Willamette Valley Vineyards: David vs. Goliath

In 2008, U.S. wine consumption and the adult per capita consumption of wine set a new record high at 2.5 gallons (breaching the previous high of 2.4 gallons in 1985), and marked the 15th strait year of consumption growth. Despite America’s growing taste for wine, it still lags far behind other traditional and new wine loving countries whose per capita consumption reaches as high as 15 gallons.

However, in coming years we believe the U.S wine industry will continue to prosper on the back of favorable demographics, strong domestic wine industries (the U.S. is now the fourth largest producer of wine among all countries), and a growing consumer base–particularly women and older generations–that is favoring wine over beer and spirits.

By 2020 we believe that U.S. per capita wine consumption will be approaching 4.0 gallons, and that in the U.S. the wine industry will be pushing the spirit industry for second place in sales by dollar volume (please see our article on page 5 in the September issue of The Age Curve Report).

Investors have a very limited choice compared to wine consumers when it comes to investing in quoted wine companies. With the exception of two thinly traded pink sheet issues, the choice can be summed up as a David (Willamette Valley Vineyards - WVVI) versus Goliath (Constellation Brands - STZ). We prefer David, or Willamette, as Constellation needs time to restructure itself for having overpaid and over-expanded, and is over-leveraged with more than $4 billion in debt due to its strategy of going for volume.

We believe Willamette is very well positioned to benefit from further market growth, and its strategy of producing quality at the expense of volume will reward investors and wine consumers handsomely over time.

The company is based in Oregon and was founded in 1988 by Jim Bernau to produce and sell premium to ultra premium wine. Its goal is to become one of Oregon’s largest wineries and establish a reputation fro producing some of Oregon’s finest and most sought after wines. The company has already received “Excellent” to “Recommended” reviews in tastings of its wines and believes its prices are competitive with other Oregon wineries.

Before looking at Willamette’s potential in depth, we believe it is important to remind the reader of the history and excellent prospects for the Oregon wine industry. Vinifera wine grapes have been grown in Oregon since 1825, around the same time that wine grapes were being introduced into California, Australia and New Zealand.

Due to a number of factors, including the dominance of California, the Temperance Movement, Prohibition and the Depression, this early chapter of Oregon wine growing efforts came to an end. Its revival came in the early 1960s and Oregon is now is the 4th largest wine producing state (see table below) with more than 390 wineries and over 19,300 acres of wine grape vineyards of which 14,900 are currently producing.

Following a ten-year run of vintages favored by full ripening and relatively minor weather problems, 2007 was plagued by intermittent periods of rain throughout the harvest, most particularly in northern Oregon. Despite this, wine continues to be a dynamic growth commodity around the state. Red wines account for 60 percent of production, with white wines filling the balance. Four grape varieties make up almost 82 percent of Oregon’s wine grape production. They include:

• Pinot Noir, with 55 percent of the total at 20,317 tons;
• Pinot Gris, with 17 percent at 6,244 tons;
• Chardonnay, with 5.6 percent at 2,076 tons; and
• White Riesling, with 4.2 percent at 1,550 tons.

Willamette Valley in western Oregon is ideally suited to growing superior quality Pinot Noir, Chardonnay, Pinot Gris and Riesling grapes. Already many of Oregon’s wines made from these grapes are developing an outstanding reputation nationally and abroad. The company’s wine production facilities are capable of efficiently producing up to 125,000 cases (297,000 gallons) of wine per year depending on the type of wine produced.

In 2008, the winery produced 287,513 gallons from its 2007 grape crush. This compares to 73,212 cases produced in 2004. In 1997, with the purchase of Tualatin Vineyards, the company added a further 59,000 gallons of wine production capacity. However, this was not used in 2008 due to the low crop yield. The company believes that its ultimate forecasted production level of 306,000 gallons per year will give it significant competitive advantages over most Oregon wineries in areas such as marketing, distribution arrangements, grape purchasing and access to finance.

The company’s brands under its Willamette Valley Vineyards label include the brand’s flagship and best selling Pinot Noir at a price range in 2008 of $19 to $50 per bottle depending of vintage. It also sells Chardonnay, Pinot Gris and Riesling. Under its Tualatin Estate Vineyards label, the company sells its flagship Pinot Noir at $35 per bottle. It also sells Chardonnay and Semi-Sparking Muscat. Under its Griffin Creek label the brand’s flagship is Syrah at $35 per bottle. It also sells Merlot, Cabernet Sauvignon, Cabernet Franc, Griffen and Viognier. For 2008, approximately 49 percent of the company’s net revenues were attributable to its direct sales force and 37 percent of sales were attributable to out of state.

Results for twelve months ended December 2008 showed turnover down nearly 4 percent at $16,048,000 from $16,711,000 for 2007. The reason for this was a weak economy and, in particular, a downturn in sales to higher-end restaurants. Net income was down to $708,594 (EPS of $0.15) from $1,686,661 (EPS $0.35) for the year prior. The main reason for this earnings collapse was the 16 percent increase in selling and administrative expenses. As a percentage of net revenue these expenses increased to 40 percent, as compared to 33 percent in 2007. These problems were well discounted in the share price by early 2009, following a near 78 percent fall from the 2006 highs.

Six month results ended June 2009 showed the company is back on track with earnings of $418,940 (up 93 percent over the prior period) on revenues that were up 5.5 percent to $7,692,621. Fully diluted earnings rose from $0.04 to $0.09. These results demonstrate the positive results of president’s Jim Bernau strategy of quickly refocusing the group’s energy away from sales to high end restaurants to emphasize sales to grocery stores. This won the company new customers as they traded down during last six months.

However, that was only part of Bernau’s new strategy of putting Willamette back on the recovery path. His next step was to cut costs by eliminating “significant shrinkage” of its products by hiring a new manager to track logistics and revamp the company’s system of storing, handling and delivering wine, and finally, he streamlined the winery’s accounting systems. He expects further savings to come over the coming year. The 2008 vintage was considered Oregon’s highest quality to date and the 2009 harvest at the present time looks like another winner.

We expect the company to show further recovery and growth in the second half of 2009 and expect Willamette to make around $0.24 versus $0.15 in 2008, and $0.35 in 2007. This places the shares at $3.75 on a December 2009 P/E of 15.6, falling to 12.0 for December 2010, assuming earnings growth of 30 percent. Further analysis suggests the shares are good value as its trailing 12 months Price-to-Sales Ratio is 1.04 (it hit a P/S of 2.5 in 2006), and its Total Debt to Equity is 0.11.

Willamette Valley Vineyards market cap is a tiny $18.3 million (4.86 million shares outstanding and a public float of 4.4 million shares), and is 2.1 percent owned by 12 institutions. The average three-month trading volume is 1,421 shares, however in the hot days of 2006 and 2007 this climbed to over 30,000.

Despite its small size, we believe the shares offer good value at current levels and present one of the only publicly traded ways to participate in the growth of the U.S wine industry. The shares are a core demographic holding in the model Beacon Master Portfolio.

Disclosure: No Current Positions, but WVVI is Featured in Our Model Portfolio.