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Is it game over for Treasury Wine Estates (ASX: TWE)


You have to feel for Treasury Wine Estates, Australia’s largest wine company, the maker of well-known brands such as Penfolds and its iconic Grange label, Wynns, Seppelt, Wolf Blass, Pepperjack and Lindeman’s.

After starting the year at just over $16, Treasury Wine Estates had moved nicely to $17.70 – then the COVID-19 pandemic stripped its market value in half, taking the share price to $8.61.

Then, having painstakingly rebuilt its value back to $10.57, Treasury was blindsided by the Chinese Ministry of Commerce’s announcement on 27 November – if posting a document on its ministry website counts as an “announcement” – that it will apply tariffs on Australian wines ranging from 107% to 212%, doubling and tripling the wines in price in the Chinese marketplace.

  • Cue a fresh share price fall, back to $8.20.

    The move was ostensibly the result of the preliminary findings of a Chinese anti-dumping investigation, which claimed Australian winemakers were selling wine below the cost of production, and causing China’s winemakers “substantial harm.”

    (When I say “blindsided,” I mean that Treasury knew about the investigation, but did not believe it had anything to fear.)

    Overnight, Treasury Wine Estates’ business in China was rendered unprofitable. TWE generates 45% of its $530 million-plus earnings in the Asian region, with a big chunk of that coming from China. But Treasury says it expects demand for its wine in China to be “extremely limited” from now on. That is a big problem, considering that 25% of the top-quality Penfolds range usually goes to China.

    It is not just Treasury: mainland China is far and away the Australian wine industry’s largest export market, with exports to China totalling $1.26 billion dollars last year.

    After years of effort, Treasury thought it had, through Penfolds, finally cracked the Chinese luxury market. In FY19, Asia – mainly China – was the second largest region for Treasury Wine Estates’ net sales behind the Americas, with sales up nearly 37% to $748.9 million. And Asia generated more profit than the Americas division. 

    After a frustrating decade-long fight in the courts against a trademark squatter, Penfolds had finally obtained trademark registration for the brand’s Chinese transliteration, Ben Fu. In September, the Vinexpo Shanghai exhibition was told that Penfolds was responsible for 66% of all the value growth of the booming $1.2 billion Australian wine market in China.

    Now, as broker Morgan Stanley puts it, the company’s sales into China will “essentially cease.”

    Of course, this isn’t about dumping. Australia has annoyed China on the geo-political front, on several matters, but it did so most notably, in May, when the government called for an independent international inquiry into the origins of the outbreak of COVID-19.

    Beijing did not like this, at all – and now it is punishing Australia.

    For shell-shocked TWE shareholders, what is the way forward?

    No-one, even the company, can really be certain if the new tariff regime will last. The company now says it will pivot its strategy to redirect the premium and luxury wines that were destined for China to other developed markets in Asia such as Taiwan, South Korea, and Japan, as well as to emerging economies, including Vietnam and Thailand. TWE will also redirect wines to other luxury growth markets including Europe, the US, and Australia; and reallocate premium grapes previously earmarked for Penfolds to other “premium” Australian brands, including Wynns, Wolf Blass, Seppelt, and Pepperjack, which it says have been “significantly supply constrained” in recent years.

    However, it is going to be a tough task to replace that Chinese demand.

    Even if it were to pull that off, earnings will still be slammed in FY21 and FY22.

    So, what does the market think?

    In a stark display that a market requires different views of a stock, here (courtesy of FN Arena) is what the first broking firms to update their view on Treasury Wine Estates since the Chinese bombshell think of TWE.

    • November 30, Macquarie: Neutral, target price $10.60
    • November 30, Citi: downgraded from Buy to Sell – bypassing Hold – target price $8.20
    • December 1, Ord Minnett: downgraded from Hold to Lighten, target price $8.00
    • December 1, UBS: downgraded from Buy to Neutral, target price $9.20
    • December 1, Credit Suisse: upgraded from Neutral to Outperform, target price $11.00
    • December 1, Morgan Stanley: Overweight, target price $10.00
    • December 1, Morgans: Hold, target price $9.00

    Only two of those target prices are below the present share price of $8.76. FN Arena arrives at an average target price of $9.43, versus a share price of $8.76 – which implies upside of 7.6%.

    Stock Doctor (Thomson Reuters) collates the views of 14 analysts, and that view is even more bullish, with a consensus valuation of $10.40 – implying upside of 18.7%, although this consensus does not show the timeliness of the valuation figures: it may not yet reflect any downgrades that have been made.

    On June 21 expectations, on Stock Doctor’s (Thomson Reuter’s) collation, TWE is priced at 22.5 times earnings, and a 3% fully franked yield, which grosses-up to 4.3%. On June 22 expectations, the forward P/E is 18.8 times earnings, and the prospective yield increases to 4%, or 5.8% grossed-up. That’s going to be attractive to a lot of investors.

    On FN Arena’s collation (7 analysts), TWE is at 24.4 times FY21 earnings and a 1.9% fully franked yield (grossed-up, 2.7%); for FY22, the FN Arena P/E is 22 times earnings, and the yield is 2.7% (grossed-up, 3.9%).

    On a total-return basis, TWE looks attractive, as long as prospective buyers understand that the company has a lot of work to do to move its wine allocations around, and find other markets. North America becomes crucial to the company now – and that is not welcome news to TWE shareholders, given that it was only a year ago that a 15% jump in cheap private label wine entering the US market hammered Treasury’s margins in that market, and took 20% off its share price.

    That was just the first in a series of three brutal haircuts applied to the TWE share price in 12 months. TWE looks alluring now – but with this stock, no buyer could ever feel that the risks are totally in their favour.

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