Overlooking Washington’s Columbia Valley

Yesterday I wrote about Ste. Michelle Wine Estates (SMWE), the Northwest’s largest winery, informing its growers that it would be taking in 40% less fruit over the next five years. Today, I explore how the SMWE changes relate to larger issues in the wine industry, recent activity at SMWE, what the changes might mean for the company, how the state’s growers and wineries might be impacted, and what it might mean for the state’s industry in the longer term.

Given the sensitivities of these issues, most of the people I spoke with asked to speak off-the-record or to speak anonymously. Note that these discussions did not include representatives from SMWE.

Ste. Michelle’s issues representative of larger problems in a changing wine industry

SMWE’s struggles in recent years are by no means theirs alone. They are due in part to larger industry issues. A search of news from the largest wine companies in the U.S. will confirm that.

In just a few recent examples, earlier this year, E.&.J. Gallo – the largest wine company in the U.S. – shut down its California-based distribution group and laid off 350 workers. Vintage Wine Estates recently sold some of its vineyards and has been cutting SKUs and headcount. Treasury Wine Estates has talked of divesting assets and recently closed the Australian producer of its 19 Crimes wines. Anyone in the industry who has not noticed these broader struggles has not been paying attention.

There are a number of issues these companies have been facing. They include but are not limited to changing consumer demographics and interests, increased competition in beverage alcohol and beyond, on-premise sales essentially being shut down during the pandemic, premiumization, distributor consolidation, inflation, supply chain issues, and other challenges. These issues can also interact with and compound each other.

For smaller wineries, which by their nature can be more nimble, the situation can be quite different. Many of Washington’s smaller to mid-sized wineries have stated that they have been experiencing great success of late. Some have even said that they’ve been having the best runs they’ve ever had.

As much as anything, when there are tectonic changes happening within an industry – and make no mistake, the wine industry is experiencing such changes – it shifts the landscape underneath companies and can lead to significant problems. When large companies experience problems, they tend to be big ones. SMWE is a very large winery. Again, though, this issue is by no means exclusive to Ste. Michelle.

Recent changes at SMWE

While SMWE reducing its fruit intake by 40% will be a radical realignment for the state’s wine industry, it is not the first such step that SMWE has taken. That said, it is by far the most drastic.

Early signs of the winery making course corrections are buried within its production numbers. For example, one of SMWE’s flagship wines went from 12,000 cases in 2014 to 4,200 cases in 2015 to 550 cases in 2016. The winery has since scaled up production to around 3,000 cases. However, this is still a fraction of what production was.

The most dramatic correction came in 2020. At that time, Altria, which was SMWE’s parent company, announced a $292 million inventory write-off as well as $100 million in losses on non-cancellable grape purchases in what was termed “a strategic reset.” This significantly reduced the acreage that Ste. Michelle was contracting.

In 2021, Altria sold SMWE to Sycamore Partners, a New York-based private equity firm, for a reported $1.2B in cash. To be clear, SMWE’s issues predate that sale, and the Sycamore purchase is not the cause of the recent acreage pullback.

SMWE has been looking for ways to raise capital to reinvest into growing the brand. In 2022, the company listed its Woodinville property for sale in whole or in part, though it has subsequently said it plans to remain on the property.

Finally, there have also been numerous changes at the top of the company. Among them, CEO David Dearie resigned in October of 2022 after a two-year stint. Chief winemaker Juan Muñoz-Oca left the company in February. (NB: Muñoz-Oca’s stay at O’Neill Vintners & Distillers was brief, as he subsequently accepted the position of COO at Stag’s Leap.) There have also been significant staff reductions, including a 5% layoff announced in February.

What these changes might mean for SMWE

The purchase by Sycamore was based in large part on SMWE’s five-year plan to get the company on better footing and to grow, providing Sycamore with a return on its investment. Prior to informing its growers about the acreage pullback, SMWE has been undergoing other changes to help the company get there.

SMWE, which had been increasingly expanding its portfolio, has refocused its efforts on the Pacific Northwest. This has included purchasing Willamette Valley’s A to Z Wine works and Rex Hill in 2022. The company also sold its interest in Napa Valley’s Stag’s Leap Wine Cellars, which it co-owned with Italy’s Antinori family, in May of this year.

Rather than a sign of escalation of SMWE’s problems, this latest move seems more like an acceptance that this is the only way for the company to get where it needs to go, as difficult as that decision is for SMWE and its growers. One grower stated that the company detailed all of its efforts when it made the announcement to growers.

“They weren’t speaking from an adversarial position,” the grower noted. “They were speaking from the perspective of ‘Here’s the problem, and we’ve got to figure out how to fix it.’”

SMWE’s contracts with its growers also likely significantly limit the company’s financial maneuverability. The winery will continue to work to get itself onto better footing in the midst of a changing industry, with this being a large step in that direction.

Growers will feel the impact

Washington growers who have partnered with Ste. Michelle and have had their contracts discontinued will take the hardest hit. Other growers will be impacted as well.

One grower was blunt in their assessment, saying, “This is going to hit the industry like a two-by-four upside the head.” In the worst case, it could be an existential issue for some growers.

“This has the potential to put some growers out of business, no doubt,” said one local winery representative.

However, many of Washington’s growers are also diversified farmers. It’s possible some of this acreage will be shifted over to other crops, though that is a substantial change.

It’s also an opportunity for growers to deal with some issues that have long been on the back burner. Among them, many older vines are infected with leaf roll virus and are approaching the point where removing/replanting the vines would be necessary. Washington has also been coming to grips with the presence of phylloxera in Columbia Valley. Many of these vines would ultimately need to be torn out and potentially replanted.

Vicky Scharlau, executive director of Washington Winegrowers, a trade association, said this was an opportunity for growers to assess their current acreage.

“We’re encouraging growers to review each vineyard block carefully and critically to remove vineyards with diseased vines, planted in suboptimal areas, or with marginal production,” she said.

Make no mistake, though. This is a seismic change for growers. As shocking as SWME’s announcement was, one grower noted that no one should have been surprised. They equated it to a teacher/student situation, saying “All the students knew that this day was coming.”

Wineries face more nuanced picture

The fallout for Washington’s nearly 1,100 wineries will be complex. SMWE taking in 40% less fruit will surely dampen fruit prices at a time when all other winery costs are escalating. That might help some wineries’ bottom line, though dealing a double blow to growers.

SMWE dropping contracts will also likely provide access to fruit that wineries would not otherwise be able to get. However, all of the state’s wineries combined have nowhere near the appetite to consume as much fruit as SMWE is dropping in its contracts.

Overall, Washington’s wineries cannot exist without their symbiotic relationship with the state’s growers. To the extent that growers struggle, decide to go in other directions with their crops, or, at worst, go out of business, that greatly impacts wineries.

SMWE has also been the company that has opened doors for local wineries across the country and around the world. With the state dominated by small producers making less than 5,000 cases per year, those doors might suddenly become harder to open. This could lead to even more wineries focusing on direct-to-consumer sales, particularly through satellite tasting rooms.

This has already been a strong trend in recent years. To the extent it accelerates, it risks exacerbating a chicken-and-egg problem. Lower national presence decreases awareness which bottlenecks demand. This makes it harder for wineries looking to grow their brands beyond the state, which is needed to increase demand.

Of course, with SMWE having a network of vineyards and custom crush facilities distributed across eastern Washington, there is the opportunity for medium to large-sized external players (and to a much lesser extent internal players) to have turn-key production facilities and rapidly ramp up production. There is also the opportunity for local producers to grow.

A very large vacuum will exist. Overall, this will be a major disruptor for the industry, presenting challenges and opportunities that are impossible to fully understand at present.

Uncertain road in the short-term, possibility for a more stable long-term

The reality is that, for more than 55 years, Ste. Michelle has been the dominant force in the Washington wine industry. All of the state’s wineries have stood on Ste. Michelle’s broad shoulders.

It’s not an exaggeration to say that most of Washington’s vineyards and wineries wouldn’t exist today were it not for Ste. Michelle. Wineries have thrived off acreage that in many cases has been planted for Ste. Michelle. A seemingly endless number of wineries can also tell stories about Ste. Michelle assisting them in ways large and small.

That worked well when Ste. Michelle was on the rise and times were good. During recent harder times, it’s meant that the state’s overall success is potentially dangerously tied to the fortunes of a single winery.

If anything, perhaps Ste. Michelle’s reduction of its fruit intake will allow for better distribution of that risk. That is, of course, the bitterest of medicines to swallow, particularly for growers who are severely impacted. The path ahead has plenty of risks too, but, clearly, staying on the same path is untenable, both for SMWE and for the Washington wine industry.

One grower, whose contracts with Ste. Michelle were dropped, summed up both the challenges ahead and the long-term opportunity for the industry.

“This will be a game-changer for the state, and its ripple effects are already being felt. It will be a very painful readjustment at a very sensitive time over the next few years, but hopefully, in the long run, we will be a more stable business.”

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