By James Atkinson
The market overreacted to the "irrelevant" announcement that Treasury Wine Estates (TWE) would take a $160 million hit destroying aged inventory in the US, according to analysts.
In a briefing note to clients, Merrill Lynch analysts David Errington, Michael Courtney and Brent Walsh said the "disappointing" news should be viewed in the context that the US holdings are "non-core assets to TWE's future growth".
They said the exhaustive analysis of TWE's US business had overlooked the company's strong balance sheet with next to no debt, and its successful strategy of increasing the availability of its high end wines via vineyard expansion and inventory build.
"At the end of FY13, we expect TWE to have +$500 million of long term inventory …having been built up from $190 million at the end of FY11."
"Within a year or two, we expect TWE to have close to $700 million of long term inventory…underpinning an ability to sell around three times the amount of high end wines that it is currently selling," the analysts said.
As a result of the company's investments in vineyard expansion, the analysts said TWE is expected to have the ability to continually replenish the increased sales of high end wines, maintaining long term inventory at around $700 million.
They predicted that by increasing threefold its sales of luxury and premium wines, TWE's Australian wine business could generate around $500 million EBITDA in FY15.
"The US is irrelevant"
The Merrill Lynch analysts said the market may again be misjudging the value of TWE by being too focused on its short term earnings, "the same oversight it made with Foster's and TWE only two to three years ago".
Errington, Courtney and Walsh said TWE's US assets are strategically well-placed and could be offloaded for around $1 billion.
"If the assets remain in the hands of TWE, we believe the assets will be materially less valuable than the $1 billion of value we estimate they are worth."
They said it was ironic that if TWE did sell its US asset base, it would in fact help its Australian export portfolio, which would then be sold through distributors unclogged by commercial wines sold to them via TWE.
"Interestingly, the best performing Australian wines into the US are where there are no established distribution channels from an affiliate US business," they said.
"And the costs of setting up such distribution would be minimal… particularly with the brand strength of TWE's high-quality Australian wines."
I think that the analyst missed the point entirely. It’s not the value of the inventory being written off, but the fact that it is there and needed to be written off, so investors have very good cause to be concerned about the marketing strategies that lead to the situation.