Oversupply and a Bubble Forming. Now What?

Somewhere early in the year 2000 my mother-in-law was moving things out of a vacation home in Mariposa CA. I volunteered my help. So together with Anthony; a young and fit assistant from the Starving Students Movers we started lumping furniture. During a coffee break where we enjoyed delicious Starbucks Latte, Anthony started sharing his stock investment strategy. Wait...what? Investment strategy? (Disclaimer: I'm invested in Starbucks at this moment.)

Anthony couldn't have been much more than 21 and it turns out he really was a student - a student taking a videotape course in "How To Retire BeforeYou're Thirty" and was day trading. He explained his trading philosophy: high growth Internet stocks. He had amassed a small fortune already and he did it all with credit cards and margin debt.

I started to wonder if I was missing out and perhaps being too cautious with my own investments. After a little more thought on my drive home, I called my broker and cashed completely out of the market. With the Tech Crash hitting just weeks later, I had discovered a new technical indicator that would define my investing strategy from then on. I called it, "the Starving Students Bubble Indicator (SSBI):

"When a Starving Student gives you stock tips, get the hell out of the market because it’s overbought."

Tiny Bubbles

 

Market bubbles come in all forms, big and small, long and short. Lasting businesses are formed on long term trends and businss decisions that need to be made need to look through those blips to the steady state.

 

Building a business on a short term trend or market imbalance like my former moving friend Anthony did is a crap shoot. The only way to make that work is find short term trends across business that repeat themselves. Wine brokers are in business to do that in some respect. They are smoothing out the short term market imbalances in supply by moving grapes and bulk wine between someone with a short term oversupply, and someone with a current need

 

Cringe Worthy Indicators

  

With that in mind, This past week I've seen a few signs in the press that make me cringe a bit because of a looming short-term over supply. The first quote came from my good friend Brian Clements from Turrentine Brokerage who said:

"Total gallons of almost all varieties listed for sale in bulk has declined as harvest gets underway. Unfortunately, much of the decrease is due to sellers withdrawing wine from the market that was not selling in bulk, often to store it in little tanks made of glass and holding 750 milliliters each. As one winemaker said recently, “Our favorite tanks are bottles.”

There are other cringe-worthy signs of the times such as this article from Bill Swindell at the Santa Rosa Press Democrat. Bill reported that custom crush has greatly expanded in the past year and then went on to cite several examples along with the reasons why, such as the strong harvests of the past two and now likely three years. Is that a short or long term trend on which to build a business?

 

Then there is the article by Jeff Quackenbush printed in the North Bay Business Journal who reported that there is more than 2,000,000 square feet of new warehouse space planned or under construction in the Napa Valley which would represent the most warehouse space available in the last 15 years. That was a time when the industry was experiencing double digit growth.

 

In reality that was a period when we had truncated sales growth in the wine business because stock outs with producers were common. Some of our clients back then sold their entire supply in six or 7 months, and sale of domestic fine wine easily hit the 20% range. Are we experiencing that kind of sales growth now? That would be a longer term trend on which to build a business if it were so. Answer: Hardly.

 

What we are experiencing is a third consecutive record yield and improving but still modest sales growth well below the growth in inventory.

 

Sales growth in the wine business while impressive in the North Coast isn't fueling this building bubble in warehouse and custom crush.  When we are talking about warehouse space, that relates to storage of gallons not increased revenue. The now likely three years in a row of record harvest yields on the West Coast has to be considered an aberration and a bubble that will evolve lower. Most things tend to revert to the mean over time.

 

What's a Winery To Do With Excess? 

The 2012 harvest was a godsend because the prior two years were so short. The 2013 harvest filled the tanks to the top in wineries and now we are lacking tank space needed for the harvest in process. Demand while going through a nice upswing now, simply isn't going to support selling wine for full price given the temporary supply imbalance. There will be discounting that will start to creep in now, right at a point when price increases in 2015 were viewed as a possibility again.

So lets look at the options wineries have this year with the 2013's in tanks:

1. Sell the bulk wine and take your loss now
2. Bottle the wine in shiners as Brian Clements discussed in his article
3. Start a second label which I discussed in the blog a few weeks ago
4. Bottle more wine for your primary label and hope you can sell more than you expect

Brokers like Turrentine will tell you planning for these temporary situations is key to managing profitability. While you don't know for certain what will happen in any vintage year, you can make estimates about your sales growth and projected demand versus your likely supply in tanks and on the vine. You can take chips off the table by selling bulk early when the odds of price decreases in the grape market is more likely, and in the same way buy for projected need when the market is at a bottom. You never want to chase a market and get flattened by a bubble.

 

Today we are seeing some intrepid investors building out warehouse and custom crush capacity to handle a short term yield issue, which will right itself in due course. Whether they are successful in their businesses is a separate question but they are coming at the opportunity from the wrong angle. For a wine business, this kind of market provides opportunity for some and will prove problematic for others.

 

SVB on Wine Advice

 

My advice when looking at excess bulk is to take your first loss and move it as soon as possible. If you are stuck in a bind now, don't try and wait out the market correction by crushing bulk, bottling shiners and sitting on them, or by bottling more than you need and speculating on an outsized year in sales. Starting a second label is equally problematic because your brand hits the market when there will be a lot of new brands from those with the same idea.

 

Each of solutions 2, 3 and 4 doubles down on your risk by adding costs. Can you get back the original cost and new costs by employing those strategies? Maybe, but you are also taking higher risk and distracting from your core business. My hope as a businessperson is that you want to make money versus recovering costs. That shouldn't generally be your goal.

 

Like my moving friend Anthony at the beginning of the article who used leverage to invest in growth stocks, leveraging inventory by adding costs when the market is temporarily long carries higher risk than the return you will get  - even with good execution.

For those in the wine business wanting to talk more about your specific strategies going forward, email me and I'll spend a little time with you.

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What do you think? What have you done with the current vintage to prepare? Do you think the building we are seeing is a building bubble? Care to pass on your own advice to the community about the strategies you tried in the past that worked or failed?

 

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