Looking forward to finer wines.
Treasury Wine Estates (ASX:TWE) shares have fallen sharply over the past month, with year-to-date gains evaporating, and then some. The sharp correction seems to have been driven by a combination of factors including challenging trading conditions for lower-priced wines, margin pressure and expectations of a sharp rebound in China sales fading. Momentum in 2H23 is tracking well below 1H23. We view the recent fall as excessive, given the positive medium-term stance with the strategic pivot (diversification and premiumisation) progressing. Penfolds luxury wines provide a strong base and management recently announced an acceleration in the strategic shift for the company.
Last week management provided some colour on the next phase in the evolution of the company’s premiumisation strategy, with a key pillar reducing the cost base of the Treasury Premium Brands division.
As costs are taken out, the focus here will be on growing priority Premium and Luxury brands, such as Wynns, Pepperjack, Squealing Pig, and 19 Crimes across key global markets. This strategy was initiated in FY21 and has since seen a material improvement in NSR per case and EBITS margin as these brand portfolios have grown by 13 points to more than 60% of division NSR. Management sees further potential for improvement, and we tend to agree.
Broadly speaking, TWE operates in three price segments, which the company defines as Luxury (A$30+), Premium (A$10-30) and Commercial (below A$10). The price points referred to are retail shelf prices.
Market trends for Commercial Wine are tough, with TWE calling out Australia and the UK. Lower-margin Commercial portfolio volumes have been decreasing and that trend is set to continue. Inflationary pressures, notably for packaging, are expected to lift the cost of goods sold in FY24, which will squeeze margins. This segment has long been problematic for Treasury Wine, although the drag is declining over time.
We view the move to direct a greater percentage of internal resources into the luxury end of the business over time positively. The major initiatives announced to restructure the Treasury Premium Brands division include a review of the Commercial wine supply chain, with a big focus on Australia and a goal to reduce costs and improve operational flexibility. The company will also explore the “divestiture and/or rationalisation of selected assets, either individually or in combination.”
Treasury Wine will provide more details about these initiatives, including timelines, financial impacts, and one-off costs, as part of its FY23 full-year results announcement in August.
The company also touched on the FY23 outlook. Consumer demand for Luxury wine remains robust across all global markets, with Luxury sales in the Penfolds, Treasury Americas, and Treasury Premium Brands divisions meeting internal expectations. Penfolds was highlighted for particularly strong momentum and consumer demand. As shown below, the segment delivered strong results in 1H23.
Penfolds – 1H23
Source: Treasury Wine Estates (ASX:TWE)
However, besides a challenging Commercial wine backdrop, entry-level Premium wine trends in the US have deteriorated in recent months, with the 19 Crimes portfolio performing below expectations. This was disappointing.
On the quantitative side, the company guided for FY23 group NSR to decline by approximately 2-3% compared to FY22, with declines in Treasury Americas and Treasury Premium Brands partly offset by growth for Penfolds. This implies a decline of around 7% in 2H23 after slight growth in 1H23. EBITS is estimated to be between $580m to $590m, representing growth of approximately 11% to 13% on F22, as the Group EBITS margin is expected to be around 23.5% (FY22: 21.1%). Although more positive than the expected top-line results, the EBITS guidance also represents an easing from 1H23, when group EBITS was up a strong 17.2% to $307.5 million as the group EBITS margin expanded 3.2 percentage points to 23.9%.
Turning to the charts, TWE’s technical look to have deteriorated after completing a Head and Shoulders pattern which is a bearish reversal (i.e. the uptrend has reversed) and this seems to be confirmed with a ‘death cross’ where the 50-day (red) moving average has crossed below the 200-day (green) moving average. This is also worsened by the fact that the 12.50 support level has been easily disregarded as TWE gapped lower after the release of FY23 outlook. At this point, the 11.2 to 11.6 support levels must hold, otherwise, a retest of the 52-week low wouldn’t be too far off.
Summary
We view the recent sharp correction in Treasury Wine Estates as overdone considering that even in a deteriorating environment, underlying earnings are set to expand in FY23. We are pleased with the overall progress in the strategic pivot (diversification and premiumisation), with this now to be accelerated.
Meanwhile, the luxury wine segment is well-positioned to endure an economic downturn and as we have noted previously, we liked the acquisition of Frank Family Vineyards in the US. We believe the tilt away from China can support growth prospects over the medium term and should there be a favourable outcome on the China issue, this would be a positive re-rating event. The current bearishness about the broader Chinese economic recovery should be a short-term issue. Entering the stock around current levels, those prepared to look through short-term headwinds and be patient holders should fare well.
We recommend Treasury Wine Estates as a buy to Members without exposure.
We do note the recent technical damage could take significant time to repair. Accordingly, those taking action should have a medium-term or longer investment time frame.
Disclosure: Interests associated with Fat Prophets hold shares in Treasury Wine Estates
