Bank: Fine Wine Trending Up

Sales for bottles priced $20 and up will increase in 2015, according to Silicon Valley Bank report

by Paul Franson
Source: Silicon Valley Bank 2014 Wine Conditions Survey
St. Helena, Calif.—Silicon Valley Bank predicts that 2015 will be a great year for premium wineries but perhaps less so for high-volume producers making wines that sell for less than $9 per bottle.

The bank’s annual State of the Wine Industry Report forecasts that an improving economy will increase sales growth for fine wine by 14%-18% and result in higher bottle prices. That’s good news for upscale wine businesses, but the market for cheap wines will continue to weaken, even as foreign competition grows.

“We are seeing real strength in the U.S. economy going into 2015, which will increase demand for wine,” said Rob McMillan, founder of Silicon Valley Bank’s Wine Division and author of the report. He added, “Despite the higher volumes, we believe we may see modest price increases in bottle prices greater than $20.”

McMillan discussed the report and the state of the industry in a live broadcast with Glenn Proctor of the Ciatti Co., Amy Hoopes of Wente Family Estates and Paul Mabray of VinTank during an event broadcast live online Wednesday.

Positive outlook
Silicon Valley Bank is a leader in banking for boutique wineries, so its bullish comments probably reflect their prospects more than that of the larger wine industry in general. Nevertheless, some of the conditions driving demand are fundamental.

McMillan added, “Declining oil prices are transferring wealth to oil-consuming countries; the employment picture is improving; the U.S. dollar is strengthening, and interest rates will move at a measured pace. As long as the industrialized world economies can hold their own, the middle-income consumer will see improved prospects.”

McMillan continued, “We are especially positive on the year ahead. We expect the fine wine business will experience accelerating growth, achieving 14%-18% sales growth in 2015. At the same time, the cellars are full with several consecutive years of very good vintages.”

Other positive factors helping fine wines include overturned blue laws, and relaxed restrictions on direct shipments.

McMillan added that starting in mid-2014, wines priced above $20 per bottle broke out strongly higher. “Trading up” is a clear trend again. Red wines in particular showed the strongest growth, and McMillan said he expects that to continue throughout 2015.

However, growth in sales of wines priced higher than $20 was driven by accelerating volume with little in the way of higher prices to the consumer. McMillan thinks that prices will start rising due to the improving economy and increasing demand. That’s welcome news to wineries recovering from challenges experienced during the recession, which seems to have finally ended.

The bank surveyed nearly 600 West Coast wineries to create the report. It maintains extensive compilation of SVB clients’ performance but does get information from some other wineries.

Key findings and predictions
Supply: He agrees with the industry in general that when the 2014 harvest is tallied next month, it will be the third consecutive harvest of heavy yield and great quality across most appellations. “We all believe it was a heavy harvest, and everyone is making their guesses, but we won't have the accounting until the Grape Crush report comes out,” McMillan told Wines & Vines.

Sales growth: After finishing the year at the top end of the predicted sales growth by his bank (6%-10% in 2014), McMillan is predicting a breakout year of growth in the fine wine category in the 14%-18 percent range in 2015.

Pricing: While the large supply of wines in the cellars should normally indicate continued depressed pricing, he believes that 2015 will be a year of both volume and price increases in the fine wine segment, driven by an improving economy and higher demand.

Demand: Wines priced below $9 per bottle performed poorly both on- and off-premise in 2014. This poor performance is likely to continue in 2015. In addition, large bulk imports will continue to dominate the wine categories at the lowest price points, but bulk imports should be held back by the size of the 2014 harvest and existing inventories.

McMillan said that the lower end of the market is already trending down. Something will have to happen to make that trend reverse course, he said, and nothing visible at this point would reverse the trend. In fact, a strengthening dollar could increase bulk imports, so the lowest end of the market from a price perspective will probably see price discounting and perhaps volume declines as well in 2015.

Planting: Grape planting is shifting regionally. Oregon and Washington are showing strong growth in planting on a percentage basis, and McMillan expects that this will continue for the foreseeable future given favorable quality and price dynamics relative to the fine wine growing regions in California.

McMillan noted that replanting is continuing in older vineyards and those infected with red blotch virus, which reduces yields and quality. But finding land for new vineyards is becoming more difficult in the North Coast due to high land costs and growing restrictions.

Meanwhile, growers in California’s Central Valley will pull out about 20,000 acres of grapes that were directed to wines priced less than $7 per bottle, in many cases replacing them with more profitable nut orchards.

At the lowest end of the market, he expected to see pricing declines given there is abundant supply and trading up. In the $10–$20 part of the market, a lot of wine is available. McMillan said, “Négociants and branded wines will soak up some of that, such that we expect to see volume increases and some discounting. Wines priced from $15-$18 will have better luck maintaining their price.”

Challenges ahead
McMillan commented in the live presentation that he considered the ongoing drought one of the biggest challenges facing California wineries. “They will have to address long-term solutions to water shortages.” Planting decisions could be impacted by climate change, too, though the report doesn’t specifically address that possibility.

In all, however, Silicon Valley Bank predicts its winery clients will continue to improve performance. “The harvest costs in the larger vintages are spread over more tons, lowering cost of sales and yielding improved gross margin. Direct-to-consumer sales, which are a smaller part of overall sales but carry higher margins, also contributed to improved margins.”

However, he said that higher general and administrative costs due to investment needed for direct sales balanced the gains from improved cost of goods sold, leading to flat profitability.

McMillan concluded, “Taken as a whole, the financial performance of wineries in 2014 was pretty good and ended on an uptick. Looking at reported financial health from our survey shows that wineries are making progress, with each breakpoint showing year-over-year improvement.”

A replay of the discussion will be available at svb.com in two weeks. The report is now available here

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