Challenges abound for Treasury Wine Estates ((TWE)) as the global economic downturn and pandemic limit luxury wine sales, reducing margins as a result. No guidance has been provided for FY21 and oversupply of wine generally is expected to persist.
The company has acknowledged the loss during lockdowns of on-premise/cellar door sales, which are higher-priced and lower cost, was underestimated. Meanwhile, broker views have converged, with those previously optimistic becoming more cautious. Morgan Stanley, however, is the contrarian and upgrades to Overweight from Equal-weight.
Now the update has clarified the risks and issues Macquarie believes the worst is out of the way and upgrades to Neutral while Ord Minnett downgrades to Lighten, believing there is risk to the pace of recovery in the high-margin ex-retail channels.
Morgan Stanley suspects the focus is now on the environment beyond FY21 and there is likely to be some re-basing of earnings, which may be disappointing in the context of the recent outperformance in the stock. Still, the broker believes the risk/reward remains skewed to the upside.
Treasury Wine has guided to $530-540m in earnings (EBITS) for FY20, amid lockdowns and continuing travel restrictions across the company’s markets as well as commercial oversupply in the Americas.
Citi interprets this to mean second half earnings were down -50% and expects a recovery should start in the second half of FY21. To be more optimistic Citi would require a recovery in Chinese demand and sales in premises such as restaurants, bars and cellar doors.
UBS downgrades to Neutral believing there is too much uncertainty. Accelerating market share loss and the uncertainty around industry oversupply are key factors. Citi agrees a continued oversupply globally will make it hard to raise prices and deal with higher grape costs.
The broker suspects the lower luxury wine intake could reduce earnings by -$100-120m over FY23-25 and it will take time for the company to fix the US business while brand investment may need to increase.
Citi believes investors should reassess the long-term sales base, which may fall, in contrast to long-term margins, which should rise. Hence, earnings could recover to the FY19 peak, but take time.
Further afield, UBS now forecasts FY25 earnings margins of 18%. The broker continues to assess Treasury Wine has a large opportunity in Asia and there is turnaround potential in the US. Still, there are questions over the speed of recovery in China and risks around Australia/China trade.
Australia
The company has announced a -30% drop in its 2020 vintage in Australia, affected by the severe summer drought and bushfires. Morgan Stanley was somewhat surprised by the implied decline in second-half earnings in Australasia, and suspects this is also a result of a shift in mix towards lower-margin wine.
On the positive side surplus 2018 vintage could be allocated to the years affected by the short 2020 vintage, which could protect Australian output pricing in FY21 and FY22, Credit Suisse suggests. Yet Ord Minnett asserts the prospect of matching unmet demand from the large 2018 vintage is “unproven”.
China
The one highlight, Morgans observes from the update, was improvement in China, which returned to modest growth of 1% over April and May. Macquarie agrees some confidence around consumption levels is returning to China.
Still, the return of celebrating occasions with a glass of premium wine is unclear and it is the lower-value e-commerce channel that is growing. Moreover, it is difficult to predict how the pandemic will affect the consumption period of China’s mid-Autumn Festival and Chinese New Year 2021.
Inventory has been depleted and this may be encouraging, yet Credit Suisse points out there would have been excess stock after Chinese New Year 2020 so it is unclear if depletion momentum reflects demand at full prices.
Penfolds
Credit Suisse suspects Treasury Wine is backing away from its de-merger plans for Penfolds somewhat. The company continues to validate the proposal yet remains intent on ensuring Penfolds and other brands are maximised. UBS agrees this does not appear to be a key priority, with the US restructure and navigating the pandemic the focus. The broker, nevertheless, envisages merit to a Penfolds de-merger.
Meanwhile, Macquarie assesses the business outside of Penfolds has diminished value and diversified liquor companies generally trade at a premium to pure wine, while Citi considers upside risk lies with the de-merger of Penfolds, resulting in M&A interest in the brand.
Americas
UBS questions whether earnings in the Americas can fully recover, noting second half earnings fell -60% in US dollar terms. The broker believes 25% earnings margins are looking unlikely without a significant downsizing or exit from commercial wines.
Yet, Morgan Stanley envisages incremental upside from the restructure of the Americas and, at the group level, anticipates a return to FY19 earnings levels in FY22. The broker asserts the de-rating in the stock was triggered by headwinds in the US business and there remains a pathway to restore earnings and achieve margin targets.
The company has reiterated its strategic priorities and announced more than $35m in annualised cost savings in FY21 following the restructuring in the US. The cost savings are pleasing yet Ord Minnett envisages a return to earnings in line with the first half of FY20 remains much further down the track.
The update signals a reliance on high-margin, lower-volume channels globally, particularly in the Americas, the broker adds. These regions are more exposed to the pandemic restrictions and the pace of recovery is likely to be slow, which creates further risk for the first half of FY21.
Treasury Wine has reiterated its dividend policy and Morgans expects a modest final dividend. FNArena’s database has one Buy (Morgan Stanley), six Hold ratings and one Sell (Ord Minnett). The consensus target is $11.39, suggesting 8.2% upside to the last share price.
