Treasury Wine Estates Ltd (ASX: TWE) shares are down 27% this year having slumped on the back of missed first-half earnings expectations, lower forecasted growth, and coronavirus fears. Shares in the winemaker recently fell more than 25% in a day following the release of the company's 1H20 profit report and revised FY20 guidance in January.
Currently trading at $11.72, Treasury Wine shares are well down from their high of $19.17 in September last year.
Lower growth in key US market
In January, Treasury Wine advised its forecast growth rate for FY20 would be lower than previously guided. This was driven by underperformance in the US in the first half which is expected to continue in the second half. Treasury Wine makes around 27% of its profits in the US. Unexpected changes in US leadership and shifting US wine market dynamics were blamed for the downgrade.
An oversupply of cheap wine across the US caused a flood of cheap private labels to enter the market. Growth in private labels of approximately 15% was recorded in a market that was otherwise flat to down. Higher levels of discounting were required to try to maintain market share across all price points. Treasury Wine's US profits slid by around 17% for the first half.
A larger than expected Californian grape harvest in 2019 and Trump's trade war with China have exacerbated the US wine glut. Tariffs imposed by China on US wine have resulted in many US producers choosing to sell their wine domestically rather than exporting it, fueling the oversupply.
Treasury Wine CEO Michael Clarke estimates the oversupply will take approximately 2 years to clear, but even then the rise in private label wines is likely to continue. "Even after the market gets balance, you've got retailers who have seen what they can make across commercial and low-end masstige wine," he told the Australian Financial Review (AFR).
Lost leadership and momentum
Changes in the American leadership team resulted in a loss of execution momentum which is expected to continue. Executive Angus McPherson, who was set to take the top job in the US, was unable to relocate permanently for personal reasons. Treasury was forced to reshuffle its North American management ranks as a result.
The upheaval comes shortly after CEO Michael Clarke surprised investors in October by announcing he intended to step down in September 2020 to spend more time with family. Clarke's leadership had been hailed by the investment community, with the CEO arriving in 2014 and presiding over an increase in the Treasury Wine's share price from below $4 at the time of his arrival to over $19 last year.
The company is now focused on resetting the American management team and rebuilding momentum. Lower growth rates are anticipated as the company reviews how it manages its US and global wine businesses with a view to building strength in the back half of FY21 and FY22.
The challenging conditions in the US market prompted Treasury Wine to reset its growth forecasts. As such, the company advised it now expects earnings before interest, tax, and self-generating and regenerating assets (EBITS) growth of 5% to 10% in FY20, down from the previously guided 15% to 20% range. For FY21, EBITS growth of 10% to 15% is expected.
Potential class actions
The surprise earnings downgrade prompted a 25% fall in the share price, reducing Treasury Wine's market capitalisation by $3.1 billion. A potential shareholder class action has been mooted with Slater & Gordon investigating the prospect. The class action would involve shareholders who bought shares after August last year when Treasury Wine announced it expected earnings to grow 15% to 20% by the end of FY20.
Slater and Gordon lawyer Kaitlin Ferris told the AFR, "[Treasury's] downgrade on Tuesday night has clearly caught investors by surprise. The company had presented a rosy picture of its financial position and claimed that the channel stuffing issues of the past were behind it." Slater and Gordon are investigating whether the company was likely to have known the market-sensitive information earlier. If so, it may have breached its obligation to update the market in a timely manner.
Maurice Blackburn is also investigating a potential class action against Treasury Wine, three years after settling a previous shareholder class action against the company for $49 million. The previous class action also centred on late disclosures relating to the US business, claiming Treasury Wine misled the market and breached continuous disclosure obligations in regard to the financial impact of over-stocked third party distributors in the US.
Treasury Wine's first-half results
Treasury Wine reported net profit after tax (NPAT) of $229.2 million for the first half, up 5%. Earnings per share increased 5% to 31.9 cents per share. EBITS of $366.7 million was reported, up 6%, with EBITS margin increasing 0.9ppts to 23.9%. A dividend of 20 cents per share was declared, fully franked.
Asia reported 19% EBITS growth to $175.5 million, while Australia & New Zealand reported 10% EBITS growth to $85.9 million. Europe, Middle East and Africa reported a 1% decline in EBITS to $32 million. Americas reported a 17% decline in EBITS to $98.3 million. CEO Clarke commented, "our first half performance in the Americas has been a setback and is disappointing given the high expectations for we have for growth in this important market."
Coronavirus fears
The Treasury Wine share price has not been helped by the spread of coronavirus in China, the company's most profitable market. Demand in the region is likely to be suppressed as restaurants close and people avoid dining out for fear of the outbreak. China is now a much more significant global player than it was at the time of the SARS outbreak, meaning economic disruption in China will have a larger impact on companies that trade within it.
According to the AFR, the SARS outbreak shaved 1 percentage point off China's GDP growth. The coronavirus outbreak is already more widespread than SARS.
The chief executive of Wine Australia has warned that Australian wine producers exporting to China will inevitably be impacted by the coronavirus outbreak, although it is too early to gauge the extent of the impact.
As reported in the AFR, Australian wine sales in China grew 12% to $1.28 billion in 2019. China makes up 44% of the total $2.91 billion sold offshore by Australian wine companies. Treasury Wine's Penfolds brand has been a significant driver of growth in China as a result of its luxury branding.
Treasury Wine's CEO has refused to make any predictions about the impact of the coronavirus, but told the AFR predictions that sales in Hong Kong would slide due to the riots had been wrong; "it's not always correct just to join the dots."
