Treasury Wine Is Not Blackmores

This story features TREASURY WINE ESTATES LIMITED, and other companies. For more info SHARE ANALYSIS: TWE

-Disconnect to valuation peers
-Asian margin differential unsustainable?
-UBS: hard to justify a Buy call
 

By Eva Brocklehurst

The Chinese thirst for Australian wine is substantial and growing. Treasury Wine Estates ((TWE)) has revealed demand for its premium wine brands is strong, in particular for the Penfolds and Rawsons Retreat brands being sold into that market.

Brokers are attracted to the increasing penetration of the Chinese wine market but several wonder whether the outlook has led to Treasury Wine becoming overpriced.

Credit Suisse has believed for some time that, with exports to Asia and China particularly strong, Treasury Wine could become unconnected to valuation peers in the spirits, wine and luxury goods businesses and trade like another Australian-China export consumer stock, Blackmores ((BKL)). Treasury Wine is now seen approaching the Blackmores price/earnings (PE) ratio on FY18 projections, yet the Blackmores business model generates much higher returns.

Has explosive growth in China led to an over-valuing of the opportunity? Citi suspects that is the case. When the company extends its reach in that market to other less recognised and lower-priced brands this should result in slower sales growth and compress earnings margins. The broker expects the wine volume to China could rise six-fold by 2030, with the biggest drivers for Treasury Wine being a greater share of Australian exports as well as per capita consumption growth in China.

Treasury Wine's volume share of Australian exports to China is around 7% but Citi believes it should be more like 14%, based on share in Australia. Outsized volume growth should persist for Treasury Wine until FY18, because the broker expects the company to be catching up to other Australian wine exporters to China.

Nonetheless, Treasury Wine's Asian margins are at 34% compared with a group average of 14% and the broker suspects the pricing difference is unsustainable. Given Australia and Europe are likely to be single digit growth markets and the company has a challenged brand position in the Americas, Citi considers the price/earnings premium is unjustified for the pace of growth and lowers its rating to Sell from Neutral.

Morgan Stanley recently downgraded to Equal-weight from Overweight, citing the recent outperformance in the stock and believing the improved outlook is now reflected in the share price. The performance also probably reflects greater confidence that management can execute on its plans, in China and the US in particular.

The broker is attracted to the increasing penetration in China and believes the global wine industry will benefit from a tighter wine cycle as supply continues to be withdrawn from the market. Morgan Stanley also suspects changes to China's eCommerce regulations will have little impact on Treasury Wine.

The broker trims earnings forecasts for FY16-18 by 5-6% as the Australian dollar has strengthened, on average, against the company's transactional currencies to date. Earnings are highly sensitive to movements in the currency. Morgan Stanley now reflects a rate of US73c across FY16 and US72.5c across FY17.

Credit Suisse downgraded the stock last month, to Underperform from Neutral, and agrees with Citi that growth in China is likely to be sourced from lower priced wines, meaning volume growth should exceed earnings growth.

The broker observes sell-side estimates call for earnings growth of 45% between FY16 and FY18 and this looks to be a challenge. The broker's forecasts incorporate 26% growth, recognising the integration of Diageo will not be easy. Both Treasury Wine's North American operations and Diageo brands were struggling at the time of the acquisition. Furthermore, the stock is expected to capture no further positive earnings movement from exchange rates.

UBS is in the Neutral camp, expecting China will continue to be a growth engine because of favourable market dynamics, while the company has successfully turned around an underperforming business with a credible and sustainable strategy. The broker expects management will be able to reinvigorate the Diageo business over the next two years.

Moreover, Treasury Wine is considered one of the few consumer-facing stocks under coverage that is capable of delivering double digit compound earnings growth on a 3-year view. While the stock is trading at a 65% premium to defensive comparables it looks fair value, and the broker acknowledges it would be difficult to justify a Buy call under its rating framework.

FNArena's database has four Hold and three Sell ratings for Treasury Wine. The consensus target is $9.03, suggesting 11.2% downside to the last share price. Targets range from $8.70 (Citi) to $10.00 (Morgan Stanley).
 

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