No China, no worries for Treasury Wine Estates it seems. The great reallocation has worked as other markets lap up the quality. Grape prices are heading lower for the next few years helping TWE to increase its gross margins. The business is set to deliver double digit EPS growth over the next two years.
Gross margins were 225bp higher in FY22 and there is room for further appreciation in FY23f. This is occurring across all divisions and is not just a mix effect from exiting low-end wines and the acquisition of high end wines. Lower grape prices will help to extend the gross margins gains in FY24f as lower Australian grape prices flow through to earnings.
TWE’s NSR (net sales revenue) was down 3.6% in FY22 reflecting divestment of the US commercial portfolio and the decline in shipments to China. This was partly offset by good growth in the premium and luxury portfolios. Roughly 83% of TWE’s wines now sell for over $10 per bottle (considered premium) compared to around two-thirds in previous years.
Investment View
The sting of the China tariffs has hung over TWE for some time. The obvious solution was to find alternative markets but executing that was a challenge. We think the fact that sales growth in the ‘rest of Asia’ has been sustained is a signal that the reallocation is working. TWE has moved over $300 million of Penfolds sales from China to other markets in a testament to the truly global brand it has become. China’s loss is everyone else’s gain, but it does not mean the Chinese market is permanently lost to TWE.
The second positive element of this story is that TWE is one of the few manufacturing businesses facing limited cost pressures. FY23f will still see supply chain and cost-input inflation pressure to the tune of $25 million, but the company’s optimisation program will deliver savings of $90 million (originally $75m) with $65 million of this in FY23f and the full run rate to flow through in FY25f based on the age of release for the Luxury wine portfolios.
The 2022 Australian vintage was in line with long term averages, but well down on the record 2021 crush. TWE deliberately took in a smaller 2022 vintage to manage its inventory position due to the ban on shipments to mainland China. We think grape prices for V22 may fall 15% after increasing 28% over the last five years (white wine prices were up 35% in that period). Bulk wine and grape pricing has been falling over the last 18 months due to the bumper 2021 harvest and the reduction in demand from China.
The cost of grapes is about 42% of TWE’s cost of goods sold across all its portfolios with approximately 68% of grapes sourced in Australia.
TWE is exuding confidence in its ability to deliver “strong, margin accretive growth in FY23”, but wouldn’t quantify this statement. We deduce it will need annual double-digit EBITS growth over the next three years to achieve its medium term aspirations. FY23f will include some input and transport cost headwinds offset by some supply chain savings and a nice chaser of price rises across all divisions.
Risks to investment view
Competition in the highly fragmented global wine industry is intense. Movements in the supply of wine can impact TWE’s profit margins. As was seen in China, tariffs can be imposed that can be damaging to earnings. TWE’s global earnings all also exposed to foreign currency movements.
Recommendation
We have retained our Buy recommendation.
FIGURE 1: FY22 RESULT
FIGURE 2: VOLUME, NSR PER CASE
FIGURE 3: EBITS
FIGURE 4: FIVE YEAR SUMMARY
