Australia | Apr 09 2014
-Confirmation of marketing strategy
-Questions over FY14 guidance
-CEO accepts there's too many brands
-Strong upside potential, in Merrills' view
By Eva Brocklehurst
A new CEO graces the stage at Treasury Wine Estates ((TWE)) but the story remains fairly similar. Michael Clarke yesterday conducted a conference call and Q&A with analysts and reiterated prior earnings guidance for the company of $190-210m for FY14. He confirmed the focus on improving retailer and distributor relationships, reducing overheads, reinvesting in consumer and brand marketing and addressing excess production capacity. The CEO also spoke about potential restructuring and brokers heaved a sigh of relief. But…
To JP Morgan this is all well and good but will the required discipline prevail when the inevitable pressure on short-term earnings materialises? The CEO has reiterated a commitment to guidance but said he does not want to chase a full year number to the detriment of long-term objectives. Citi thinks the transition from reducing trade spending to a step-up in marketing has risks. Marketing will have to increase for some time before trade spending can be cut. Hence those long-term objectives may be a long time coming. To CIMB it's a case of, with promotional programs already in place for the fourth quarter trading, trade support being pulled back to avoid a repeat of the channel loading that occurred in the prior comparative quarter. As a result, volume growth forecasts for the second half in Australasia have been reduced and CIMB thinks this will also hold back a recovery in volume growth in FY15.
It's too early to tell if Michael Clarke will achieve what many of his predecessors failed to do and JP Morgan remains unconvinced. Largely because there's a lack of valuation support, strategic uncertainty and continued disappointment likely for the second half and FY15 results. The broker believes any bull case is predicated on the potential to lift value through asset divestments and this is either priced in or unconvincing. CIMB notes the stock is trading at a slight discount to the average FY15 earnings multiples for large international wine businesses. The broker suspects a steeper discount is warranted because of the risk around the Americas and Asia for the business. CIMB's recommendation is therefore, Reduce.
Deutsche Bank notes the CEO emphasised a lack of emotional attachment to brands and that everything is on the table for consideration. Michael Clarke remains enthusiastic about the US business because of the cost cutting and potential step-up in marketing. He also thought China presented a big opportunity. The broker also noted Clarke's statement that it was harder to differentiate brands on price and that commercial brands might be "better in somebody else's hands". Specifically, the CEO conceded the company had too many brands. Deutsche Bank urges caution at the mention of China, where business could be subdued for a number of years, compounded by excess inventory at the distributor level. The challenges associated with selling through a concentrated retail channel are likely to be compounded by a decreased appetite for premium wine in China. It adds up to a Sell rating for Deutsche Bank.
Citi notes the flagging of asset sales to cull the brands but thinks sales are likely to be in crushing and bottling rather than vineyards. Hence this is not going to provide the positive read in book value that the market would be hoping for. The question is just how much the brands are worth, given the proliferation of wine brands in the US and Australia.
BA-Merrill Lynch casts aside the doubts. If four objectives are met, the broker is confident TWE can reach its upside potential. These include allowing the CEO to operate independently, a continued investment in high end luxury wines, competent management of the commercial wine portfolio and exiting poor performing businesses, notably the US wine assets and parts of the commercial portfolio. If this happens then earnings can improve to a point which would justify $10/share in Merrills' opinion. Sure, events over the past nine months have dented the broker's confidence but Merrills is not giving up yet and retains the only Buy rating on the FNArena database.
CLSA is encouraged by the conviction that a turnaround can happen. The broker thinks there's significant value in the assets and retains Buy rating. The premium strategy should improve margins and smooth earnings and the endorsement by the new CEO is encouraging. The broker believes Treasury Wine suffers from a higher cost of doing business than rival Constellation Brands. Reducing this gap is critical to sustainable returns, and CLSA maintains a view that re-investing the proceeds of cost cutting in brands and sharing the the benefits with retailers is the sensible way to go. Marking to market the inventory, land, vines and plant generates a tangible asset value north of $5.50 for CLSA, and there is also the prospect that some of the value of these assets may be realised.
UBS welcomes the necessary reduction in overheads, capacity and brands. The broker also welcomes the commitment to forecasts, but does not expect the company will deliver. With the FY14 earnings likely to miss guidance, the broker thinks this will be the catalyst to clear the decks. A large problem for Treasury Wine, according to UBS, is the fact that two dominant customers continue to grow their own private label brands. The pricing power of Treasury Wine's commercial, and potentially premium, brands is being weakened. UBS is optimistic about Asia as well as Europe but thinks turning around the Americas is a difficult proposition. The Sell rating is retained. The main risk to this recommendation, UBS acknowledges, is corporate activity – or that the turnaround proves the sceptics wrong.
On the FNArena database there is one Buy rating, two Hold and five Sell. The consensus target is $3.71, suggesting 6.0% downside to the last share price. The targets range from $3.15 (Credit Suisse) to $3.90 (Macquarie) with one outlier, Merrills at $5.50.
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