Diligence Insights for Lenders Involved in the Cased Wine Market

Steve Katz  

Hi, everybody, and thanks for taking time out of your schedule today to listen in on our Hilco Global Smarter Perspective podcast. As returning listeners know, I’m your host, Steve Katz. And if this is your first time joining us, welcome, we’re really glad you could tune in. We got a great program for you today we’re going to be visiting again with our friend Sandy Mickas of Hilco Valuation Services. To talk more about wine, one of my favorite topics, and I’m sure a lot of people’s favorite topic out there. This time, it’s cased wine that we’re gonna be talking about, and we’ll be digging into some of the most important things that lenders should know. In terms of evaluating prospective borrowers or existing portfolio accounts that are involved in the California case wine industry, Sandy is a Valuation Director at Hilco Valuation Services and has appraised numerous businesses in many areas of the wine industry, including traditional and state wineries throughout California and Washington state, as well as E-commerce retailers purchasing and bottling both foreign and domestic wines. So Sandy, welcome back to the podcast.

Sandy Mickas  

Thank you. It’s great to be back.

Steve Katz  

Well, glad to have you on again, was a great discussion last time. Maybe you could just get us rolling by providing a bit of a background on what we talk about when we’re talking about case wine specifically?

Sandy Mickas  

Sure, yeah, I’m happy to do that. So case, wine is essentially finished goods, or what a normal lender would consider finished goods where it’s wine that has been bottled, labeled, and is ready to sell. And it’s generally referred to as casegoods. Because in the industry as a whole, they use a nine liter equivalent as a standard unit of measure. So people who drink a lot of wine will know that it can come in various size bottles, 750 milliliter being the most standard size. But yet it also comes in larger sizes and smaller sizes. So essentially, a standard case would be 12 750 milliliter bottles, also referred to as the nine liter equivalent, and although not all wine is sold in 750 milliliter bottles, it would generally always be converted to a nine liter equivalent for the purpose of reporting their inventory. So that there’s a standard by which to measure the sales as well.

Steve Katz  

Okay, got it. So then when we’re talking about cased wine, we’re really talking about essentially finished bottled wine that’s sold through a range of channels. Is that correct?

Sandy Mickas  

Yeah, that’s exactly right, Steve, the channels that the wine is sold through is going to be determined based on the licensing that the winery holds. So you’ll find distribution to retail stores, online E-commerce channels, if the company has their own website, tasting rooms, or wine clubs, traditional distributors and restaurants and bars. Now, some wineries are going to have licensing to sell directly to restaurants and bars where others won’t, and they can only sell through distributors. So the distribution channels are determined by each winery individually, based on the licensing and distribution has shifted a little bit. During COVID, we saw a definite shift, given that the on premise chains were closed restaurants, tasting rooms, you know, bars, those channels, which are referred to as on premise, or closed down during COVID. And we saw a shift towards more retail sales, which actually was more favorable for the lower end wines. Higher end wines are generally consumed in restaurants or at events, weddings, bigger functions, we don’t see as much consumption in the home of higher end wines. So many wineries saw their higher end brands struggling where their lower end brands were selling much more quickly. And oftentimes, you know, were selling through at rates that they had not seen and sometimes couldn’t keep up with. So now that the you know, everything’s opened back up again, the COVID pandemic is over. We’re seeing the shift comeback somewhat for the higher end wines, but really not stabilizing to where it used to be and the lower end wines are still continuing to sell through at higher rates than pre COVID. So it’s interesting to see the dynamic. And I know there are a lot of publications that expect that that’s going to continue to balance itself out over the next year as the new vintages start coming through. So we’ll wait and see. But there’s definitely been a shift toward the lower end wines and that’s caused a little bit of an oversupply in some of the higher end casegoods. On the other hand, there has been a shortage in certain areas of grape production. So it is sort of balancing itself out, it seems, overall in the marketplace.

Steve Katz  

Interesting that it would go in that direction. So how does how does wine these days stack up in the hierarchy of preference for most people, as compared with other alcoholic beverages these days? Because I feel like I’m, you know, when I’m out in a restaurant, I’m not really out at bars much anymore. When I’m out at dinner. I see a lot of people with mixed drinks or hard alcohol, maybe more than I’ve seen. It’s just anecdotal. But I’m just wondering, you know, how does, how is wine fitting into the overall mix of what’s being consumed these days?

Sandy Mickas  

Well, it’s very interesting, because we do see the spirits category increasing. And wine, when we look at the consumers for wine, so baby boomers, which will be an age range of 58, to 76, roughly, are the top consumers. However, their spending isn’t increasing the way that you know, the wine industry would like it to be. So we see the newer generation coming in and not spending as much on wine, they’re more apt to buy the lower end wines, versus the higher end wines, or they’re shifting more to spirits. So we definitely are seeing that the younger generation is not drinking as much wine at their current age as the older generation is now or was when they were younger, if that makes sense. So it’s definitely a shift. And wine is not as popular as it was previously, although the numbers are still increasing, when we see the rate of growth in the wine industry, it is still growing, even when we look at consumption, which was estimated at 3.18 gallons per person in 2021, which is up from 2.72 gallons in 2011. So we’ve seen that trend in the last 10 years. However, we don’t expect that type of trend over the next 10 years to increase at that rate. It seems like that’s just not the case. Now, you never know. I mean, things come and go, right? So wine seems to be a staple, whereas some of the spirits and I would say more trendy drinks, you know, often come and go, we saw that with the seltzers. They became very, very popular for a while and now they’re sort of fading off. So it’ll be interesting to see that going forward.

Steve Katz  

Yeah, I think that’s very true. They do tend to be more trendy, and particularly, you know, for Wine Enthusiasts, they seem to be more life lifelong enthusiasts, then someone who kind of moves from the latest spirit to the to the newest, latest spirit, I suppose. But it’s very interesting. And I would think, though, given what you just explained, the industry would be relatively concerned and on top of the situation strategizing to minimize any potential effects of further reduction. Moving ahead, is that the case or you know, what’s the the general attitude there?

Sandy Mickas  

Yeah, we see some of the bigger brand name wineries, you know, marketing more to the younger generation with social media and things like that, and also marketing more heavily the lower price point wines and I think that’s where the The compromise is going to be with the wineries. Obviously, they’d like to produce less high end wine, but on a go forward basis. I think they’ve come to realize a lot of them that more lower priced wine is probably the route that’s going to be taken, you know, over the next, I would say 10 years. I’m just, you know, that’s my opinion. And you know, that’s not any sort of a fact. But just from what I’ve seen, and in talking to everybody in the marketplace, that seems to be the consensus, we see wines like Rose as being much more popular now than even they were 10 years ago. And also, sparkling wines are much more popular now. So what the wineries are doing is just shifting their production to what the consumers want and a high end red wine meal Cabernet, that traditionally was bringing in the most money may not be the case going forward, and they’re going to have to adjust accordingly.

Steve Katz  

Yeah, I mean, if you can balance that out with, you know, higher frequency of consumption, and people are drinking more, you know, more Rose than they would otherwise. And that compensates for the cost differential between what used to sell I think that’s part of the strategy, right?

Sandy Mickas  

Yes, definitely.

Steve Katz  

And what about, I know you wanted to talk about, really what lenders should be focusing on with potential borrowers, or existing borrowers that they’re reviewing, in terms of diligence. Do you have some thoughts that we can pass along to lenders on diligence focus in the coming 6 to 12 months?

Sandy Mickas  

Yes, I absolutely do. And I think what’s important from lenders to understand is the wine industry. And when we look at wine as a finished product, bottled finish, you know, ready to sell. It’s, it’s not the traditional type of inventory that they may be used to looking at, from an analysis standpoint, and a lending perspective. So I think the biggest difference that I think should be understood is when we do an appraisal of finished wine, we don’t do a SKU level analysis that would traditionally be done in most appraisals. And the reason that we don’t do that is because every time a wine comes out, for a vintage year, it will be assigned a SKU number by the winery. So if you have a 2020 Rose, it’s going to have a SKU number than the 2021 comes out, it’s going to have a different SKU number because they have to track their sales at the SKU level. However, in a traditional SKU level analysis, we would look at historic sales of each SKU in the inventory. And we would determine the value to some degree based on the historic sales volume. Well, oftentimes wineries will put out a, say a 2019 Cabernet, they will produce it, but they may not offer it even for sale for two years, they will hold it in the bottle, and let it continue to age in the bottle before they offer it for sale. And in the meantime, they’re selling through their prior vintage year Cabernet. So when we look at wine, we have to understand that it’s not going to be a SKU level analysis, that’s going to drive the value, what we’re going to look at if most wineries will have what they call a label level, or a hierarchy where we can identify, Okay, this label is a Cabernet, or a Merlot. That’s their main brand product line. And so every year, they’re going to have a new vintage SKU under that label. And so what we do is we generally will roll up the inventory at to the label level, or whatever the winery calls it. And then we will do some analysis of the historic sales at that level. And it’s not uncommon for a winery, a high end winery to have two to three years worth of finished goods, which I think many lenders would find alarming, because, you know, most companies shouldn’t have that much inventory. But under the circumstances and the way the business model is with aging, high end wine in a bottle for up to a year or two. It’s reasonable to see that and I think that’s something that lenders have to get comfortable with. Because if they can’t get comfortable with it then, you know, it may not be a good fit for them.

Steve Katz  

Yeah, I mean, it’s, it’s a, it’s a little bit counterintuitive right to the typical inventory, thought process in retail or something else. But yeah, very, very interesting.

Sandy Mickas  

And we also see that in what we call library wine. So library, why oftentimes wineries will create their higher end wines, and then they will withhold some of it and will not sell it. So, you know, say they have 100 cases left of the 2017 Cabernet, they will hold back 100 cases, and then just start selling the 2018 next, and they create what we call a Wine Library. And this is only done, I think it’s important to understand this is only done on higher end, typically red wines, that generally will continue to improve with age. And it’s a fine line of trying to understand what is wine that is slow moving, and just isn’t selling well, versus what is true library wine that the company purposely did not sell through. And sometimes that can get a little blurred. And so we have to be very careful with that. And we have to really work with the winery to understand their procedures on things like that. But again, oftentimes, with some of the higher end brands, with their library wine, we find those have the highest value because their cost basis, some of these go back to the 80s, even maybe the 70s. And the cost basis back then was much lower. And so when you look at the margin of what you could sell it for now versus that cost, it’s much much higher than you know, even what you would get now with current wines. So we believe in certain circumstances, if those wineries were to offer their libraries for sale, they would sell, you know, quickly, obviously, depending on the brand, and the type and, and a lot of other circumstances, but there are definitely many wineries out there with library wines that, you know could get a pretty good return in a liquidation. And so it’s complex, because most lenders again are not used to seeing something so old have such a high value, which happens oftentimes in our appraisals. So it’s another anomaly that we really only see in wine, to some extent we you know, we would see it in bourbon or other types of spirits. But really wine at this age, you know, 20 to 30 years, is really the main one. So that’s another thing. In addition to that, there’s definitely some seasonality with wineries that I think lenders need to understand. They do a harvest in the fall, they’re going to do their crush and fermentation and barreling. So they’re going to have a big influx of bulk wine in, you know, the third and fourth quarter. And then what they do is they do a big bottling, typically, when you have a real high end seasonal winery, they’re going to do their bottling in the spring, to free up space for that fall harvest. So in the spring, you’re going to see a significant increase in finished goods, obviously, the bulk wine is going to decrease the the case wine or the finished goods are going to increase significantly. So you’re gonna have to anticipate that with advance rates, and things like that, because that’s a pretty traditional cycle that wineries use. Now, some of the really big wineries, they’re in production, you know, year round, and so you aren’t going to see, you’ll still see it at the harvest time because you can’t get around that. But you won’t see it as much in the bottling because many of those really large wineries are bottling year round. But again, it’s something that the lender needs to anticipate sometimes, so that they’re prepared for that and don’t get caught in any type of an over advanced situation when the product is moving from bulk to finished or, you know, vice versa, you know, or when you see that.

Steve Katz  

Makes a lot of sense. Yeah. So anything else on the list of diligence?

Sandy Mickas  

The only other thing I would really suggest that lenders pay close attention to is the excise tax. And we’ve seen circumstances where you know, if you don’t have the right people in place to ensure that your excise tax is being paid. I’ve seen federal tax liens for many millions of dollars when the taxes aren’t being paid timely and properly. So that’s something that we always advise lenders about is ensuring that the excise tax is paid. And we account for that in the liquidation scenario that we provide. Oftentimes wineries will use third parties to do that for them, because those are the experts, which we find to be beneficial. But that’s really the main, those are the main concerns, I would say, for the lender to understand.

Steve Katz  

Yeah, well, that’s, that’s terrific. And I just while you’re talking, I was thinking a little bit more about how to how to equate that the library wants to something that lenders might be more familiar with. And to me, it seems it’s a little bit like intellectual property, right? If a company has some, you know, patents, or historically significant photos, in its archives, and they’re just kind of just sitting there, and but liquidation, those things can be worth a lot of money. It’s just that nobody really ever thinks about or doesn’t really focus on that stuff. So maybe that’s another way for lenders to, to get their hands around, you know, some of these different aging inventory type issues as they think about the industry. So Sandy, thanks. That’s fantastic. We appreciate you sharing all the info and if listeners do have questions, so how can they get ahold of you?

Sandy Mickas  

Well, thanks for having me back. And listeners can feel free to reach out to me via email at smickas@HilcoGlobal, it’s s M I C K, a s @Hilcoglobal.com. Or my cell phone is 626-622-3237. And of course I can also be reached on LinkedIn.

Steve Katz  

All right, great. So can I so we can we can talk to each other the listeners can get a hold of us also. So listen, thanks again, Sandy. And listeners, as always, we hope that this smarter perspective podcast provided you with at least one key takeaway that you can put to good use in your business or share with a colleague or client to help make them that much more successful moving forward as well. And remember, you can always check out more great podcasts and articles featuring timely insights from local experts like Sandy, at HilcoGlobal.com/smarter-perspectives. Until next time, for Hilco Global I’m Steve Katz.