Makers of high-end wines caught in 'dead zone'SOURCE
By Kevin McCallum
THE PRESS DEMOCRAT
Published: Monday, September 7, 2009 at 6:20 p.m.
Hedge fund manager Eric Flanagan spent millions to build the finest boutique winery money could buy.
He purchased 120 hilltop acres with panoramic views of Bennett Valley, hired the best vineyard and winemaking consultants, and spared no expense in constructing his Flanagan Family Winery.
Complete with caves bored deep into the hillside and the finest French oak fermentation tanks and barrels, the modern, curved-roof facility opened in 2006.
But Flanagan, who manages New York-based EMF Financial Products, made a critical mistake — he assumed California's high-end wine market would continue its inexorable march upward.
He found out how wrong he was last fall, just as his $100 wines were trying to gain traction in the market. The economy was in free fall, housing prices were plunging and consumers were pulling back sharply, eating out less and shunning luxury goods.
His timing couldn't have been worse.
“I think the efforts we made in the winery were good,” said Mark Mazzoni, assistant winemaker since 2006 and its only full-time employee. “It's everything else that was falling apart around us.”
The winery, including 16 acres of cabernet sauvignon and syrah vineyards, is now for sale for $8.5 million. An adjacent property is listed for $1.5 million, recently reduced from $2 million.
The demise of Flanagan Family Winery is just one stark example of a powerful shake-up under way in the U.S. wine industry. Consumers who for decades have been steadily trading up to higher-priced vintages have reversed course, trading down to cheaper wines in search of better values.
Some think the reversal will be short-lived; others say something has fundamentally changed in the wine business.
“There is permanent shift in the consumer's perception of the value of wine,” said Robert Nicholson, principle of International Wine Associates in Healdsburg. “We would be naive if we did not realize that was not happening before our very eyes today.”
The sudden retreat is leaving behind plenty of casualties.
Inventories at high-end wineries are building. Wine club memberships are being canceled as consumers lose their jobs or cut back expenses.
Layoffs have hit major wine companie like Constellation, Fosters and Kendall-Jackson.
Grape growers are watching prices plunge 30 or even 40 percent compared to last year's record prices. Sonoma pinot noir that sold for $2,800 a ton last year might today sell for $1,800, according to brokers.
And an increasing number of wineries and vineyards are going on the block.
“There are more wineries that are in the process of selling than at any time in my memory,” said Rob McMillan, founder of Silicon Valley Bank's wine division.
The shift is good news for many low-cost producers, such as Central Valley producers E&J Gallo and Bronco Wine Company, both of which are seeing sales soar. But for the North Coast, the heart of the U.S. fine wine industry, it's a far different story.
The majority of the region's wineries are small, family owned operations selling much, if not all, of their wines above $20.
Sales of those wines are off as much as 15 percent this year, said analyst Jon Fredrikson, partner at Woodside-based Gomberg, Fredrikson & Associates.
For those selling wines over $50, the landscape looks even bleaker.
Many wines from $50 to $125, of which Sonoma and Napa has plenty, are in a “dead zone,” McMillan wrote in his April “State of the Wine Industry” report.
Of all winery operators surveyed for the report, those in Sonoma and Napa were the most pessimistic about their prospects in 2009, McMillan wrote.
The second-quarter results showed that pessimism was warranted, said Fred Reno, chairman of the Henry Wine Group in Benicia, a distributor of many high-end imported and domestic wines.
“In my opinion, this was one of the worst quarters that anyone has seen in the fine wine business ever,” Reno said. “The consumer has totally traded down and I think wineries are kidding themselves if they think this is a one- or two-year deal. This is a three-year deal, at a minimum.”
He should know. Reno's company is a respected distributor of imported and domestic high-end wines, including marquee Sonoma County brands like Kistler, Hanzell and Seghesio.
He predicts a shakeout is coming for weaker, high-end players who have borrowed heavily but no longer have the cash flow to keep their bankers at bay.
“There is a perfect storm waiting out there for some of these guys,” said Reno, who is also a part-owner of the Sonoma pinot noir brand Emeritus.
The trouble is brewing largely unnoticed because overall wine consumption is up.
Total wine shipments in California increased about 5 percent by volume so far this year, an indication that the fundamentals of the overall industry remain strong, Fredrikson said
More young adults are drinking wine, and Americans still drink far less wine per capita than Europeans, indicating the industry still has plenty of room to grow, he said.
Despite the better news about the economy, wine sales at restaurants remain weak, particularly at white tablecloth establishments.
“I'm a little surprised that it hasn't recovered,” Fredrikson said. “It's disappointing. I think it shows people have reined in spending and are still being very conservative.”
High-end wines may see a spurt in sales as restaurants and distributors replenish inventory in anticipation of the holidays, but it won't be anywhere near previous levels, Fredrikson said
“Unfortunately, it's going to be a real slow comeback,” he said.
That's because consumers are unlikely to return to their freewheeling spending habits anytime soon, even if the economy does recover, industry experts agree.
With so many good wines being made at affordable prices, both in the U.S. and abroad, consumers who go hunting for values will inevitably find them.
“Consumers are now saying, ‘I traded down, and guess what, I found good wines,'” said John Gillespie, president of the Wine Market Council, which studies the habits of U.S. wine drinkers.
As high-end wineries lower prices and negociant-style wineries find a bigger supply of better grapes at lower prices, the quality of the lower priced wines will continue to improve. This may further convince wine drinkers they don't need to spend a lot to get a lot, Nicholson said.
Wines selling for $25 and $50 will still have a market, but the typical consumer will view them as wines reserved only for very special occasions, he said.
That will cause particular pain for wineries that are undercapitalized, struggling with heavy debt burdens, or are new to the market. All are likely to struggle more than established players, he said.
“Those who are doing well in this environment are those that are reasonably priced and well-established brands,” Nicholson said.
Constellation Brands, the largest wine company in the world, saw U.S. wine sales slip 1 percent in the latest quarter, ended May 31. The U.S. market performed well compared to overseas markets such as the United Kingdom largely because the company in recent years has focused on acquiring trusted, established brands selling for under $20, such as Robert Mondavi and Clos du Bois.
“People are moving a little bit more toward trusted brands that have more legitimacy and more history with people,” said Lou Applebaum, senior vice president of corporate strategy for Constellation Brands. “There seems to be a little less experimentation.”
The company laid off 100 people in June in a restructuring that collapsed three wine divisions into one, said spokeswoman Nora Feeley.
Annual revenue for Santa Rosa's Jackson Family Wines is up slightly, with the strength of brands such as Kendall-Jackson, long the best-selling chardonnay brand in the U.S., balancing out the weakness of some of the other luxury brands in the portfolio, according to owner Jess Jackson.
“Our core business is very healthy,” Jackson said.
Several of its high-end brands, however, are struggling. Some are off 30 percent, some more than 40 percent, he said.
The company laid off about 170 people earlier this year and has been consolidating wine divisions and winemaking facilities in an effort to save money.
Smaller wineries often have fewer cost-cutting options.
The Healdsburg tasting room for Toad Hollow Vineyards is discounting wine more than it has in the past to try to drive sales.
“In the past, there wouldn't necessarily always have been a sale going on, but now there's always something on special,” said owner Frankie Williams.
At the nearby tasting lounge for Thumbprint Cellar, owner Scott Lindstrom-Drake has sweetened the deals for his wine club members, who can now get up to 30 percent off on wines in an effort to make up for wine club cancellations.
“People are getting laid off from their jobs and losing their homes, and they're having to drop their wine club membership,” he said.
And as the retail traffic has dropped off in downtown Healdsburg, Lindstrom-Drake shifted more of his wine to distribution on the East Coast, where they are selling well, he said.
While some see large numbers of wineries for sale, Fredrikson said he doesn't see a “wholesale shakeout in the market.”
“Most people will get through this. They may lose some money, but I still believe that the industry balance sheet is healthy,” he said.
The discounting of wine may actually end up helping the industry overall, Nicholson said. Better wine at lower prices will draw more wine drinkers, who will inevitably, as the economy improves, return to exploring higher priced wines, he said.
McMillan agreed. “I don't care who you are, everyone aspires for more. Everyone aspires to better things,” he said.
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