Australia | Oct 24 2012
– TWE slashes FY13 growth forecast
– Turnaround still expected in FY14
– Brokers not convinced
By Eva Brocklehurst
Treasury Wine Estates ((TWE)) certainly flushed out the commentary after fine tuning earnings forecasts at its Annual General Meeting. CEO David Dearie's reference to mid single digit earnings growth for FY13 was a stark downgrade from guidance at the FY12 results, while a forecast of "growth greater than the 15.8% average of the past two years" for FY14 has been greeted with a little skepticism. Brokers rushed to pare their estimates for the global wine supplier, which boasts three continents, 54 brands and 11,000 hectares, and consensus earnings growth forecasts on the FNArena database dropped to 3.1% for FY13. Consensus forecasts have earnings growth rebounding to 23.1% in FY14.
BA-Merrill Lynch was the most positive of the bunch, noting the company was not managing the business to drive short term earnings. Okay, BA-ML does see the extent of the downgrade for the first half of FY13, around 20%, and the extent of expected rebound in the second half, around 23%, as somewhat extreme but compliments the company on not bringing wine sales forward at a discount to smooth earnings. So, glasses are raised and a Buy is maintained, the only one in FNArena's database. BA-ML has the top target price at $6.50. Targets range down to Macquarie's low (who did not re-rate the stock) at $3.43. BA-ML has reduced its earnings growth estimate to around 6% for FY13 but notes FY13 was always going to be a tough year for TWE with higher costs coming from a poor 2011 harvest, IT expenditure after the split from Foster's and a costly dispute with a retailer. The broker was unimpressed with the fact that, before Foster's spun out its wine business as TWE, premium wines were often sold early to retailers at a hefty discount to their full value to deliver short term earnings growth.
The divergence between the first half weakness and second half rebound stretches assumptions for UBS too. UBS believes the significant increase in high value, longer-term inventory might prove successful but there is always the risk of securing price increases for large volumes of premium wine in a tougher market. This earnings downgrade also ended what UBS described as a 'remarkable' share price rally and it downgraded the stock to Sell, as did Deutsche Bank. Deutsche acknowledged that the exceptional 2012 vintage and substantial inventory of premium red wine will result in strong earnings in FY14 but believes this has already been factored in, given the share price appreciation of around 40% this year ahead of the downgrade. The broker has the stock trading on almost 19x its FY14 estimate. There's a problem too, Deutsche feels, with the substantial impact of the two major retailers on the company's business.
RBS, while preferring to retain a Hold rating, also states its concern over the power wielded by the retailers. It cites protracted negotiation with a major customer, while now complete, that has materially disrupted trading in the first quarter of FY13. With 60% of the off-premises market shared between two customers, RBS wonders about potential for a similar disruption in the future. Despite being resolved, exclusion from promotion and sale catalogues has negatively impacted volumes, the broker suspects. RBS assumes wine producers will benefit from improved pricing over the next two to three years as inventory levels reduce after several years of oversupply. However, favourable industry conditions are, in its view as well, captured in the share price on a FY13 forecast price/earnings of 23 times.
JP Morgan, too, sees valuations watered down after the recent appreciation of the share price and has been the most bearish in terms of earnings expectations. It has revised forecasts for FY13 from flat to down 3%. This broker believes that market expectations for earnings are overly optimistic given the inherent difficulties in the industry and has retained a Sell recommendation. JP Morgan expects the smaller luxury wine profit pool to produce a relatively flat year again in FY14, before a strong rebound in earnings in FY15. The broker believes that the current share price is factoring in a 20% depreciation of the Australian dollar as a base case, which offers a poor risk/return.
Several factors reduce certainty for the stock in Goldman Sachs' estimation, including sensitivity to the changes in trading and agricultural cycles. Nevertheless, this broker is a bit more positive about the medium term outlook and expects strong earnings growth of 21% over FY14 and FY15. It's not enough to avoid a drop in the 12-month price target, which for Goldman falls to $5.01 from $5.26. The rating is maintained at Hold. Morgan Stanley, positive on wine fundamentals and happy to hold the shares, has nonetheless recommended investors take profits with the stock trading at 22.6 times its FY13 earnings estimates. It therefore downgraded the stock to Hold. Morgan Stanley believes TWE can achieve 20% EBIT margins, but not in FY13. Higher-than-anticipated IT costs and lower-than-expected savings drive changes in this broker's estimates and it will take substantial growth from a smaller part of the wine portfolio to generate EBIT growth of the required magnitude. Morgan Stanley also expects the share price will fall in absolute terms over the next 30 days. This is because the price, having rallied recently, makes short term valuation much less compelling.
The FNArena database now shows six Sells, one Hold and one Buy on Treasury Wine. The consensus target is $4.23 — a full 15% below the last traded price.
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