| February 2005 | The Industry's Leading Publication for Wineries and Growers | www.winebusiness.com |
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As part of our review of the state of the U.S. wine industry, Wine Business Monthly compiled its second annual ranking of the top 30 U.S. wine companies by U.S. case sales. These wine companies represent more than 90 percent of the U.S. wine market. In exclusive interviews with WBM, the leaders of these companies spoke about where their companies are heading, how they plan to get there and the challenges they face today. The leaders of the largest wine companies also shared their views on the state of the market as a whole. All acknowledged that the past few years have been difficult ones, characterized by a perfect storm of oversupply, economic downturn and competition from imports. However, industry leaders interviewed by WBM said they're cautiously optimistic, primarily because (1) a falling dollar may slow the pace of imports and is seen boosting exports, (2) the economy appears stable, (3) the grape supply situation is more balanced than it was one year ago, and (4) sales are increasing. Three of last year's top 30, including Robert Mondavi, were purchased by other wine companies, and three new ones made this year's list. One of the wine companies experiencing significant volume increases was Don Sebastiani & Sons, which inched its way higher on the list. What follows is an overview of what industry leaders are saying about the state of the wine industry. Bottoming Out Most leaders believe that the perfect storm is over. The economy is growing again, the falling dollar is decreasing the threat from imports and, most importantly, the industry seems to have worked through the oversupply of grapes and bulk wine. The Economy As the economy goes, so does the wine business, and executives interviewed by WBM said they see the state of the U.S. economy improving, albeit slowly. If there was one item in particular that seemed to worry them, it was the possibility that the economy could falter, dragging down the wine business with it. "If the economy continues to come around, it will help the business," said Bill Newlands of Allied Domecq Wine USA. "We have endured some difficult years, and now the economy is warming up and we will benefit from that," Domain Chandon president and CEO Rodolfo Horsz said. "The economy has picked up in the U.S.," Franciscan Estates's president and CEO Jon Moramarco said. "We're continuing to see better sales velocity, both retail and on-premise, but I don't think we're back to the on-premise levels of early 2000. Imports and Exchange Rates For the second year in a row, industry executives said they see the U.S. dollar's decline relative to other currencies helping fend off imports while boosting export prospects. Yet previous expectations that exchange rates would slow imports only came to fruition to a small extent in 2004. This was because some companies hedged currencies and some wineries were willing to sacrifice volume for margins. Most leaders expect exchange rates to have a larger effect on imports in 2005. "The euro is at $1.35, and we believe it will go to $1.60 in the next 18 months," Delicato chief executive Chris Indelicato said. "In 2005 you will see the effects of the dollar on imports. I don't think we've seen it yet because a lot of people hedged." "You can't hedge indefinitely," Franciscan's Moramarco said. "It's going to be harder for Australian wines to have the growth rates they've had," R.H. Phillips chairman John Giguiere said. "At some point, market share won't be as valuable as profits." "The Australian dollar is relatively strong based on historical comparisons with the U.S. dollar, which should put pressure on the Australians to take price increases," Kendall-Jackson president John Grant said. "Tracking imports, we can see a small slowdown. Instead of growing in double digits, they'll grow in single digits." At least one company leader, however, sounded a cautionary note for those who believe that a weak dollar will significantly slow the sales of imported wine. "The dollar is a mixed bag because a lot of the companies that have become involved have multiple currencies in play, so over time, the currency thing equals itself out," Allied Domecq's Bill Newlands said. A Changing Supply Picture Most executives believe we are through the worst of the over-supply problem. "Supply is a relative thing, and you could generalize and say the supply-demand curve is equalizing," Kendall-Jackson's John Grant said. Some large wine companies continue to negotiate their way out of contracts with growers, while others are starting to line up new contracts because of a perception that there may soon be the opposite problem: supply shortages. It has been widely reported that more than 100,000 acres of wine grapes were pulled out of the ground in California during 2002 and 2003, which helped balance grape supplies. "The wine business is very cyclical, and the cycle we've just gotten through involved a great influx of foreign, lower-priced competition," Jay Shoemaker of Niebaum-Coppola Winery said. "This made it harder to grow the top line during the last three or four years. There was a shift away from super premium and very expensive wines. In the cycle we're headed into now, we're worried about the opposite of the grape glut: not enough supply and constraints on processing." A "Turnaround" Year Industry leaders said the wine market has bottomed out. There were apparent differences of opinion about how soon pricing will increase, but a general perception that the industry's most difficult times are behind it. Several executives mentioned that sales in restaurants have rebounded, but are still nowhere near the levels they reached three or four years ago. "This has been a turnaround year," Ste. Michelle Wine Estates president and CEO Ted Baseler said. "It appears 2003 was the bottom for many and that things have shifted, which is positive for the entire industry." The market remains very competitive but Baseler said the restaurant and travel sectors are rebounding. "We're still seeing a lot of low-priced wine and people with serious inventory concerns moving wine at any price, but there seems to be some moderation, which is good." "The marketplace seems positive, C. Mondavi & Sons vice president and treasurer Pete Mondavi Jr. said. "The overall trend is not explosive growth by any means, but at least we're seeing some positive signals." "I think we're somewhere past the bottom but not very far, and we are in a growth period," Hahn Estates president Bill Leigon said. "I'm not as optimistic as a lot of people I talk to. I think it's going to be a slow recovery but that we're going to see growth." "We've had short crops in 2003 and 2004, the economy is picking up, and people are spending a little more freely," observed J. Lohr proprietor Jerry Lohr. "Wines with good flavors and authenticity, that meet people's expectations, are doing fine. The ones that are a little simpler aren't doing as well." One theme that emerged from conversations with industry leaders is that the costs of doing business are increasing but the margins wineries are seeing generally are not. Many continue to cut costs where they can. Bob Torkelson of Trinchero Family Estates said executives at his company worry about external factors such as globalization, consolidation and inflation. He said many wineries are feeling squeezed but lack pricing power in the marketplace. "Prices need to come up," said John Kautz of Ironstone Vineyards. "Our expenses have gone up and case prices haven't. We need to keep moving the prices up. Costs of everything have gone up. Insurance, fuel, you name it. You certainly have to have price increases for the grower segment, or the grower segment can't survive, so that has to get passed through." Predictions and Outlook for 2005 Most leaders of the "WBM Top 30" companies were optimistic about 2005. They are predicting (or maybe hoping?) that prices will begin to rise this year and that demand for wine will continue to increase. Another trend they see continuing is a proliferation of new products. Increasing Prices Most executives interviewed expect retail prices to firm as an oversupply of grapes and bulk wine experienced during the last couple of years subsides. Several industry executives said they believe the changes in the supply picture are already being reflected in the marketplace. "We're already seeing a scale-back in the level of discounting and promotional activity," Constellation Wines-U.S. president and CEO Jose Fernandez said. "I think the big story in 2005 will be that inventory is extremely short," Chris Indelicato said. "It could create a shortage and drive up pricing," There was at least one dissenting voice, however, regarding prices increases. "Our experience is there's still a tremendous worldwide wine glut, and we have been very aggressive (on pricing)," said Don Sebastiani of Don Sebastiani & Sons. "I think a lot of artificially high prices were reduced back to where they should be." Product Innovation From speaking with the leaders of the nation's largest wine companies, it becomes apparent that each has taken steps to deal with recent market challenges and trends, whether they've repositioned brands, launched new ones, or made operational changes to improve the bottom line. The wine industry is more dynamic and innovative than ever, and competition for consumer mindshare is getting more intense. More than 200 new wine SKUs were introduced in the U.S. market last year. "The wine industry is a little different than other consumer goods industries," Kendall-Jackson's John Grant said. "Diversity is celebrated in wine because consumers like to explore. That's different than other consumer goods segments. There will be more wineries in the U.S. next year, and I think the marketplace can sustain that." "I'm optimistic," Bonny Doon president Randall Grahm said. "I lament the fact that there's a narrowing of distribution channels and that the mid-sized producers have gone the way of the horse and buggy, but I think the business is pretty dynamic, with people moving in interesting directions. The business is healthier now than it was just a few years ago, but I still have the same kvetches: There's a largely homogenous style of winemaking, and I'd like to see more diversity in style and content." Increasing Demand Another theme that emerges is that wineries are optimistic about young adults starting to embrace wine and about per-capita consumption increasing as new wineries emerge throughout the country. "With wineries in all 50 states, we are slowly but surely on the verge of getting wine into the American culture," Jerry Lohr said. "It will probably take 20 years but we're beginning to do it." Long Term: More Consolidation Clearly, an overriding theme in the wine industry in 2004 was consolidation. Three of WBM's Top 30 of 2004 fell off the list because they were swallowed up by other companies: Robert Mondavi was acquired by Constellation Brands; Golden State Vintners was bought by The Wine Group; and Chalone Wine Group accepted a buyout offer from Diageo. Many executives interviewed by WBM agreed that a clearing out of mid-sized wine companies may be inevitable, though virtually all pointed out that there is room for small and mid-sized players with winning business models. Just a few months ago it seemed implausible that Robert Mondavi would not be owned by the Robert Mondavi family. Two different wine businesses seem to have emerged: the corporate giants and the smaller family-owned artisan producers. "Bruce Willis made a movie, Last Man Standing," Trinchero's Torkelson said. "The Trincheros think they may be the last family-owned winery standing." Allied Domecq's Bill Newlands said the Mondavi sale was a unique transaction and probably something of a single scenario. "I'm not sure the Mondavi sale by itself will immediately cause a continuing ripple effect," he said. Dan Leese of Beringer Blass, on the other hand, said the Mondavi takeover could hasten the next deal. "I would be surprised if you didn't see us being aggressive in the future as well," he said. "I think a lot of that is inevitable whenever you have consolidation around the industry." Peter Mondavi Jr. of Charles Krug said consolidation is driven by economies of scale, but more importantly, to facilitate the distribution system. "When a winery goes out there with a large group, they can command an incredible level of attention at the distributor level because distributors are consolidating," he said. "Supplier-side consolidation follows." Many executives see consolidation as a good thing for the industry. "We're still such a phenomenally fragmented business category. Most categories are tremendously consolidated," said St. Michelle's Baseler. "I don't think we're ever going to have that in the wine business, but having a few large companies that drive the category is probably not unhealthy at all." "There will continue to be consolidation in the wine business, and it will be good for the consumer because efficiencies will allow people like us to invest in quality," Diageo Chateau & Estates president Ray Chadwick said. "The interesting thing with the wine industry is even though we'll have consolidation, you will see more small wineries, and I think it's great for total consumption in the U.S.," Franciscan's John Moramarco said. "These small wineries popping up in every state bring more recognition of wine to people in every state, and the benefit of that long term is making the U.S. more of a wine drinking country."
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