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Tuesday, March 16, 2010

Trouble in Napaland: Popping of the Wine Country Bubble

A major shift in consumer sentiments and buying patterns is causing significant dislocation in Napa Valley, especialy among growers/wineries with poor financial positioning. 

In the period 1991 to 2008, U.S. retail wine sales grew by 66% but fell by 3.3% between 2008 and 2009.  Sales of bottles in the super-premium category ($30 and above) fell by 15% while sales in the premium category ($15 and above) fell by 10%.  U.S. wine sales decline can be traced to three direct forces: (i) the impact of cheaper wine from Chile, Argentina, and other areas; (ii) consumers trading down in their buying preferences (there may be some causative influence between (i) and (ii); and (iii) a falloff in the restaurant wine sales market as recession-racked consumers stay home in droves.

Within this market environment, wineries are having a tough time moving inventory and some have resorted to such heretical practices as doing private label wines or selling in bulk.  In the case of bulk wine sales, the sell price of the wine could be lower than the cost of the grapes to the winery.

The turmoil in the wine market has had significant knock-on effects for wine industry real estate.  According to Silicon Valley Bank, as many as 10 wineries and vineyards will change hands in distressed sales or foreclosures between 2010 and 2011.  Further, property loan defaults in the month of January were four times higher than one year ago.

Napa land values are currently averaging between $150,000 and $200,000 an acre for land planted with red varietals.  This is a 15% decline from the 2007 peak.  This reduction in land values is affecting everyone but even more so the new arrivals.  These "newbies" made their money in real estate or finance, came into Napa with the romantic notion of crafting the next Screaming Eagle, and bought land at the peak of the market in pursuit of this dream.  This approach has saddled them with enormous initial costs, costs which are unsupportable in a down consumer environment.  And, given the decline in land prices, and bank credit tightening, it is very hard to refnance loans without a bulletproof story.

The strongest players in the industry are seeking to turn this turmoil to their advantage.  For example, Bill Harlan, of Harlan Estates, has purchased 21 acres of an Oakville property called Diamond Oaks Winery from a businessman named Dinesh Maniar.  This same Dinesh Maniar has two other properties in the area that are also facing foreclosure.

In a KQED forum on the state of the Napa wine industry, Robert Nicholson of International Wine Associates has stated emphatically that the sky is not falling.  He sees the market experiencing some adjustment but continuing to be strong overall.  The U.S. wine market, according to Robert, has a very strong core group of wine drinkers in that 90% of the the wine consumed is drunk by 20% of the population.  He is very optimistic about the long-term prospects for the market as the 44 milion marginal drinkers, and those who do not currently drink wine, continue to be exposed to the beverage.

It is possible that current wine price declines will be the silver lining in that long-term picture painted by Robert.  If lower wine prices solidify the marginal drinkers, and attract the non-drinker, it would have positive implications in that today's entry-level wine drinker is tomorrow's premium wine drinker.

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