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Golden State Vintners Hopes Supply Report Isn't Crushing

Look for the California Grape Crush report, to be released Wednesday, to shake up wine shares.

After almost recovering from a botched insider sales filing, Golden State Vintners (VINT) awaits a potential witchin' on Wednesday when the state of California is slated to release its grape crush report for the 1998 harvest. For the wine industry as a whole -- but especially for GSV -- this report carries triple-witching weight, something like when the CPI, inflation rate and jobs figures are all released on the same day.

If the brokerage analysts are even half-right about the overarching importance of wine grape supply, this report could be the single number that determines the fate of wine industry profits -- and stock prices -- for at least the next year.

To get a handle on this witch's brew, let's look first at Golden State Vintners, which supplies both bulk and custom bottled wine to the likes of

Robert Mondavi Winery

TST Recommends

(MOND)

,

Beringer Wine Estates

and

Archer Daniels Midland

(ADM) - Get Report

. GSV has been a sort of orphan stock ever since its IPO last July. After hitting the market at $17, the shares began an immediate power dive, losing almost 59% of their value by the time they bottomed out on Oct. 15, at a mere $7.25 a share.

Since then it's staged a rally, closing at 13 5/8 Friday.

So what's up with this near-death experience and the subsequent miraculous recovery? Nothing that makes for any kind of fundamental sense. After all GSV has a smart, experienced management team, blue-chip customers and respectable growth in revenues ($112 million for FY1998 over $95.8 million in 1997) and net income up 46% to $11 million for the same period.

Brokerage analysts unanimously blamed last year's drop on an Aug. 4

Barron's

article that talked of a coming wine glut. But that excuse fails to explain why VINT started its Olympic luge imitation more than a week before the

Barron's

piece appeared.

In reality, the slide probably happened because the company fumbled a key post-IPO insider trade filing. Because of a delay in filing, it

appeared

that Golden State insiders had bailed out just six days after the IPO, dumping more than a million shares worth $16.8 million -- a staggering sum considering that the whole IPO raised just under $34 million.

The chat boards buzzed and the stock plummeted. Turns out that the shares in question belonged to

SBIC Partners

, one of the company's backers, and that the prospectus stated that their shares would be offered as part of the IPO from the get-go. Not only was this notification buried in one of the largest kitchen sink S-1s in wine IPO history, but they should have realized that most people don't even read the short ones. Somebody at the underwriters (

Goldman

and

H&Q

) should have had their eyes on this ball.

So VINT's drop didn't make much sense. But neither does the new chorus from brokerage analysts singing of a recovery driven by higher bulk wine prices, and the expectations of an inadequate 1998 harvest. That may play alright in Manhattan, but out here in wine country there's an alarming amount of plenty.

Signs of Excess?

First of all, three weeks ago we saw Mondavi unloading some 200,000 cases of excess French wine inventory destined for its Vichon Mediterranean brand. This accounted for two-thirds of its entire $6 million restructuring charge and sliced 15 cents off earnings. Then along come bulk wine brokers such as the

Joe Ciatti Co.

(the largest in America). They say bulk wine prices are creeping upward, and characterize the market as having adequate supplies rather than shortages.

"Historically wine has been sold more like an agricultural commodity ... driven more by supply than by any other factor," says Vic Motto, senior partner at

Motto, Kryla & Fisher

, the industry's top accounting and consulting firm. Motto says the logical answer is to "manage for profitability, not for volume."

As sensible as this advice is, most of the industry simply does not listen, and instead of spending on marketing and promotions that would serve to increase demand and support higher prices, they continue to cut prices and offer distributors "depletion allowances" -- essentially paying distributors to buy the wine. And this is the key reason that supply leads the industry and its retail pricing around by the nose.

So what can happen when the wine world begins a new year of reality on Feb. 10?

Well, for one thing the speculation and second guessing about the harvest size will be put to rest. If the harvest comes in at 2.4 million tons, as most predict, then there should be adequate quantities of wine -- not a glut --

if

consumption can keep up. Remember that smaller harvests of 2 million to 2.3 million tons were the average during the glut years of the early 1990s. It was tanking consumption that was the problem.

The $10,000 Question

Obviously, consumption is the factor that can turn an average harvest into a glut or shortage, and on that score, the messages are mixed as well. Industry statistical guru Jon Fredrikson of

Gomberg, Fredrikson & Associates

told a major wine trade show in late January that 1998 wine consumption posted its lowest growth rate since 1993, showing a gain of only 2.6%. While wines that cost more than $7 did show a 14% gain, that segment, according to Fredrikson, make up only 23.7% of wine volume, although it made up 44% of revenues.

This is bad for the industry in general because newer wine drinkers usually start with the less expensive wines, such as jug wines, and these showed a 4% decline in 1998 over 1997. "We're not bringing in new consumers," Fredrikson told his audience. The decline in jug wines and a relatively small 6% increase in popular premium wines selling for $3 to $7 could also spell trouble for Golden State Vintners, since the wines it makes sell mostly in these price ranges.

The outlook for consumption did get a boost on Friday when the

Bureau of Tobacco, Alcohol and Firearms

handed the industry a potential piece of good news. They approved an optional sticker that gives a carefully crafted nod to wine's presumed health benefits, and that can be applied to bottles next to those ominous-looking government-mandated warning statements. It was a report in 1991 on

CBS' 60 Minutes

on wine and health, some may recall, that caused wine sales to skyrocket, accounting for almost all of the consumption increases in the ensuing decade.

The new sticker may yet be torpedoed by previously threatened political and legal challenges. One may stem from conservative U.S.

Sen. Strom Thurmond

(who sadly lost a daughter to a drunken driver). The other is from the legion of neo-prohibitionists like the

Center for Science in the Public Interest

, who have previously tried to save the nation from Mexican and Chinese food, as well as movie theater junk food.

And as if that's not enough, if the California harvest does something unanticipated -- such as come in at 2.6 million or 2.7 million tons -- then wine prices at every level could begin to fall even more than they did in 1998.

That would be a mixed blessing: good for the wine consumer and potential hell for wineries and their investors.

Lewis Perdue is the editor and publisher of Wine Investment News, which covers the 22 publicly traded wine and liquor companies. While Perdue does not hold any positions in the companies discussed in this column, he is the chief technology officer (on a consulting basis) to the e-tailer Wine Society of the World, which may, from time to time, discuss purchasing or other agreements with wine companies. He can be reached at lperdue@ideaworx.com.