Investors have been waiting for some time for the much-touted Australian “food boom” – a surge in agricultural commodity exports to rival that which has unfolded in mineral commodities – to take meaningful shape on the stock market.
The nation’s agribusiness stocks, for a range of reasons, have not made great cases for investment – only a small chunk of Australia’s agribusiness industry is actually open for investment, in the sense of being publicly listed – but the growing demand for food globally means the sector must eventually make it on to the radar screen of investors.
And the combination of wine and cheese could make a lot of sense.
The wine comes in the form of Treasury Wine Estates (TWE), which was spun out of Foster’s Brewing in May 2011. Treasury is the largest wine stock left on the Australian Stock Exchange (ASX) – in fact, it is the world’s largest pure-play wine company, with more than 80 brands, including Penfolds, Wolf Blass, Lindemans, Wynns Coonawarra Estate, Pepperjack and Beringer. Treasury is the largest Australian wine exporter by value.
The cheese
The cheese comes to the plate in the form of either Bega Cheese (BGA) or Warrnambool Cheese & Butter (WCB), or – as looks likely – a merged entity. Bega Cheese has lobbed a takeover offer on smaller rival Warrnambool – of which it already owned 18%.
The outcome of this takeover battle will not be known for a while. Bega’s cash-and-scrip offer values Warrnambool at $5.78 a share, a 30% premium to the closing price the day the before the offer was announced. The Warrnambool board has told its shareholders to take no action in relation to the offer.
[1]But if Bega were to absorb Warrnambool, the combined group would have a market capitalisation of about $650 million, and be a significant dairy exporter. The smaller Warrnambool generates about half of its revenue from exports: the Bega proportion is about 35%.
The “Begabool” entity would produce about 350,000 tonnes of dairy products a year, across the milk, whey powders, infant formulas, butter and cream categories, with annual revenue of about $1.5 billion. As well as being larger, Bega also comes to the proposed marriage in a stronger financial position: it recently achieved $1 billion in revenue for the first time, while Warrnambool saw its profit halve last year, amid flat revenue and rising costs.
A combination of the two companies would have a significant export business in China, the epicentre of the wave of new consumers emerging in the developing markets. A decade ago, China hardly imported any dairy products: now it is the second-largest dairy importer in the world.
The wine
Combine that with the wine exports of Treasury Wine Estates, and you could have a lucrative exposure to the developing world and its growing consumer spending power. Treasury is the largest wine stock on the Australian Stock Exchange (ASX): in fact, it is the biggest pure-play wine stock in the world. Half of its sales come from North America: the proportion from Asia is much smaller, but growing.
[2]Since 2007, wine exports to China have risen more than threefold on a value basis to $241 million. While that is still only 6% of total export volume, Chinese demand is growing such that it is likely to become the number two consumer and importer, after the US, by 2016, and is expected to move ahead of the US by the end of the decade. Clearly, the opportunity for wine exporters into China is huge.
In the short term, however, investors must negotiate the fallout from Treasury’s mismanagement of its inventory – which earlier today claimed the scalp of chief executive David Dearie.
In July, Treasury shocked the market with the admission that it would have to tip $35 million of wine down the drain in the US because it could not sell it, having over-estimated demand. The company was also hit with another $40 million worth of discounts and rebates, to get excess inventory off its hands, and copped a further $85 million of non-cash expenses because of cancelling grape contracts due to oversupply.
In total, booking $160 million of losses related to that excess inventory halved reported earnings for FY13. But at an operating level, while Treasury’s US earnings fell 14.5%, its earnings from Asia were up almost 36%.
Treasury’s future focus will increasingly be on leveraging its portfolio of highly recognised brands to tap into the demand for premium and luxury wine in Asia. Competition from other wine-exporting countries like Argentina, Chile and South Africa will be stiff – as it has been in North America – but Treasury will be hoping that the A$ stays low enough to maintain its wines’ competitiveness.
At present, investors in Treasury are backing growth rather than income.
The analysts’ consensus sees TWE earning 28.1 cents a share this financial year and 33.1 cents in FY15, by when the effects of the July write-down should finally be out of Treasury’s financial bloodstream. From those earnings it is expected to pay dividends of 15.8 cents and 18.9 cents. At a share price of $4.50, that prices TWE on a yield of 3.5% in FY14 and 4.2% in FY15. Unfortunately, franking credits have been denuded for the next two years at least, meaning shareholders have temporarily lost the yield augmentation of franking credit rebates. And because of the lingering inventory concerns, they have to look over the immediate horizon for clear air for the company’s export prospects.
As for “Begabool,” investors don’t know yet what shape it will take, let alone what the dividend position will be. But the growth prospects of “the wine and cheese” stocks should not be overlooked on yield grounds alone.
[3]Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.
Also in the Switzer Super Report:
- Peter Switzer: When will this bull market run out of steam? [4]
- Paul Rickard: Regulator overkill – SMSFs outperform, despite ASIC criticism of size [5]
- Greg Fraser: Stock in focus – TPG Telecom [6]
- Penny Pryor: Sydney houses hit $1 million median [7]
- Rudi Filapek-Vandyck: Buy, Sell, Hold – what the brokers say [8]