Looking For A Bubble To Happen

More and more I’m hearing about how the craft beer bubble is going to burst for a myriad of reasons, none of which are too separate from day to day issues we see in many other industries in our banking world. Most breweries are small businesses that face the usual round of challenges. Is the craft bubble going to burst? I say no, but like with most things that see rapid growth, we are in for a serious market correction and when it starts to happen the land will decry that the bubble has officially burst. This isn’t new, at least in VT, we saw this 20+ years ago when the first round of what was then called micro brews came, and most went, for very similar reasons that we are seeing today, history certainly does repeat itself. Many small breweries came and went, and in many cases they closed for all the usual reasons, not the least being product quality, management and an overleveraged balance sheet (look up Catamount for a nice case study on too much too quick). Worth noting are there are some survivors from that initial movement, to include the likes of Magic Hat and Long Trail.

 

It is a great time to be a beer drinker but becoming increasingly crowded as a beer producer. I think a market correction might be good for the long term sustainability of the craft industry. Just walk into any craft beer store and you will be overwhelmed with the myriad of choices in not only brands but also styles. IPA continues to be the style of choice in our region, with new variations being offered up all the time (juice bombs sound familiar). Let’s not forget the latest trend, which is sours (which I happily subscribe to and can’t get enough of).  I’m in VT, the home of the east coast IPA, which boasts more breweries per person than any other state in the union, and couldn’t be happier to be here. Seriously, a client call to a brewery far exceeds many of the other ways we as lenders get to spend our time. I find that I’m in perpetual need of documents from my brewing customers and more often than not I’m going to find a way to go there in person to pick them up!

A market correction will mean banks will suffer from bad financing decisions, in particular some banks are very late to the game and seem ready and willing to throw money at anyone that makes beer, good or bad. The real challenge is who determines what is good and what is bad, in particular when you have a flashy group of out of state investors imitating what they think is “hip” and thus you get these banks financing 30 bbl systems for folks that are just coming on to the scene. The familiar story is a few folks in another industry want a change, pool their funds, find a brewer and voila, you have yourself a brewery. If this group shows up at the bank with some liquidity, hipster beards and a flashy business plan it seems banks are ready to party (having more often than not even sampled the product).

I’m always concerned when I see a new brewery business model that is dependent on pushing product out of state to garner more sales, and to some degree riding the VT name and beer reputation isn’t a bad play. At issue is there is a lot of good beer out there state to state and shelves are overflowing. As Bankers we need to take a hard look at sales projections that assume significant out of state sales. Looks good, as most projections do, but know that these shelves they plan to land on are overflowing with all sorts of creative bottles and cans, and often from more local producers than the product they plan to send in. What does that mean? You need to ask yourself, how can your client’s product stand out, get to the front of the crowded case? Here is how. It has to be good, real good. AND it has to have a story, one that people will like and feel good about. Sounds easy right but there has been an influx of new breweries producing sub par product, and craft beer fans are fickle, you get one maybe two shots to become a part of their drinking cycle, and if you aren’t bringing you’re A game, you aren’t going to last long.  Now take that crowded case risk and couple that with products that “evolve” as they live on a shelf (and often not in a good way) and you not only need to stand out, but you also need to see good turns so that your beer isn’t sitting on a shelf and losing quality because of it. People aren’t going to give a “stale” beer a second shot usually, not with so many options.  

What about getting on lines at the myriad of craft beer bars that have opened up in the past 8 years? Good luck. These are hard fought lines to be on, and even harder to stay on with a par product, these places have reputations to preserve and need to make sure they are dedicating lines to what is hot and what are proven winners. Fold in the distribution angle and getting a line (and staying on) gets even more difficult.

I can’t stress enough how staying true to your story is critical. Craft beer drinkers can sniff out those that are in it for the genuine craft, and those that are at the table because there is money to be made.  Just as important is that a brewery stay loyal, local and involved in its community. That harkens to my focus on making sure the “story” is right, and that the people making the beer are making it for the right reasons, and of course that the beer is crushable.

So when these “create the demand” breweries, more often not these are 30 bbl plus sized breweries, aren’t sustainable and their product starts to sit on shelves we’ll see places starting to fold up and the world will declare “the boom is over” when in reality it isn’t, it’s just sorting out the mediocre from the quality, and in my opinion we are going to see this happen sooner than later.  If any model seems to be working on a consistent basis it is the smaller sized breweries, selling direct to consumers from their location, and self-distributing initially, which equals a better experience for the consumer and better margins for the brewer.

I spoke to Jen Kimmich, co-owner of The Alchemist Brewery, brewer of some of the best beer in the world (yes they make Heady Topper, but have been reintroducing the world to some of their other offerings from the pub days, Crusher? Focal Banger? Luscious?) to get her insights on current craft trends. She cites access to raw materials, specifically hops as a number one concern as more and more breweries hop (see what I did there) on the IPA train. Kimmich states “there are challenges with securing high quality hops. We are fortunate that we have been in business 14 years so we have strong relationships and contracts with our growers. I hear from new brewery owners that they often have difficulty acquiring the hops they planned on using for their flagship beers”. That challenge will only grow as more breweries enter the fray and as mid to larger breweries secure larger percentages of the crop. So as bankers looking at these businesses we need to be asking these supply side questions often and early!

Bart Watson, Chief Economist for the National Brewer’s Association provided a more national perspective and very much disagrees that we are in for a bubble burst. Instead he cites the increased competition as the main driver behind anticipated industry stabilization. He states “Although I do think we’ll see closings rise in the future, I don’t currently see signs that we’re entering a bubble”. As to a lender’s role in this he notes “while there might be some sloppy lending out there, I think a lot of lenders have scaled back expectations as market growth has slowed”. He goes on to note that the issue is less with the number of breweries and more with the middle of the market producers that are focused on production and distribution/retail presence. Reiterating points above he notes “the vast majority of breweries (70%+) are 1,000 barrels or less and selling a high percentage of their beer direct (with correspondingly higher margins). Many of them will still go out of business (since running a small business is hard and there are a million places to screw up), but I’d expect success rates to still stay well above many comparable industries (restaurants for instance)”. He concludes that the predicted  bubble is better represented as a normal competitive marketplace. For us lenders his last comment was perhaps the most telling and one we should heed “we’ve been somewhat spoiled in the brewing industry with openings:closings running 8-10:1. That’s the unusual part. By being in the midst of rapidly expanding demand growth there was a window where nearly everyone could succeed. That window is closing and/or closed depending on your geography. Yes, more breweries are likely to close – but that’s something that many (including myself) have expected for years”.

Does this mean you should steer clear of craft beer? Of course not, but you need to really dig in to the whole story, and look at the competition, and look closely at the immediate market. I attended a meeting recently where a popular brewer noted that every community can support a nice 7 to 10 barrel brew pub, and that model which includes direct sales out the front door of beer, will make for a nice living if they put out a nice product. This is a more organic and sustainable model that could someday grow into something more. I subscribe to incremental growth and thus far that focus has been successful for the parties I work with. We’ll see how this all shakes out over the next 24 to 36 months but all I can say is be ready for some closings, don’t be surprised by them, and most importantly don’t give up on craft beer when it happens, there will always be a place for this incredible industry full of great jobs, great people and great products. We as bankers can still support this very vibrant industry and act as critical business partners going forward.