Treasury Wine Estates seeks to deliver shareholder value

Summary

• The US wine market was flooded by heavy supply in the first half 2020, causing profit margins to deplete for TWE
• A potential demerger is on the cards, seeking to separate highly profitable Penfolds portfolio.
• TWE has been served with 2 class action lawsuits this year.
• Additions to the executive team had been made to complete M&A and strategy focus.

Treasury Wine Estates Limited (ASX:TWE)

Treasury Wine Estates was perhaps among the best growth stocks on ASX until January this year. In January, the Company lowered its guidance, owing to margin depletion. In the US, the rising cheap wine supply caused substantial price wars for the businesses in the commercial wine segment.

Cheap private label brands had plundered the US markets in late 2019. In addition to the blow from the US markets, the erstwhile COVID-19 situation in China also induced the sell-off when the Company noted its lower profits.

Wine supply in the US increased in 2019, which also prompted high-end producers to sell exclusive brands at the retail chains. In January, the management of the business noted to divide the segments of the business into commercial and luxury.

They also noted that excess wine build-up in the US caught many players by surprise. Management reported that EBITS margin of the US business slipped to 16.1%, but they expected margin to reach 25%.

Class actions have been served on behalf of shareholders

Since January, the Company has been served with two class action suits. Both the lawsuits are filed in Supreme Court of Victoria. Slater + Gordon and Maurice Blackburn have filed the claims on behalf of plaintiffs.

Plaintiff brings the claims on behalf of the shareholders. Solicitors claim that Treasury Wines had breached the provisions of Corporation Act, Consumer Law and ASIC Act. They claim that the Company has engaged deceptive, misleading conducts and failed to comply with continuous disclosure rules.

Potential demerger of Penfolds

In April, the Company provided an update on the outcome of a strategic review. It is assessing the possibility of a separate listing for Penfolds business on ASX through a demerger by the end of 2021. The Company’s intentions to consider the demerger of Penfolds and its associated assets build on the strategy to focus on premiumisation and having a separate focus on luxury and commercial business.

Treasury Wine believes that a potential demerger will likely deliver long term value for the shareholders, enabling Penfolds to drive its luxury business in a number of countries where it originates its business.

While Ex-Penfolds (New TWE), the business would focus on promoting a shift towards luxury and also optimising its commercial portfolio of brands. Management noted that Penfolds accounts for ~10% of revenue and over half of the profits, with a completely different strategy compared to the rest of the business.

A possible demerger within the business would allow the separate entities to focus on strategic priorities and deliver long term growth prospects for the respective businesses. But the Company, (ex-Penfolds), will continue to have its position as the largest globally integrated wine platform.

The transaction remains subject to a detailed evaluation of value to the shareholders, as well as approvals from the Board, shareholders and regulatory bodies. If approved, they expect demerger to complete by the end of the calendar year 2021.

Business restructuring

TWE intends to maintain the premiumisation focus and take further initiatives to lower the footprint of the lower margin business, particularly in the US. Supply chain of the business would be restructured to lower the costs of goods sold.

Management seeks to offload selected brands and production assets. It would also reduce the commercial brands with lower margin. TWE would also adjust its organisational structure and operating model to deliver the optimal scale of business, enabling lower costs and better engagement with clients.

One-off costs would be associated with the restructuring of the business, which would be less than annualised savings delivered through lower fixed costs. This assumption excludes the potential profit or loss that would be incurred through sale of assets.

It seeks to retain a smaller portfolio of commercial brands that would be profitable and continue to deliver customer proposition across its regions. A smaller number of commercial brands would be complemented with a premiumisation strategy.

COVID-19 trading update

In China, the Company’s staff had returned to work along with most of the partnership network. And, nationwide lockdown impacted the business in Q3. It was working to resume operations with the partners, but socialising and consumption level were subdued.

In other regions, the momentum had been strong as customers stocked wines through the end of Q3, while online channels were resilient as well. However, the performance was tilted towards lower margin products. Other than e-commerce, channels were closed due to shutdowns.

The Company did not experience impacts on the supply chains of the business. It expected that certain markets will likely be impacted by the higher level of social distancing measures. Also, it maintains an investment-grade credit rating with significant room in its financial covenants, as well as a diversified maturity profile.

Hired M&A expert

Earlier last month, it was reported Stuart Boxer would join the company as Chief Strategy and Corporate Development Officer, which is a newly created role. He will emphasise on the transformation and business improvement, growth, commercial investment strategy and mergers and acquisitions.

The COVID-19 led disruptions have impacted business of Treasury Wines– in addition to the deterioration in the US market. Management is undertaking a strategic review and a potential demerger is on the card. Additional information would be made available in the near future.

On 3 June 2020, TWE last traded at $10.42, up by 3.579 % from the previous close.