Australia | Jun 09 2021
This story features TREASURY WINE ESTATES LIMITED. For more info SHARE ANALYSIS: TWE
Chinese tariffs have hit Treasury Wine Estates hard, but management is working even harder on a revised global strategy. Early optimism equally focuses on some kind of normalisation post covid
-Expectations are that Treasury Wine's Asian business will return to pre-covid sales by FY24
-The volume of Australian wine exports to Hong Kong has been raising eyebrows
-Treasury Wine is exploring alternative luxury markets via targeted marketing campaigns
By Miles Wu
Following China’s escalating hostility since the outbreak of covid-19, the share price of Treasury Wine Estates ((TWE)) has been going south.
Starting from mid-January in 2020, Treasury Wine shares have lost approximately -33.6% versus the 2.2% net gain booked by the ASX200.
While brokers and pundits generally assumed the heavy five-year Chinese tariff is the key detriment to the free-fall of the share price, on the positive side Credit Suisse analysts, among others, have already expressed their view the company’s Asian business will return to pre-pandemic levels in FY24.
More importantly, the prospect of Treasury Wine does not seem as bad as it sounds. When taking a closer look at its one-year share price, the stock is currently showing signs of consolidation breakout after pondering on the mid-range of 52-week high and 52-week low.
Although China accounted for around 30% of group earnings and a 3.3% in five-year compound annual growth rate to FY20, Treasury management in the meantime implemented various mitigation measures to weather the storm.
Apparently, according to press reports, investors are betting that Australian wine shipments (Penfolds) will turn to the grey market in Hong Kong while onshore Chinese drinkers are being ‘punished’ by the tariff imposed by the Chinese authorities.
Goldman Sachs analyst Andrew McLennan expects ongoing volatility for years to come as wine companies work out new markets and channels, though there is an obvious rise in sales of Australian wine to Hong Kong and exports to frontier markets in the last quarter of 2020 have raised eyebrows.
Looking at Treasury Wine’s most recent interim result and investor presentation, the company is restructuring its China wine business as part of its plans to change the global operating model. The company is moving quickly in diversifying its sales to other global markets.
The new focus is on luxury growth markets in the US, Australia and other parts of Asia via driving consumption through targeted marketing campaigns.
The company also signed an agreement with the Republic National Distributing Company to distribute its Penfolds California Collection in multiple US states. The cost saving measures are expected to save -$10m from FY22 onwards.
While this stop-loss measure helps Treasury Wine to buy time during a difficult period, the company is heading to divest a significant portion of the commercial brand portfolio in the US, which enables management to further focus on higher margin luxury wine that supports the regional margin target of 25% in operational earnings.
Macquarie has already increased its own operational profits forecast to $515m from $495m due to the delivery of the company’s global supply chain optimisation program.
The broker’s recent research update suggests negative news with material effect to the share price is by now mostly priced in.
The wine company expects lower second half earnings when compared to the first half due to the provisional tariff from China.
Treasury management has worked on restructuring the supply chain by delivering a capital investment plan of $68.4m in 1H21. The plan includes investment in South Australian luxury winemaking infrastructure and e-commerce platforms to reduce reliance in the US following its commercial portfolio exit.
Not giving up on China
Despite all disruptions and cautious plans to reallocate trade in the regions of the Americas, A&NZ, EMEA and Asian markets outside of China, CEO Tim Ford said earlier in February the group will retain its presence in China – it is still trying to stamp out counterfeit wines in the country.
Treasury Wine looks to transform Penfolds into using grapes from China to regain its strong sales.
The Shanghai based business head Tom King, who runs Penfolds, is also confident on the strong demand from high-end customers.
The long-term goal is to sit on a margin between 40 to 45%, with hopes to invest directly in China’s consumer market rather than exporting wines from offshore.
Let’s not forget the impact of covid-19 on Treasury Wine’s business. This unfavourable pandemic has played a huge part in the decline of earnings.
All regions (Americas, A&NZ, China, Rest of Asia and EMEA) suffered a decline of -23% in earnings in the first half of FY21 compared to a year ago. This is reflected in the significant decline of channel sales through on premise, cellar doors and travel retailers in all regions given lockdowns and travel restrictions.
With hopes of reopening and consistent recovery of consumption in a number of markets including Thailand, Malaysia and Korea, management at the company is clearly betting on a strong rebound in sales volumes in the near future when normality restores.
When looking at the seven stockbrokers monitored daily by FNArena, it is clear from the onset that caution dominates.
The consensus price target for these seven is below the present share price. Only one of these seven -stockbroker Morgans- has put forward a twelve-month price target that is still well above today’s share price.
Not surprisingly, the stock only generates one Buy rating, amidst five Neutral/Hold ratings and one Sell from Citi.
Treasury Wine shares have rallied from near $10 in early May to near $12 in early June.
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