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Treasure Chest: Overvaluing Chinese Wine Demand

Treasure Chest | Aug 01 2017

Goldman Sachs has downgraded Treasury Wine Estates to Sell, suggesting Chinese demand growth is abating.

-Asian wine demand booming
-Market pricing in overly strong growth
-Goldman sees price and margin pressure ahead

 

By Greg Peel

Back at the end of June, Citi, using data up to the end of April, suggested Treasury Wine Estates' ((TWE)) Asian earnings could surprise to the upside. Australian wine sales were sluggish, US consistent, UK surprisingly strong and China “incredibly” strong.

However, Citi noted that the lofty valuation the market was affording the stock actually required an upside surprise to be justifiable. To that end, Citi retained a Sell rating.

In mid-July, both Citi and Morgan Stanley noted the weakness of the 2014-15 vintages meant FY18 would see weaker earnings for the company. Citi also noted increased costs from launching a French brand and upgrading IT. Both brokers nevertheless agreed that much stronger 2016-17 vintages would mean a return to form in FY19.

Citi retained Sell, still unable to reconcile an FY18 forecast earnings multiple of 28x. Morgan Stanley, on the other hand, retained Overweight, noting Asian demand is booming, Treasury Wine is only in the first stages of building its Asian business, and the first Diageo vintages will be sold in FY18.

Goldman Sachs has just completed a “deep dive” into the Chinese wine market.

Treasury Wine’s share price has tripled over three years, Goldman notes, coinciding with the company’s rise from number nine exporter of wine to China to number one. The broker calculates that on current valuation, the market is pricing in 30% year on year growth in Asian wine demand for FY19-27.

But Goldman believes the confluence of factors that has driven growth to date is abating. China is experiencing changing market dynamics and changing patterns of consumption. The one-time benefit of the China-Australia free trade agreement will pass, vintage variations will limit luxury wine production in Australia, and as the company expands its reach into western China it will meet a less affluent demographic.

Goldman thus sees pressure on both prices and margins in the Chinese market, and has lowered FY18-19 Asian earnings forecasts.

The broker has also changed its valuation model. Previously, 85% of valuation was based on discounted cash flow and FY19 enterprise value to earnings ratio, with 15% attributed to a potential takeover. Now the broker has removed its takeover consideration and splits valuation 50/50 between DCF and EV/EBITDA.

The result is a drop in target price to $10.50 from $12.00. As Treasury Wine was trading over $13 last week, Goldman has downgraded to Sell.

Goldman Sachs is not an FNArena database broker. The seven database brokers covering Treasury Wine have a consensus target of $11.93 and a split of two Buys, three Holds and two Sells.

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