Silicon Valley Bank 2015 State of the Wine Industry Report

By Rob McMillan Executive Vice President & Founder, Silicon Valley Bank Wine Division707.967.1367 [email protected]

State of the Wine Industry 2015

Wine report

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17 Predictions:

Looking back, moving forward

8 2014:Ourpredictionsinreview

12 2015:Ourviewonwhat’snext

216 Demand forecast:

Up and to the right19 Shiftsinoilproduction

favortheU.S.consumer

23 AstrongerU.S.dollarmeanscheaperimports

24 Interestratesarelikelytorise

25 U.S.consumersshowconfidenceintheeconomy

26 U.S.employmentoutlookriseswiththetide

28 TheMillennialshaven’ttakenoverjustyet

332 Supply:

New challenges impact planting and pricing

34 Supplyandconsumptionshiftworldwide

37 RecordyieldscontinueontheU.S.WestCoast

442 Bottle pricing:

Highs move higher and lows trend down

547 Financial

performance: 2015 looks like a breakout year

Table of contents

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Come along with us as we explore how economic factors, increased demand, record yields and pricing opportunities are setting the stage for one of the better years the industry has seen in a decade.

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The2000filmstarsTomHanks1asChuckNoland,aFedExexecutivewhoaskstheloveofhislifetomarryhimandthengoesdowninaplanecrashintheSouthPacific.Hesurvivesthecrash,washesuponadesertedislandandlearnstoliveoffwhateverthetidewashesin.

He’sdesperate,butresourceful—heevencreatesanimaginaryfriendoutofavolleyball,whichhenamesWilson.Afterbeingstrandedformorethanfouryears,Chuckfinallymakeshisescape.Butwhenhereturnstocivilization,hefindsthathisfiancée—alongwiththerestoftheworld—hasmovedon.

Afterthemarketcrashweallexperienced—whichwasn’tanywalkonthebeach—theeconomyandthewinebusinessarenowreturningtoaboutwherewewerebeforethecrashinmanyways.But,likeChuck,we’refindingthatnoteverythingisasweleftit.

Thingshaveindeedchanged,andthere’snothingwecandoaboutthat.Weneedtoberesourcefulandstayfocusedonournextmove,justlikeChuck.Thequestionis:Doyouseethenewdayinaclearlight?Ifyoudo,howwillyounavigatetosuccessinthisevolvedworld?

Inthisreport,SiliconValleyBankgivesyouacompass.Basedonourextensiveexpertiseanddeeprelationshipsinthewineindustry,weasseswheretheindustryfindsitselftoday,andofferourviewonwhereit’sgoingin2015.

Don’t tell anyone, but I love movies that tug at the heartstrings. I guess I’m just one of those guys

who likes tractor pulls and walks on the beach. That’s probably why one of my favorite films is Cast Away, the symbolic backdrop for this year’s State of the Wine Industry report.

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Predictions: Looking back, moving forward

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2014: Our predictions in review

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State of the Wine Industry 2015 | Predictions: Looking back, moving forward

WhenChuckNolandrealizeshe’sstranded,heconsidersjumpingoffacliff.Butfirst,hesetsupatesttodetermineifitwillwork.Itdidn’t,andwhenhelookedbackonhisexperiment,hesaid,“Itwaswhat,ayearago?Solet’sjustforgetit.”

ItwouldbegreatifwehadawaytotestourbeliefsbeforejumpingofftheproverbialcliffasChucktriedtodo,especiallythisyearaswemakeeconomiccallsonoil,interestratesandcurrencies,whicharenormallysuckers’bets.Trackingallthecomponentsthatimpactthewinebusinessandeconomy,thenforecastingoutayearisahugechallenge,butweknowithelpsourclientsplantheircoursefortheyeartocome.

Beforewelookforwardto2015,let’sputthepastbehindusandreviewthepredictionswemadeinour2014report.

When we create this report each year, we begin with a fundamental understanding of consumer demand versus current supply. It sounds simple enough, but the surrounding business conditions continue to evolve each year right along with the consumer and the economy.

Global and U.S. economic factors• Wecontinueinaperiodofdomesticeconomic

stagnationthatshouldresetourviewofgrowthopportunities,businessreturnsandpricesforyearstocome.Othereconomicpredictions:

– Short-termandlong-terminterestrateswillcontinuetobeverylowandstableforthenext12monthsandprobablylonger.

– Oilpricesareanunknownatthispoint,butwiththeUnitedStatesnowleadingtheworldinproduction,lowerpricesatthepumparehelpingwithmiddle-classrecovery.

– UncertaintyfromWashington’sinabilitytodevelopabudgethasbeentemporarilyliftedasoftheendof2013,butthedebtceilingdebateloomsforFebruaryorMarchof2014withoutaccountingmaneuvering.

– TheFedwillreducebondpurchasesbutretainanaccommodativepolicyfor2014atleastasemploymentlevels—particularlytheparticipationrate—areviewedwithgreaterfocus.

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– Consumercreditisnotgrowingsubstantiallyandprobablywon’t,basedonincreasedregulationandmorecautiononthepartofborrowers.

• AfterayearofgrowthinU.S.GDPin2013,weexpect2014tomoderateonaquarter-to-quarterbasis,butshowbetteryear-over-yearresultsattheendof2014.

• TheeurowilllagtheU.S.recovery,andthecurrencywillweakenasquantitativeeasingslowsintheUnitedStates,leavinganopportunityformorebottledimportsandadditionalpricingcompetitionfromoffshore.

Supply• In2013,wesawasecondconsecutiveharvest

ofexcellentqualityandyieldacrossmostappellations.

• HarvestontheWestCoastwasagainlargethroughallthreestates.InCalifornia,weareestimating3.94milliontons,makingitthesecondlargestharvestonrecord.

• Inventoryisbalancedinallsegmentsaslongasthe2014harvestisaverageandconsumerdemandincreasesaspredicted.

• Thewinesatthehighestpricepointsreportparticularlyshortinventorypositions.Thehighvolumeandverysmallestateproducersreportinventorypositionsslightlyabovetheirrequirements.

• Massivebulkimportswillcontinuetodominatethelowest-price-pointwinecategories,butbulkimportsshouldbeheldbackbythesizeofthe2013harvestandsuppliescurrentlyincellar.

Demand• SVB’spredictionofsalesgrowthinfinewinewill

increaseforthefirsttimeafterthreeyearsofconsecutiveandaccuratepredictionsofdeclinesingrowthrate.Wepredictsalesinthefinewinebusinesswillincrease6–10percentover2013.

• Webelievewearetrendingtoatransitionpointthatwillprovechoppyformostretailers,astheBoomershitretirementandtheeconomicstateoftheMillennialsreplacingthemiscloggedwithhighlevelsofstudentdebtandweakjobprospects.WhilealldatapointtoincreasingdesireforconsumerfinewineintheU.S.population,thecapacityfortheseyoungerconsumerstomoveupmarketmaybeimpacted,leadingtoagreaterseparationbetweenluxurywinesand“aspiringluxury”wines.Thepricepointsbetween$10and$20shouldseethegreatestconsumerdemand,inadditiontoluxurywinesandthosedeliveringanenhancedconsumerexperience.

• TheMillennialgenerationisconsumingmoreforeignwinethanothercohortstoday.ThelikelyoutcomeisnotpositiveforU.S.producersgoingforward.Amarketingorderdeliveringapositivemass-marketmessagetoconsumersaboutdomesticwinequalityissomethingtheindustryshouldstronglyconsider.

2014: Our predictions in reviewcontinued

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Pricing• Therearebroadexpectationsinthewine

businessagainthatbottlepriceincreasescanbetaken.Webelieveincreaseswillagainprovedifficult,thistimemorebecauseofthevolumeofwineavailableforsaleversusadeterioratingeconomy.

• Grapepricinghashitahighmark,andcontractsshouldseerenegotiationsdownwardinexchangeforterm.Currentsupplyhasalreadyadjustedpriceslower,reflectingcurrentheavysupplystocks.

Planting• Grapeplantingisrestrainedcomparedwithprior

periodswhensupplywasinbalance.TheCentralValleyisatthegreatestriskinplantingaheadofdemand.

• Withoneofthedriestwintersonrecord,andfollowingthreedroughtyears,waterconditionsenteringthisfourthyearofdroughtmayplayalargerroleinplantingandproductiondecisions.Preparationfortheworst-casesituationforyourvinesandwineryshouldbeconsidered,andremediationandhedgingstrategiesshouldbedevelopedattheearliestpossibletime.

Financial performance• Thegeneralfinancialconditionofthewine

industryisimprovingslowly.Attheendof2014,winerieswillsaythattheyearwasgood,butnotgreat,financially.

• Grossprofitofwinerieswillbenegativelyimpactedin2014duetohighergrapecostsfromthe2012vintageyear.

• M&Aandvineyardacquisitionswillcontinueatarecordpacein2014.

• Direct-to-consumersaleswillcontinueasthelargestgrowthchannelformostwineries.

• Finewineproducerswereunabletopasshighercostsontoconsumersorrecoverhigherpricingfrompriorperiodsin2013.Weexpectthattocontinuein2014.

Some 2014 predictions we got right:• WedidcorrectlypredicttheFedwould

reducetheirbondpurchasesbutretainanaccommodativepolicyandnotbeboundbytheirpriorstatementaboutunemploymentrates.Wethoughttheywouldlooktoothermeasuresofemploymentsuchasthelaborforceparticipationrate,andtheydid.2

• TheUnitedStatesdidleadtheworldrecovery,andtheEurozonelagged.

• Theharvestlastyearwasthesecondlargestonrecord,butwewerealittlelightinthetonnageguess.

• Thebottlepriceincreasespresagedfromwinerysurveyresultswerehardtocomebyforproducers.

• Grapepriceswereatahighpoint,andwe’veseenrenegotiationsdownward.

• Bulkimportsinthelowestpricesegmentshavebeenheldbackbythehugeharvest,andthedroughthasproducedchangesinproductionandplantingdecisions,withtheCentralValleyinthemostvulnerableposition.

• Wepredictedinterestrateswouldcontinuetoremainlowfortheyear.

• WenotedbetterGDPonayear-over-yearbasisatyearend2014,butwedidn’texpecttohit3percentgrowthfortheyear.Thatwasagoodcall.3

And a few things that didn’t turn out as forecast: • Wehintedatlowerpumpprices,butthedropin

oilwe’veseenexceededourexpectations.

• Ourleadcommentregardingeconomicstagnation,whiletrue,overstatedthepotentialoftheU.S.economy,whichhasprovenmoreresilientinthesecondhalfoftheyear.

• Whiletheeurodidweakeninthebackhalfof2014,wehaven’tyetseenincreasedoffshorecompetitionorbulkimportsasweguessed.

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LikeChuckNoland,youmighthavethoughttoyourself:“Igottakeepbreathing...becausetomorrowthesunwillrise.”Andthesundidrise.

Thecurrentsthatmighthavetossedyouaroundonedayalsobroughtpositivechangethenext,maybebecauseyourodeitoutonaraft,orperhapsyouusedthisreportasameansoffixingyourcoordinatesanddevelopingaplan.

Asinpreviousreports,ourpredictionsforwhat’sonthehorizonareinformedbyourexperienceslivinginthebusiness,ourannualWineConditionsSurvey,analysisandinterviews.

We’vearrivedatthefollowingtouchpointsthatwehopewillhelpyousetyourcoursein2015.

2015: Our view on what’s nextThere may have been some years after the crash when you or someone you know didn’t have a clue what to do next.

Global and U.S. economic factors• WeareseeingrealstrengthintheU.S.economy

goinginto2015,whichwillpushwinedemandup:

– Oilpricedeclinesaretransferringwealthtooil-consumingcountriesandwilldeliverhundredsofmillionsofdollarsinstimulustoU.S.consumersin2015.

– TheemploymentpictureisimprovingatanacceleratingpaceintheUnitedStates.WeexpecttheU3unemploymentrate(theprimarymeasureofunemployment)willapproach5percentduringtheyear.

– Japan,ChinaandtheEUaredeliveringsub-optimalresults,andthosecurrenciesareweakeningagainstthedollar.

– ThelikelihoodtheFedwillincreaseratesin2015hasgrown,andwepredictsomemovementinmessagingfirstinearly2015,andactualratemoveshigherbyQ3.

– Interestratemoveswillhappenataslowpace,giveninflationwillbeincheckfromlower-pricedimportsandfuelsavings,leavingdeflationstillaconcern.

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2015: Our view on what’s nextcontinued

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– WebelieveU.S.GDPgrowthwillimproveover2014andcomeinnear3percentforthefullyear.

– TheunknownintheworldequationisunrestfromcountriessuchasRussiaandIran,shouldtheiroil-basedeconomiesfaltermorethantheyalreadyhave.

• AslongastheindustrializedworldeconomiescanholdtheirownandnotdragdowntheU.S.economyastheirownrecoverycatchesup,themiddle-incomeU.S.consumerwillseeimprovedprospects,andwewillbetoastingtothat.

• Thedropinthepriceofoilhasbeenduetosaggingworlddemandearlyintheyear,butwebelievetheimpactofthefrackingboomhasaddedtothesituation,puttingoilpricesintoastrongdownwardtrend.Weexpectoilpricestoremainlowthroughout2015.

Supply• Whenharvestisanalyzedandreported,we

expectwe’llannounceathirdconsecutiveharvestofheavyyieldandgreatqualityacrossmostappellations.Thatisunprecedented.

• Whiletherearevarietalsandregionswherethereisexcesssupply,webelievefinewineproducerswhofeelslightlylongwillfindthegallonsintheircellartobeablessingindisguisebytheendof2015.

• Massivebulkimportswillcontinuetodominatethewinecategoriesatthelowestpricepoints,butbulkimportsshouldbeheldbackbythesizeofthe2014harvestandsuppliescurrentlyincellar.

Demand• Startinginmid-2014,winespricedabove$20a

bottlebrokeoutstronglyhigher.“Tradingup”isacleartrendagain.Redwinesinparticularshowedthestrongestgrowth.Weexpectthattocontinuethroughout2015.

• Growthinsalesofwinespricedabove$20wasdrivenbyacceleratingvolumewithlittleinthewayofpriceincreasesgettingthroughtotheconsumer.

• Winespricedbelow$9perbottleperformedpoorlybothonandoffpremisein2014.Thepoorperformanceislikelytocontinueinto2015.4

• Afterfinishingtheyearatthetopendofourpredictedgrowthinsalesof6–10percent,wearepredictingabreakoutyearofgrowthinthefinewinecategoryinthe14–18percentrangein2015.

We are predicting a breakout year of growth in the fine wine category in the 14–18 percent range in 2015.

Pricing• Whilethelargesupplyofwinesinthecellars

shouldnormallyindicatecontinueddepressedpricing,webelieve2015willbeayearofbothvolumeandpriceincreasesinthefinewinesegment,drivenbyanimprovingeconomyandhigherdemand.

Planting• Grapeplantingopportunityisshiftingnorth:

– OregonandWashingtonareshowingstronggrowthinplantingonapercentagebasis,andweexpectthatwillcontinuefortheforeseeablefuturegivenfavorablequality/pricedynamicsrelativetothefinewinegrowingregionsinCalifornia.

– ThegrowingregionsintheNorthCoastarerunningintodifficultyinpermittingandhighlandcosts.Replantingiscontinuinginoldervineyardsandthosewithredblotch.Suitablesitesforexpansionarebecomingmoredifficultwitheachpassingyear.

– TheCentralValleyreportsitwillpullabout20,000acresofgrapesthatweredirectedtowinespricedunder$7,whicharestructurallyoversupplied.5

Financial performance• Direct-to-consumersaleswillcontinueasthelargest

growthchannelformostwineries.

• Mostwinerieswillsay2015wasoneoftheirbestseasonsbytheendoftheyear.

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Demand forecast: Up and to the right

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The hardest job a winery owner has is balancing wine supply with demand

two years before it’s sold. Of course, there are supply issues to be dealt with in any given year. But when there is good supply, as is the case today, determining how much wine to bottle is pretty difficult without first deriving a sales growth forecast.

To do that, you have to understand the direction the trade winds will take consumer demand next year. The good news we are happy to deliver: We believe consumer demand for higher-priced wine will be up and to the right in 2015.

As Chuck Noland said, attempting to get back to civilization on a makeshift raft: “This could work! This could work ...”

19 ShiftsinoilproductionfavortheU.S.consumer

23 AstrongerU.S.dollarmeanscheaperimports

24 Interestratesarelikelytorise

25 U.S.consumersshowconfidenceintheeconomy

26 U.S.employmentoutlookriseswiththetide

28 TheMillennialshaven’ttakenoverjustyet

Our base financial forecast for 2015We are particularly positive on the year ahead. We expect the fine wine business will see accelerating growth, while at the same time, the cellars are full with several consecutive years of very good vintages.

Oil pricesTheglobaleconomywasslowinggoingintotheendof2014,butbeneaththatwasthecrashinoilpricesthatwilltransfertrillionsofdollarsinwealthfromoil-producingcountriestooilconsumers.Asofthiswriting,Europe,JapanandChinaareeachworkingonmethodsofsupportingtheireconomieswiththeirownversionofquantitativeeasing,rightatthesametimetheUnitedStatesisendingitsbond-buyingprogramsandstartingtoshowsignsofstabilizedGDP.

The economyTheworldeconomiesarestillquitefragile,anddeflationisariskthatcanpulldowntheimprovementtheUnitedStateshasmadethusfar.Thatsaid,thecountriesweshouldbemostconcernedwithareJapan,thoseintheEuropeanUnion,ChinaandIndia.Eachofthosecountries,alongwiththeUnitedStates,benefitsfromthecollapseinoilprices.It’salittleoptimistic,butwebelieveloweroilpriceswillprovetobethecatalystthatignitesmorerobustbusinessconditions.

Interest ratesInterestratesplayarolein2015.WebelievetheFedwillhaveahardtimeraisingratesinthefirsthalfoftheyear.Oncerecoveryismorecertain,iftheworldpoliticallandscapeiscalmandifourforecastoflowoilpricesprovesout,wedoexpectrateincreasesinthebackhalfof2015.

Consumer confidenceWhilearaiseininterestrateswillslowconsumerspending,webelieveGDPgrowthwillendtheyeararounda3percentgrowthrate,andtheUnitedStateswillstarttoleadtherestoftheworldalongineconomicimprovementwithourconsumerspurchasingimportedgoods.

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State of the Wine Industry 2015 | Demand forecast: Up and to the right

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Theeconomyhasbeenmakingmeasuredprogress,butheadinginto2015,therevelationoffracking6asaforcehasaddedbetween0.5percentto1.0percenttotheU.S.GDP,oraboutathirdoftotalGDPaccordingtoestimatesfromBridgewaterAssociates,GoldmanSachsandothers.

TheUnitedStates,whichwasimportingtwo-thirdsofitsoilatapoint,isnowproducingtwo-thirdsofitsneed.Theemergenceoffrackinghasledtoaradicalchange:U.S.oilproduction,whichwasroughlyhalfofSaudiproductioninJuly2011,hasnowincreasedtojust10percentbelowSaudiproduction(Figure1).Asofthiswriting,thepriceofoilhasdroppedtobelow$50abarrel.Atitspeak,onJuly3,2008,itwas$145.40abarrel.

Whydoesthismattertothewinebusiness?Highgaspricesareataxondomesticconsumptionofgoodsandservices.Lowergasprices,whicharedown$1.00offtheirhighpointasofthiswriting,favorablyimpactshippingandproductionofindustrialgoodsandaddabout$230billiondollarsannuallytoU.S.disposableincomeatthatprice(Figure2,seepage21).

Lowergascostsareparticularlygoodforthemiddle-wageearnerswhohavethusfarlaggedtherecovery.Thatgroup,whoaremorelikelytolivehandtomouth,willspendeverydollartheyget.

Shifts in oil production favor the U.S. consumerThe big story of the U.S. economy going into 2015 is the precipitous decline in oil prices.

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7.5

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1991 1996 2001 2006 2011 2016

Figure 1

Daily oil productionMillions of barrels per day

n Saudi Arabia nUnited States

2014

Source: Bloomberg, Silicon Valley Bank

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ThatinturnhelpstheUnitedStates,whoseeconomyisbuiltonconsumerspending.The$60fallwearealreadyseeinginpriceputsabout$1,000peryearinanaveragefamily’spocketifthepriceismaintained.7

Whileearlierpricedropsweremorecloselylinkedtoaslowdowninworldeconomicoutput—andsomeeconomistsstillbelievethedropisonlyabouttheworldslowdown—pricesshouldbeheadedlowernomatterthecause,withsomeanalystspredictingoilwillfallbelow$40abarrel.A$40fallinthepriceofoil,whichiswhatwe’veseenfromJunetoNovemberof2014,representsashiftofroughly$1.3trillion;closeto2percentofworldgrossoutput.Thattransfergoesfromproducercountriestoconsumercountries.

ThelosersintheUnitedStateswillbetheoildrillingcompanieswhohaveexpensivelandleases,whichatthecurrentpricearehittingtheirbreakevenonpumpingcosts.Regionalbanks,companiessupplyingequipmentandoilservices,andprobablyrealestateinTexasmaywellseesomecontractionsaswell,butunlikelythekindofimpactseenafterthe1986oilpricecollapse.

Formostofthewinebusiness,Texasisanimportantconsumingstate.TwentypercentoftheTexaseconomywasbasedontheenergysectorinthemiddle1980s,whenoilcrashedandtookthestatedownwithit.Butatthispoint,Texashasdiversifiedsubstantiallytothepointwhereenergyisonly11percentofthestate’seconomy.8Still,weshouldexpectourfriendsintheRepublicofTexastofeelthepinchin2015.

Whatitmeansislower-pricedoilisn’tacyclicalchangeoranotherbubble.Thebubblewaspoppedwhenoilhit$145abarreljustbeforetheGreatRecession.Wedon’tknowexactlywherethebottomis,andsomepredictaboomerang,withpricesratchetingbackup.

Fromourposition,thisisnotashort-termpriceadjustment,butratherasecularchangethatwillhelpheavyusersofoil,includingcountriesintheEuropeanUnion(EU),Japan,China,theUnitedStatesandIndia,eachofwhomareimportantcontributorstoahealthyworldeconomy.ThisisagoodthingfortheU.S.economyandtheaveragewineconsumer.

Lower gas costs are particularly good for the middle-wage earners who have thus far lagged the recovery.

Shifts in oil production favor the U.S. consumercontinued

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$4.10

$3.85

$3.60

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$2.84

$2.59

$2.34

$2.09

$1.84

$1.592007 2008 2009 2010 2011 2012 2013 2014

Figure 2

Average retail U.S. gas priceRegular gas price ($USD/gallon)

2 columns (6.3”w)

1 columns (3”w)

Source: GasBuddy.com

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Hereintherealworld,shiftsinthevalueofcurrency—particularlyintheU.S.dollar—havefar-reachingimplications,wellbeyondourownlittleisland.

Intheearly1980s,wesawaverystrongdollarandveryhighinterestrates.ThedollarwassostrongthatimportsofforeignwinebegantocrushouremergingU.S.winebusiness,whichwasstillstrugglingwithwinequality.9Itwasn’tuncommonbackthentofindaverynicebottleofBordeauxfor$10againstaninterestingdomesticwinelikeawhitecabernet,oramustangsinglevarietal.Astrongdollarmakesimportscheaper,increasingtheopportunityforforeigncompetition.

TheU.S.dollarhasseenremarkablestrengthoflate(Figure3).Sincethemiddleof2014,itsvaluehasclimbedalmost10percentcomparedwithabasketofworldcurrencies.Whythedramaticchange?

Currenciesarerelative,andtheimprovementintheU.S.dollarispartlyduetoaslowdownintheworld’smajoreconomies.Atthesametime,theU.S.economyhasshownsignsofrealstrength.Japanhasgonebackintoarecession.China’sGDPhasbeendeceleratingforsometimeasitstruggleswithaswitchfromaproducingeconomy

toaconsumingeconomy.AndinJune2014,theEuropeanCentralBankunveiledarangeofanti-deflationmeasuresmeanttoweakenthecurrencyandimproveexports.Thedropinoilpricesplaysaroleinthestrengthofthedollar,andintimesofworldturmoil,theU.S.dollarservesastheworld’sreservecurrency.

WeexpecttheU.S.dollartocontinuetogainstrengththrough2015,astheU.S.economyimprovesaheadofworldindustrialeconomies,andinterestratesbegintorise.

A stronger U.S. dollar means cheaper importsIf you were on a deserted island nation like Chuck, what would you use for currency? Of course, the answer is nothing, because currency has no value if there is no one to trade with. 1 columns (3”w)

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Figure 3

U.S. dollar indexn DXY Currency PX low nDXY Currency PX last nDXY Currency PX high


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Interest rates are likely to risePredicting movements in currencies, oil prices or interest rates is probably a foolish endeavor, but call me a fool.10 Each of those price changes impacts our winery and vineyard clients.

Inparticular,anincreaseininterestrateswillraisewineries’costsoffinancing,whichimpactstheirdecisionmakingandtimingoncapital-expenditurebudgets.Forthosewinerieswithoutlocked-inrateprotection,thatwillalsoreduceprofitabilityonfloatingratedebt.11

FromaU.S.domesticperspective,ourCentralBankendeditsbond-buyingprograminlate2014asplanned.Intheory,thatshouldhavedrivenrateshigher.BecausetheU.S.dollarisstilltheworld’sreservecurrency,andRussiadecidedtodestabilizetheUkraine,afloodofworldpurchasesactuallyloweredbondratesforaperiodaftertheprogramended(Figure4).That’swhyit’ssofoolishtoactuallypredictpricemovements.12

Whilethe2013announcementoftheendoftheFedbond-buyingprogramcausedachillintheU.S.stockmarket,theplannedendcombinedwiththestill-improvingU.S.economicindicatorshadnorealimpactattheendof2014.

Now,withstrongyear-endeconomicdatain2014,anydiscussionofrateincreasesbeingheldoutinto2016hasbecomequieter.Thegrowingconsensusisinterestrateswillstarttoincreaseinthemiddleof2015.13Afterall,theFedhasconsistentlymessagedthatrateincreaseswillbedatadependent.

Withyear-end2014growthinemployment,rightalongwithgrowthinhoursworkedandwages,thedataareprettyconclusive.WearepredictingachangeinFedforwardguidanceinQ1andactualrateincreasesinQ32015.

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1% Dec2013

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Figure 4

10-year treasury rates decrease in 2014


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U.S. consumers show confidence in the economyAfter the U.S. economy crashed and consumers washed up on the beach of broken dreams with no shelter or home, they found they were locked in a battle just to survive.

LikeChuckduringhislowpoints,consumersbegantoexpressdoubtandfear.Concernsaboutourfinancialsystemledtotherealizationofthegrowingdividebetweenthehavesandhave-nots,withmanywonderingifwewereevergoingtomakeitbackwithoutchangingtheeconomicrulesandstatusquo.

FortheUnitedStatestotrulyregainitsfooting,weneedtoseethemiddleclassre-establishitstraditionalpurchasingstrengthandstarttopaddleoutintotheeconomicsea.Thegoodnewsforthoseconsumers:Yourshipiscomingin!

Whilewedon’ttalkmuchaboutconsumerconfidenceinthisreportbecauseit’salaggingindicatorofeconomicactivity,itisworthnotingthatGallup’smeasurementofeconomicconfidencehastakenadecidedlyupwardmovementinthebackhalfoftheyear(Figure5).14Thatiscoincidentwithmanyothermetrics,includingwhatweseeinfinewinepurchasingactivity.Whatismoreimportantinmymindistheacceleratingconfidenceshowninthemiddle-incomeconsumersmakingmorethan$90,000ayear.Thatisagrowthopportunityforthewinebusiness.

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Figure 5

U.S. economic con� dence index scores by incomen Middle and lower income (less than $90,000 annually)

nUpper income ($90,000+ annually)

2012 2013 2014Source: Bloomberg, Silicon Valley Bank

For the United States to truly regain its footing, we need to see the middle class re-establish its traditional purchasing strength.

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U.S. employment outlook rises with the tide

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Figure 6

Employment strengthTotal private job openings, hires and quits (seasonally adjusted, in thousands)

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Recession

nHires

nJob openings

n Quits

Source: Bureau of Labor Statistics

While there are various measures of economic vitality, nothing is as important as employment.

TheU315CivilianUnemploymentRateisthemostcitedmeasureofunemployment,andasofthiswriting,theratehasdroppedto5.6percent.16Morethan300,000newjobswerecreatedinNovember,making2014alocktofinishasthestrongestyearofjobsgrowthsince1999.Theunemploymentratecontinuestodeclineinasteadyfashion.Atthecurrentpace,itshouldhit5.5percentinthesecondquarterof2015.

TheBureauofLaborStatisticsreportsthatjobopeningshavenowsurpassedthegrowthfrom10yearsago(Figure6),andemployersinmanyindustriesarereportingdifficultyagainfindingemployeesforthehospitalityindustry,aswellastechnicalandskilledlaboropenings.Asofthiswriting,restaurantandhotelopeningshavethe

longest-openjobpostings,arguablybecausetheyarelowerpaidjobs.Atsomepoint,thosesalaryoffershavetocomeup,whichagainisagoodsignforthemiddleclass.

It’sperhapsabitcounterintuitive,butanotherencouragingsignisthatmorepeoplearequittingtheirjobs—asignthatemployeesaremoresecureintheirjobsandconfidenttheycanfindbetter-payingopportunitieselsewhere.Ifthesetrendscontinue,it’sonlynaturaltoexpectanuptickinhiringandsomewageinflation,asigntheeconomyisheatingup.WiththestrengthoftheNovemberjobsnumbersandgiventhegrowthinjobopenings,weexpecttoseewageinflationstarttoemergeasatrendbeginninginQ22015.

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The Millennials haven’t taken over just yetWhen Chuck went down in the South Pacific, he was an overweight, middle-aged, clean-shaven executive. Four years later, he was a bearded, skinny man who looked like he was from the Middle Ages. Imagine his shock when he returned to the world he once knew to find that his appearance wasn’t the only thing to change dramatically. His fiancée had remarried, she had a daughter and something he had never thought possible had come to pass — there was now a pro football team in Nashville!

Cominginto2015,producersinthewineindustrymightfeelthatsamesenseofshockanddisbelief.WithallthehypeoverthepastdecadeabouttheMillennialgenerationovertakingtheBoomers,ifChuckwereinthewinebusinessandreturnedtohislifetoday,hemightexpecttofindtheteetotalingBoomersinrockingchairswiththeMillennialsattheheadofthetable.Butdespitethehype,thathasn’tcomeevenclosetohappening.Millennialshaveyettomakeadentinthefinewinebusiness.Sowhythedifferencebetweenthemediareportsandreality?

Inordertotakeadominantroleintheeconomy,theyoungergenerationneedsjobsthatpaywellandanappetiteforthejuiceofthevine.ThelatestdatafromtheU.S.DepartmentofLaborshowstheworkforceissplitinequalthirdsbetween

Boomers,GenerationXandMillennials(Figure7).Whileequallysplit,thereareimportantdifferences.Boomersarestartingtohitretirementageandpullingbackfromtheworkforce,whileMillennialsarejustgettingstartedintheircareersormaystillbeinschool.17Thosewhoareinjobshavethehighestunemploymentratesandanunnaturalburdenofdebtfromstudentloans.

Anothercriticaldifferencebetweenpotentialwineconsumersisincomeandwealth.Tobeameaningfulconsumeroffinewine,youneedtobeinthetop25percentofwageearnersintheUnitedStates,orsubstitutewineforfoodinyourbudgetasI’vebeenknowntodoonoccasion.Aswe’vedocumentedinpastreports,thevastmajorityofthenation’swealthlieswithBoomers.

60%

50%

40%

30%

20%

10%

0%

20

18

16

14

12

10

8

6

4

2

0

Figure 7

The workforce in 2015Projected size of U.S. labor force (in millions) by age

16-19 20-24 25-29 30-34 35-39 40-44 45-49 50-54 55-59 60-64 65-69 70-74 75-79 80+

Figure 8

Potential � ne wine consumers by agePercentage of families in group ($75,000–$100,000+ annual income)

21-24 25-29 30-34 35-39 40-44 45-49 50-54 55-59 60-64 65+

$100,000+

Source: U.S. Census Bureau, Silicon Valley Bank

nMillennials

nGeneration X

n Boomers

n Silent Generation

Source: Department of Labor

60%

50%

40%

30%

20%

10%

0%

20

18

16

14

12

10

8

6

4

2

0

Figure 7

The workforce in 2015Projected size of U.S. labor force (in millions) by age

16-19 20-24 25-29 30-34 35-39 40-44 45-49 50-54 55-59 60-64 65-69 70-74 75-79 80+

Figure 8

Potential � ne wine consumers by agePercentage of families in group ($75,000–$100,000+ annual income)

21-24 25-29 30-34 35-39 40-44 45-49 50-54 55-59 60-64 65+

$100,000+

Source: U.S. Census Bureau, Silicon Valley Bank

nMillennials

nGeneration X

n Boomers

n Silent Generation

Source: Department of Labor

29

In order to take a dominant role in the economy, the younger generation needs jobs that pay well and an appetite for the juice of the vine.

30


Thereisanobviousandstarkdifferenceinincomesamongthethreecohorts.Figure8(seepage29)depictsthepercentageoffamilieswithineachagebandwhomakemorethan$75,000.Aswe’veconsistentlypointedout,thegreatestspendingyearsarebetween35to55yearsofage.Thedatashownhereindicatethemajorityofpeoplecapableofbuyingwinefallwithinthatagegroup.

InourannualWineConditionsSurvey,18weaskedwinerieswhohavecustomerrelationshipmanagement19systemsinplaceandcouldtracksalesbyagegroup,totelluswhatthecohortmarketshareswerefromeach,showninFigure9.Notsurprisingly,theBoomersleadsalesinthefinewinecategory,andtheforgottenGenXhasthesecondlargestmarketshare.Theresultsofthissurveyquestionhavenotmateriallychangedinthethreeyearswe’vebeenaskingit.

Whenwesortouttheresponsesfromthesurveybyaveragepricepoint(Figure10),wehaveanotherwaytounderstandrealbuyingbehavior,segmentingwinedrinkersbypricesegment.Boomersaredominantacrosstheboardonprice,takingthemarketshareineverypricerange.GenXshowsupsecondinmarketshareinallprices.MillennialsappeartohavealargermarketsharethanMatureshowever,withtheexceptionofthehighest-pricedwines,andtheyarestartingtoovertakeMaturesinthelower-pricedcategories.

Wecan’tstressmoreemphaticallythatoneday,Millennialswillbeatthecenteroffinewinesales.Buttherealityis—nomatterwhatagenerationiscalled,themostactivebuyersoffinewineandluxurygoodswillcontinuetobeinthe35-to55-yearagegroup.Theyoungergenerationisjustnowenteringanagewheretheycanparticipateinamoremeaningfulway.Today,thelargestconsumingcohortistheBoomers,andthecohortwiththegreatestimmediategrowthopportunityisGenX.That’swherewealthiscentered,andthat’swhereincomesupportspurchasingathigherprices.

1 columns (3”w)

Figure 9

Year-over-year sales trends in � ne winen2012 n2013 n 2014

50%

45%

40%

35%

30%

25%

20%

15%

10%

0%Millennials

(21-36 yrs old) Gen Xers

(37-48 yrs old)Boomers

(49-66 yrs old) Matures

(67+)

Source: Silicon Valley Bank 2014 Wine Conditions Survey

The Millennials haven’t taken over just yetcontinued

Today, the largest consuming cohort is the Boomers, and the cohort with the greatest immediate growth opportunity is Gen X.

31

50%45%40%35%30%25%20%15%10% 5% 0%

Figure 10

Boomers top the charts in bottle sales across all price points

n Boomers (49-66 yrs old)

n Gen Xers (37-48 yrs old)

n Millennials (21-36 yrs old)

n Matures (67+)


<$15 $15-$19 $20-$29 $30-$39 $40-$69 >$69

Bottle prices

32


Supply: New challenges impact planting and pricing

3

33

34 Supplyandconsumptionshiftworldwide

37 RecordyieldscontinueontheU.S.WestCoast

Last year, we began our report with this: “Perhaps the biggest story of 2013 was

grape supply — which is better than having the economy get top billing.”What a difference a year makes, because this year the economy got top billing, in a good way. This year’s grape supply is, well, one more year of ho-hum great quality and big yields for the third year running, which has pressured grape and bulk prices lower.

So, put yourself in the position of a grape grower. You had three great years in a row. If you were in sales, three record years would get you big bonuses. But what does that get you as a farmer? Lower prices for your grapes and a collapsing spot market. It just doesn’t seem right, but the lot of grape growers is being subject to the whims of Mother Nature. At times, it seems they have no control over their destiny.

They might feel like Chuck Noland, who looked back on his experience and said, “I had power over nothing. ... I knew, somehow, that I had to stay alive. Somehow, I had to keep breathing.”

34

State of the Wine Industry 2015 | Supply: New challenges impact planting and pricing

Supply and consumption shift worldwide In recent years, the traditional producing countries seem to have suffered greater variability in weather events impacting both volume and quality.

Worldconsumptionofwinehasstalledoutatabout240millionhectoliters(Figure11),butthereisaclearshiftinconsumptionawayfromFrance,ItalyandSpain,andtowardtheUnitedStates,theUnitedKingdom,ChinaandArgentina(Figure12).Today,about39percentofwineisconsumedoutsideEuropeancountries,comparedwith31percentin2000,20andtheUnitedStatesisnowtheworld’stop-consumingcountry.

Worldproductionhasbeengoingthroughashiftforaboutadecade.Since1998,thehigher-consumingcountriesofFrance,Italy,Spain,PortugalandtheUnitedKingdomeachexperiencedsignificantdeclinesinpercapitawineconsumption,somuchsothatby2006,Europewasproducingabout150millioncasesmorethanitcouldsell.Cateringtopopularsentiment,insteadofdumpingthewine,producerswerepaidfortheirsurplusinwhatwastermedemergency distillation—

2 columns (6.3”w)

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 est 2014

Figure 11

Worldwide production vs. consumptionn Production

n Consumption

300

290

280

270

260

250

240

230

220Mhl

Source: L’Organisation Internationale de la Vigne et du Vin

35

ItalyFrance

40

35

30

25

20

15

10

5

0

U.S.Mhl

GermanyChina U.K. Russian Federation

Argentina SpainAustralia

Figure 12

Global consumption trends2000-2013

n Increased consumption in millions of hectoliters

2 columns (6.3”w)


36


aprogramwhereexcessgrapeproductionwasconvertedintoindustrialethanol.Finally,theEUrecognizedtheobviousnon-marketsupportmechanismswerekillingpricesfortheirsuccessfulfarmersandperpetuatingadisastrousoversupply.

Afterseveralyearsofnegotiations,theEUputintoplaceacontroversialCommunalRegulation(CMO)inlate2007,phasingouttheemergencydistillationprogramentirelybymid-2012andpayingEuropeangrowerstouproot175,000hectares(about430,000acres)ofeconomicallyunsustainableandlesser-qualityvineyards.

Spain,Italy,France,PortugalandHungaryhavebeenthemajorbenefactorsoftheCMO,and—inconcertwithincreasingworlddemandandmoreEUexports—theresulthasbeenthatthelakeofwinethatonceexistedinEuropehasnowdrieduptoapond.Still,withthoseinitiatives,in2014theOrganisationInternationaledelaVigneetduVin(OIV)announcedFrancehadagainreclaimeditstopspotoverItalyamongworldproducers,with46.2millionhectolitersproducedintotal.21

Italyhasledtheworldinexportvolumesforsometimenow(Figure13);however,FranceleadsItalyandSpaininthevalueoftheirexports,witheachreportingthevalueofexportsat€7.8,€5.0and€2.5billioneurorespectively.CountriesmakingmovesinworldexportsincludeChile,whichhasmovedintothefourthpositionworldwideoverAustralia;andSouthAfrica,whichhasleapfroggedseveralcountriestomoveintothesixthspot.

Supply and consumption shift worldwidecontinued

Figure 13

Trends in export volumesSix-year span (2008-2013)


25

20

15

10

5

0

South Afri

caMhl

Argentin

a

Portuga

l

New Ze

aland

U.S.

German

yChile

Australi

aIta

lySpain

France

37

Thiscontinuesapatternthatbeganwiththe2012harvest,whichpresentedarecordyieldinalltheWestCoastwine-growingstates.Californiahitarecord4.02milliontonsatharvest,withOregonandWashingtonexperiencingequallyoutstandingvintagesinbothqualityandvolume.

WineriesdesperateforsupplycomingofftwoconsecutivelowproductionyearsinCaliforniastillboughtupprettymuchalloftheuncontractedfruitthatwasleftandavailablein2012,andwerepaidwellfortheirexcessproduction.

2013wasanotherlargeharvest—slightlyoffthe2012productionrecordinCalifornia,butstillfantasticquality.OregonandWashingtonexperiencedmoredifficultgrowingconditionsin2013.

Now,withtheoutstanding2014harvestinCalifornia,onehastowonderifthe4milliontonharvestisnowthenorm.Or,willvolumeofdomesticallyproducedfruitretreat?

EachoftheregionsontheWestCoastreportedexcellentqualityin2014,withthePacificNorthwestleadingtheway,followedbyNapaandSonomaCounty.Lodi,theSierraNevadaandtheCentralValleyalsoreportedgoodqualitybutwithgreatervariability.TheCentralValleyandCentralCoastreportedexperiencingthegreatestvariabilityduetodroughtandwindinsomelocations,whichreducedberrysizeandyield(Figure14,seepage38).

California’s high yields create excess supplyMostestimatesforthe2014harvestaresomewherearound4milliontonsasofthiswriting,whichwouldmakeitthethirdlargestharvestonrecord.Ourguessisslightlylowerthanthat,basedondiscussionsandinformationfromourannualWineConditionsSurvey(Figure15,seepage38).Butwefallintolinewiththegeneralconsensusthattheyearwillprovetoberightuptherewiththelargestthreeorfourcropsizesever,andtheheavyvolumeischangingtheshapeofthesupplybalanceinthebusiness.

Record yields continue on the U.S. West CoastIn 2014, we ended with a three-peat in California thanks to another great harvest and yield. Oregon had perhaps its best harvest of all time, with both strong yield and excellent quality, and Washington reportedly experienced nearly ideal growing conditions and normal yields.

38


Figure 14

Percentage of wineries reporting excellent harvest quality

87%Oregon

64%

25%

73%Washington

72%Napa County, CA

Sonoma County, CA

58%Lake County, CA

50%Anderson Valley & Mendocino County, CA

50%Central Coast, CA

50%Mid-Coast, CA

46%Central Valley, CA

44%Sierra Foothills, CA

Lodi & Other Delta Counties, CA

2014: High yields, high quality

25

20

15

10

5

0

Figure 16

Bulk wine available by regionMillions of gallons

nCentral Coast nNorth Coast nSonoma nNapa nCalifornia overall

2006 2007 2008 2009 2010 2011 2012 2013 2014

62%

43%

85%

Figure 15

The Paci� c Northwest led the pack in reporting higher-than-average yields

Oreg

onW

ashi

ngto

n Na

pa C

ount

y, CA

Mid

-Coa

st, C

ASo

nom

a Cou

nty,

CACe

ntra

l Coa

st, C

ACe

ntra

l Val

ley,

CA

Ande

rson

Val

ley &

Men

docin

o Cou

nty,

CA

Lodi

& O

ther

Del

ta C

ount

ies,

CASi

erra

Foot

hills

, CA

Lake

Cou

nty,

CA

100%

90%

80%

70%

60%

50%

40%

30%

20%

10%

0%


Source: Turrentine BrokerageSource: Silicon Valley Bank 2014 Wine Conditions Survey

2014: High yields, high quality

39

2010and2011werepoorharvests,asyoucanseebythebigdipintherightsideofFigure16.Butatthetime,givenwherewewereinachallengingrecovery,itwasn’tatotaldisastertohaveacouplethincrops.

By2012,winerieshadpushedthroughthebulgeininventoryfromdeceleratedsalesandstartedneedingsupplyagain.Therecord2012harvestwasmetbyproducersandgrowersalikewiththesamejoyChuckexperiencedafterhelostandthenfoundhisbestfriend,Wilsonthevolleyball.

2013wasadifferentexperienceforgrowers.Withtherecordyieldfrom2012stillfillingcellars,bulkwinereadilyavailableand2013contractsbeingfullymetfromtheoutsetofharvest,someexcessgrapeswerelefthanginglongerthanneededjusttocleartankspace,overageoptionsweredeclinedbywineries,someexcesscouldn’tfindahome,andenforcementofqualitystandardsatdeliverywasthenorm.Grapesthatwouldhavebeengladlyacceptedin2012,flawsandall,wererejectedoutrightin2013.Spotpricesalsoshoweddeclinesaswouldbeexpected.

Thisiswhatwepredictedinlastyear’sreportforgrapesupplybalancein2014:

“Onthewhole,we’renotworriedaboutthebulkmarketbeingheavyatthispointdespitetwoback-to-backrecordyears,norarewetoodisturbedbyanyofthevarietalreportsofslightexcess.It’sreallygoingtogetdowntowhatconsumptionandharvestlookslikein2014.Withourviewofbothbetterconsumptionandguessinganaverageyieldin2014,webelievewearereallypretty

well-positionedinthecellarsandwithbulkavailability,withtheslightexceptionofmerlot,chardonnayandlower-costbulkjuiceintendedforhigher-productionwineries.”

Thepredictionwasprobablyjustaboutright—ifonlyMotherNaturewouldhavecooperatedandgivenusanaverageyield.Whileourtakeonlower-costjuiceseemedspoton,giventhethirdconsecutiverecordyield,thereisnowafairamountofjuiceouttherelookingforahome,butactivityonbulkpurchasingislowbecauseproducershavewhattheyneed.

Today,youcanprettymuchdescribetheshapeofsupplyaslong,asyoumovefurtherdowntheladderofexpectedpriceperton.It’sverylongunder$8andslightlylonginthewinedestinedformiddle-tierbottlespricedbetween$9and$18.However,thehighest-pricedbottles,andparticularlyredwineandNorthCoastcabernet,areshort(Figure17,seepage41).

Shifting cargo in low-priced winesOnceChuckwasabletoescapethebarrierreefinhisraft,hediscoveredhowhislow-pricedconveyancewasn’twell-engineeredforthewindandweatherthehighseasthrewathim,andhislittlecraftstartedtolosepiecesinthemidstofthestorm.Inasimilarway,thegrapegrowersproducingforthelower-pricedsegmentshaveexperiencedoutsideforcesontheiroperationsandhavelostsomepiecesoftheirtraditionalbusinessmodels.

In California, one has to wonder if the 4 million ton harvest is now the norm. Or will volume of domestically produced fruit retreat?

Record yields continue on the U.S. West Coastcontinued

40


41

TheCentralValleyhaslongbeenandstillisthegatewayforU.S.consumerstocuttheirteeth.Inthiswriter’sview,it’scriticaltothelong-termhealthoftheU.S.winebusiness.Asearlyas2004,we’venotedthethreatimportedbulkwinecouldhaveonourCentralValleywinegrowers,particularlythoseproducingwineforthelowest-pricedwinesegment.ItwascleartousbackthenthattheInternetwouldmakeaccesstounlimitedamountsofbulkwinearealpossibilityforthelargest-productionwineries.Ifthereisn’tanydifferenceforthoseproducersexceptprice,ourCentralValleygrowersaremoresignificantlydisadvantaged.Webelievedthatneededtobeaddressedinsomewaybackthen,andwestillbelievethatnow.22

InaNovember2014presentationattheSanJoaquinValleyWinegrowersAssociation,thepresentersnotedseveralissuesthatneededtobedealtwith.Thepartofthemarketproducinggrapesdestinedforwinespricedlessthan$7hadbecomeoverplanted.Foreignbulkimportsthattypicallygointothosebottlesweretakinganequivalentof30,000,000casesannuallyinmarketshare,whichissomewhereneartheequivalentof60,000acresofgrapeproductionlost—cededtoforeigncompetition.

Uncomfortablewouldbethebestwaytodescribethemoodin2014intheCentralValley.Whilecontractedfruitdeliveredgoodprices,uncontractedgrapesintheBigValleyattractedpricesaslowas$100perton,impactingabout10–15percentofthevalley’stotalproductionaccordingtoestimates.

Cabernet Sauvignon

Est. tons crushed

Bulk inventories Bulk demand

Napa Valley î î Strong

Sonoma County î î Strong

North Coast î è Strong

Central Coast ì ì Moderate

Northern Interior ì ì

Weak to moderate

Southern Interior ì ì

Weak to moderate

Chardonnay

Est. tons crushed

Bulk inventories Bulk demand

Napa Valley è ì Moderate

Sonoma County î è Moderate

North Coast î ì Weak

Central Coast ì ì Weak

Northern Interior î î Weak

Southern Interior î î Weak

Figure 17

Supply and demand 2013 vs. 2014

Source: Turrentine Brokerage

Record yields continue on the U.S. West Coastcontinued

42

Bottle pricing: Highs move higher and lows trend down

4


43

44

State of the Wine Industry 2015 | Bottle pricing: Highs move higher and lows trend down

After a thorough search for Chuck, covering the area where his plane was believed to have gone down,

everyone was left with the only reasonable conclusion: Chuck had been lost at sea. Turns out, they didn’t have all the information. In reality, Chuck’s plane had veered hundreds of miles off course.

Whenyouaddupallthedatapointswiththewinebusinessasweknowandasdiscussedabove,manypeoplewillsaytothemselves:heavyinventoryloadsequallowerbottleprices.Thatisareasonablethoughtprocess,becauseinastaticenvironmentholdingdemandconstant,anincreaseinvolumeshoulddecreaseprice.But,thatsimplisticviewignoresafewfactors.

WhenweaskedparticipantsinSVB’sannualWineConditionsSurveyabouttheirexpectationsregardingbottlepricein2015,wedrewsomeinterestingconclusions(Figure18).Theexpectationofpricedecreasesin2015isminimal,butmoreprevalentinthelower-pricedsegments.Thatseemstoflyinthefaceofeconomictheory,sincewehavethreeyearsofgreatyields.Buttheblacktrendlineinthechartgivesonecluewhythewineriesmightberightinthisquestionthisyear.23Theshapeoftheinventorycurveistiltedup,withwineriessellingthelowest-pricedwineslesslikelytoexpecttheycandrivepriceincreases.That’sconsistentwiththeinformationpresentedabove,whichshowsthe

lower-pricedsegmentsarelongandthehighest-pricedwinesareshort,particularlyinredwine.It’salsoconsistentwithwhatweknowaboutcohortpurchasingbehavior,withtheyoungestconsumerspreferringlower-pricedwines,butlackingthefinancialresourcestomovetheneedle.

2015willallowsomeincreasesinbottlepricesabovethe$20pricepointandperhapsslightlybelowthatinredwinebecauseofanimprovingeconomyandwinesthatareclosertobeinginbalance.Thelowerendofthemarket—below$8retail—isalreadytrendingdown.Somethingwillhavetohappentomakethattrendreversecourse,andwecan’tseeanythingatthispointthatwouldreversethetrend.Infact,astrengtheningdollarcouldincreasebulkimports,sothelowestendofthemarketfromapriceperspectivewillprobablyseepricediscountingandperhapsvolumedeclinesaswellin2015.

45

Figure 18

Pricing expectations among wineries

<$15 $15-$19 $20-$29 $30-$39 $40-$69 >$69

Bottle prices

100%

90%

80%

70%

60%

50%

40%

30%

20%

10%

0%

Decrease ên Moderate to strong

decrease

n Small decrease

n Hold prices

Increase én Strong increase

n Moderate increase

n Small increase

2 columns (6.3”w)


Atthelowestendofthemarket,weexpecttoseepricingdeclinesgiventhereisabundantsupplyandtradingup,whichisn’tagoodrecipeforsuccessinthissegment.Inthe$10–$20partofthemarket,thereisalotofwineavailabletobesold.Négociantsandbrandedwineswillsoakupsomeofthat,suchthatweexpecttoseevolumeincreasesandsomediscounting.Winespricedfrom$15–$18willhavebetterluckmaintainingtheirprice.Despitethehighervolumes,webelievewemayseemodestpriceincreasesinbottlepricesgreaterthan$20.

The shape of the inventory curve is tilted up, with wineries selling the lowest-priced wines less likely to expect they can drive price increases.

46

State of the Wine Industry 2015 | Financial performance: 2015 looks like a breakout year

47

Financial performance: 2015 looks like a breakout year

5

Anunderstandingofwhathappenedinthepastandaninformedviewofwhat’scomingnextiscritical.AsChuckNolandsaid,“Weliveanddiebytime,andwemustnotcommitthesinofturningourbackontime.”

Eachyearinthisreport,wetakealookatthefinancialconditionofwineries,reviewhistoricaltrendsandforecastasalesgrowthbandforthefinewinesegment,whichwedefineaswinessoldover$20retail.In2014,wepredictedsalesgrowthof6–10percentandexpecttoendintheupperendofthatrange,ifnotapercentagepointortwoaboveit.Consistentwithourinformation,SymphonyIRIGroupdatafrommarketingconsultantsWines&Vinesfor12monthsinoff-premiseaccountsshowpositiverevenuegrowthof6percentfortheperiodendinginNovember2014,with13percentgrowthindirect-to-consumersales.

TheeconomyhadaroughQ1in2014duetoweather,butsalesofhigher-endwinesmadeastrongcomebackinthebackhalfoftheyear.Salesoflower-pricedwines,however,droppedoffinvolumeandwerediscounted.

Overallwineconsumptionincreasedforthe20thstraightyear.Overturnedbluelaws,betteremployment,relaxedrestrictionsondirectshipmentsandcustomerstradinguptomorepremium-pricedwinesallledtotheindustry’simprovedyear-over-yearsuccessin2014.

Wineries report a solid 2014Gettingfinancialinformationaboutthewinebusinessisalittlemoredifficultthangettingtop-linesalesnumbers.Thewinebusinessisafamily-runindustry,andfinancialstatementsandreturnsaren’tjustwashinguponthebeach.Asbankers,wehavetheinformation,andforyearswe’vecondensedthatdataintostatisticsthatwegivetoourclientsforfree.Asaresult,peoplefromSpokanetoSanDiegocontactusaboutgettinghelpinfinancialmodeling.IalwaysdisappointthemwhenIsaytheinformationisreservedforclientsonly,butIcanofferthedatainFigure19,shownhere.

You have to watch your business, identify issues and potential problems, then take early action. That means

planning and using financial statements and other business metrics to quantify your performance.

48


58%

57%

56%

55%

54%

53%

52%

51%

50%

49%

48%

47%

46%

45%

60%

50%

40%

30%

20%

10%

0%

-10%

2 columns (6.3”w)

Dec 2007 Dec 2008 Dec 2009 Dec 2010 Dec 2011 Dec 2012 Dec 2013 Sept 2013 Sept 2014

57.1% 55.3% 52.4% 53.7% 53.2% 53.4% 53.1% 52.64% 54.42%

22.3% 2.0% -3.8% 10.8% 12.2% 7.7% 9.2% 6.3% 8.22%

16.3% 9.5% 2.2% 6.7% 6.1% 6.9% 3.9% 5.4% 5.72%

Figure 19

Financial performance of premium wineriesn Sales growth

n Pretax pro¬ t

n Gross margin

Source: Silicon Valley Bank Peer Group Database

Aswelookatthefinancialpositionofwineriesthispastyear,startingwithdatadevelopedfromSVB’sPeerGroupDatabase,24revenuegrowththroughtheninemonthsendingSeptember30,2014,wasabout8percent,thecenterofourpredictedrange.Ourdataarenotseasonalized,andweexpecttoseetheimpactofastrongOctober-November-December(OND)2014sellingseason25rampupend-of-yearsalesafteraweakONDperiodattheendof2013.For2015,weareforecastingabreakoutsalesyearinfinewine,withayear-over-yearincreaseof14–18percent.

49

Overturned blue laws, better employment, relaxed restrictions on direct shipments and customers trading up to more premium-priced wines all led to the industry’s improved year-over-year success in 2014.

Keepingthegoodnewscoming,whilewehaven’tseenbottlepriceincreasesin2014,wehaveseenanimprovementinthecostofgoodssoldonaverage,duetothefrontedgeofthelargervintagesenteringthesalesstream.

Harvestcostsinthelargervintagesarespreadovermoretons,loweringcostofsalesandyieldingimprovedgrossmargin.Direct-to-consumersales,whichareasmallerpartofoverallsalesbutcarryhighermargins,alsocontributedtoimprovedmargins.Highergeneralandadministrativecostsduetoaheavierinvestmentneededfordirectsaleswashedoutthegainsfromimprovedcostofgoodssold,leadingtoflatprofitability.

Takenasawhole,thefinancialperformanceofwineriesin2014wasprettygoodandendedonanuptick.26Lookingatreportedfinancialhealthfromoursurveyshowsthatwineriesaremakingprogress,witheachbreakpointshowingyear-over-yearimprovement(Figure20).27

WhilethereisahighchancewecouldmissthedegreeandtimingoftheU.S.currencyimprovement,dropinoilprices,Fedactions,impactofadeceleratingworldontheU.S.economy,orthenegativeimpactofhigherinterestratesontheeconomy,wearecommittedtoourbeliefandpathandthinkthedirectionalimprovementweareseeingisrealandsustainable.

LikeChuckNolandinthefinalsceneinCast Away,wecan’tbecertainwhatthefutureholds,butgivenwhatwe’vebeenthrough,we’reoptimistic.Ashestandsatacrossroads,he’sasked:“Where’reyouheaded?”Chuck’sanswer:“Well,Iwasjustabouttofigurethatout.”

30%

25%

20%

15%

10%

5%

0%Dead On life support Very weak Slightly weak Good Strong Very strong Rock solid

Figure 20

Financial health: year-over-year comparisonn 2013 n 2014


50


Financial performance: 2015 looks like a breakout yearcontinued

Taken as a whole, the financial performance of wineries in 2014 was pretty good and ended on an uptick.

51

1. Q:WhatdotheauthorRobMcMillanandTomHankshaveincommon?A:Bothwerebornin1956inMt.DiabloHospitalinConcord.BothattendedCaliforniaStateUniversity,Sacramento.Bothareextraordinarilywealthy.…Well,maybenotthelastone.

2. Thelaborforceasapercentoftheciviliannoninstitutionalpopulation.

3. U.S.BureauofEconomicAnalysisdataattradingeconomics.com.

4. Thereisnoagreed-uponreferencepointfortheterm“finewine”intheindustry.Weuse$20abottleasadefinition,becausewehaveaccesstoseveraldatabasesthathaveabreakpointat$20ormore.

5. www.winesandvines.com/template.cfm?section=news&content=142644.

6. Shalefracking:en.wikipedia.org/wiki/Hydraulic_fracturing.

7. www.washingtonpost.com/opinions/robert-samuelson-key-facts-about-the-great-oil-crash-of-2014/2014/12/03/a1e2fd94-7b0f-11e4-b821-503cc7efed9e_story.html.

8. TheSouthwestEconomyFirstQuarter2011,FederalReserveBankofDallas,p34.

9. Here’salittleeconomictriviaforyou.ThePlazaAccordwasanagreementsignedtoweakentheU.S.currencyandwasthefirstpublicsuccessfulcoordinatedactmadebyCentralBankerstostabilizeworldcurrencymarkets:en.wikipedia.org/wiki/Plaza_Accord.

10. OKgoaheadandsayit:Rob?You’reafool.Nowgobacktodoingsomethinguseful.

11. IknowthisstuffbecauseIactuallyamabankerinthewinebusinesshandlingclientneeds,andIworkforaliving.ThiswritingstuffiswhatIdoinmycopiousfreetime.

12. Rob,you’restillafool.

13. Bloombergsurveyofeconomists,October2014.

14. www.gallup.com/poll/179810/economic-confidence-index-month-high.aspx.

15. UnemploymentRateU3:data.bls.gov/timeseries/LNS14000000.

16. BureauofLaborStatistics:www.bls.gov.

17. Formoreontheseconsumers,seemyblogpost:bit.svb.com/1y0uIK9.

Endnotes

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http://www.winesandvines.com/template.cfm?section=news&content=142644

http://en.wikipedia.org/wiki/Hydraulic_fracturing

http://www.washingtonpost.com/opinions/robert-samuelson-key-facts-about-the-great-oil-crash-of-2014/2014/12/03/a1e2fd94-7b0f-11e4-b821-503cc7efed9e_story.html

http://www.washingtonpost.com/opinions/robert-samuelson-key-facts-about-the-great-oil-crash-of-2014/2014/12/03/a1e2fd94-7b0f-11e4-b821-503cc7efed9e_story.html

http://en.wikipedia.org/wiki/Plaza_Accord

http://www.gallup.com/poll/179810/economic-confidence-index-month-high.aspx

http://data.bls.gov/timeseries/LNS14000000

http://www.bls.gov

http://bit.svb.com/1y0uIK9

18. SiliconValleyBankconductsaWineConditionsSurveyeachyearinconjunctionwithAVA’sthroughouttheWestCoast.In2014,wesentthesurveyouttoabout4,000wineries,andnearly500responded.Ifyouwouldliketobeincludedinthesurveyinthefutureandreceivegratisresultsandanalysis,pleasecontactPennyNorthropandrequestthatyoubeaddedtooursurveylist:[email protected].

19. Customerrelationshipmanagementisamust-haveforwineriessellingdirect:en.wikipedia.org/wiki/Customer_relationship_management.

20.L'OrganisationInternationaledelaVigneetduVin(OIV)statisticalreleases.

21. CiattiGlobalMarketUpdate,November2014:www.ciatti.com/sites/default/files/november_2014_ciatti_world_report.pdf.

22. Ifyouwouldliketoreadalittlemoreaboutmy“footinmouth”experienceofthisprediction,seemyblogpost“IsCaliforniaWineataPricingInflectionPoint,”atSVBonWine:http://svbwine.blogspot.com/2012/07/is-california-wine-at-pricing.html.

23. Onquestionsofexpectations,weavoidthecommonsurveymistakeofaskingsomethingrespondentshavelimitedcontrolover.Whilepriceincreasesfallintothatcategory,wedon’talwaysacceptthegeneralbeliefaswasthecaselastyear.Wetestthetheorytoseehowitholdsup.Weknowwinerieswanttopassonhighercoststoconsumers,andthisyearincertainpricepoints,webelievetheycan.

24. TheSVBPeerGroupDatabaseisaproprietarydatabaseofbothclientandnon-clientfinancialstatementsgoingbacktotheearly1990s.Withit,SVBisabletobenchmarkaclient’sfinancialinformationagainstahighlyrelevantpeergroupandreviewindustry-leveltrends.

25. Inthewinebusiness,themonthsofOctober,NovemberandDecemberrepresentabout40percentofannualsales.

26. “Prettygood”isdefinedingenerallyacceptedaccounting15principlesasfinancialperformancethatisonestepbetterthan“good.”

27. Reportedfinancialhealth,whileimprovinginallcategories,didhaveonenotablereportednegativechangeyearoveryear,andthatwasinthe“dead”category.Wehavetocallthereportingintoquestion,sincereportingwhenoneisdeadisonlypermissibleinChicagoelections.

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mailto:[email protected]

http://n.wikipedia.org/wiki/Customer_relationship_management

http://www.ciatti.com/sites/default/files/november_2014_ciatti_world_report.pdf

http://svbwine.blogspot.com/2012/07/is-california-wine-at-pricing.html

About Silicon Valley Bank

Formorethan30years,SiliconValleyBank(SVB)hashelpedinnovators,enterprisesandinvestorsmoveboldideasforward,fast.SVBprovidesarangeoftargetedfinancialservicestobusinessesofallstagesandsizes,withspecializedexpertiseinthetechnology,lifesciences,energyandresourceinnovation,venturecapital,privateequity,andpremiumwineindustries.ThroughofficesacrosstheUnitedStatesandaroundtheworld,SVBofferscommercial,internationalandprivatebankingservicesthataddresstheuniquechallengesandopportunitiesinnovatorsface.(Nasdaq:SIVB)

Learn more at www.svb.com.

Silicon Valley Bank’s Wine DivisionFoundedin1994,SVB’sWineDivisionoffersfinancialservicesandstrategicadvicetopremiumvineyardsandwineriesintheUnitedStates.Withoneofthelargestbankingteamsinthecountrydedicatedtothewineindustry,SVB’sWineDivisionhasofficesinNapaandSonomacountiesandservesclientsinthefinewineproducingregionsofCalifornia,OregonandWashington.

Learn more at www.svb.com/winedivision.

Silicon Valley Bank’s proprietary Peer Group metricsSVB’sPeerGroupAnalysisprogramtracksandcomparesavarietyoffinancialmeasuresamongpremiumwineries.Withfinancialinformationcollectedfrommorethan100premiumwineriesoverseveralyears,SVBgivesclientsexclusivebenchmarkinginformationandinsightsintotrendsshapingtheindustry.

Contact usFormoreinformationaboutthisreportorSiliconValleyBank’sWineDivision,pleasecalloremail:

Rob McMillanExecutiveVicePresidentandFounder707.967.1367rmcmillan@svb.com

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©2015SVBFinancialGroup.Allrightsreserved.SiliconValleyBankisamemberofFDICandFederalReserveSystem.SVB>,SVB>Findaway,SVBFinancialGroup,andSiliconValleyBankareregisteredtrademarks.

B_WD-14-13762.Rev.1-15-2015

Thismaterial,includingwithoutlimitationtothestatisticalinformationherein,isprovidedforinformationalpurposesonly.

Thematerialisbasedinpartoninformationfromthird-partysourcesthatwebelievetobereliable,butwhichhavenotbeenindependentlyverifiedbyus,andforthisreasonwedonotrepresentthattheinformationisaccurateorcomplete.TheopinionsandpredictionsexpressedinthispiecearethatoftheauthorandnotnecessarilythatofSiliconValleyBank.

Theinformationshouldnotbeviewedastax,investment,legalorotheradvice,norisittobereliedoninmakinganinvestmentorotherdecision.Youshouldobtainrelevantandspecificprofessionaladvicebeforemakinganyinvestmentdecision.Nothingrelatingtothematerialshouldbeconstruedasasolicitation,offerorrecommendationtoacquireordisposeofanyinvestmentortoengageinanyothertransaction.

Foreignexchangetransactionscanbehighlyrisky,andlossesmayoccurinshortperiodsoftimeifthereisanadversemovementofexchangerates.Exchangeratescanbehighlyvolatileandareimpactedbynumerouseconomic,politicalandsocialfactors,aswellassupplyanddemand,andgovernmentalintervention,controlandadjustments.Investmentsinfinancialinstrumentscarrysignificantrisk,includingthepossiblelossoftheprincipalamountinvested.Beforeenteringanyforeignexchangetransaction,youshouldobtainadvicefromyourowntax,financial,legalandotheradvisors,andonlymakeinvestmentdecisionsonthebasisofyourownobjectives,experienceandresources.Opinionsexpressedareouropinionsasofthedateofthiscontentonly.Thematerialisbaseduponinformationwhichweconsiderreliable,butwedonotrepresentthatitisaccurateorcomplete,anditshouldnotberelieduponassuch.

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Silicon Valley Bank 2015 State of the Wine Industry Report

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