-Inventory build strategy questioned
-US commercial cycle may be turning
-Strong lift to Oz high-end sales expected
By Eva Brocklehurst
Treasury Wine Estates (TWE) has taken a few hits on the chin recently, none the least being a hefty inventory write-down. Some brokers think the stock may be a little punch drunk and have reviewed its value. After all, the company does have some nice product for which demand is always there. Macquarie put the thesis about some months back that Penfolds was by far the most valuable of the assets and the rest of the brands were just complicating the story. More on that later.
Deutsche Bank took a look at Treasury Wine's inventory recently, assessing the merits of accumulating wine inventory for sale at a later date. That is, seeing whether the price appreciation for vintages of premium wines over several years delivers a return to shareholders if inventory is held back from sale. The trigger for this re-assessment is that non-current inventory has lifted materially over the second half of FY13, driven by an impressive 2012 vintage.
Deutsche Bank's analysis suggests that, in most cases, it is better to sell the wine. Price appreciation in Treasury Wine's premium wines has been insufficient to justify the accumulation of inventory for later use. There are some merits to accumulating inventory in a good year because it can smooth earnings in the event of a bad vintage but, to the broker, this is the process of normal business and should not be a driver of the stock price. To that end, Deutsche Bank retains a Sell rating, given the stock's stretched valuation and poor return profile.
Treasury Wine will write down around $200m in FY13 in inventory and lost revenue. Credit Suisse summed up the initial reaction to the news by noting the decision avoided the issues of strategy, governance, accountability and brand equity. The lack of investor confidence in these issues was expected to put pressure on the share price in the medium term and it did.
Subsequently Citi decided to be more positive, upgrading the stock to Neutral from Sell to incorporate a cyclical upturn in the US wine industry. The Americas business will benefit from a growing shortage of US wine grapes and this should drive Treasury Wine's margin higher, by 970 basis points from a trough in FY14. US commercial wine has the most upside for Treasury Wine, in Citi's opinion. While high end wines are enjoying solid growth, low end wines continue to face intense competition caused by excess supply. For Treasury Wine, this commercial segment accounts for 70-80% of volume, but only 30-40% of earnings. The flagship Penfolds brand - Penfolds Bins, RWT, St Henri and Grange - make up only 0.2% of US volume. While the commercial segment faces current hardship, this is where Citi sees the best opportunity if the wine cycle turns.
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