Goldman Sachs upgrades Treasury Wines to Buy on pivot to strong ex-China growth

Having concluded that Treasury Wine Estates (ASX: TWE) is now re-entering a growth phase with a more diverse and defensive business, Goldman Sachs has upgraded the wine giant to Buy from Neutral, with the price target increasing to $14.70 from $12.0.

With US-based Frank’s Family Vineyards (FFV) expected to boost confidence in sustainable quality growth, especially in light of a -60% of loss in China revenues, post China tariff hikes, the broker expects sufficient premium market demand to support a revenue range of $380m-$450m (TWE FY22 $385m).

This revenue range implies a circa 21% market share of the premium import market and circa 6% total wine market across these seven Asia focus markets.

Refocus on US

The broker believes recent developments put paid to lingering doubts over how sustainable the growth in Penfolds Asia-ex-Mainland China will be, especially given the outperformance of volume shift from the China market since import tariff hikes were first announced 27th November 2020.

As a case in point, Goldmans’ believes the proven redirection of Penfolds China volumes, coupled with the refocus of Treasury Americas on premium/luxury, marks an inflection point for the group’s re-emergence as a more diverse and defensive business.

Some interesting numbers to set this in context include:

• Penfolds mainland China was $400m revenue in FY19 versus $22m in FY22

• Penfolds Asia ex Mainland China was $140m in FY19 versus $385m in FY22

The broker has increased its FY23-25 sales and net profit (NPAT) estimates by 1%-5% and 5%-13% and now expects the company to deliver 16% NPAT 2022-25 compound annual growth rate (CAGR).

The company is currently trading at a 12-month forward P/E of 22.6x, versus Goldmans’ target price implied P/E of 26.3x.

Five key drivers of Goldmans’ outlook

Goldmans’ reached the above conclusions after questioning:

• Quantitatively: With the increase in amount of sell-in to these markets, what market share is implied and has it exhausted local premium market opportunities?

• Qualitatively: To support the higher revenues, what channels and level of penetration is implied and do these retailers have the capability to support luxury wine brand-building and sell-through?

CY21 market share implies sizeable growth opportunity ahead: The broker estimates that Penfolds had total wine market share of 4.5% including 5.6% off-premise and 2.8% on-premise. This implies 15.8% for premium import market, which still represents a sizeable opportunity for future growth, especially in South-East Asia as income/capita continues to grow.

CY21 distribution analysis suggests high quality retail trade/on-premise focus: Penfolds is likely to have higher share in these higher quality modern retail channels given its more brand/premium price point focus. Hence, the broker expects more collaborative and joint business planning, leading to more transparency and control.

Medium term opportunity supports $380m-$450m revenues without diluting quality: Goldmans’ estimate that in the medium term, Penfolds is able to achieve both a distribution point gain as consumption demand continues to increase. For on-trade and e-Commerce growth, the broker assumes a 5% and 8% 3-year CAGR respectively.

Longer-term opportunities lie in distribution breadth and depth across the region: In the longer term, the broker sees further opportunities of growth to come from further depth and breadth of distribution in the seven Asia Focus Markets. This including going deeper into specialty retail as well as higher sales/point of distribution with expanded Country of Origin and tailored portfolio construction.

Increase Penfolds earnings (EBITS) margin expectations in FY23-25 on higher quality distribution: Based on its analysis, the broker has not adjusted its already strong outlook for Asia-ex-Mainland China sales significantly. The broker has already increased its Penfolds earnings (EBITS) margin forecast for FY23/24/25 to 42.5% respectively from 42.1%, 39.7% and 40.8% previously.

What other brokers think

Treasury Wines is up 7% in the last 12 months.

Consensus on Treasury Wines is Moderate Buy.

Based on Morningstar’s value of $12.32 the stock appears fairly valued.

Based on the seven brokers that cover Treasury Wines (as reported on by FN Arena) the stock is currently trading with 12% upside to the target price of $14.22.

While UBS retains a Buy rating and $14.75 target price, the broker flags a cautionary note on the parlous state of cost of living in Britain, the largest export market for Australian wine.

Treasury Wines share price over 12 months.