Apart from a rogue case or two of Penfolds, the lack of wine shipments into China has only temporarily hurt Treasury’s business. The return of that volume would obviously be welcomed but the company has not been idle.
In November 2020, the Chinese government imposed a draconian duty of 175.6% applied to the value of TWE wine in containers of two litres or less imported into mainland China. The duty will remain in place for a minimum of five years. In 1H21, TWE’s EBITS contribution from Australian wine sold into China was $78.2 million, but this has shrunk to just $2 million in 1H22.
TWE’s portfolio and global reach has been robust enough to reorganise and undertake meaningful changes to improve the quality of its portfolio, particularly in the Americas.
TWE’s 1H22 EBITS declined 6.7% to $262.4 million due mainly to some brand divestments and the loss of earnings in China. But with higher margin channels recovering, lower grape prices likely in Australia and the acquisition of Frank Family Vineyards in California, we think earning scan grow from here.
TWE’s luxury inventory increased 18% year-on-year in 1H22 but has only stepped back up to levels seen in FY19.
Treasury Americas reported 1H22 sales down 9% but EBITS increased 19%. This reflects the repositioning of the company’s US portfolio following recent divestments and the Franks acquisition.
We think a recovery in the cellar door, travel retail and on-premise channels is underway after being hindered by COVID-19, and should support earnings growth into FY23f.
Grape costs had been rising in 2H20 and 1H21, but a strong grape harvest in Australia this year should lead to a fall in grape prices over the next two years. The 2021 vintage for Australia was a record and was 33% above the 2019 vintage. It is possible that the 2022 vintage could be 3-10% higher than 2021. Given the reduced export volumes over the past year, pricing could fall by at least 10%, perhaps even more for red grapes. But TWE is planning a smaller grape intake in 2022 so the EBITS impact may not be as large as implied. Even so, lower grape price will be helpful for earnings over the next 2-3 years.
Each division has its own target margins and while Penfolds is achieving its EBITS margin of 40-45%, the other two divisions are not yet meeting their targets. Treasury Americas needs to see further pricing growth while Treasury Premium Brands should try to divest or exit lower priced wines in its portfolio in order to lift prices and profit margins.
Investment view
We think TWE has been through the worst of its challenges and has the potential to increase earnings over the next three years. Lower grape prices, improved portfolios in Treasury Americas and Treasury Premium Brands, and a better channel mix could all contribute.
TWE’s aim is to produce high single-digit average earnings growth over the long term from sustainable top line growth. The Penfolds brand has demonstrated great resilience with net sales revenue and EBITS outside China increasing by 49.1% and 32.1% respectively on a constant currency basis. The reorganisation of TWE’s business divisions has allowed the Penfolds brand to shine and provided some transparency on the issues of the other two 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.
