Report says 'flight to value' to continue for wine consumers

NORTH COAST -- This year is shaping up to be another challenging one for the wine industry on the North Coast as signs of recovery in the U.S. economy and consumer spending slowly take hold, according to an economic report released today.

"The health of U.S. consumers will improve in the near term but is still some distance away from a full recovery," wrote Ed Martinez, senior economist with Moody's Economy.com, in the industry report prepared for the Sonoma County Economic Development Board.

Key indicators of that health are retail sales, personal savings rate, consumer confidence, stock market indexes, home prices and household net worth. They have improved from the depths of the recession a year ago but remain below levels at the start of the economic recession at the end of 2007, according to the report.

For example, the savings rate for the first two months of this year was 3.1 percent, which was lower than the 3.9 percent average for the first half of 2009.

"However, expectations of weak-at-best economic and labor improvements weigh on any outlook for an end to consumers' flight to value in the near term," Mr. Martinez wrote.

Unemployment rates in the U.S. and Sonoma County were 10.4 percent and 11 percent in February, compared with 7 percent to 8 percent for both a year before, according to government statistics. That is projected to decline starting next year.

At the same time, personal income is forecast to grow at less than 2 percent this year.

The shift to lower-priced wine has been dramatic for wine sales last year and is expected to continue this year, according to the Moody's Economy.com report. A key measure of high-end wine sales has been restaurant and other on-premise sales, and that sector has been hammered, with sales in that channel off 6 percent to 9 percent overall last year, according to industry analysts at Gomberg Fredrikson & Associates.

The drop in sales for mid- to high-priced wines was more dramatic, reaching 20 percent to 30 percent, according to North Coast wineries contacted for the Sonoma County report.

"For smaller wineries, the combination of falling sales and accumulating inventories has been damaging to their balance sheets," Mr. Martinez wrote. "The number of defaults and foreclosures of wineries in the North Bay wine-growing areas surged last year."

Distressed sales of wineries or vineyards, what he calls "bargain transitions," are an inevitable and necessary part of the business cycle, according to Rob McMillan, founder of Silicon Valley Bank's Premium Wine Division and author of the institution's annual industry economic forecast.

He affirmed his initial prediction in a forecast preview in November of more such "transitions." The 2010-11 Silicon Valley Bank wine industry forecast is set for release in early May.

"It's not a V-shaped recovery; it's a long L," Mr. McMillan said last week. "Everything we see right now is improved business top line, but it does not speak to profitability or nationally the economy being improved and all the other echoes of the crash lingering in the background. So there is still some pain in the economic process."

Some of those "echoes," he noted, are global sovereign wealth and the "destimulating" effect of some funds from various federal stimulus initiatives coming back to the Treasury. Such sovereign wealth concerns include the fiscal fitness of Greece, Iceland and Portugal and projections of significantly higher U.S. national debt in coming years.

Yet the long-term prospects for a rebound for North Coast wine businesses are good, according to Mr. McMillan and Mr. Martinez.

The share of "core" consumers, or those who drink wine at least weekly, increased from 2000 through 2009, replacing decreasing purchases by "marginal" drinkers, according to the Moody's Economy.com report.

That helped boost overall U.S. wine sales last year to 1.9 percent volume growth over 2008, though at the expense of revenue from discounting.

Also potentially positive for the future, those of legal drinking age among the so-called Millennial generation of consumers, now age 15 to 32, have been more apt to become "core" consumers than the previous generation, Mr. Martinez noted. However, many of those younger consumers also have been hard hit by job cuts in this recession.

North Coast wineries may be able to mitigate the effects of prolonged slow growth in high-end wine sales by greater diversification of pricing tiers, according to the Moody's Economy.com report.

"It brings up a two-tier marketplace, because if you want to price for quality you will make investments locally, but other wine companies that have increased market share have been mixing wines of different regions in their portfolio and picked up national contracts such as Ruby Tuesday's and Southwest Airlines' new bottle sales programs," Mr. Martinez said last week.

A route for supporting higher-priced wine long term could come from an effort by Sonoma County wine and grape trade groups to back legislation for wine "conjunctive labeling," or connecting the county name with district names such as Russian River Valley as the place of origin for the grapes. Research funded by the backers suggests that the additional place name would boost prices for lesser-known areas, such as Bennett Valley, and not hurt those of more well known ones.

A meeting of leaders from American Viticultural Areas to decide on support for the proposal is set for April 27. Should the votes back it, the proposal would be introduced this legislative session, likely by Assemblywoman Noreen Evans, according to Nick Frey, president of Sonoma County Winegrape Commission.

"We've had verbal support from the entire local delegation that, if we got our ducks lined up and there was not strong opposition, they would support too," he said.

Some vintners who intentionally list only their subappellation on their labels have spoken out against the plan.