Treasury Wines has announced a write-down of $354 million pre-tax, or -33%, to its Treasury Premium Brands division. The write-down reflects weak profitability in commercial wine under $10 per bottle, of which Treasury is not alone. In many respects, we see the announcement as accounting catching up to the market reality for such wines. The bigger question on our mind is what form a divestment of commercial brands could take. These commercial brands are less than 5% of group gross profit but may be close to 20% of volumes. The challenges in commercial wine vindicates the increasing focus on luxury wines in the market. 

Australian wine exports have rebounded in the June 2024 quarter, largely given the sell-in of wines to Chinese retailers and distributors. Total exports were up 81% year-on-year. While it is good news, we will need more time to judge the rebound in Chinese consumer demand for Australian wine. Nevertheless, it does suggest concerns about excess supply already in China may be overdone.

Treasury’s site trip and our meetings in Paso Robles have highlighted the advantage Treasury has in this fast growing wine region. Treasury’s existing facilities combined with extra luxury wine supply at DAOU provides an underpinning for sales and EBITS growth in the Americas. The distinct advantage at Paso is its far lower cost of production. We expect the company to deliver on synergies and double-digit revenue growth from its luxury portfolio and investor confidence in the DAOU acquisition will grow following the trip.

The removal of Chinese tariffs on Australian wine exports is positive for Treasury Wines. However, the company’s emphasis of a “modest” impact initially reinforces to us that the tariffs were a catalyst to diversify Treasury’s market exposure. As a result, China will be an incremental market, which means incremental costs (we estimate $30 million in next 12 months) as well as a three-year wait for meaningful incremental China earnings. Sales into China will be smaller in quantity, but higher priced than historically.

Treasury Wines reported earnings down 6% in 1H24. While a weak result, conditions are likely to be much stronger next half. We expect organic EBITS growth of 9% in FY24e and 5% in FY25e. The upside from China tariff removal and contribution from DAOU are the key catalysts for the business. If wine tariffs in China are removed in late March, there could be a 4%-10% EBITS uplift as the company as the company sells more mid-tier Penfolds volumes and there is a global re-pricing of the Bin range to 2H24.

Treasury Wines has announced the acquisition of DAOU Vineyards. This deal highlights a dramatic shift over the past four years by Treasury from a commercial to luxury wine player in the US market. The deal is returns dilutive initially and slightly EPS accretive. The cost synergies look very plausible and additional distribution reach highly likely, making the deal slightly value accretive over three years.

The decision by China to remove tariffs on barley is good news for Treasury Wine Estates. We place a 51% probability of wine tariffs being removed within the next six months. The upside to earnings could be 16% within 12 months and 32% over four years.

Treasury’s guidance suggests group revenue will fall about 7% in 2H23e. We estimate Treasury Americas revenue could be down 23% in USD terms. This is a large drop from three factors – reduced 19 Crimes sales, lower Sterling brand sales and the Californian fires impacting Vintage 2020 luxury wine released. While the luxury sales should rebound, we are more cautious on 19 Crimes and Sterling, which may have to reset lower as smaller brands. Given the deteriorating 2H23e, growth in FY24e will be impacted. We forecast FY24e revenue of $2,437 million, growth of 1%.

Treasury Wine’s recent US investor tour provided a reinforcement of its direction, rather than any change. The company is clearly focused on premium wine growth, with an increased emphasis on new product development and a desire for bolt-on acquisitions. The reality for the company will be very low volume growth and a continued mix shift leading to modest revenue growth. Marketing investment may rise once EBITS margins targets are hit in our view. We expect 16% EBITS growth in FY23e and 11% in FY24e.

We initiate coverage of Treasury Wine Estates. After a tough 18 months, we expect stabilisation in earnings the shift to a “divisional” model that separates Penfolds will put the spotlight on that segment. The loss of earnings from China is painful, but the reallocation to other markets is likely. The company has scaled back its Americas business to focus on premium wines. The simplification of Treasury and focus on its core brands should support both sales and margins.