Australia | Sep 26 2019
Treasury Wine Estates expects to drive growth by investing in its French portfolio and offering the premium Penfolds brand to a wider consumer base in China.
-Penfolds from France likely to be sold predominantly in China from FY22
-Increased confidence Treasury Wine can achieve margin targets in the US
-Acquisitions considered unlikely in the near term
By Eva Brocklehurst
With its restructuring plans bearing fruit in the US, Treasury Wine Estates ((TWE)) remains upbeat about the significant opportunity in China, looking to grow overall wine market share via imported wine and expand its distribution in Chinese cities by 50% over the next three years.
Growth will be driven by investment in the French portfolio as well as the regional expansion, which should help reduce working capital. The broad Asian growth strategy is to be supported by a continuing focus on elevating the Penfolds brand where demand remains strong.
The first Penfolds French vintage is underway and Penfolds from France is likely to be sold predominantly in China from FY22. The company has reiterated its intention to become the number one importer of French wine into Asia, expecting to achieve this by FY22. To this end, vineyards have recently been purchased in Bordeaux.
Treasury Wine intends to increase usage of its Shanghai warehouse and reduce reliance on the container model for distribution. Nevertheless, Macquarie points out a strong reliance on untried new regional ranges creates uncertainty in the Chinese market. Citi is also cautious, noting Penfolds is an Australian brand and a French product is an untested risk.
Credit Suisse believes the Chinese mid-autumn festival in August was testament to the strength of the Penfolds brand and came despite the geopolitical climate. Growth has occurred against a much weaker backdrop for the wine industry which stemmed from competitor de-stocking in a slower economy.
In the Americas, Macquarie notes branding improvement is evident while cost controls have improved. Treasury Wine has undertaken some structural changes in an effort to reduce costs and extract synergies from the acquisition of operations from Diageo.
The strategy is to access the 18% distributor margin in key parts of the US and the company has indicated it is "tracking in the right direction". Macquarie assumes 20% of distributor margin is recaptured but assesses 50% retention is possible.
Expansion will also include increased availability of the over US$10 wine segment which includes luxury and masstige. A target of 25% margin in the Americas is slated and Credit Suisse models 23% by FY23. From the briefing, Ord Minnett is now more confident the company can achieve its margin aspirations via improved availability and distribution.
A de-merger of the commercial portfolio is off the table, it appears, unless there is a transaction whereby the luxury portfolio can be expanded at the same time the commercial business is offloaded.
Credit Suisse points out the acquisition front is quiet at present, as those that are up for sale do not fill the requirements of the Treasury Wines portfolio. Still, if such a transaction were to occur and involved a luxury, high-growth brand then the company's stock could add around $1, in the broker's assessment.
Macquarie suggests a de-merger of the lower-priced portfolio, which represents around 30% of sales, could still happen, if the commercial portfolio of the acquired company and that of Treasury Wine are de-merged together.
Without such a benefit, the broker concurs this is an unlikely development as the commercial business is now more profitable. Citi points out the company's commercial wines have fallen to 30% of revenue from 50% five years ago and are likely to shrink further.
Citi suggests Constellation Brands' wine business potentially fits with Treasury Wine's profile but such a large acquisition would require equity, or potentially a share issue to Constellation Brands. UBS, too, is doubtful M&A is on the cards for the near term and remains more likely beyond 2020.
As Australasia is a mature market the strategy is now one of incremental growth and vintage quality remains of importance. The company has pointed to continued premiumisation and increased its investment in the luxury portfolio as a result. UBS envisages upside in the medium-term stemming from this effort. There is an emerging consumer preference for light and refreshing styles, the company notes amid growth in red varietals such as grenache.
Treasury Wine has made a $150-180m capital investment in its luxury wine expansion in Australia. Grape supply will come from additional grower contracts and improved luxury grape conversion. New grower contracts are becoming available as competitor volumes exported to China weaken.
The European market remains challenged and Brexit is a headwind. The company is addressing the Brexit-related challenges by having a separate supply chain to continental Europe. Opportunity is still envisaged in luxury brands amid further innovation in packaging and the prioritising of certain countries and cities.
New guidance is for a earnings margin in Europe in the mid teens. Credit Suisse models a flat margin, it was 15% in FY19, with the potential impact from higher costs relating to Australian grape prices.
There was no trading update and the company reiterated FY20 guidance and medium-term targets. Australasian market share of 25% is envisaged, now 22%. FY20 earnings growth guidance is 15-20%, slightly skewed to the second half.
All up FY21 risk is skewed to the upside, in Macquarie's view, driven by the supply of luxury products, growth initiatives in China and margin improvement in the US. Citi retains a Sell rating, assessing margin gains in the Americas need to be realised in order to meet consensus expectations along with a better vintage in FY21. The main risk, UBS envisages is material slowdown in Asia and any stumble in executing the restructure in the Americas.
FNArena's database has five Buy ratings, one Hold (Morgan Stanley) and one Sell (Citi). The consensus target is $18.79, suggesting 4.3% upside to the last share price. Targets range from $15.60 (Citi) to $20.50 (UBS).
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