Australia | Nov 28 2012
-Luxury brand expansion plans
-Strategy supported by brokers
-Long lead time problematic
-Penfolds asset not fully exploited
By Eva Brocklehurst
After a company presentation brokers were quite bubbly on Treasury Wine Estates ((TWE)). The part of the business that intrigues them is Penfolds, the originator of the famous 'Grange' tipple. Penfolds falls into the luxury wine category, which TWE is intent on expanding. TWE management has noted the majority of grape price volatility, historically, has been in commodity, commercial and lower-end wine products. Luxury wine grape prices have been far more stable due to the excess demand for these products in the market.
Macquarie has upgraded TWE to Hold, citing the the fact that Penfolds is one of the most profitable wine brands in the world. In fact, Macquarie suggests an in specie distribution to create The Penfolds Wine Company and estimates earnings could exceed $430m in five years. The broker values TWE at a pro forma $4.3 billion ($6.55 a share) and carves Penfolds out at $3.1bn. Macquarie's price target for TWE is a bit more grounded, at $5.75. The FNArena database has a consensus target price of $4.52. More on Macquarie's ideas a bit later.
Deutsche Bank analysts are a little more sober and have a price target of $4.30 and a Sell rating. They urge caution as, while conditions in the global industry are improving and TWE has a sensible strategy, the stock is fully valued and there is a substantial agricultural risk. Deutsche said the briefing served as a reminder that the profitability of TWE is highly dependent on agricultural variability at a number of levels – country, region, vineyard. This can impact both wine grape production yields and fruit quality, which affects the supply and cost of goods for premium wines. The risk is mitigated a bit by the fact that TWE's luxury wines are multi-region and not reliant on the grapes from a particular vineyard. The broker is also wary that returns on TWE's recent investments will take some time to be realised, given the maturity time lag and the fact that the projects are in anticipation of future demand.
TWE management noted in the presentation that "global supply is heading towards balance" and was positive on the long term prospects, given cycles in the wine industry have historically run for 7-10 years. Land under vine has been falling in Europe, consumption is growing and wine grape and bulk wine prices are rising globally. Global production of the 2012 vintage was at a 37-year low but this was reported to be as a result of weather-related issues in Europe, which will likely normalise next year. Yields in Australia have been low by historical standards, however, Deutsche is concerned that, if the supply/demand dynamics are improving globally and future growing conditions are favourable, a return to historical yields may lead to excess supply.
JP Morgan says the strategy in expanding its luxury wine production capability is sound, given the stronger returns generated in the category. However, this broker's concern is that the share price is factoring in more earnings growth in the short to medium term than is likely to be delivered, given the lead times involved. Additionally, the market is likely to be underestimating the required capital investment, and the balance sheet expansion that will occur in the next few years to pursue the luxury wine strategy. As a result, JP Morgan believes there are more attractive investments in the sector on a risk/return basis at present. Moreover, the broker contends, with the stock trading at $5.19, the Australian dollar would need to depreciate by around 20% against the USD, GBP and EUR from current levels for the stock to be fair value. While this is not impossible, it's not considered likely in the near term. JP Morgan's share price target is $3.80.
Macquarie, pursuing its thesis that TWE would be better off spinning out Penfolds, considers the market is pricing TWE for either a significant lift in earnings and/or a takeover. The broker has modelled earnings outcomes under the existing business model and cannot create consensus outcomes. TWE doesn't report brand business unit results but Macquarie estimates TWE is overly reliant on Penfolds, which accounts for around 5% of sales volume but 25% of gross profit. Macquarie says its FY13 numbers have been unchanged for six months, despite a 35% reduction in consensus estimates, yet it remains at the bottom of the market in earnings estimates for the next three years. Macquarie has therefore pondered the scarcity value in the Penfolds brand and how best to realise it. As Penfolds is a part of a mass market brand portfolio, its route to market is often hostage to distribution arrangements for other brands. Macquarie's conclusion: the best way to exploit Penfolds' scarcity value is to establish it as a separate luxury brand, led by a winemaker and distributed on a direct to consumer basis.
On the FNArena database TWE is rated a Sell by JP Morgan, Deutsche Bank, Credit Suisse, Citi and UBS. Hold ratings are held by Macquarie and CIMB. BA-Merrill Lynch rates it a high risk Buy and tops the consensus target price range at $6.50. The bottom of that target range is $3.50, held by Citi and Credit Suisse.
See also Treasury Wine's FY13 Hangover on October 24 2012.
[Ed :1990, Southcorp acquires Penfolds; 2005, Foster's acquires Southcorp; 2010, Foster's spins off Southcorp (TWE); TWE to now spin off Penfolds? One might ask, what was the point of the last 22 years?]
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