Dividend Stocks

Treasury’s volume share gains and positive mix shift support strong enough brand assets

Business Strategy & Outlook

Treasury Wine Estates has increasingly focused on building high-end brands in its portfolio, particularly in luxury (bottles priced above AUD 20) and “masstige” (bottles priced from AUD 10 to AUD 20) wine. With this focus, the company’s revenue from higher-end wines has risen to over 90% in fiscal 2022 from 43% in early 2014, both from growth in its high-end products and purposeful reduction of low-end, or commercial, wine sales. Continued end-market premiumization to benefit Treasury, leading to market share gains in Australasia and North America, which together made nearly half of operating earnings in fiscal 2020. In recent years, global wine consumption has proven sluggish, but high-priced wines have bucked this trend, with luxury and masstige volumes growing at mid- to high-single-digit rates in developed regions such as Australia and the U.S., per company estimates. However, Treasury faced an installation of a sizable tariff against its imported product in China in fiscal 2021, effectively shutting the door in what was arguably Treasury’s most important market, comprising 30% of earnings in fiscal 2020. The company plans to reallocate some of this wine to other markets, but the associated sales and marketing efforts will take time, reducing growth from previous expectations.

Treasury also faces risks from unfavorable weather effects, sensitivity to the consumer cycle, and inelastic industry supply that frequently results in wine gluts or shortages. That said, the diversity of Treasury’s grape and bulk wine supply should significantly mitigate these concerns. And bringing in a significant proportion of its grape and bulk wine from outside suppliers increases the proportion of variable costs and ensures a lower-cost supply in times of surplus. But it cannot be believed Treasury’s volume share gains and positive mix shift support strong enough brand assets to offset industry fragmentation, a proliferation of branded offerings, limited customer switching costs, and potential for changing consumer tastes. As such, despite a strong position in Australia, the company will likely continue to combat competitive pricing and promotional activity globally.

Financial Strengths

Treasury is in good financial health. The firm’s net debt/adjusted EBITDA ratio, including operating leases stood at 1.8 times at June 2022, and EBITDA to cover interest expense (including operating leases) an average of 8 times over the next five years. The company’s next major debt maturity is in fiscal 2024, but there are no issues either relaying or refinancing this payment. At June 2021 the company’s liquidity, comprising cash and undrawn committed debt facilities, was solid at approximately AUD 1.3 billion. Over the long run, there’s probably some room for additional debt, given management’s target of net debt/adjusted EBITDA of 2.0 times through the cycle, potentially stretching to 2.5 times, compared with the low levels today. That said, the company will remain focused on maintaining an investment-grade credit profile. The company aims to pay out 55%-70% of its earnings as dividends; an average of about 65% over the next five years. Treasury can continue to pay out dividends near the top of this range, but anticipate dividends to be only partially franked from fiscal 2025. While Treasury is an Australian taxpayer, the majority of earnings are derived outside Australia, and the available franking credits to be exhausted more quickly than they are replenished over the coming years.

Bulls Say

  • Wine consumption growth in Asia should continue growing at high rates over the long run, and is a high margin business for Treasury given a focus on luxury and mid-range wine. 
  • Treasury’s focus on higher-priced wine than in the past puts the company on-trend in global wine, and should drive substantial earnings growth as profitability expands. 
  • Additions of new high-end wine brands, either organically or through acquisition, drive better grape utilization, improving margins, and higher ROICs.

Company Description

Treasury Wine Estates is an Australia-based global wine company that demerged from Foster’s Group in 2011. The company is among the world’s top five wine producers, and owns a portfolio that includes Australian labels such as Penfolds and Wolf Blass, U.S. wines like Chateau St Jean and Sterling, and newly launched names such as 19 Crimes and Maison de Grand Esprit. An acquisition of Diageo’s wine business in 2016 added additional U.S. brands including BV and Stags’ Leap. Treasury owns over 130 wineries, with more than 13,000 planted hectares.

(Source: Morningstar)

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