Overextended North Coast vintners face credit challenges amid lower wine values

While the 2019 North Coast grape harvest ranked only sixth largest ever in tonnage, it followed the record-sized 2018 crush that brimmed winery tanks just as the trajectory of wine sales growth was starting to flatten.

Full tanks and ratcheting down of expectations for wine sales growth have sent pricing for grapes and wine vintners already have crushed down to levels about half of what they were just a year ago. While this means that consumers are expected to eventually get great deals on wine at the shelf, it is also affecting how much vintners can leverage the value of existing wine to operate.

“Most of our clients still experienced growth last year,” said Charles Day, North Coast regional manager for Rabo AgriFinance. “The negative attitude (in the wine business now) has a lot more to do with looking at reduced (sales) expectations against inventory levels that are pretty high from the harvests we've had in the past couple of years.”

‘A LOT OF HIGH-PRICED INVENTORY'

But hits to vintner top-line revenue and pressure on gross margins isn't something that has emerged yet, he said.

Margin pressure is expected to be largely from the entry of more negociants and primarily on wineries heavily selling through the U.S. beverage alcohol three-tier system post-Prohibition of producer, wholesaler and retailer. Negociant is a historical French term for vintners that buy wine from producers in bulk then package it for sale at retail under a negociant's labels or at wholesale via brands created for retailers.

“In the case of Napa cab, you've got people who are not only sitting quite a bit of inventory, but honestly sitting on a lot of high-priced inventory,” Day said. “The prices they paid for it in '16, '17, '18 was at pretty high prices. The expectation during harvest of those years was that you'd be able to pass along those price increases. I don't see that happening in this market.”

In December 2018, excess Napa Valley cabernet sauvignon wine was selling in bulk for $25–$40 a gallon, with wine from the best appellations priced at the top end of that range, but in February 2020 it was selling for $18–$25, according to Turrentine Brokerage. Pinot noir from the choice Sonoma Coast and Russian River Valley regions was selling for $12–$14 a gallon at the end of 2018, with top-end vintage 2017 pinot fetching $2 more a gallon, and is now going for $7–$9. And chardonnay from those Sonoma County subappellations went from $12–$15 to $7–$9.

‘PERFECT STORM' OF CAPITAL WOES

A common tactic to finance the expansion of production storage to handle a swelling inventory of grape juice headed through vinification toward the bottle is tapping working capital, but that could lead vintners into a “perfect storm” of credit challenges, according to Clay Popko, North Coast regional banking executive for Santa Rosa-based American AgCredit.

“A lot of operators will see a line of credit that's not being used, so they do long-term winery improvements or buy barrels on that line of credit,” Popko said.

That becomes a problem because instead of using credit lines for production of the asset being collateralized (wine inventory), the borrower has spent it on storage of that inventory, he said. Such fixed assets would have been better served by a term loan matched to the service life, which typically three years for barrels.

“Then once they've tapped out their credit line, they come in for a loan,” Popko said.

WHEN INVENTORY GOES ‘STALE'

Two other interrelated challenges with winery working capital is not only how the value of collateral has changed with market conditions but also whether that inventory has become “stale,” the definition of which lenders typically negotiate with vintners based on the style of their wines, Popko said.

“It is very difficult to sell or liquidate wine that is out of vintage,” he said. “If all the others are selling 2018 chardonnay, and you are trying to sell 2017, it sends a message.”

That's where the individualization of the lending relationship comes in. A given wine may have a recycle cycle that's a vintage behind similar products on the market because of added aging or other brand approaches.

“From a collateral standpoint, we understand that, but we may say, ‘Hey, we know you're individually selling 2017, but you're still selling 2015 and 2016 chard. When your distributor is working on (selling) 2015 chard and then they go to another city and see your 2017 chard, it adds confusion to the market,” Popko said.

Inventory outside of a vintner's normal release cycle and changing liquidation value of that wine - what a lender could sell it for in bottle or bulk - comes into the collateral value equation for lines of credit collateralized with inventory, Popko said.

So far, winery lenders are asking more questions about the value of wine sitting in their clients' tanks and barrels, but it hasn't become a fervor yet, according to Steve Fredericks, president of Turrentine Brokerage, a Novato-based broker of grapes and bulk wine that also does collateral value reports.

“It's not like we're getting a lot of calls that collateral value is killing us,” Fredericks said.

‘OVERADVANCED' WORKING CAPITAL

If a vintner is sitting on a large inventory of wine in bulk, and it's not realistic to be able to sell the wine bottled, the lender may adjust allowable advances on asset-based credit line, according to Day. Depending on the credit line, the borrower provides inventory value updates monthly, quarterly or some other schedule. While he looks at the ongoing value of the inventory, higher stockpiles will impact value.

“If the winery is on a quarterly borrowing base and the value of the bulk wine has dropped so much that there is a negative balance and the winery is overadvanced, that sparks a conversation with the client,” Day said, noting that collateral valuation can be skewed by few bulk-wine sales, similar to what can happen with vineyard valuation.

A common lending strategy for winery lines of credit is to value collateral on the lower of cost or market, then offer credit at a percentage of that value, say 50%-60%. So collateral Napa cab that had been valued at $40-$50 a gallon but is now in the low $20 range can result in a dramatically lower borrowing capacity for the vintner.

Smaller, family-owned wineries and closely held vintners, the under $25 million financing deals Popko works with, don't solely tap inventory and receivables for credit collateral, as they have more ready access through their company structures to assets such as estate or vineyard real estate. Larger vintners with company structures cross-collateralize their credit lines across holding, production, real estate and vineyard companies.

“We anticipate we will start seeing that soon if winery inventory sales start slowing down, but we haven't seen it yet,” Popko said.

But adjusting debt levels downward isn't easy for wineries, according to Day.

“Wineries may look at their vineyards or if they have multiple labels they may consider selling noncore labels, but it is not the ideal time to bring those assets to market,” Day said. “With the market readjustment going on, the prospective buyers are cautious.”

But such conversion of assets or other changes in leverage structure to cover credit challenges may be more trouble than it's worth.

“If a lender does not expect it to be a long-term issue, then they are not likely to restructure the debt,” Day said.

Jeff Quackenbush covers wine, construction and real estate. Contact him at jquackenbush@busjrnl.com or 707-521-4256.