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Treasure Chest: Treasury Wine Oversold

Treasure Chest | Nov 06 2018

FNArena's Treasure Chest reports on money making ideas from stockbrokers and other experts. Several brokers point out there is more to Treasury Wine than just China and the recent sell-off may be overdone.

-US market changes may be a significant growth opportunity
-US should receive more luxury wine, boosting margins
-Acquisition opportunities abound in the US


By Eva Brocklehurst

Slowing demand in China has preoccupied investors recently but Treasury Wine Estates ((TWE)) boats more than just China among its earnings drivers, and these may be under-appreciated.

Morgan Stanley believes the sell-off on the back of growth concerns emanating from China is overdone. China has been the greatest contributor to the company's earnings growth recently so, when macro economic indicators weaken, investors become, understandably, cautious.

One of the drivers for Treasury Wine, Morgan Stanley observes, is the lift in the price of the Penfolds range. The increase in the median recommended retail price was 11.1% at the annual launch in October.

The broker also expects Maison de Grand Esprit margins may be approaching those of Penfolds and expects this brand to continue expanding as the company secures greater supply. A similar opportunity is also expected with the new Italian portfolio that was launched in September.

While reflecting slower growth in China in its forecasts, Morgan Stanley still expects 18% compound growth in earnings per share from FY19-21. The broker envisages little risk to FY19 guidance for 25% growth in operating earnings (EBITS) and upgrades to Overweight from Equal-weight, with a target of $20.

On the other hand, Citi wonders whether earnings risks are building. The value of Australian bottled red wine exports to China fell -24% in the September quarter versus growth of 106% a year ago. Citi suggests the large growth numbers in the prior year imply the outlook is flat at best. This is a growth business, the broker acknowledges, but that growth and margin expansion is expected to moderate.

Deutsche Bank points out that the data signalling exports to China slowed materially is based on Wine Australia's report, and the Chinese business of Treasury Wine constitutes a large portion of that data. Citi concurs, in this respect, that demand for wine in China has largely been driven by a switch to imports not by per capita consumption growth.

US Wine

Macquarie is increasingly convinced about the margin improvement that is likely in the US. This is a significant growth opportunity for Treasury Wine, as changes to the route to market will deliver control over around 25% of its US distribution. Successfully executing distribution changes will deliver margin upside of around 2-2.5% in FY20, on the broker's calculations.

While execution risk is high in the mandated US three-tier distribution structure, recent feedback from the industry implies that Treasury Wine has laid a strong foundation for success. In comparing Treasury Wine with Constellation Brands, Morgan Stanley is confident that the company can lift its margins in the Americas over the long-term. Constellation Brands makes 20% more profit per litre than Treasury Wine, despite achieving a 12% lower average selling price per litre.

US wine distributors make margins of 16-20% on average and occasionally as high as 30%. Macquarie calculates a reinvestment rate of 50% would allow Treasury Wine to build the business and invest in assets & branding. The broker believes, as the business already has a sales, marketing & distribution team, reinvesting half of the distributor margin is realistic.

Along the same lines Morgan Stanley suggests, as Treasury Wine benefits from its investment in winemaking and luxury conversion capabilities, the US business should receive a greater allocation of luxury wine and this, in turn, should boost margins. The company also has an ability to build new brands in the US such as 19 Crimes, which in FY18 was a 2m case per annum brand.

Meanwhile, the stock has underperformed the market by -12% in the three months to October 30 and its multiple has de-rated to a five-year low, Macquarie points out. The broker also expects the company to remain on the acquisition trail, with the principal focus on the US.

While a deal is unlikely until the route-to-market changes are finalised, the broker estimates an acquisition of the likes of Ste Michelle, owned by Altria, would be around 6% accretive to earnings, assuming a 15:85% debt:equity funding structure. A combination of the recent sell-off and increased confidence leads Macquarie to upgrade to Outperform from Neutral, raising the target to $18.22.

FNArena's database shows four Buy ratings, two Hold and one Sell (Citi). The consensus target is $18.40, suggesting 16.2% upside to the last share price.

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