St. Helena, Calif.-based Beringer Wine Estates (Nasdaq: BERW) operates six wineries in the Golden State. We spoke with CEO Walter Klenz about the challenges of marketing to 20-somethings, replacing the time-honored cork, and the weather.
TMF: I guess the best way for us to start would be to just have you give us the capsule description of Beringer and what exactly you guys do.
Klenz: We are a group of six premium California wineries, plus a small imported wine division. We import some wines from several countries and the United States as well. We are essentially a fully integrated wine production and marketing company. We own and control more than 10,000 acres of vineyard land in California and we have six wineries in California that produce wines from our own grapes and grapes that we buy from outside growers under six different brand names, obviously the best known being Beringer Vineyards and Napa Valley.
We have two other smaller Napa Valley wineries, one called Stags' Leap Winery, which we acquired in 1997, and another called St. Clement Winery, which we acquired late last year. We have three Napa Valley properties -- Napa Valley being not the largest, but certainly the best known and most prestigious grape-growing area in California. Then, in neighboring Sonoma, which is another well-known and prestigious grape-growing area, we have two wineries: Chateau Souverain and Chateau St. Jean. Chateau St. Jean was an acquisition we made in 1996. They both focus on wines grown and produced in Sonoma County.
And then our sixth winery in California is called Meridian Vineyards, and it's based in what we call the central coast of California, essentially half way between Los Angeles and San Francisco in the Santa Barbara-San Luis Obispo area, which is a new, but up-and-coming grape-growing area. Meridian focuses on wines that we grow from our own vineyards, and we buy grapes from those grape-growing areas. In addition to that, we import wines -- about 5% of our revenues from Italy, from Chile, and from France.
TMF: Do you do any export business?
Klenz: Yes, we do a little bit of export business. It represents less than 5% of our revenues, but we do export -- to Europe, primarily, and also to Canada and Japan.
TMF: Is that a proportion you would expect to change over time?
Klenz: That is certainly one of our future focuses of growth. We are, as one of the larger premium wineries in California, very well developed in our domestic U.S. market, having the number one market share for premium wine in the U.S. But, internationally it has not been as big in the past as we see it being in the future. We see the opportunity to get closer to 10% of our revenues from export in the years to come.
TMF: Beringer has been around for quite a while. What are some of the challenges in terms of building and maintaining a national wine brand in this country, and also transferring that overseas?
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We see the opportunity to get closer to 10% of our revenues from export in the years to come.
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Klenz: The roots of the company, as you say, go back literally 125 years to the 1870s in Napa Valley. And Beringer has, for the last 10 or 15 years, been one of the major premium brands in the U.S. We have a business strategy that says we really want to develop a portfolio of brands, not just a single mega brand, that focus on different niches of the wine business. Different from a price point, different from a distribution channel focus, different from an offering portfolio.
What we've been able to do is develop a very strong distribution network. Getting your wine to the consumer in the U.S. is a much more torturous process than it is in a lot of other consumer product categories because of the legalities associated with the distribution of wine. There is what's commonly called the three-tier distribution system in the wine business, where your wine virtually, almost without exception, has to be sold to an independent wholesaler in a market, which generally represents a state, and in turn that wholesaler sells to a retailer, who ultimately sells to the consumer.
So, you have to develop strong marketing programs not just with the consumer, but with the retailer and distributor tiers. One of the things we've been able to do domestically -- that we hope to be able to translate internationally in the years to come -- is develop a very, very strong and well-developed network of distributors around the U.S. who see our brands as a top priority within their product line.
Unlike perhaps some other food categories or beverage categories, you typically are not dealing with exclusivities with a distributor. A distributor typically distributes a wide range of brands of spirits and wine, so you're having to essentially compete for his time and attention to get your product onto the retail shelves or into restaurants. That's something that we've done extremely well because we bring a lot of scale and a lot of volume and revenue to a distribution network. Because we have a number-one market share for premium wines, that gets us a strong amount of attention from our distribution network.
TMF: In reading over your 10-K, you said earlier that the premium wine segment is the majority of your business and also the real growth area for the industry, is that correct?
Klenz: Well, essentially, in the wine business, the wine boom in the U.S. started in the 1960s. After Prohibition, the wine industry almost died. It started coming back in the 1960s and it came back essentially as a jug-wine business: "Give me a glass of white wine." That fueled an enormous amount of growth in our industry for about a decade, from the late 1960s until the early 1980s. Then the consumer started getting exposed to varietal wines -- cabernet sauvignon, chardonnay, zinfandel -- wines that are named after the grape variety from which they are made, that are higher quality, higher image.
The $5 price point was sort of the first entry retail price point for premium wines. Now it's very much moved into the $8 to $10 price point. The consumer within the premium category is starting to trade up from the low end of the premium category into the middle or higher end of the premium category.
It really comes back to what we think are some fundamental, sociological trends of wine consumption. Wine has moved from being sort of the "cocktail substitute" of 20 years ago, to a meal-related beverage, a more traditional wine usage. That tends to favor the consumption of premium wine, because premium wines deliver more flavor intensity and they go better with food.
We see this as a long-term trend. This is a trend that literally has gone on for 20 years and there doesn't seem to be anything in either the demographic trends over the next 10 or 15 years or in the sociological trends of how people are eating that will change it -- people are eating more diverse foods, and a Mediterranean diet, and all the things that tend to favor increased wine consumption. We do believe that premium wine consumption will continue to grow by double digits for the next five or 10 years.
TMF: When you are talking about reaching out to new customers, who are you really trying to get to buy your wine?
Klenz: The biggest group of new premium wine consumers is coming from existing non-premium wine drinkers. There is also a lot of discussion in our industry about how to get the next generation, the 20-somethings or whatever we want to call them, into the wine consumption pattern.
My feeling is, frankly, that it comes naturally through normal social and business relationships and pressures that you get. When you are 20-something, you're out drinking beer with the guys to a certain degree. As you get into your late 20s and early 30s, you get married, you start to get into a business environment, you have to start to entertain both from a business and a personal point of view. All those tend to move people toward wine consumption and premium wine consumption.
There's a lot of talk in the industry about how can we accelerate that process, and I'm not so sure that's something we know how to force. Some of these alternative beverages you hear about -- flavored wines, for instance -- there is a feeling that perhaps they are good entry vehicles for people to get at least a wine-like experience, although they certainly don't taste like traditional wines. There have been two or three waves of these over the last 20 or 30 years. There were the pop wines of the '60s and '70s, and the wine coolers of the '70s and '80s, and now we have this new category of flavored varietal wines as well.
These products sort of ebb and flow, and they tend to have a fairly short life cycle, at least historically. I think a number of people go back to their prior beverage consumption patterns, whether it's to go back to beer or back to alcoholic spirits, but some stay and try more traditional wines.
Our sale of the [$5 to $7] Napa Ridge brand was really partially related to the fact that we want to focus more on the premium end, but also because we have two very, very strong brand entries in that rapidly growing $8 to $10 retail price point -- which is really the sweet spot of the industry -- with Meridian and Beringer. We wanted to focus on two major brands and Napa Ridge really had not reached the kind of scale that would make it as big and as profitable a brand as the other two.
That's distinct from the other part of our portfolio -- the higher-priced brands that sell typically for $15 a bottle and up -- where scale is not really as critical because you're not selling those wines through the mass-merchandising distribution channels. You're selling them primarily to restaurants and to fine wine shops where you don't need to have the brand scale that you do when you sell through a supermarket or a club store environment.
TMF: I've noticed that some beer companies are moving toward some alternative packaging for a number of reasons, and I wonder if there is a better or a cheaper way to package wine besides the old bottle and cork, or if you are locked into that for reasons of tradition and consumer expectation?
Klenz: The one area of fairly intense activity is not so much the bottle, but the cork. The cork is a natural product that has been used for hundreds and hundreds of years and it works great. The problem is that it is a natural product and, therefore, potentially -- at the rate of, some people say, 1%, 2%, 3%, 4% -- you can get a slight odor to the wine that's called "corkiness."
We're testing a range of alternative closures that would use an artificial material to essentially replace the natural cork. There are people even talking about going back to the traditional screw cap of 30 or 40 years ago, which is functionally a very good closure.
In wine, we exist and succeed or fail in a very high-image category, where consumers have very image-related feelings about brands and packages, and screw caps still have a residual legacy of being non-premium. But, we believe over the next five years you will definitely see some movement toward trying some nontraditional closures, particularly looking to replacing cork to a certain degree because of some of the problems associated with it.
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The millennium was a good solid bump to our business, but it wasn't the enormous bump that a lot of people predicted.
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TMF: Your business, broadly speaking, is beholden in many ways to the weather. I wonder how early you can sense those kinds of trends and what sort of things you can do to hedge against that?
Klenz: Frankly, one of the issues we face in the wine industry from a financial markets point of view is, to be very honest with you, that investors are sort of over-focused on the agricultural nature of the business. Like any food or beverage, we need raw materials just like the people who make Corn Flakes do. We are clearly dependent on the agricultural nature of our business, which is why we control a significant amount of our own premium grapes.
But, in the wine business, the ability to sell or not to sell wines is not an on/off switch with regard to quantity. Because if the wine production process is a relatively long one, there's a lot of inventory -- much more inventory in our business related to some current sales rates than there is in almost any other product category. So, you have the ability to manage your sales through the ups and downs of vintages, from a volume point of view, by being able to manage your inventory.
Right now, we are selling wines from grapes that were made in three, four, or even five different vintages. We're not totally dependent on vintage "X" selling in year "X plus one" because of the different aging schedules of our wines. The qualitative factor is probably important to a great degree only in the very expensive wines. There the vintage is a much greater factor in your ability to successfully market the wines. In the mass market side of the business, they come from such diverse sources within California that there are less vintage-related qualitative differences and much less market sensitivity.
I'd be wrong if I said we were absolutely immune from the sharp ups and downs of agricultural movements, but we can mitigate the vast majority.
Getting back to your first question, we have a very sophisticated forecasting system in place for our own vineyards and for our outside growers, so that early in the spring -- and even now to a great degree -- we have a very good idea of what the relative size of the crop is going to be and we can take actions to mitigate that now.
One of our advantages is that our management team here has basically been in place for 20 years. The guy that runs the vineyards for me has been with us 21 years, and the Beringer winemaker has been here for 23 years. They have seen virtually every combination of conditions in the marketplace and the production cycle, and have the experience to be able to react quickly and ahead of our competitors to make sure we can stay where we want to be from a supply point of view.
TMF: Should we expect any kind of [business] hangover, so to speak, from last year with the millennium party madness?
Klenz: The industry and I were quite concerned about how we would come out of the holiday season last year because of the millennium-related activity. Clearly what happened is the millennium was a good solid bump to our business, but it wasn't the enormous bump that a lot of people predicted. In fact, the business that we're looking at is quite strong and has not slowed down at all because of the "post-millenium hangover."
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