Industry Sector Report Wine Industry Insider 2011 SONOMA COUNTY
2011 Wine Industry Insider July 2011 The Sonoma County Economic Development Board (EDB), in partnership with the Sonoma County Workforce Investment Board, is pleased to present the 2011 Wine Industry Insider for Sonoma County. Our research partner, Moody s Analytics, provided the research for this report. Highlights of the 2011 Wine Industry Insider include: Falling wine inventories caused by severe weather in 2010, which significantly reduced the grape yield, is a key positive price driver for wineries. Growing price stability will allow a recovery to finally begin to take hold in the wine industry. The wet winter, with rainfall 30% higher than normal, ended drought conditions and will temporarily help wine grape growers cope with increasing limitations on water use. Wine consumption in the U.S. grew by 2% in 2010 to pre-recession levels, sales increases were largely concentrated below the $25 a bottle price category, limiting the benefit from producers of high-priced wines. The long-term outlook for the wine industry is positive as demographic trends suggest the consumer market will remain strong. Thank you for your interest in the Economic Development Board s research. For additional information, questions, comments, or suggestions please contact us at (707) 565-7170 or visit. Sincerely, Ben Stone Executive Director 2011 Sonoma County Economic Development Board. The Economic Development Board (EDB) believes all data contained within this report to be accurate and the most current available, but does not guarantee its accuracy or completeness. Use of data from an outside source does not represent an endorsement of any product or service by the EDB, its members or affiliates. This publication can be made available in alternative formats such as Braille, large print, audiotape, or computer disk. Please direct requests to (707) 565-7170 and allow 72 hours for your request to be processed. This report was prepared by Sarah Claxton Deming.
Sonoma County: Wine Industry Insider Recent Performance Sonoma County winemakers face an improving, but still-challenging environment. Although wine sales have begun to improve in recent months, evidence suggests that wine drinkers recession-sparked flight to value has not begun to reverse, but rather is slowing at best. Falling wine inventories and growing global markets in developing Asia in particularare among the near-term positive price drivers for wineries. Sonoma County winemakers will soon encounter growing price stability, which will allow a recovery to finally begin to take hold within the industry. Production decreased substantially at Sonoma County s vineyards in 2010 after the large harvest of 2009. Total grape tonnage decreased by 9.7%. Production of red wine grape varieties, the county s largest crop, decreased by 10.1%. Among major red varieties, zinfandel experienced the largest decline 39%. White wine varieties decreased 9.2%; chardonnay production, which makes up most of the county s white wine output, increased 9.5%. Wine consumption in the U.S. managed to grow in 2010 by 2%, according to Gomberg, Fredrikson & Associates. In contrast to the previous two years, last year s increase in consumption was less reliant on steep discounting. Total wine sales increased by 5%, back to 2008 levels. However, sales increases were largely concentrated below the $25 a bottle price category, limiting the benefit to county producers of high-price wines. Growth in wine consumption extended to international wine markets. The value of exports of U.S. wines increased by 25% following a drop in exports in 2009, according to the Wine Institute. Exports to the largest markets of the European Union and Canada increased by 15% and 30%, respectively. Exports to Hong Kong more than doubled, making it the third-largest market. The value of U.S. wine imports increased 7% last year after declining in 2009. Imports from the emerging wine regions of New Zealand and Argentina had the largest increases, 30% and 25%, respectively; shipments from the largest sources of imports, Italy and France, increased only 7% and 3%, respectively. Australian imports declined for the third consecutive year. Macro Drivers The U.S. economy is gaining traction. U.S. GDP grew 3.1% in the fourth quarter of 2010 and 2.9% for the entire year, following a contraction of 2.6% in 2009. Business sentiment has improved measurably since the beginning of the year, helping to improve the near-term outlook. GDP will grow 3.5% this year before surpassing 4% in 2012. Downside risks to the forecast are federal, state, and local government budget cuts and rising oil prices. The pace of labor market improvements will accelerate in the near term. The U.S. unemployment rate will increase briefly before falling below 9% by the beginning of 2012. The strengthening labor market will allow personal income to grow 4% in 2011 and 4.4% the following year. Consumption will improve in the near term and will move closer to full recovery. Consumer spending has already returned to its prerecession level, and the Standard & Poor s 500 has strengthened to more than 80% of its 2007 peak. In contrast, household net worth has recovered only slightly less than half the losses incurred during the recession, as house prices resume their decline. Limited declines in the savings rate will temper improvements in consumer spending and will delay a substantial return to quality by value-oriented wine drinkers. The savings rates fell below 6% at the end of 2010. However, the savings rate is expected to remain above 6% through 2015 more than double the average from 1998 to 2008. With more personal income stored in savings, the recent flight to value among some middle-income wine drinkers may become permanent. 5 4 3 2 1 0-1 -2 2008 Consumers Reap Surplus From Discounting Beer, wine and liquor store sales, $ bil, 3 mo MA (L) Wine prices, % change yr ago, 3 mo MA, ths (R) 2009 2010 3.20 2011 Sources: Bureau of Economic Analysis, Bureau of Labor Statistics 3.55 3.50 3.45 3.40 3.35 3.30 3.25 Consumers will continue to reap benefits from the slow recovery of wine prices in the near term, including for high-quality wines from Sonoma County. Along with discounted prices, consumers have an increasingly wider choice of private label wines often sold directly by wineries to retail stores. Retailers, including U.K.-owned Fresh & Easy Neighborhood Markets, are introducing new collections of low-priced private labels wines from wineries in high-quality production areas such as Napa and Sonoma counties. 3
Moody s Analytics Wine Industry Insider Industry Drivers Plentiful water supplies bode well for wine grape production to rebound in 2011 for Sonoma County grape growers following the severe weather that resulted in crop losses in 2010. An extremely wet winter has left the county with a cumulative rainfall of more than 35 inches through the end of March- 130% of normal. Despite plentiful water supplies, uncer-tainty surrounds the future ability of growers to access water for frost protection purposes. Under proposed state regulations, diversions for frost protection from the Russian River would be regulated by a yet-to-be formulated body. Growers fear that if the county were to return to drought conditions in the future, cumbersome limitations would make them unable to fight off late-spring frosts, exposing their grape crops to large losses. Chronic state and local budget woes across the country are sparking interest in further loosening restrictions on wine sales in order to increase tax revenues. A bill has been intro-duced Connecticut that would allow the retail sales of alcohol on Sundays, and proponents are seeking to extend wine sales to grocery stores in New York. However, concerns with lost tax revenues are complicating efforts to privatize state-run wine and spirit stores in Pennsylvania and Virginia. Sonoma County s reputation as a major wine-producing area will grow over the next several years as a result of recent legislation and marketing efforts. A state requirement that wines produced in the county include the phrase Sonoma County along with its American Viticultural Area was signed into law in the fall and will go into effect in 2014. Similar laws are credited for increasing the profile of other California wine-growing areas including neighboring Napa County. Local winemakers will also benefit from industry ef-forts to increase the profile of California wines in growing international markets. County wines are among the bottles featured by California Vintage a Californiathemed wine bar chain that is expanding throughout China, Japan, Singapore and Taiwan. Pricing Prices for wine grapes prior to the 2010 harvest remain under pressure. While stressful for wine grape growers, lower grape prices are beneficial for wineries as wine grapes make up a significant portion of their production. However, wineries must still balance out their input costs with wholesale and retail price points that are only beginning to show signs of improvement. The outlook for retail pricing for high-price wines will similarly begin to slowly ease from negative to moderating as 2010 vintage wines begin to enter the market in late 2011 and early 2012 at the soonest. Off-premise sales of older vintage wine bottles priced $20 or more increased 13% over the three-month period ending in February, according to Nielsen Co.; however, the gains were partially boosted by price discounting that is still dragging down wholesale and retail prices. As a result, aficionados of fine wine can still enjoy more bottles at a fraction of their former cost. Internationally, efforts to reduce a glut of wine will begin to bear fruit in the form of re-duced supplies. The continuing destruction of wine grape plants in Australia and the streng-thening of the Australian dollar relative to the U.S. dollar will help to further reduce the amount of Australian wines in the world mar-ket. Wine grape growers in New Zealand are similarly restricting production of wine grapes in order to stop the precipitous decline of their grape and wine prices. In contrast to contracting Australian and New Zealand pro-duction, Argentine wine producers have boosted exports in order to capitalize on the downward shift to value by U.S. wine con-sumers. Argentina surpassed Chile to become fourth-largest supplier of wine to the U.S.in 2010 amid a strengthening Chilean peso and the loss of inventory as a result of Chile s major earthquake in early 2010. Operating Expenses Downward pressure on wine grape prices will take time to dissipate. The smaller grape crop in the fall of 2010 did not result in higher prices paid by processors for grapes grown in Sonoma County. Instead, prices fell by 8% outpacing the 5% statewide decline. Easing inventories of wine and a decline in statewide wine grape acreage to its smallest size in 13 years will help to stabilize prices in future harvests. 125 120 115 110 105 100 95 90 Argentine Wines to Increase U.S. Market Share 85 2010 Euro Chile Australia Argentina Source: Moody s Analytics 11F 12F Favorable exchange rates and increased exports will help Argentine wines to capture additional U.S. market share in 2011. Stimulatory fiscal policies ahead of the 2012 election will keep the Argentine pesos from strengthening against Chile s currency, increasing the appeal of Argentine wines to still value-conscious U.S. wine con-sumers. In 2010, Argentine wineries capitalized on U.S. consumers shift to value and increasing awareness of malbec wines, boosting their wine exports by 12.5% from a year earlier. 4
Moody s Analytics Wine Industry Insider Operating Expenses Labor costs will begin to edge upward in 2011, although at a moderate pace. Sonoma County s unemployment rate will fall below 10% by the end of 2011 as job growth sur-passes 2% for the first time since 2006. Labor market improvements will once again increase alternative employment opportunities for field workers although not enough to lead to severe shortages. The recession had previously reversed the outflow of field workers to other industries, particularly construction. As a result of recent industry consolidation, wineries are unlikely to experience a sharp upturn in hiring in the near term. Employment at the county s wineries edged up slightly through the middle of 2010, the latest period of detailed employment data available, but remained below prerecession levels. Some nonlabor costs will increase for So-noma County wineries in the near term. In particular, oil costs are rising as a result of po-litical instability in the Middle East, increasing the cost of fuel and other energy items. The outlook for a modest recovery at best in pricing power for high-quality wines will limit the ability of wineries to pass along higher costs to consumers. Instead, wineries may be more in-clined to further automate operations such as bottling and even pruning. Profitability Consumers slow return to quality wines will delay the recovery of profits of high-end Sonoma County wineries that are geared toward high-margin restaurant sales. After declining during the recession and recovery, restaurant wine sales experienced modest growth in 2010. However, many restaurants have been able to boost on-premise sales of quality wines by offering discounted bottles purchased in still-oversupplied wholesale channels. Restaurants and airlines have also increased their offerings of lower-cost wines produced and bottled outside the county. The slow recovery in demand for high-price wines will have an impact on winery ownerships in Sonoma County and other high-price California wine-growing areas. Facing declining sales, international conglomerates such as Brown-Forman and Constellation Brands have closed or sold parts of their wine operations, including wineries in the county. These divestures and the sale of distressed wine properties have opened the door for new investments by foreign wine companies from Australia and Chile. The outlook for currencies from major wine-exporting countries in 2011 offers a mixed picture for the handful of largevolume Sonoma County wineries that export wine abroad. The U.S. dollar is expected to appreciate against the currencies of only two major wine exporters to the U.S. Argentina and the European Union. This will help low-price wines from the former gain additional U.S. market share and make higher-cost wines from the latter more affordable. The dollar will lose value only relative to New Zealand s currency, while maintaining relative value with the Chilean peso and the Australian dollar. This will help prevent or at least slow a surge in wine imports from these low-cost growing areas. Long-term Outlook Demographic trends suggest more positive long-term prospects for the Sonoma County wine industry. Core wine drinkers those who consume wine at least weekly now account for 91% of all wine consumption and were largely responsible for keeping the growth rate of overall U.S. wine consumption positive during the recession and during the weak recovery. Total U.S. wine consumption surpassed French consumption for the first time last year, although per capita wine consumption still lags that of the French. The expectation that future wine drinkers will embrace high-price wines will also benefit the Sonoma County wine industry in the long term. Although the millennial generation the population cohort now aged 17 to 34- suffered reduced employment and income levels during the recession, they have embraced wine consumption at a faster rate than earlier generations and have been more willing to trade up to higher-price wines. Slightly more than half of this age cohort is composed of core wine drinkers. This share will grow over the next several years as additional millennials reach legal drinking age and the entire cohort increases its income-earning potential. Severe Weather Reduces Grape Yields Sonoma County wine grape tonnage, % change yr ago, 2010 Merlot Sauvignon Blanc Pinot Noir Cabernet Sauvignon Chardonnay Total Zinfandel -35-30 -25-20 -15-10 -5 0 5 10 Source: USDA A smaller wine crop harvest in the fall of 2010 will help to alleviate a glut of high-priced wines. Declines were widespread among the counties major red and white varietals, with the exception of merlot grapes. The 9.7% drop in county tonnage far outpaced the statewide decline of 2.7%. However, the decline in the county s average price paid by wine processors 8% was greater than the average state price, reflecting declining pricing power for the producers of quality wines amid shifting consumer demand. 5
Moody s Analytics Wine Industry Insider Upside Risks The quick recovery of high- and middle-income consumption (of wine purchases in particular) would accelerate the recovery of high-price wines produced in Sonoma County. While consumers expectations of future employment conditions have surpassed pre-recession levels, expectations for income have not, helping to keep savings rates elevated. Once consumers are more confident about their ability to earn and sustain higher wages, a larger share of wine consumers will be willing to trade back up to quality. Growing overseas markets especially in Asia offer the potential to offset slowly recovering demand for high-price wines in the U.S. and Europe in the near term. Further depreciation of the dollar versus the Chinese yuan will increase the affordability of Sonoma County wines for the growing number of affluent Chinese consumers. Downside Risks Successes in increasing access to direct wine shipments could be reversed by a bill under consideration in the U.S. Congress. H.R. 1161 would exempt states from the interstate commerce clause and allow the prohibition of out-of-state wine shipments, while still allowing in-state shipments. California wine producers, who accounted for 61% of the U.S. wine market in volume terms in 2010, would be the most hurt if the bill is approved and signed into law. A lack of diversification between high-price and lower-price wines would hinder Sonoma County winemakers transition into a structurally changing wine market. Producers from lower-cost wine-growing areas of California have been able to increase retail market share during the recession and the initial recovery period. They have also been able to capitalize on their affordability in order to enter into new distribution channels including national restaurant chains and airlinesthat have increased their exposure to new wine drinkers. 60 Recession Permanently Boosts Savings 8 50 Total home equity balances % change yr ago (L) 7 40 30 Personal savings rate % (R) 6 5 20 4 10 3 0 2-10 00 02 04 06 08 10 12F 14F 1 Sources: BEA, Equifax, Moody s Analytics The deep recession will have a lasting impact on consumers, changing the competitive structure for Sonoma County wineries. In the face of steep losses in home equity and, until recently, a weak jobs recovery, the personal savings rate has jumped to more than double the average for the 10-year period prior to the recession. With access to home equity eliminated, the savings rate will remain elevated into the expansion. This will impact consumers purchases for luxury items including wine. 6
With Acknowledgment and Appreciation to Local Key Businesses Supporting Sonoma County Economic Development: Director Executive A CO U Y SO OM NT N Sponsor C A LIF O R N IA RE P U B L IC A G R I C U LT U R E INDUSTRY R E C R E AT I O N County of Sonoma Board of Supervisors County of Sonoma General Services, Real Estate Division Sonoma County Health Services Sonoma County Transportation & Public Works