Stein’s Law and the Coming Crisis in Argentinean Wine

Stein’s Law, named for famed economist Herbert Stein, holds that if something cannot go on forever it will stop.  Unsustainable trends ultimately yield to the inevitable in one way or another.

Stein’s Law seems to be simply stating the obvious, but you would be surprised how many people find a way to ignore the obvious when it is in their interest to do so.  As Upton Sinclair wrote, “It is difficult to get a man to understand something if his salary depends on his not understanding it.”

Argentina’s Inflation Problem

And so we consider the case of the Argentinean wine industry. It’s not just the wine sector, of course, it’s the whole Argentinean economy, but wine is especially affected.  Something’s going to happen according to Stein’s Law, because it can’t go on forever as it has up to now, but it is hard to know exactly what.

The problem begins with Argentina’s high inflation rate. The official statistic puts the annual increase in consumer prices at around 10%, but this number is viewed with disbelief by the international economic community. The Economist magazine quit publishing the official figure in 2012, saying “Don’t lie to me, Argentina” to the officials there. The most commonly cited estimate of the actual inflation rate is 25% per year.

Inflation is a sensitive political issue in Argentina as it is in every country that has ever experienced a hyperinflation crisis (think Germany, for example). Some in Argentina go to great lengths to deny the obvious reality of inflation.

The story (which may be true) is told about a McDonalds restaurant in Buenos Aires that displayed all the usual products on its big backlit menu board except the signature Big Mac. Where’s the Big Mac? Oh, we have that price hidden around the corner so that no one will see it — especially the people from The Economist magazine who use it to estimate the purchasing power of the peso in their Burgernomics index!

Inflationary Squeeze

As a recent article on The Drinks Business website suggests, high inflation is putting the squeeze on Argentina’s wine producers. (The squeeze is made worse,  I understand, by government policies that restrict imports of products used in wine production as part of a general policy to control foreign exchange reserves). Production costs (grapes, labor, etc.) may have doubled over the past four years, putting a squeeze on margins.

It is difficult to pass these peso costs along to consumers in the U.S., Canada, the U.K. and Brazil, the main export markets. Consumers are price sensitive and while the average export price of  varietal Cabernet and Merlot wines have risen by 7.2% and 24.8% respectively in the past year, this provides only limited relief from rising costs since Malbec takes the lion’s share of the export market and its dollar export price has risen by just 1% in the last year and by an average of only 2.8% per year since 2009.

Purchasing Power Inaction

The textbook remedy to this situation is for the foreign exchange value of the peso to fall to achieve what economists call Purchasing Power Parity. In a system of market determined exchange rates, according to the PPP theory, a 25% fall in the domestic purchasing power of the peso due to inflation should result in a 25% decrease in its foreign exchange value.

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And indeed the peso has depreciated, but not by nearly enough to overcome the inflation difference between Argentina and the four main export markets. The peso has fallen in value by about 20% in the last two years, if we look at the official exchange rate, so each dollar of export earnings brings in more pesos,  but inflation-driven peso costs have increased by much more.  That puts a real squeeze on margins. This can’t go on forever — something has to give.

[I’m told that the black market exchange rate is 8 pesos per U.S. dollar, far below the official rate of about 5 per dollar. Such a big differential is often an indicator of crisis to come.]

Something’s Gotta Give

What happens when a country gets itself caught in a squeeze like this? Well, the conventional wisdom is there needs to be a sharp currency devaluation followed by monetary tightening to control inflation. This is a painful process and Argentina has been through it before. What if the government ignores the conventional wisdom? Internal adjustment must eventually take place to restore competitiveness if external adjustment through the exchange rate is ruled out.

A recent Wall Street Journal article about real estate prices in Buenos Aires shows one pattern of adjustment. The dollar prices of luxury apartments have tumbled as owners seek to cash out of their real estate investments and buy into the more credible U.S. currency.  The WSJ reports that

In May last year, Argentine President Christina Kirchner strictly limited access to U.S. dollars and other foreign currencies in a bid to stem capital flight. With the Argentine peso facing about 25% annual inflation (government figures, widely discredited, set the rate much lower), and an unofficial exchange rate that has effectively devalued the peso sharply, demand is high for dollars.

These days, the main feature that foreign buyers say they look for in a Buenos Aires property has nothing to do with closet space or a wide terrace. It is a seller with a bank account outside Argentina to which they can legally wire funds. This is a way to get around having to convert any dollars wired into Argentina into pesos at the official rate, after which it is nearly impossible to convert back into dollars at the official rate.

Something will have to give in the wine industry, too, if the exchange rate doesn’t adjust and the currency controls continue. In the meantime, I think every effort is being made to control costs and to keep margins out of the red. But, as Herb Stein might say, this can’t go on forever so somehow it will stop.

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Herbert Stein may be best known today as father of Ben Stein, the actor, law professor, and columnist, but he was ever so much more famous in his day as a chairman of the president’s council of economic advisers

Little known fact: the Pabst beer company held an economics competition in 1944 (the year of the Bretton Woods conference)  for the best plan to sustain high employment in the post-war era. Herb Stein’s plan was named the winner from among the more than 36,000 entries. He was 28 years old and the prize was $25,000 — the equivalent of $330,000 today.

Argentinean Wine: A SWOT Analysis

The first thing we did when Sue and I arrived in Mendoza was to walk to the offices of Área del Vino, the group that publishes Vinos y Viñas magazine, the WineSur website and provides economic and strategic analysis to the wine industry here. We met with Javier Merino, Área del Vino director, and Gonzalo Merino, director of WineSur. They got our visit off to a flying start.

Our discussion was wide ranging. Gonzalo is working on new media projects to expand the market for Argentinean wine and reach a new generation of consumers. Javier was just back from Hong Kong and China and keen to discuss the potential new markets there. Both were happy to talk about controversial questions, such will the Malbec boom be sustained and whether Torrontés really is The Next Big Thing.

Their analysis has been very useful to me as I have met with wine-makers, winery owners and managers. Based on all these discussions I have prepared this SWOT analysis, which represents my current thinking about Argentinean wine today. This is a work in progress (and necessarily very brief), so I welcome comments that correct my thinking or re-direct my analysis.

Strengths

Argentina has many strengths. The most important may be that it has a “hot” brand, its signature Malbec. When wine enthusiasts think of Argentina they think of Malbec and vice versa — a strong identity that many wine regions envy.

But, as I will explain in future posts, Argentina is not just Malbec (or even just Malbec and Torrontés as some writers propose).  Quality extends across a broad spectrum of wine varieties, styles and price points, which is a very good thing.

Weaknesses

That said, the industry is very dependent upon exports of Malbec to three main markets, the United States, Brazil and Canada.  There would be trouble if Malbec exports to these markets were to falter due to either a decline in demand to a shift to some other “hot” variety.

The domestic market for wine is very substantial, but it is still dominated by low-price basic wines — another weakness. The Argentinean industry would be much stronger if a larger domestic market for quality wines could be developed.

Water is also an issue here as it is in many wine regions. Not an issue today, Javier told me, but for the future. And of course the future is fast approaching.

Threats

There are a number of very serious economic threats that cloud the short term outlook. Domestic inflation is high in Argentina. The government estimate is about 10%, but I failed to find anyone who thinks that it is less than 25%.  Production costs are rising rapidly– labor, grapes and other inputs are increasingly expensive. Land prices for new vineyard projects seem to be growing exponentially.

Revenues are not increasing at the same rate, with the result that margins are being squeezed.  In fact, the pressure is on to cut prices in the competitive U.S. market. It is not clear how long the current combination of rising costs and falling revenues (or soft revenue growth) can be sustained.

I visited several wineries that were clearly focused on increasing efficiency in an attempt to claw back margin without sacrificing quality.  But I also heard rumors of wineries that were taking the perhaps desperate move to source lower cost grapes from other regions to stay in business. The concern was that quality would suffer and The Brand undermined.

Opportunities

There are many opportunities and they fall into two categories: new wines and new markets. By new wines I mean a movement to expand Brand Argentina beyond value Malbec, both into the higher reaches of the wine wall and into other varietals. I’ll be writing more about this in future posts.

I’ve already written about the new markets. As I listened to Javier discuss the great potential in countries like Brazil, with large and growing populations and fast economic growth I knew just what he was talking about: The BRICs (and the New BRICs). Javier believes that the BRIC-like markets  are the key to the next stage of Argentina’s export growth. Because geography still matters in both wine and economics, Brazil is a particularly attractive target, but both Hong Kong and China are high on the list.

Argentina’s China card is that its wines could fill an open market niche. Not cheap bulk wines like those from Chile and Australia. And not overpriced prestige labels like those from France. Quality Malbec from Argentina would be more affordable (and in most cases better) than the French and of course much better than the bulk wines. Distinctive, too, on several dimensions.

But China’s a tough market to break into, as I have said before.  China will require patience and good luck as well as good wine.

The new market with the greatest potential for Argentinean wines may be Argentina itself.  Nearly everyone I talked with said that the best thing that could happen would be for the domestic market for quality wine to expand, making the industry less dependent on exports and less vulnerable to inflation and exchange rate changes.

Bottom Line Analysis

So what’s the bottom line? Well, of course, I believe that the long run opportunities are important, but it seems to me that the short term threats are on everyone’s mind right now, in particular, the inflation-exchange rate squeeze. If inflation continues at high rates and the U.S. dollar – peso exchange rate stays stuck at about 4 pesos per dollar, some producers here will be squeezed out of the U.S. market. Perhaps they can sell to Brazil or on the domestic market, but the prospects are not good if everyone tries to shift focus at once.

What is keeping the exchange rate stuck at an over-valued level? Politics and fear, I suppose. There’s a presidential election in the fall and everything here has taken on a political significance, so it is no wonder that holding the line on the exchange rate (and denying that an inflation problem exists) would be political, too.

And then there is the fear.  Argentina has experienced inflation-devaluation vicious cycles in the past. Inflation leads to a falling currency, which adds to inflation pressures, which forces the currency down even more. Etc, etc.  There’s a worry here that lowering the exchange rate would set the cycle off once again and nobody wants that.

Fear and politics are powerful forces. Argentinean wine, for all its strengths and opportunities, is caught in the squeeze.

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Thanks to Javier Merino, Área del Vino director, and Gonzalo Merino, director of WineSur for meeting with us in Mendoza and to everyone who has talked with us about wine economics in Argentina during our stay here.  Watch for future posts that examine particular elements of the Argentina wine story in more detail.

Vineyard Plague: The Dutch Disease

As if things weren’t bad enough in Australia, now there’s this: the Dutch Disease. No, it isn’t a fungus spread when you plant tulip bulbs in the vineyard or something you saw on the television series House MD. It’s much more serious than that. And it’s hitting South Africa, too. Look out!

Australia’s Perfect Storm

I’ve written several times about Australia’s continuing wine crisis. It seems like everything that could go wrong has gone wrong. Too much heat, too little water, excess capacity, collapsing demand — even smoke-tainted grapes caused by runaway brush fires. Yikes!

Now there is more bad news and it’s the result of too much good news? Good news is bad news? Yes. Read on.

The Dutch Disease is the name economists give to the problem of too much good news in one industry and its negative impact on the rest of the economy. If one sector of the economy gets hot on global markets (think oil exports, for example) one effect can be that export sales increase the demand for the country’s currency, causing it to appreciate in real terms. The rising currency value makes all the nation’s other products more expensive on foreign markets, sending them into a tail-spin.

The Good News the Bad News

That’s how good news in one part of the economy can backfire. The Economist magazine apparently invented the term to describe the dilemma of the Netherlands after a big gas field was found there in 1959.

The good news / bad news in Australia is clearly the fact that China’s economy is growing rapidly and sucking in the natural resources that Australia has in considerable abundance. But big purchases of the Australian dollar needed to pay for these products has pushed the currency up, making Australian wines more expensive here in the U.S.

This helps explain why off-premises sales of Australian wines are still falling here even though many other segments of the wine market are recovering. Recent Nielsen retail data show the U.S. wine market growing by 4.3 percent in the period ending in August, but sales of Australian wine fell by 7.5 percent (data from the November issue of Wine Business Monthly).

As the chart above shows, the Australian dollar has continued to appreciate since these data were compiled, magnifying both the Dutch Disease problem and the sense of crisis in the Australian wine industry.

South Africa Also Hit

South Africa seems to be experiencing the Dutch Disease as well. There are many factors that have contributed to the sharp rise of the Rand against the dollar, but surely the surge in gold prices must be the most important one. As speculators and investors who have worried about inflation turn to gold, their purchases have driven up the value of South Africa’s currency as well.

This helps explain why sales of South African wine in the U.S. have been in a bad slump. Nielsen data indicate that South African wine sales fell by 8.3 percent in August and by 9.4 percent in the last year.

The U.S. dollar’s rapid recent fall will affect all countries that depend on our huge markets for exports, but inevitably some will be hit more than others.  Those like Australian and South Africa who suffer the Dutch Disease will be challenged the most.

We’ve entered an era of extremely unstable currencies, reflecting both the inherent instability of international financial flows and the increasingly cut-throat battles in the global currency wars. Inevitably many industries — including wine — will get caught in the cross-fire.

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Big Squeeze on Small Wineries in Argentina

Argentina is generally seen as the big winner in the current U.S. wine market. Sales of Argentinean wines have surged at every price point led by the signature Malbecs, (something that I wrote about in a recent post).  The big picture is great — perhaps the New World’s biggest success story since Marlborough Sauvignon Blanc hit the scene.

Both Sides Now

The devil is in the details, however, and a more detailed analysis of Argentinean exports suggests that some parts of the industry are facing significant challenges. As usual, my source for news and analysis about wine in Argentina is WineSur, which reports that small wineries are really feeling the squeeze in the critical U.S. export market. (See the report by Gabriela Mazilia. )

Small producers are what economists call “price-takers.” They cannot do very much to control the prices they receive on the export markets and they don’t have much control over input prices, either. While a great many business decisions are theirs to take, some of the most critical factors are beyond their control. This is true for all businesses, of course, but more so for some than others.

Mazilia’s report suggests that small Argentinean producers are feeling the squeeze from both sides of the market. Costs are rising rapidly, perhaps especially for the goods and services that winemakers require. Argentina’s  inflation rate is about 10% according to official statistics, but unofficial estimates put the number at about 25%, amongst the highest in the world today. Yikes!  The Economist‘s Big Mac Index reports that Argentina’s currency is much less undervalued now than a year ago even though the exchange rate has depreciated, which is consistent with rapidly increasing local prices.

Magnified Price Effects

Small producers would like to pass higher costs forward to consumers or backwards on to input suppliers, but neither of these options seems possible at this time. Mazilia’s report suggests that export price increases of 5%-10% are possible for wines that retail in the USD 10-18 range, where Argentinean wines are seen as good values. Increases for more expensive wines are apparently out of the question — the market for $20+ wines in the U.S. is just too competitive, too filled with expensive wines selling a a discount.

One problem Argentinean exporters face is that every 10% increase in the price they receive is magnified in absolute terms as the wine passes through the supply chain. One producer cited the dismal math that a USD 1 increase in FOB export price translates into a USD 4 increase in retail prices. Here is an example from the WineSur report:

A case in point is the winery Sur de los Andes. The firm’s owner and manager, Guillermo Banfi, announced: “In the course of this second semester we’ll raise prices from 5 to 10%, in particular in our line of classic wines. We won’t touch the prices of the great reserve line or of our icon wine. Margins have shrunk so much that there’s no way we can keep absorbing the high increase in costs.”

When asked how much of a margin of increase could be born by an Argentinian wine without losing market share, Banfi provided an example that illustrates the situation in the US, a reference market. “In the US, our wines in the USD 10-18 retail price segment sell very well – these are wines with an FOB price of USD 3-5. With an FOB price of USD 3, the consumer price is around USD 11. A rise of 5-10% would imply an increase of USD 1-2 in retail prices, which would have a negative impact on sales, since pricing is a very sensitive issue in this segment.”

Not Much Wiggle Room

Small producers are caught in a squeeze without much room to wiggle. If they don’t raise prices they will watch their margins disappear. If they do, well, they risk finding themselves in unfriendly market territory.

“The problem is that there will be a radical change of scenario for Argentinian wines in the USD 10-20 retail price range. Up to now, these wines have sold well because they are, on average, superior in quality to similarly priced European wines. But from now on, the gap in quality will be narrower, and we’ll be competing with wines of similar quality and price, from regions with a longer standing presence in the market.

Turbulent Tide

It sounds like Argentina’s small producers face an uncertain future, but this is nothing new. The great success of Argentina’s large international wineries in the U.S. market has masked a churning pattern among smaller winemakers. Each year several dozen small wineries enter the U.S. market, but each year others are forced to exit as the turbulent tide advances.

International connections, effective distribution, economies of scale and brand prestige are always advantages in competitive international wine markets. The are especially important to Argentina’s struggling price-taking small producers today.

Vinonomics: The Mouton Cadet Index

Richard Hemming, whose writing appears on the  Jancis Robinson website, has invented the Mouton Cadet index to measure international differentials in wine prices. It is an interesting project that is worth following.

Hemming’s price index, which he is calling Vinonomics (in homage to the Freakonomics craze), works like this. First he selected a high-volume wine that is in very wide international circulation to serve as the one-item “market basket” for his international comparisons. Mouton Cadet, the ubiquitous Bordeaux wine, is a great choice since it is so widely distributed (a “15-million-bottle, 150-country brand distributed from Andorra to Zimbabwe,” according to Hemming).

Mouton Cadet may not be the wine sold in the most different countries — Moët & Chandon Champagne would be my pick for that honor — but using Mouton Cadet keeps the Big Mac spirit of tracking the price of an everyday product, not a luxury good.

Sky High in Seoul

Hemming then searched the internet and other sources for prices of Mouton Cadet in as many countries as he could. He converted these prices to Euro, USD and GBP at market exchange rates and published them on the website. (He is hoping that readers will send in additional price data to help complete the table.)

The price differentials that Hemming finds are quite large.  The French ‘home country” price for Mouton Cadet is given as EUR 9.55, which is incredibly more than the reported price of the same wine in the United States (USD 7.99 or about EUR 6). Within the Eurozone, where trade is allegedly free, Cadet’s price runs as high as EUR 19 in Austria and EUR 21 in Italy. So much for the “Law of One Price!”

What’s the cheapest place in the world to purchase Mouton Cadet? So far Hemming’s low price leader is the U.S., where French wines struggle to sell in a crowded and very competitive market, followed by Hong Kong (EUR 8.56).

The most expensive? South Korea (EUR 26), Brazil (EUR 21.5) and Italy (EUR 21). The difference between the high and low price is stunning. It is easy to explain South Korea’s high price in terms of transportation costs, regulatory expenses and multiple middleman markups, but the high price given for Italy is difficult to understand. Hard to know who would pay so much for Cadet in Italy.

Bordeaux with your Big Mac?

Hemming’s research project is based on  the Economist’s famous Big Mac Index (BMI), which tries to measure the relative purchasing power of different currencies by comparing the local prices of McDonald’s ubiquitous hamburger.  Here is a table showing the index as of July 2010.

The table shows that Japan and Australia are very close to Purchasing Power Parity — the condition where a U.S. dollar has the same purchasing power abroad (when exchanged at market rates) as at home.  The dollar cost of a Big Mac is approximately the same in all three countries.

Norway’s currency is very over-valued according to the BMI.  A Big Mac that sells for USD 3.73 in the U.S. costs a whopping USD 7.20 (converting at market exchange rates) in Oslo. The high cost of buying a Norwegian Krone contributes to the hamburger’s high dollar price there.  The Swiss Franc is almost as over-valued — a Big Mac costs the equivalent of USD 6.19 in Geneva.

Hong Kong and China have undervalued currencies by this measure. A Big Mac costs less than the equivalent of USD 2.00 there. The harburger is cheap in part because the currency is so cheap in these countries.

Wine vs Burgers

The Big Mac index is far from a perfect measure of relative purchasing power, but it is not a bad guestimate because Big Macs are standard products with easily discoverable prices and most of the cost of producing a Big Mac takes place within the country in question. I’ve found that if the BMI says a country’s currency is over-valued then it probably is, although not necessarily by as much or little as the index suggests.

The Mouton Cadet index is very interesting for what it tells us about wine prices, but it is probably less useful as a measure of PPP. The wine, of course, comes from France unlike the locally-produced burger ingredients and the local price in South Korea, for example, is influenced by that cost basis (adjusted for exchange rate effects) plus transportation costs. The biggest “local content” factors are the local taxes and  wholesale and retail markups within South Korea, which are probably quite high.

Mind the Gap

At this point the Mouton Cadet index is most interesting to me for the questions it inspires (I’ve always said that questions are more interesting than answers). Who’s buying that EUR 21 Cadet in Rome (and are they interested in buying a bridge I happen to have for sale?)

What accounts for the high price in South Korea? The exchange rate is certainly  part of it. The South Korea Won is undervalued relative to the EUR according to the BMI. A Big Mac costs USD 2.82 in Seoul and USD 4.33 in Paris — a 50% price differential. The exchange rate therefore might explain 50% of the price gap between the Mouton Cadet price in France and South Korea. What accounts for the rest? (And does that fact that South Korea has no substantial domestic wine industry that I am aware of affect the mark ups on foreign wines?)

And what about Brazil? The Euro is actually  undervalued relative to the Brazilian Real according to the Big Mac index, and so the exchange rate is not necessarily a factor in Mouton Cadet’s high price in Rio. What other factors account for the big price gap?

I hope Richard Hemming continues with this project. It would be interesting to have data for additional countries (Japan? Russia? India?) and to see how the rankings change over time and relative to Big Macs.

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I’d like to encourage interested readers around the world to send Hemming local store prices for Mouton Cadet so that he has better data both for international comparisons and to get a sense of intra-country price dispersion.

Good News & Bad News from Oz

Sometimes the good news is that the bad news could be much worse. At least that’s how it seemed to me when the wine economists met at UC Davis last week to discuss the continuing Australian wine crisis.

Kym Anderson, a leading expert, spoke about the problems in Oz at the symposium on “Outlook and Issues for the World Wine Market” and I thought his assessment of the “challenges” Australia faces was pretty grim.  Big oversupply. Falling grape prices. More and more quality grapes sold off at fire-sale prices in the bulk market (40% this year compared to 15% in the past).

The best selling white wine type in Australia isn’t from Australia any more — it’s Marlborough Sauvignon Blanc. Even the Australians are tired of “Brand Australia” Chardonnay!

Maybe, Baby

Professor Anderson looked for a light at the end of the tunnel and was able to point to some potential sources of relief. Maybe water reforms could be implemented. Maybe R&D to help the industry deal with climate change would produce results. Maybe the new export strategy to promote Australia’s regional diversity and wine families would catch on. Maybe the China market will open wider and drink up the surplus.

Since the bad news was so compellingly concrete and the hopeful notes so speculative, I took the overall forecast to be very dark indeed. Imagine my surprise, then, when I attended a talk by another Australian expert the next day who described  Anderson’s presentation as optimistic! When the good news is this bad, the bad news must be really bad.

Bad News, Bad News

Sure enough more bad news arrived shortly thereafter in the form of a Wine Spectator article, “Aussie Wine Company Faces Angry Creditor,” concerning the financial problems of The Grateful Palate group, which exports many hot brands to the U.S. market including the unlikely-named Luchador Shiraz shown here.

Trouble is brewing in Australia. The Grateful Palate’s Australian affiliates, which produce wine under labels such as Bitch Grenache, Evil Cabernet Sauvignon and Marquis Philips for American importer Dan Philips, are in receivership and face the danger of possible bankruptcy. Growers and other creditors for the South Australia-based affiliates of the company received notice on June 18. Many growers, already facing tough times, worry that they’ll never get paid for fruit they sold Philips.

Philips, the company’s founder and owner, confirmed that he is in negotiations with his top creditor, Dutch lender Rabobank, but declined further comment. The bank initiated the action to put Grateful Palate International Pty Ltd and several related Australian companies into receivership. The most prominent is R Wines, a partnership with winemaker Chris Ringland, but 3 Rings, a joint venture involving Philips, Ringland and grower David Hickinbotham, is also part of it.

This is bad news, of course, but bad news is no longer a surprise to those of us who are following the Australian wine scene. Perhaps it is really good news of a sort — an indication that the necessary industry shake out is gaining speed. Hard to tell good news from bad.

Darker or Brighter?

The same situation applies to the Foster’s de-merger situation. Foster’s, the Australian beer giant, bought into the wine business at the top of the market, paying an estimated $7 billion for an international portfolio of about 50 top brands including Penfolds, Wolf Blass and  Beringer. The investment may be worth as little as $1.5 billion in today’s market.

Foster’s beer business is an attractive target for global giants like SABMiller, but not with the wine portfolio attached. So Foster’s announced a de-merger to allow the beer group to move ahead independently of the wine group. What will happen to the wine business?  Who will buy these assets in today’s depressed environment?

When I posed this question to an Australian winemaker several weeks ago the answer came back quickly: China! Everyone in Australia is paranoid about the Chinese buying up our natural resources, and so we are convinced that they will buy up Foster’s wine business, too.

Interesting idea, I thought at the time. No multinational wine firm (Constellation Brands? Gallo?) would want to go bigger right now. But maybe a Chinese firm that wants to break into the global markets would take the bait. Might make sense. Maybe.

Bright Idea

Sure enough, the Bright Food Group. (Mission: “To build the company into a leading enterprises group in the national food industry, with famous brands, advanced technology, strong competitive power and deep influence in the world by the end of 2015.”)  recently signed a three-way memorandum of understanding with the New South Wales government and the China Development Bank to explore opportunities for the Bright Group to invest in the sugar, dairy and wine industries.

A Financial Times article reports that  the company is interested in “global top ten players in wine, sugar, food packaging, commodities and healthcare sectors.” Bright Food is currently studying both wine and beer assets in Australia, but has not decided to buy either yet according to the FT.

Many Australians no doubt consider the potential sale of yet another natural resource business to Chinese buyers bad news in terms of their economic sovereignty, but that bad news might actually be the best news they can expect given the sorry condition of the global wine market today.

Wine, Recession and Argentina

The global economic crisis has been bad news for Argentina, but good news so far for Argentinian wine. Will the wine part of the story have a happy ending or, like so many Argentinian economic booms, turn eventually to bust?

Bad News and Good

The Economist Intelligence Unit reports that Argentina’s economy has been hard hit by the economic crisis. The economic forecast is gloomy (see below) with the only good news being that inflation, while still high, is falling.

Given rapidly declining business and consumer confidence, the government’s fiscal stimulus measures will have a limited effect, and we expect the economy to contract by 3% in 2009, before only a mild recovery in 2010.

Unofficially measured inflation will ease to 10-15% in 2009, as private demand falls. The official rate will end 2009 at 6.8%, with a similar rate in 2010.

The peso will continue to depreciate in 2009 owing to weaker foreign-exchange inflows, before the pace of depreciation slows in 2010. The current-account position will weaken in 2009-10.

The Argentinian wine economy situation is sunnier.  The May 2009 issue of Wine Business Monthly includes two reports that paint a bright picture of Argentinian wine trends.

The first story is a competitive analysis of Argentina wine in the United States market.  It reports that U.S. imports of Argentinian wine have risen dramatically in recent years, from 2.6 million cases in 2006 to 4.3 million in 2008.  The total value of Argentinian wine in the U.S. rose from $75 million to $146 million in this period.

It is important to put this increase in perspective, however. Total Argentinian imports are roughly equal to the annual output of a single US winemaker, Washington State’s Chateau Ste. Michelle. So the Argentinian presence is rising, but from a modest base.

Molto Malbec

Unsurprisingly, Malbec is Argentina’s calling card in the U.S. market. Malbec’s share of Argentinian wine imports increased from 35% to 48% over 2006-2008 measured by volume and from 44% to 55% measured by dollar value. I was interested to learn that Argentina wine sales are rising at all price points, not just in the value brand segment as you might imagine.  But value is still important.  Argentinian wine prices are rising, but still relatively low.  The article reports that the average FOB price has increased from $29 to $33 per standard 9-liter case.

In the same issue the results of the Nielsen company wine market survey for the period ending 2/7/2009 are reported.  Argentinian table wine imports were up 40% by dollar value for most recent year.  This compares to a 10 percent increase for Chile, one percent for Italy and a one percent decline for Australia.  Overall growth in imported wines was 2.4 percent by dollar value for the most recent year.

The 40 % annual rise is spectacular, but  Argentinian wines account for just 1.4 percent of U.S. domestic wine volume compared with two percent for Chile, nine percent for Australia, almost 10 percent for Italy. This shows that Argentina either has a lot of room to grow in the U.S. market, as optimists will perceive, or a lot of work to do to escape niche player status.

American Exceptionalism

I think the Argentina producers were wise to focus on the U.S. wine market for their export surge.  Although the European Union is more important to Argentina in other major export sectors, the U.S. is the target wine market, and that’s a good thing in this economic environment.  EU wine consumption has long been in decline because of demographic and market shifts, for example, while wine sales have been rising in the U.S.

The recession is likely to depress wine sales growth in both the U.S. and the EU, but the impact will be less in the U.S., I believe, if only because I think the recession will be shorter here. My current thinking is that the U.S. economy will benefit from greater short term fiscal and monetary stimulus, compared with the EU, and more effective medium term structural adjustment.  That said, the recession is and will be very severe.

Early U.S. evidence suggests that wine sales have actually continued to rise during in the first year of the recession, when measured by case volume, although the dollar value of those sales has declined as consumers trade down.

Opportunities and Threats

Reading the latest articles on WineSur, a noteworthy Argentinian industry website,  it pretty clear that Argentina producers appreciate both the opportunities and threats inherent in the current situation.  The opportunities — to establish a market presence built around good value and the rising popularity of Malbec — are significant. But I think it must be hard for Argentinians to see silver linings without looking around for associated dark clouds — their country has suffered repeatedly from the global market booms and busts.

Some of the threats are strictly economic. Argentinian producers are currently benefiting from a falling peso value relative to the US dollar, for example, which helps their wine hit market-friendly price points in the US.  But the falling currency is in part a reflection of high domestic inflation rates, which ultimately lead to higher production costs. A lot will depend upon how the inflation (cost) and exchange rate (export price) factors balance out in the future.

Some of the threats relate more to the fickle nature of the wine market itself.  Malbec and Argentina are nearly synonymous today, but this could change as other wine regions adopt their signature varietal. A recent visit to the Walla Walla AVA, for example, found many producers experimenting (successfully, I think) with Malbec.  Argentina has the first mover advantage in Malbec and must capitalize on this because it will face more competition in the future.  This happened to New Zealand (Sauvignon Blanc) and Australia (Shiraz) and I do not think Argentina will be different.

In exploiting its Malbec lead Argentina will need to strike another difficult balance, between establishing a useful “house style” that will build market identity and letting this deteriorate into a stylistic “monoculture” that soon bores consumers.  It seems to me that Australian Shiraz is currently suffering from the “monoculture” curse, perhaps unfairly, while New Zealand still benefits from a popular “house style,” although I’m not sure how much longer it can ride the gooseberry wave, especially given the vast quantities of Sauvignon Blanc that need to be sold.

Argentina is at a crossroads at a critical moment and moving in the right direction.  Count me cautiously optimistic regarding the future of Argentinian wine.

Update: Just hours after I posted this piece about Argentina the following item appeared on the Decanter.com website.

Argentine wine harvest down 25%

May 1, 2009  / Jimmy Langman

Due to climatic conditions, this year’s wine harvest in Argentina will be down 25% as compared to last year.

According to Argentina’s National Wine Institute, hail in some provinces, and overall higher temperatures in February and March, are factors in the lower production output this year.

The lower production this year has occurred despite Argentina having a 12% increase in land under cultivation for wine grapes.

Guillermo Garcia, president of the National Wine Institute, said: ‘If there had not been an international crisis, we would not have been able to provide wine to countries with developed markets.’

Garcia added that Argentine wine companies need to begin keeping more than three months of stock on hand to make up for such production shortfalls.

Exequiel Barros of the Mendoza-based Caucasia Wine Thinking consultancy told decanter.com that many Argentine wineries are worried about their ability to supply medium-priced wines but added: ‘We need to see how the international outlook develops this year before we can dare to make any projections.’

In Chile, wine growing areas that are not irrigated, such as Cauquenes in the Maule Valley, are predicting a similarly low harvest, with an estimated drop in production from 30 to 40% because of higher temperatures and low rainfall.

Most wineries in Chile, however, are reporting a good harvest. ‘The lack of rain has been good for this year’s harvest. But wineries in the far south, such as in the Bio Bio, may experience changes to quality because of the higher temperatures,’ said Edmundo Bordeu, professor of oenology at Chile’s Catholic University.

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