How Treasury Wine Estates Ltd could head north of $10

Credit: Penfolds

After a meteoric rise in the past year or so, Treasury Wine Estates Ltd (ASX: TWE) announced this morning that it was divesting 12 non-core brands and approximately 1 million cases of wine from its Commercial portfolio.

In recent times Treasury has been, quote, ‘managing down’ its portfolio of ‘Commercial’ (read: cheaper) wines in order to capture more high value customers, particularly in China. The economics of cheap wine are unattractive and so far Treasury’s decision to move into more upmarket segments has been quite successful.

Even better, today’s announcement will have nil impact on Treasury’s earnings in Financial Year 2016 (“FY16”) and beyond as the brand portfolio is being sold at book value, and other costs will be covered by cost savings from the company’s recent supply chain optimisations. Today’s announcement is a step towards achieving ‘mid-teens management EBITS’, or Earnings Before Interest, Tax, and fair value changes to Self-regenerating assets.

This measure is a way of looking at the percentage of revenue that is kept as actual earnings after the costs of production and sales are accounted for. Previously in 2015, Treasury’s ‘Management EBITS’ margin was around 11.5%, and in 2014 it was around 10.3%. If ‘mid-teens’ margins can be achieved by 2020 as management is planning, this would represent a step up in the profitability of Treasury’s operations.

Management stated that its EBITS for FY16 will be in line with market expectations, and between $330 and $340 million, up from $225.1 million in FY15.

Don’t forget the ‘Brexit’

Treasury also included a note about the recent ‘Brexit’ vote and the subsequent depreciation in value of the UK currency. As a result of its hedging program and the relative insignificance (less than 10% of EBITS) of its European operations, Treasury does not expect any material changes to its FY17 earnings expectations.

Treasury Wines appears to have much of this year’s earnings growth already built into the share price, but if the company can continue to improve its margins and grow sales, it wouldn’t be a stretch to see shares above $10 in the near future. Management continues to take steps in the right direction, and today’s update was good news for shareholders.

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Motley Fool contributor Sean O'Neill has no position in any stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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