THIS IS WHY CALIFORNIA GRAPE AND VINEYARD PRICES ARE RISING

BY JEFF QUACKENBUSH, NORTH BAY BUSINESS JOURNAL

Capitalizing on growing thirst nationwide for the higher-end wine the North Coast is known for is intensifying demand for sources of capital, according to longtime local lenders.

Mechanics Bank last August brought on veteran wine banker Dan Aguilar to restart the lender’s North Coast position in the industry. In December, the North Bay commercial banking manager brought on seasoned agribankers Samantha Foster and Debbie Watson to the commercial banking team based in Napa.

Bill Rodda, managing director of agribusiness for Santa Rosa-based American AgCredit, has been in North Coast lending since the early 1980s. At the same time as the recent retirement of three-decade North Coast farm banking fixture Terry Lindley, the institution has added four lenders recently.

Aguilar and Rodda talked with the Business Journal about the impact of growing consumer demand for wines over $15 a bottle is having on the capital needs to produce it in the North Coast.

How healthy are North Coast winery and vineyard company cash flows?

DAN AGUILAR: I’ve been focused on wineries and vineyards for about 20 years in my career in Napa Valley and Sonoma County. And I’ve never seen the industry prosperous and more successful than it is now, especially at the high end. Cash flows, profitability, balance sheet capitalization, the ability of wineries to price in the market — all just remarkably strong right now.

BILL RODDA: Wines that are accelerating the most are in the $15-plus-a-bottle category. That’s important because that’s what we do up here, by and large. We had three years of good quality and quantity crops, and the last two years were reduced. That wasn’t a bad thing to stabilize inventories.

In the North Coast, demand for vineyards continues to be keen. In Napa County, there continues to be extreme demand for cabernet [sauvignon] land. It really is a cabernet county. What we’ve seen most recently is ground that historically has been planted to noncabernet varietals in some of the more southerly areas.

Not Carneros but the Oak Knoll area and cooler areas closer to the water are going to be converting from merlot and chardonnay into cab, because the economics are there. You can get more dollars for cab than those other varieties. We’re seeing conversions in areas where it may not be the best varietal, but it’s all about money.

There are some sales pending that will push the upper limits of land values right now in some the premium areas with winery permits too. Values continue to move up, up, up in Napa County.

That is also true in Sonoma County. Not extraordinary values, but we’ve seen records set for value of pinot noir acreage was a pension fund deal in Annapolis for $170,000 an acre. That’s probably a top end now.

We have a lot of things driving the land value in Sonoma County. Demand for home sites, which are a component of smaller vineyards with 10–20 acres, continues to be extremely strong. When you get into larger wineries it is more of a winery play, but demand for chardonnay and pinot ground is still keen.

We’re starting to see even more polarization of plantings and development into the [American Viticultural Areas aka appellations] that they’re known for, what they do best. That’s what people are gravitating toward or converting to. Russian River area at the top end is pinot, and owners of acreage are converting to pinot. Dry Creek is more of sauvignon blanc and [zinfandel]. Alexander Valley is cab ground, by and large. Highest and best use, so to speak.

We’ve seen values in the last year go up, on the extreme end, go up by 25 percent. It’s fair to say that in the past year we’ve seen vineyard values go up 10–15 percent.

If you have a winery-site component, that’s a whole different thing. Winery sites continue to hold and increase in value. What our lenders do when we look at a property that has a winery site permit or potentially would have one — on a good area and is accessible — they will value the permit just by itself. Just having a permit is a tangible value, because getting permits in the county is getting harder and harder.

So valuation looks at permit value and building value of the winery then the vineyard acreage valuable and if plantable acres that’s a different component.

Cab is driving Napa County, and pinot is the top value varietal in Sonoma County. But chardonnay still is growing and is the largest variety grown in Sonoma County. It’s a faster cash flow for wineries. [Chardonnay winemaking] is usually about a year, so they get it back faster.

How is the big overall growth in high-end sales affecting local demand for financing such as inventory, receivables?

AGUILAR: There was a big step up in demand for inventory and receivables financing with the large 2012 harvest and the need for wineries to finance that inventory growth. Since then, the average harvest has been about that size to down in the last couple of years. All that has been digested and internalized.

Wineries continues to expand and grow, so there is moderate demand for inventory and receivables financing.

The real demand I see out there is as wineries continue to seek to secure their grape sources by buying vineyards. A lot of the bank growth has been in long-term debt to acquire vineyards and, perhaps, expand existing production facilities.

That is probably going to slack off now, because there just isn’t a whole lot out there to acquire. A lot of what’s available has been purchased by the big guys — Gallo, [Jackson Family Wines], Vintage Wine Estates, The Wine Group and so on.

On the other side of that, you have regulatory pressure against expansion, and that’s posing challenges. … It’s certainly driving prices up. If you do find a vineyard to buy or a wine brand to buy, you’re going to pay more for it, because there is a finite supply of quality vineyards for these brands.

One of the things that’s driving the values of vineyard and winery properties is people are realizing it’s harder to start a new winery with entitlements for production facilities and tasting rooms, because regulators aren’t approving these things as much as they used to.

The perception is if you don’t buy it now, you won’t be able to find it later. There’s not much new supply coming online, so that’s driving up prices.

All these things combine for a huge increase in the real estate value of assets in the last few years. Real estate tends to go in a step function, and we’re just going through the most recent step up in real estate values in the North Coast. Banks will lend on the values of the properties, and if the appraised value is there, then the banks will lend on it.

It may be a challenge for smaller companies to afford the debt service on the acquisition prices of these properties. Smaller companies may be getting priced out of that market. If a company needs to borrow money to buy something and it is competing against a large winery with the cash resources it might be at a competitive disadvantage. That’s probably why you see so many transactions being done by the big guys and not by the smaller guys. Even though the smaller guys have the money to afford [the purchases], if they have to borrow money it’s a more complicated deal for them, and the seller opts for the big guys, who can close faster.

True for any lender, the minimum amount of time, including ordering the appraisal, is minimum 60 days. That’s assuming the winery has completed its due diligence. The big guys, if they have done their due diligence, can get it done in less than a week. All they have to do is get the documents prepared, reviewed and close it. They already have large lines [of credit] already in place that are flexible enough that they can tap it if they need to, or they have cash laying around to close with.

RODDA: As prices go up, people will need leverage, because this industry is so capital-intensive. Our winery lines-of-credit needs continue to go up, because the value of the inventory continues to go up.

Inventories for most of our wineries seem to be in pretty good balance right now, meaning they are not long on anything. There was a concern there after we had the third consecutive large crop [in 2014]. Everyone usually harvests all the grapes, and wineries sometimes take them at reduced prices. But you have got to make sure you don’t oversupply what your demand for your bottle price is or you have a second program [brand]. [North Coast tonnage] the last two years have been less.

We measure inventory in years, unlike most things sold in other industries measured in 30-day or such periods because you’re making a lot of them. Inventory turns here may be 12 to 24 months or longer. When you have that kind of carry of inventory, you absolutely need credit.

The other part of that is the cost of building has gone up. There is a demand for contractors. The price of acquiring a vineyard has gone up. So the demand for credit has gone up.

How are higher grape and bulk-wine prices affecting capital needs in the North Coast?

AGUILAR: Moderately. Among our clients, when they talk about higher grape prices, they so far have been able to pass them along in bottle prices to a certain extent, but it’s not resulted in a lot of margin improvement.

Margin improvement comes from growing the [direct-to-consumer] channel or changing the product mix to a higher-priced [shelf-keeping unit].

But it does reinforce the desire among wineries to go out there and lock down grape prices by buying their own vineyards.

I do see grapegrowers being a lot more aggressive in asking for and getting for price from wineries. There’s been a shift in the psychology of grapegrowers. They see they’re finally able to get more of what they’re due.

Some of the wines that are really being affected by the upward adjustments in the grape prices really haven’t hit the market yet, especially some of the high-end [cabernet sauvignon wines].

At the high end, wineries have been concerned about taking price increases and wondering when they’ll get pushback from consumers. Despite all the hand-wringing, I’ve rarely seen much consumer reaction from high-end wineries taking price increases. You’re going from $170 to $175 a bottle. If they’re buying wine at that price point, it just doesn’t seem to be of that much concern. Same is true for wines at the $65–$75 price point.

Now you get down to the $15 price point, it can be dicey, because now you’re looking at shelf space at grocery. And that becomes an issue.

RODDA: As prices go up, people will need leverage, because this industry is so capital-intensive. Our winery lines of credit needs continues to go up because the value of the inventory continues to go up.

The other part of that is the cost of building has gone up. There is a demand for contractors. The price of acquiring a vineyard has gone up. So the demand for credit has gone up.

What law or rule changes are, will or could be affecting the local wine business most?

AGUILAR: One is regulations on winery production facilities and tasting rooms. There is quite a bit of demand for existing and new winery companies to get approvals to build them, but it is difficult to obtain them in Sonoma and Napa counties. That is an almost artificially imposed price-support mechanism. It’s not intentional by Napa County or Sonoma County, but it has the impact of supporting winery and tasting room prices.

The other factor is anything related to labor. Liberalizing or restricting labor in vineyards or in the cellars. Lack of or supply of vineyard workers is critical for the health and success of the industry. A lot of vineyards weren’t planted with mechanization in mind, so it’s not feasible to do that. So to get the fruit harvested, you need the labor. And if you can’t get the labor, what happens to those companies and those brands and the industry overall?

That’s a great concern of ours.

RODDA: Sonoma County is starting to clamp down on hillside vineyards. We’re kind of running out of spots. Napa is pretty much planted out, and they have a very dramatic hillside situation with homes there. People have gotten into trouble taking out trees. All the flatland has been pretty much taken up, so we’re getting into the more challenging areas. You’d better be playing by the rules and talking to all the state and local agencies.

And water is always going to be an issue. But the Central Valley has not received the rain we have, and those groundwater supplies will take years to be replenished.

Jeff Quackenbush (jquackenbush@busjrnl.com, 707-521-4256) covers construction, commercial real estate and wine.

How healthy are North Coast winery and vineyard company cash flows?

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