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.

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The Dance of Grape Pricing

 



ABC. It's Easy As 1-2-3

 

The vines flowering this time of year remind me of seventh grade. Maybe its the Aqua-Net hairspray smell the flowers produce but that's when we had our first crack at dancing after school which made institutionally official, our life-long quest to read the minds of the opposite sex. Filing into the sour milk scented cafeteria one sweltering afternoon, the boys took up their station on one wall while the girls occupied the opposite wall. The girls giggled and pointed at us prepubescent pimply-faced males while we in turn stared blankly back across the barren dance floor. "ABC. It's easy as 1-2-3" from The Jackson 5 cranked at volume eleven in the background, so we started to move to the music right where we stood thus signaling in our Cro-Magnon genetic way that we could dance. Well, we could if we wanted to. We just didn't want to. The girls of course had been practicing their dance moves since 3rd grade in front of their full-length closet mirrors. Us boys? We were playing baseball, football, kick-the-can, capture the flag, and tiddlywinks, oblivious to girls - unless you count the observation of cooties.
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If you want to skip my meandering memories from 12 year olds first dance experience, you can skip down To The Point Now.
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Half the Battle is Mental

Standing there with the weight of expectation hanging heavily in the air; those expectations based on the boys leadership, we stood clueless with results likely to meet our poor mental preparation. You see back in the day, boys were the ones that had to ask girls to dance. A girl who asked a boy to dance would be considered a floozie. So growing uncomfortable by the minute with an empty dance floor and rising to the challenge, we each used what we had in our arsenals to solve the problem: our competitive instincts and ability to formulate a plan. We just needed one song we had heard before with a recognizable beat, and we could fake this dancing thing.

We surveyed the other wall for just the right bubblegum smacking female; someone who wasn't too popular or foxy who might decline our invitation, or too unpopular or doggish because you would catch grief from your pals dancing with her, someone at least glancing your way from across the room on occasion signaling a possible positive outcome.

Then the time came. The perfect song would start to play. This was it. You were ready. Now or never. Steeling up our nerves, we started across the empty floor wobbly-legged on a mission feigning some degree of confidence and most importantly looking at the ground, never once looking directly at the girl of your intentions or walking in a direct path toward her lest someone think you actually liked her.

Executing the Plan

In the other side's bivouac, huddled in a close knit circle the girls shouted into each others ears to be heard over the music, all the while pretending they didn't notice a boy flanking their closed group. Then with heart pounding, you saw the feet of girls knowing you had arrived at the target location. Reaching up, you tapped the girl on the shoulder and were greeted with an unpracticed look of surprise. "Oh! ...ugh.... Hi?" Eyes looking up into hers now locked in anticipation of the question, you suddenly come to grips with a massive error in judgment. The girls all looked smaller from across the room! Your eyes were right about the level of her ...um ..... her chest. Turning around and retreating would be an embarrassing option which would be seen as weakness by both sides. You had to move forward with the plan, so the words ebbed forth like molasses trickling from your dry mouth, "Hey! Ugh ...you .. a ... ughhh....  You want to dance?" Leaning forward and down, she screamed back into your ear the most blessed word known by man; "Yes."

Things Not Going to Plan: Adaptation Rules the Day.

You were the man! With your spirits soaring and in charge now, you grab her sweaty palm and tow her to the center of the room. Then, just as you start to assume your pre-imagined, partially squatting dance position, elbows bent, fists clenched, forearms parallel with the floor, and thumbs up in the air ........ the song suddenly ends. Oh crap! A second error in judgment. You took too long to strategize, slowly walk in feigned confidence, and then stumbled on your words. You missed the song that you maybe could dance to.

Now with the room in silence except for the buzz of gossip coming from the walls, a bead of sweat trickles down your temple. Adaptation is required. Entirely off the plan now, luck intervened when the girl said, "Let's just do the next song...if you want."

Relieved but apprehensive as the scratchy sounds of the needle are heard seeking the groove on the next 45, you tilt your head down and sideways to hear the beat of the new song, your nose unintentionally directed toward your armpit. You realize that you smell like you haven't showered in a week, even if you did shower last week. And then the roof collapses on you as you hear strings. It can't be but  .......  OH MY GAWD! It's a slow song!

You both stare at each other wide-eyed in fear. You are both going to have to go through with it and hold each other. Cautiously you place your hands on her hips while she reaches out to rest her elbows on your shoulders. Staring into her eyes, you try a couple moves and the next thing you know your face comes in contact with her .... um .... her chest, and she's actually wearing a bra! She's no girl! She's a woman and you are touching her! For the first time in your life, you really wished you'd showered and listened to your sister when she said you needed deodorant.

Well that's what someone told me happened back then. That never happened to me of course but it does remind me of the dance that starts about this time of year on crop size and grape price.

To The Point Now

This is the point in the year when growers line up on one side of the dance and talk about how small the crop is going to be so price is going to have to go up. On the other side of the room are the producers who talk about how big the crop will be and steel their nerves and make decisions about their needs for harvest. Should we lock in now or wait until we hear the song start at harvest? Will price go up or can I take advantage of a big year and get some low-priced juice?

Talking to one of my readers and winery clients this past week, I heard something for the second time this spring: Early estimates of crop size portend another large crop. While not impossible, to think that we will get another record year like last year - back to back ... it would be about as unusual as a girl agreeing to dance with me in the seventh grade. 

Before we can really get a handle on what might happen to price, you first have to have an idea of what is happening with producers and their supply to determine their appetite for grapes. Are they selling their wine?

In the SVB Wine Industry Report released in January, we predicted the year was going to start off slow from the perspective of GDP. Growth trends in wine sales had been dropping for 3 years running and the Fiscal Cliff wasn't making the investment environment any less risky. We predicted getting pricing increases early in the year would be difficult and we said the second half of 2013 should see improving trends as the economy benefited from the middle class joining in the recovery.

We're we right? Early returns on wine sales this year demonstrate that the first quarter was slightly better than we'd guessed and sales growth was tepid but positive. The economy is doing slightly better than expected too and pricing increases have been taken in modest amounts, reflected more by reductions in promotional allowances. From that we can intuit, as we predicted there is only limited pricing power in the hands of producers so supply is at least in balance and not long.



Steve Fredricks, Turrentine Brokerage

Talking Friday to a wine broker who will go unnamed, I got a few pieces to the puzzle regarding bulk supplies. I'm told that the juice that's been sitting in tanks from the large harvest has been moving along at a steady pace. Asking his view of expected harvest yields, he offered the view that I share as well at this stage: no matter how many clusters per shoot people see, it really is just too early to extrapolate anything from that.

Last year there were fewer clusters than people are seeing today and we still ended up with a record harvest. To get there, we needed perfect conditions through the entire season in all appellations. This season we are three to four weeks ahead of normal due to a warm spring and lack of rain. Conditions could be perfect, and then again we might get a rain in July. Last year we were also coming off some weak harvests and needed crop, so farmers tried to hang more tonnage. This year coming off a large crop, farmers who farm for above average volume could be in for a surprise at harvest if yield comes in as large as last year. Farmers should be hedging their bets this year with that knowledge and only look at specific varietals like chardonnay and high-value cabernet as places more likely to find spot buyers. From the perspective of this unnamed broker and my opinion as well, anyone betting on a second massive crop while possible, is making a bad bet.



Coming Together 

Managing grape supply is like the dance. Growers and wineries line up on opposite walls and try to read the minds of each other in addition to the consumer, but all send mixed and lagging messages.

Half the battle is mental. You need a plan. The plan should include measures of long term control of your most important grape supplies, and those should be intertwined with a strategy that hedges the lengths of grower contracts so they don't expire at the same time and thus create wide variability in your inventory cost.

You want to be an important partner. Surveying the other wall, don't get into a place where you are a minor player and more easily declined when market conditions change. Growers want a balance in customers as well. They don't want a scillion people running through their vineyards trying to control cultural practices by row.

Execute in a defined way on the grape plan and don't be prone to following the gossip coming from the walls. Talk to people without a bias who have supply and pricing knowledge like unnamed grape brokers, or maybe your favorite wine banker who's in therapy still over his seventh grade dance experiences.

Be prepared when plans go awry. When the music stops suddenly and your plan is crushed, do you have a backup strategy? Where can you get more grapes and where do you have relationships that allow you to adjust a contract if necessary? In any business but particularly the wine business, make sure you have the capital and a banking relationship that allows you to survive those unexpected changes. Especially today if you are struggling even a little with cash flow in this interest rate environment, think about the level of debt you possess and what that interest expense will look like with normalized rates. Short-term rates are going to increase in the next 18 months.

Finally be creative and remain positive. Some of the best marketing plans and products were developed when the plan didn't pan out. So when you end up with lemons, figure out creative solutions to adjust. We talk to our clients constantly about creative options. Its what we do for a living. Recognize even when you get stuck dancing with someone who has their chest in your face, there are always positives behind every dark cloud.

Sorry for the long post. I hope it was at least entertaining. It was theraputic for me.

What do you think?

• Where will the harvest come in with yield this year?
• What are early indications in your AVA with crop? 
• Are you seeing additional plantings to support growing demand?
• What is happening to the price of grapes in your market?
• How are sales of bulk wine? Can you find what you need at the right price? 

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