Lower grape prices are likely over the next few years providing the backdrop for a punchy earnings recovery for Treasury Wine Estates. Ironically, the effects of Chinese tariffs on Australian wine have contributed to falling grape prices. Other catalysts will combine to lift TWE’s earnings by an estimated 10% pa through to FY24f.
The 2022 Australian grape harvest is expected to be above average and, combined with the impact of weaker export growth due to the loss of sales to China, is expected to weigh on grape prices. We think red wine prices could fall by 15% for this harvest.
Better growing conditions has produced another healthy vintage in 2022 around 1.90-1.95mt after a bumper vintage in 2021 produced 2.03mt which was 13% above the five year average.
Grape prices in 2021 were surprisingly stable given the given the increase in production, but this may simply reflect the lag in supply and demand response given grower contracts. Reality is now catching up with grape prices which we expect will fall by at least 15% for V22.
For context, red wine prices are up 28% over the last 5 years while white wine prices are up 35%. In 2021, red wine prices fell 4% but white wine prices increased 11%. Globally, there has been a shift in preference towards lighter wines such as pinot noir, rose and white varietals at the expense of shiraz and cabernet sauvignon.
Data from global wine broker, Ciatti, shows that bulk wine prices are down over 50% in two years for Australian red wines. The bulk wine market typically is more volatile and is an early indicator of changes in the supply-demand balance.
The grape price cycle can be slow moving given the timeframe to plant new vines and the willingness to remove old ones. The latter is often a slow process, but we should expect to see the warm, irrigated inland areas of Australia as the first to pull out vines although with good access to water at the moment, this could be an elongated process. That would prolong the current downturn in grape prices which we expect to remain subdued for about 5 years.
The cost of grapes accounts for approximately 42% of TWE’s cost of goods sold (Figure 1) as a blended, volume weighted average across its commercial, premium and luxury wines. TWE also has a geographic spread for the source of its grapes (Figure 2) with about 68% sourced in Australia.
TWE’s wines are skewed towards those that require an ageing process which means there is a lag between the vintage year and when the product eventually impacts sales and earnings. For example, approximately 80% of luxury wines are sold three fiscal years after the harvest.
For commercial wines, 95% is sold the following fiscal year. It is also worth noting that due to the loss of exports to China, TWE has excess wine from the 2021 vintage.
The lower price of grapes for the 2022 and 2023 vintages should therefore benefit TWE by an estimated $75-80 million through to FY25f. Some of the benefits will be passed through as lower prices.
Other catalysts include a rebound in on-premise, cellar door and travel related channels which have been suppressed throughout the pandemic.
TWE has a $75 million supply chain saving program underway that will begin to show up in FY23f then fully in FY24f.
The recent acquisition of Franks Family Vineyards in California should add about $14 million in incremental EBITS for FY23f.
TWE should also see some modest organic growth of 3-4% across its business as global conditions recover.
Investment view
Lower grape prices for the next few years adds to the appeal of TWE’s earnings outlook. The company has seen off the worst of its challenges and now has several factors shifting in its favour. The reorganisation of the business has shown the resilience of the Penfolds brand and the portfolios of Treasury Americas and Treasury Premium brands has been improved. RISKS TO
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.
