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.

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.

What Does the End of QE Mean for Wine?

Everyone likes Fridays. This Friday is a little more special so I decided to post a non-Sunday blog for the first time. Why the deviation? Because Friday is the day we receive the most hours of sunlight in 24 hours .... and then its all downhill after that.

While that sounds a little gloomy phrased up that way, consider that its coming from someone who has been following and predicting the movements in the economy and wine business the past few years. Its been enough to make anyone gloomy especially since I've been consistently right. (Editors note: Please don't wake me and remind me of a forecast that was wrong. Thank you.)

Anyway, something happened yesterday that is making me put on economic sunglasses to protect my eyes: The Fed announced the economy is looking pretty darned good, inflation is in check, and unemployment is coming down to manageable levels. Add to that the US Credit Rating was raised back to AAA about 10 days ago and that is down right exciting right? What did the markets do? The Dow dropped 200+ points and the 10 year Treasury Bill rose 13 basis points. In fact the 10 year, which is the benchmark used for vineyard and acquisition financing has increased about 40 basis points since May. So what gives? If this is good news why is the market off and what does that mean for the wine business?


In conjunction with the other good news, the Fed announced they were going to pull the monetary sucker out of the Market's mouth of the toddler-like economic recovery, and targeted an end to their Quantitative Easing program starting early in 2014 and ending mid-year. The market has been feasting on cheap money for a long time and the announcement and timing was just a little more firm than many suspected, putting a damper on the investors mood.

 

Along with the announcement, the US dollar strengthened because there is now a higher return realized from investing in US$. In addition, the dollar also gained strength because the announcement demonstrated the US is not like Japan and won't be forever in a weak growth environment. A stronger dollar will mean we should see cheaper imports and that's a risk in a business that is running at balance to short in grapes and juice.

The announcement also signals an end to a cycle that has led to the lowest rates in the history of the US, and created a refinance stampede from wineries and vineyards in the past couple years. While the short term rates are for the present still low, the long end of the yield curve is trending up as noted to the left, and rates should continue to go higher based on this announcement. At some point in the next 24 months, it appears we are likely to see the short end of the rate curve start to rise as well.

 

Higher long term interest rates normally mean stabilized land values as higher interest costs mean larger property payments and a property can only produce so much in the way of cash flow so that lowers the sales price of land. In the case of vineyards, that may or may not prove out because the supply of vineyards is also lowish, and there has been a rush by many in the business to acquire new producing vineyards to support their programs driving land values higher. If this signals higher consumption levels, wineries will be looking for even more land. That's a long discussion and will have to wait for another Sunday.

 

The good news in all of this is the US Consumer is indeed making headway coming back and our economy is leading the World in showing recovery. Employed and confident consumers buy more wine, and higher priced wine. Higher bottle pricing will be needed if the wineries are going to be able to pass on the higher price of grapes that growers have been taking during the first half of this year. Consumers aren't quite there yet in being willing to spend more on wine but hopefully we will see that soon. That too is a blog post for another day.

 

Bottom line is the consumer is coming back so we might start spending our way back to prosperity .... which has always amused me ... that we can eat our way to prosperity, consume the worlds goods and be the envy of most other countries in the process. Doesn't that seem unnatural in some economic Darwinian way?

Back on point, this announcement signals rate increases will be coming. A 6% prime rate isn't that unusual. What happens to your winery's profitability if we see short term rates go up 3.00% in the next couple years at the same time consumers demand is growing and imports are cheaper?
 

Hopefully you've already locked in your capital and rate structure and got your piece of the cheap long term real estate money Ben Bernanke has been handing out, so your business wont be subject to a cycle of growth financed by higher priced debt in a margin strained wine industry.

 

Its a lot to digest and this barely touches the subject on the business and the changes we are going to see in this next cycle. For now I'd suggest you enjoy Friday because its all down hill after that ........... ( I'm talking about the hours of sunlight of course .....)

 

What do you think about the Feds announcement? Please sign in and offer your thoughts.

How Much Do Wineries Really Make?

Our most popular post from last year is brought current with the 2012 financial information. The question at hand is: "How much do wineries really make?

The answer of course is ......(drum roll please ....) Not enough. Finding the facts is almost as hard as chasing unicorns in this business because the wine business is private. Its a family owned industry with even the largest; Gallo a family owned company. But its really quite amazing from the perspective of what is shared between neighbors in the wine business. There isn't the sense that your neighbor is a rival or competitor. Its more of a club feel in many ways. If you need something, its quite normal to check in with your neighbor. Need a tractor because yours went kerput? No problemo. Need a little welding and custom fabrication on a pump? I'll be right over with a welding rig.

There is a competitive side that abounds in the business too of course. When it comes to sharing financial information and customer lists, good luck! Ask a winemaker neighbor how its going financially, and you'll get a mixture of liars dice, false bravado, partial truths and ..... well ..... the following video is the best explanation of how that game is played.......

It's no wonder our winery and vineyard clients at Silicon Valley Bank are drawn to our Benchmarking Database. Its not a guess or inflated bravado. The data in the set are composed of  thousands of reviewed and audited financial statements and they go back to 1990. We can group peers by region, varietals produced, business model and many other factors. You might be able to fool your neighbor on your cost of goods sold per case, or make a little white lie on your growth rate last year but as a banker, we get the real information so we are a little harder to fool. Our clients get free access to the averages and information produced, so they benefit by sharing. That kind of data doesn't exist anywhere else.

So back to the title question: How much do wineries really make? 6.9% pretax at the 2012 year end. That's a lot less than dreamy consumers imagine.

This chart is one that I present each year in the State of the Industry Report and use in most of my speeches. (You can see a larger view with by clicking on it.) Its a summation of the financial performance of the wine business since the 2004 calendar year. The tan-ish bars represent gross margin (sales minus the cost of sales), and the darker line is pretax profit. The lighter line is industry sales growth. You can back into total operating expenses as an expense if you are interested, by adding pretax profit and gross margin, and subtracting the sum from 100%.

What you notice from the chart is gross margin is far from consistent. Even if grape sales were constant, trade discounts and pricing opportunity will vary year to year changing the gross margin. But the reality is purchased grapes run through cycles and estate wineries have higher and lower costs of goods based on farming costs and yield. As you can see though, gross margin and then profit do move in waves.

What's happening right now? We are seeing producers starting into an era in which their gross margins are and will be squeezed. You can see the impact of price discounts from 2007 to 2009 where we found bottom out of the recession. Then in 2010 and 2011 we saw improved conditions as grape costs fell off their pre-crash levels and . Today we are experiencing the higher costs of light yields in 2010 and 2011 which in 2012 were offset by reigning in promotions and discounts.

In 2013, we will start to see the higher grape costs from 2012 entering the income statements. Those costs aren't fully passed on to the consumer which means those pre-tax profit margins you see are likely to fall a bit in the next several years, at least on average.

There will always be some neighbors who do better than others. I'll bet our imaginary neighbor didn't know what was happening with the industry benchmarks .... or did he?

This is the appropriate time to add .... the preceding "film" contains statements and opinions which are fictional in nature. Any similarities to real people or wineries are purely coincidental and unintentional. And besides, no winery owner I know would be caught dead in that red sweatsuit looking like they were wearing a diaper. I've never met anyone like that.

Anyway - those are the facts on winery profitability and the bottom line. Wineries are being squeezed and in our opinion are likely to see more of that in the near term being unable to pass pricing increases to consumers. Economically, we may start to see improvement in the back half of 2013 and that may help somewhat.

Those are our thoughts. Feel free to weigh-in and offer your thoughts and comments below.