Treasury Wine Estates Receives Lukewarm Reception

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– Treasury Wine Estates lists following de-merger of Foster's 
– Brokers initiate coverage with Hold and Underperform ratings
– M&A interest possible, Aussie dollar a key earnings driver

By Chris Shaw

Following the de-merger of the wine and beer operations of Foster's ((FGL)), wine group Treasury Wine Estates ((TWE)) commenced trading on the Australian market yesterday. Treasury Wine Estates has a portfolio of more than 50 wine brands that together generate revenues of around $1.8 billion and about $210 million in earnings before interest and tax.

The commencement of trading has been met by the commencement of research coverage of the shares, with UBS, Goldman Sachs and Credit Suisse all publishing initial views on the stock. UBS and Goldman Sachs have initiated with Hold ratings, while Credit Suisse has an Underperform recommendation.

Key drivers of earnings for Treasury Wine Estates, according to UBS, include forex, as every 1c move in the AUD/USD rate impacts earnings by 1.5%; and any macroeconomic recovery, as FY11 earnings are likely to be significantly below peak levels.

On UBS's estimates, Treasury Wine Estates is likely to deliver reasonable earnings growth of 2.4% this year and 9.7% in FY12 in net profit after tax terms. This reflects expectations of a lift in margins on the back of some volume and pricing growth in Australia and some volume growth in the Asian and American operations. 

Goldman Sachs also sees potential for capitalised annual growth in earnings before interest and tax terms of 20% through FY14. Australian dollar forecasts are a swing factor with respect to these forecasts, as if spot currency rates were applied during the forecast period these estimates would decline to single-digit earnings growth.

Setting aside currency movements, Goldman Sachs suggests medium-term drivers for Treasury Wine Estates will be continued improvement in product mix and growth in premium products in the Asian market.

Achieving gains in earnings over the medium-term is likely to be a challenge in the view of Credit Suisse, which argues the wine industry at present is characterised by low barriers to entry and high levels of customer power. As well, industry growth overall appears to be declining, this before the potential of a strong Australian harvest in March of 2012 to return the industry to an oversupply situation. 

Assuming the harvest next year is a good one, Credit Suisse sees some pressures emerging with respect to growth in the Australian business. There are similar questions over the outlook for the US business in Credit Suisse's view, as US wholesale inventories are high and this suggests intense promotional activity in FY12. Such promotions impact on margins.

In line with its Underperform rating, Credit Suisse has set earnings per share (EPS) forecasts for Treasury Wine Estates at 17.7c in FY11 and 15c in FY12. UBS in contrast is forecasting EPS of 22c in both FY11 and FY12, while Goldman Sachs expects EPS will come in at 2.9c this year and 23.3c in FY12.

Plugging these forecasts into their models, price targets have been set at $2.70 for Credit Suisse, $3.55 for UBS and $3.80 for Goldman Sachs. Goldman Sachs does concede there is downside risk to its target to around $3.20 if the Australian dollar continues to hold at current levels.

What justifies its target according to UBS is the potential for corporate activity. At a multiple of 10.4 times FY12 earnings before interest and tax, Treasury Wine Estates is trading below the top-end of a rejected private equity bid made last September. 

This bid was priced in a non-competitive process and was an initial offer, which suggests to UBS some M&A interest will re-emerge now the de-merger has been completed. Goldman Sachs agrees there is potential for corporate activity, while pointing out the more than $2 billion valuation of Treasury Wine Estates limits the number of potential buyers.

While a break-up of the group is a possibility Credit Suisse suggests such a move is unlikely in the short to medium-term given expectations of earnings downgrades. In such an environment, Credit Suisse sees any suitors such as private equity putting off an approach until the earnings outlook becomes clearer.

What could happen is some brand rationalisation. Credit Suisse sees this as a better way to create value given smaller, bolt-on acquisitions have tended to deliver good returns and a few of the current brands of Treasury Wine Estates appear to be in decline.

Shares in Treasury Wine Estates today are higher and as at 11.50am the stock was up 11c at $3.47. Since listing the stock has traded between $3.14 and $3.50.
 

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