Vineyard Investment: Observations and Recommendations
By: Kevin Martin, Penn State Extension Educator
The following article illustrates the business cycle of the juice grape market. Long-term demand for juice has been stagnant. Long-term demand for boutique and local wine has been growing slowly. At the moment the U.S. wine industry is hitting its stride and in a very different stage of the price cycle. In fact, the U.S. wine industry is providing an important buffer to juice grape growers, which are finding more and more of their commodity being used in fermented and craft beverages.
Despite the differences in trends and the business cycle wine grapes remain a global economic market subject to a similar business cycle. Small growers and value added growers will remain somewhat isolated from macroeconomic trends but will likely still see some exposure to these risks. The following observations illustrate the importance of using working capital when prices are relatively higher to prepare an agricultural operation for periods of declining prices.
Current juice grape markets also directly impact the actual price of some native grape varieties as well as the relative value of hybrid grape varieties. Growth in the wine industry is driving an increase in the price of acid, relative to the price of sugar. While brix previously defined commodity value, earlier harvest dates allow juice to be utilized to support newer trends in wine production. We are now seeing a shortage of acid in the market and a shift of actual acreage and production toward fulfilling that need.
As Lake Erie vineyard owners move through this grape market cycle, observing the various strategies employed to position the operations for future continued success is both interesting and informative. While bulk prices have fallen by 60% from peak, farm gate value of Concords with markets has fallen between 20% and 60%. While there is no average grower, the weighted average decline in farm gate value is 30%.
Growers entering the period of price decline in varying financial positions. As a result, we are seeing varying strategies on operations. Equipment investments are almost holding steady. Primarily the focus has been on mechanization and renewal of depleted assets. Many of these investments are sometimes less than optimal for the vineyard but they remain evidence of strong farm finances thus far. Controlling capital expenses can improve financial efficiency, unless the investments provide significant improvements in operational efficiency. That being said, it does indicate that some growers remain in a position of relative strength.
As markets were disrupted by marketing contract cancellations and reductions, we are seeing an increase in the growth of average farm size. These investments make a great deal more sense. The increase in farm size usually shows a decrease in the amount of capital per acre. Over the long-term these investments, when priced correctly, should provide positive returns for these growers. The main concern in increasing business size during a commodity price trough is planning cash flow for the entire length of the recovery.
In prior cycles we have seen this work out to varying levels of success. With credit now tightening a bit growers that over extend themselves sometimes rely on reducing production costs in an attempt to weather the storm. Sometimes in a dry year like this, there is money to be saved on spray applications. Overall, though, consistent and forced frugality based on available finances tends to lead to vineyard decline. In a business where maximum production is highly correlated with maximum gross profit, this can undermine a business plan that justifies a mortgage very quickly.
On the other side of things, growers that have the financial resources and make conservative yield and price estimates tend to do well. For instance, if a grower can make a land purchase work operating under the assumption of 85% of historical yields at current prices for 5 years, that grower is in a sustainable position to survive under some of the greatest historical challenges the industry has faced. His risk would be a challenge of unprecedented proportions based on a new normal, rather than historical information.
We are seeing some growing pains as the number of vineyard operators managing more than 300 acres is growing very quickly. Despite multi-row equipment, new harvesters, and innovative strategies at these sizes full-time laborer(s) are a new normal. Traditionally the growth of acreage has not outstripped the pace of technological innovation. Now we are seeing a dramatic increase in paid labor costs between May and August. This was a period in time when only the largest growers hired help. Now, we have a significant number of 100 – 200 acre growers finding a need for full time labor. Those growers are no longer the largest growers in the industry.
At 200 acres a farm can justify some year-round paid labor. With the average age of growers very close to social security early retirement age, I don’t see outside labor putting an undue strain on farms if kept to a minimum and managed well. There’s the rub, of course. Growers typically specialize in growing, not managing a workforce. Farms less than 175 acres also require year round labor that should likely total less than full-time, unless the grower owner is above retirement age.
One real struggle with full-time labor management will be the balance of a growers’ ability to pay as compared with the workers’ ability to find opportunities elsewhere. The trend of increasing paid labor during the growing season began during the 2007 downturn, when local unemployment got very close to double digits. Contrast that with today, a market with declining unemployment, increasing wages and low grape prices.
A typical model is about one FTE per 100 acres of grapes, minus the first 100 acres. So a typical grower would have 1 FTE on a 200-acre farm or 2 FTE on a 300-acre farm. All of the labor is not new. Typically, year round labor does replace many of the functions and services traditionally provided by seasonal and temporary work. Even so, as a point of reference, every dollar of wage increase is an additional cost of three cents per vine or $20 per acre.
Growing a farm from 100 acres to 200 will require the development of some labor management skills. Effectively using and managing hired help and delegating tasks will increase the efficiency of hired labor to allow for adequate compensation and the relative growth of farm profitability.
For some perspective on justifying the cost of labor to increase farm size, we only need to look as far as capital and depreciation. A 100-acre grower would usually see a decline in depreciation from over $300 per acre to $200 per acre by doubling farm size. Furthermore, the capital invested in the farm, on a per acre basis would also decline. Capital investment would decline from $7,250 to $6,500.
The decline in depreciation and capital investment are operating on many of assumptions but those assumptions are based on typical farms we observe. A relatively frugal farm would have relatively lower expenses. A farmer with newer and more advanced equipment would have higher expenses. Generally speaking, the relative savings is somewhat uniform. More specifically, though, we should address the extremes. A grower likely to over-invest in capital will be much more successful with a larger farm. A grower that drifts toward being overly frugal will operate with more relative success on a smaller farm. He will still improve efficiency by growing, but perhaps less so. As an example, eventually the repair work on the Mecca harvester becomes cost prohibitive and represents a strategic risk for the business and its ability to harvest before processors close.
Despite the example above, generally speaking the grower that tends to be overly frugal on capital expenditures, but not operating costs, will likely be the most successful of all grower types as that grower expands his operation and remains flexible and open to strategic and important capital investments.
The strategic expansion of vineyards will continue to be a long-term trend. For individual operations, expansions should be timed when cash-flow, resources and labor allows. Growers with an ability to meet those criteria are the most likely to find expansion sustainable. Given the current market climate, the ability of growers to take on significant acreage is surprising. It does bode well for the long-term sustainability of the industry, as it appears most of these investments are likely sustainable.
Despite some recent indications that prices are rising very slightly, those trends are young and processor specific. When planning out over the next 2 – 5 years, I do think it is fair to plan for relatively flat prices. I don’t expect dramatic declines in price at this point. Some upside, at some point, is inevitable. Trying to determine exactly when that happens is impossible. I might expect higher prices in the next 5 years, but when planning for business operations I would not count on it.