I want to continue today on the theme of ASX listed beneficiaries of the rising Chinese consumer spending.
Rising wages and incomes lead to changes in diet. In alcoholic beverages that leads to marginal dollars being spent on wine over beer.
The major China-facing ASX-listed beneficiary of this structural growth theme is Treasury Wine Estates. TWE is more recognisable as the “Penfold’s” business spun out of Fosters a few years ago.
TWE’s key brands include Penfold’s, Wynn’s, Wolf Blass, Lindeman’s, Rosemount and Rawson’s Retreat. I’m sure we all know one or two of those brands. Under CEO Michael Clarke, TWE is a genuine growth stock. The company has consistently upgraded earnings forecasts then beaten those forecasts. That happened again this year when TWE upgraded forecasts to 1HFY16 EBIT of between $140m and $150m, and then delivered beyond the mid-point of that range when confirming 1H results in February.
What most analysts and I found encouraging was the quality of the results, which was cash realisation of 126% and all businesses delivering margin and EBIT growth. This is encouraging as TWE have been reinvesting current earnings back into future sales growth initiatives, reminding you life isn’t all about dividends.
To put this reinvestment in growth in context, TWE increased its selling and marketing expenses by +$40m in the 1H. This is a major increase in TWE’s investment in its current and future sales. It’s clear this is working to drive sales with 1H sales growth +10% in constant currency and +20% in reported currency. In a world where top line sales growth is hard to find, these are excellent numbers.
Since the 1H result we have seen analysts upgrade forward year forecasts significantly, taking the correct view that, in the years ahead, TWE earnings will benefit from the combination of strong sales growth, cost of goods sold being materially lower and economies of scale in marketing spending to increase. The company has strong internal momentum, which shouldn’t be underestimated.
The other development worth not underestimating is TWE’s opportunity in China. Changes to TWE’s distribution in China have helped drive very strong North Asia volume growth (+149% yoy). Part of this was driven by a fivefold lift in marketing spend in China and a higher allocation of luxury wine. But to put this in context, TWE is only a small player in the Chinese domestic wine market at this stage. Therein lies the opportunity over the years ahead.
TWE’s share of the 219m unit case Chinese market is just 0.6%. This accounts for 2% of Chinese wine imports. While this is up from 0.2% in FY08, analysts estimate that TWE’s China markets share is far less than in developed markets (2-4%) and peer Asian countries (2-5%). On that basis, TWE looks underexposed in China when compared with other developed and emerging countries. This is partly because China previously hasn’t been as large a focus as it’s become now for TWE, while previously Australian wine was viewed as expensive in China, leading to lower than achievable sales growth.
However, consumption of wine in China, especially high-value wine, is significant in China. Overall consumption is growing at +4%, with Australian wine exports to China rising by +66% in the 12 months to December 2015. Higher value wine is growing at even faster rates.
Looking forward, it is estimated that should TWE achieve 4% of the Chinese market, in line with peer markets, that Asian EBITs could reach $300m. That would be a threefold rise from current levels. All things being equal that would equate to around $3.00 a share in value being added to TWE just on the China growth angle.
This Chinese growth opportunity is presenting itself as TWE’s America’s business is turning the corner. It’s worth noting that TWE’s America’s business reported a +67% increase in EBIT. This growth should continue as US imports of Australian wine increase and the weak 2015 Californian vintage leads to a more balanced US domestic wine market.
The world’s major premium wine companies all attract multiples associated with “luxury brands”. That’s fair enough because they are true “luxury brands” linked to rising wealth and consumption. Let’s look at current and future multiples for TWE’s global peer group.
While TWE commands similar P/E multiples to its peers, those P/E multiples are unfair on TWE as they are currently reinvesting heavily in the branded business as mentioned above. On EV/EBITDA multiples, TWE is very cheap versus its global peers and I think that is the valuation measure to look at.
The other point to focus on is GROWTH. I believe current consensus analyst forecasts for the next few years will prove conservative. That has been the case for the last two years and will continue to be case in my opinion. Below are my forecasts for EPS for TWE v. current analyst consensus.
If my forecasts prove right then you can see TWE EPS will have more than doubled from FY15’s 22c by FY18. What this also means is TWE will be in a structural earnings upgrade cycle and attract a P/E premium for that structural growth. I’d also be very surprised if TWE’s EV/EBIDTA multiple didn’t expand to the global peer group or beyond.
I believe TWE is a classic example of a structural growth stock. I believe the macro tailwinds for Australian export wine will remain strong and TWE has the management team to deliver on the China opportunity. All things being equal, TWE should be a core portfolio holding for the next three to five years as it delivers way above market (asx200) EPS growth and gets re-rated to a true global luxury brand stock.
I’d be using this period of a slight bounce in the AUD/USD cross rate to accumulate TWE shares. I don’t think the AUD/USD rally will be sustained beyond 76 US cents and therefore any underperformance of Australian exporters is a buying opportunity. TWE fits into my broader high conviction theme of the rising Chinese consumer. If this goes according to plan, and so far it has, TWE should be re-rated to a mid-teens share price over the years ahead and could also become a takeover target by another global major.
The AIM Global High Conviction Fund owns TWE shares.
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.
