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Treasure Chest: Is Treasury Wine Under-Appreciated?

Treasure Chest | Jan 18 2017


One broker believes the market is underestimating the opportunity available for Treasury Wine Estate as the Chinese discover Australian wine.

– Morgan Stanley upgrades
– China under-appreciated
– Americas to turn around


By Greg Peel

A couple of years ago, Treasury Wine Estates ((TWE)) was unloved. It has not been a great journey for the company both before and after it came into existence as an individually listed entity.

Many moons ago, wine conglomerate Southcorp though it was on a winner in consolidating many well-known Australian wine brands and jumping on the bandwagon of popularity of Aussie wines overseas. Unfortunately for Southcorp, that race had already been run. Aussie wines were already becoming “so last year” in the likes of the US and the UK.

Southcorp responded by "merging" with beer giant Foster’s – a move which was to ultimately bring down the company’s CEO and force Southcorp to be broken up. The more valuable beer business was sold off to a multinational. The remaining, out-of-favour rump of a wine business became Treasury Wine Estate.

Even in its early life, Treasury suffered from excess inventory issues, particularly in the US. The market refused to get behind the company, despite one analyst famously suggesting the stock was worth $10 on the strength of the Penfolds brand alone (the share price was half that at the time). That analyst eventually conceded defeat, around about the time Treasury decided to pour all its excess inventory of cheap coiffers down the sink.

That move signalled the beginning of a recovery. The share price has since exceeded $10, no doubt leaving one analyst torn between being bitter and smug. While cheap and cheerful Aussie wine retains a level of balanced popularity in the US and UK, among domestic and other imported offerings (including from South America and Eastern Europe), premium Aussie wine sales have failed to excite. But then along came China.

The average Chinaman’s tipple of choice has to date been beer or baijiu, the latter being a grain-based spirit boasting 40-60% alcohol by volume. But as the well-known tale of the growing Chinese middle and upper class plays out, the Chinese are now embracing wine. And in particular, Aussie wine.

According to a survey conducted by the analysts at Morgan Stanley, Chinese consumer preference is undergoing a long-term gradual shift from beer/baijiu to wine. And the Chinese are not like the Yanks and Poms who lean towards those cheap and cheerfuls. The Chinese prefer wine priced abovef RMB1000. When Aussie wine first hit England, it was all about keeping the price point under ten pounds.

The survey also found Aussie wine is growing in popularity at the expense of French wine. All this is pointing to potential growth upside for Treasury Wine exports. The company is further supported by Aussie wine as yet being hard to find in China, and by a broad-based presence in the country that can help alleviate that issue.

Having conducted the survey, Morgan Stanley now believes the market is under-appreciating the upside available for Treasury Wine in China.

There has been little new news out of the company since its AGM in November. No trading update or specific guidance was provided at the meeting but management was very upbeat, probably because, brokers suggested at the time, wine prices were on the rise. Management introduced a long term aspirational earnings margin of 30%. The general feeling among analysts was that this was a bit pie in the sky.

The biggest problem for Treasury Wine remained the underperforming Americas. On this subject, Morgan Stanley notes the company is now placing a greater focus on “priority” brands, cost discipline, and divestment of commercial volumes. The analysts believe the Americas business is well placed to turn around.

As a comparison, Treasury Wine generates 17% higher sales per litre than global beverage giant Constellation Brands, the analysts note, but 37% less profit per litre. Constellation is generating the sort of margins Treasury is aspiring too, and Constellation is thus showing it’s not beyond the realms.

Coming back to recent price rises for Aussie wine, Morgan Stanley notes the company is highly leveraged, such that a price rise for Penfolds falls mostly to the bottom line. Treasury lifted prices by 8-17% in October. If similar 25-30% mark-ups are assumed, retail prices in China and Hong Kong are at a 20-60% premium to Australia, the analysts note.

Morgan Stanley has upgraded its recommendation on Treasury Wine Estate to Overweight from Equal-weight, lifting its share price target to $13 from $10. This puts Morgan Stanley’s target well ahead of the pack (of FNArena database brokers) that have not reviewed their numbers since November. The consensus target rises to $10.41.

Ord Minnett is the only other database broker to have a positive rating on the stock, albeit Accumulate, which is a shade less committed than Buy. All other brokers are sitting on Hold or equivalent ratings other than Citi (Sell), who sees the aspirational 30% margin goal as overly optimistic (or at least did so last year).

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