast. I was actually being optimistic on what was ahead for us, but people didn't hear it that way. My speaking invites started falling like the stock market. I've never been invited back to speak in front of that Grower Association again. From all sides the message was, "If you don't have good news to report, then we'll find someone who can." Well, OK then, go ahead and listen to your excessively optimistic speakers and see if I care. My dog still likes me and my mom still ...... well ...... my dog still likes me anyway.
 

"The housing correction poses the biggest risk to our economy. Our economy and our markets will not recover until the bulk of this housing correction is behind us." Treasury Secretary Henry Paulson, 11/12/2008

This video was what we saw just months after the speech I made noted above. It was pretty stinking gloomy. The stock market was in the crapper and home prices crashed. With speed never before seen and perhaps treading on Constitutional Authority, the Government and Secretary of the Treasury Hank Paulson started to make investments in the Banks through the TARP program and several other initiatives. Ben Bernanke started to throw money at the financial system and economy. The banking system and Detroit were stabilized. But with the markets dragging bottom and hundreds of billions of dollars being thrown at US industry, the average voter started asking the question, "When do we get a bail out?" The answer came soon enough though most of America missed the memo when Fannie and Freddie were put into conservatorship to protect the US mortgage market from vanishing, causing a free-fall in house prices.

So where are we today? Fannie is actually starting to repay the bailout money (Self serving note: the Bank bailout through TARP was paid back with a sizable profit to tax-payers thanks to the strings Paulson put on that Bailout.) Of course Detroit is now going Bankrupt, but the American Auto Industry was able to rationalize their insane Union compensation plans, and has a chance to pay back a large part of that bailout, if not all of it .... well most of it anyway. The economy isn't healed but the most recent Case-Shiller Index had this happy news last week:

"As of May 2013, average home prices across the United States are back to their spring 2004 levels. Measured from their June/July 2006 peaks, the peak-to-current decline is approximately 24 to 25 percent. The recovery from the March 2012 lows is 16.5 percent for the 20-city index."

Essentially the news is, housing prices are back! In the Bay Area consumers even see an overheated market again with multiple offers and short listing periods. So I was wondering now ...... just where is the recovery in terms of the measures in the chart at the top of this page? My speech back then said that we had to revert to the mean. Paulson said we wouldn't see the economy and markets recover until we had the bulk of the housing correction behind us. Did we get there? The current information out there suggests we have reverted to the mean and are now showing home values at 2.85 times median income. Of course the bad news in that is we will likely see growth in home prices slow now due to investors cashing out and more of the average mortgage payment going to interest, thus reducing the amount of house a person can afford. Being an optimist, we are at least not looking at another bubble. Housing growth will take place as median incomes rise.

Consumer Comfort Index at 5 year high

Don't get me wrong. There is a lot to do still to heal housing and the mortgage business. Banks aren't able to make home loans anymore and sell them as packaged securities. Prior to the crash, that was half of all new bank lending. Now it's 0%. Banks now have to keep the loans on their books or sell them to Fannie or Freddie for the present. While its nice to know they are starting to turn the corner, last week President Obama outlined plans for the wind-down of the Governments involvement in those institutions. Having just gone through qualifying for a home loan, I can tell you first hand that the mortgage business is dramatically different than it was.

In the SVB State of the Wine Industry Report released in January, we predicted bumpy going in the first half of the year and an upturn in the back half with average fine wine sales growth in the 4% - 8% range. While there are still plenty of variables out there that can throw that forecast off, I think at this stage with the good news in housing and retail sales hanging in still, its remains a good forecast.

The middle class consumer is showing resilience, housing is now below 6 months of inventory which typically signals a short market, and the Fed is talking about ways to slow their bond purchases in response to what seems like a healing economy. We have a lot to look forward to in the last half of the year, and I'm hoping my pre-recession gloomy speeches will be forgiven by the organizers in hindsight, and maybe my phone will ring again since I have happy news to report? Oh well  ..... at least my dog loves me.

What do you think? Where is the last half of the year headed? Are we going to hit my sales forecast for fine wine this year? What about the mortgage and housing markets? Are they going to stall or improve? There are lots of moving parts but please log in and offer your perspective for the community.

Mid-Year State of the Wine Business

There are several thingies (......that's a technical economic term) that are happening right now that all link together in some form to drive components and the present direction in the wine business. Since this is a blog though, and blogs are generally top of mind and brief, discussing the state of anything is going to either violate the Constitution of the Blogosphere or the tenants of mildly meaningful research. Instead, I'm going to leave out a pantload (......that's another technical economic term) ... of discussion topics such as demand for wine, and go with the top 4 thingies worth pondering at this point in the year.

• The first thingy is water. There isn't any as the video above portrays. That's not good. And it's not just  a Central Valley thingy. This water thingy is running throughout the Ag. and wine industry and will only get worse.
• Second is the heat wave from the past week. Early discussions suggest the heat will reduce expected crop size by 10% plus or minus due to sunburn from the recent record heatwave. A related issue vis-à-vis supply is the size of the world harvest in the Southern Hemisphere.
• Third is rising interest rates. That does all kinds of thingies to the wine business.
• Fourth: the world is shrinking and so is the market share for US produced wine.

Even Edyie Gorme Knows it

Let's start with the last point. In May I saw an article in the Modesto Bee that said Gallo is launching a wine with juice from four continents. Because of the interwebs and the increased speed of communication the world keeps getting smaller every day and that continues a decade long impact on wine making and wine sales. It wasn't that long ago getting bulk wine from foreign sources wasn't really possible in any measure. We tried that in the late 90's when we were really short winegrapes but it didn't really take off. In fact it probably set Chile's reputation in the USA back a decade. Today, the issue is more price instead of grape supply. When the big guys can save a penny, they pick up a phone and buy juice like it was crude oil, and have it shipped in to fill supply gaps and lower the overall cost of varietal blends. It hits the dock, and the next day its in the tanks for blending and bottling. Back in the day, that would have been wine that was produced from the Central Valley.

I'm Channeling Milton Friedman ........

Rising interest rates. I recently wrote in this Blog about the Feds actions signaling the end of quantitative easing and what that means for the wine business. Never in the history of the world has there been such a coordinated effort by the worlds Central Banks to pump in liquidity and try to stop world economies from falling into a global slide. That said, each of the Central Banks have also been operating in self-interest too. Its just their interests seemed to have all aligned over the past 5 years. So what happens when self-interest at the Central Bank level diverges? We end up with uncoordinated policy leading to surprises and lots of finger pointing from other countries who don't agree with a sovereign country's approach to manipulating their currency to their own benefit.

What is clear at present is the US Economy is ahead of world economies in recovering. As our domestic interest rates rise, foreign currencies depreciate unless they increase their own rate structures to attract capital inflows. If they don't they lose in the carry trade translation. The expectation in Europe should be to do nothing and let their currency sink versus the dollar so their exports to the US have a rate advantage. But there are many who expect to see European rates rise "in sympathy." I'm doubting that as of this writing. My guess today is we see the US dollar strengthen across a basket of currencies leading to cheaper imports overall, and that keeps our purchasing power up at the consumer level, and inflation contained. The problem, is a strengthening dollar equals cheaper wine imports, for both bottled and bulk wine.

My Akward First Dance

The heat wave is part of a larger discussion on grape supply. Its hard to get a firm grasp on where that is. We took an stab at that subject earlier in the year in this Blog. The upshot in that post .... after treating my readers to intimate details of my first dance in 7th grade, is that growers and producers have different interests and benefit from fanning the flames of over or under supply. Once we get into late July though, the picture starts to become a little more clear and pure speculation starts to give way to partial reality. We wrote about that very thing last year when we asked, "Is there really a grape shortage?"  When we wrote that, the early year consensus was we were short on grapes, but the pre-harvest read last year suggested something else was going to happen and we ended with a record crop. This year the discussion of a large crop has dominated the early discussion, and at the same time growers have been holding out for higher prices and getting them early in the season. That doesn't make sense from a current year perspective if we are long again this year. But there are two parts to the grape and bulk business, the current outlook and the long-term trend.

Turrentine Bulk Volumes

The growers are looking at the long term position which is trending to shortage or is already short in many price points and varietals. The short term trend in grapes is a little different. The recent heat wave it appears has had an impact on many growing areas and crop losses have been discussed in the 10%-15% range in many circles. Also worth considering is tanks are still brimming after the record 2012 harvest and producers aren't really forced to fill short term needs today. More likely they will want to make sure they have tank space and sell down some of their excess wines creating an odd collision of a longer current bulk market, and a shorter long term market. As an aside, recent press out of Argentina and Australia suggest good harvests, some of which will be certain to hit our shores. That also has to play into the discussion. What I take away is the current grape supply is surprisingly a little long, but the long term supply is going to be short.

Drought might be a crack in California's Recovery

Last thing to note is water. Water is something (....not a thingy in this case) that gets plenty of discussion in the San Joaquin as noted in the above video. The farmers there almost never get more than 50% of their allocation anymore and have salt issues to deal with from ocean intrusion into the Bay. The Federal Government knew about the drainage problem when they put the Federal Water Project together but they never did anything about it and still aren't - unless you count Governor Moonbeam's Peripheral Canal II attempt as a Federal plan. In any case, it does bring in the specter of Climate Change which we covered in a earlier blog titled Bovine Excrement & Global Warming (are you getting tired of the gratuitous hyping of my blog yet?) ..... anyway, the bottom line is whether you are a believer in climate change or not, you have to believe we are experiencing interesting weather and can't help but recognize that we live in an arid state that has increasing demands from population expansion and increasing legislation surrounding water use. That factor is increasing in importance each year and will have an impact on domestic supply.

The Ghosts from Italian Swiss Colony say...

So ........ all that said, where are we mid-year?

• It looks like harvest is trending to be normal to maybe slightly above normal.
• Long term supply is going to be short with normal harvests in the next few years.
• World supply seems enhanced by good harvests in the Southern Hemisphere.
• Rising interest rates will strengthen the US currencies leading to cheaper imports which does have an impact on our wine growing brothers and sisters in the Central Valley in particular, especially when water - or the lack of it cuts into supply, and the damage from the just passed heat wave is factored in to the equation.
• Grape supply and juice seems adequate if not a taste long for now based on last year's harvest and and expected average to above average return this year, but still should be short-ish going out for the next few years.
• There is every reason to believe imports will continue to get a larger share of the US consumer dollar.

Its a lot to cover for a blog and I know that I'm hanging on a thread by bloviating on a blog but that was pithy and doesn't begin to really cover all that is going on in this wonderful business in which we work. We will have a more complete view after doing our annual Wine Conditions Survey in October this year. We hope you will participate in that effort.

Please ping me if you want to participate in the annual Wine Conditions survey. We normally have between 500 - 700 wineries participate in exchange for the consolidated results.

So ... what are your views at mid-year? Please sign in (with a name please or a pseudo-name if you prefer), and share your own thoughts with the forum about what you are seeing at this point in the season, what you find of interest or any thingy you think I have wrong.