Treasury Wine Estates is an Australian based spinoff of the wine business of Fosters Group. It was spun off for the all the reasons that create interesting spinoff investments. The business is the result of a ~10 year roll up of several Australian and California wine brands sold globally that is facing the headwinds of a strong Australian dollar and a glut of Australian grapes. It cost about $6bn to assemble is now trading for $2bn. The combination of goodwill write downs depressing earnings at Fosters and horrible outlook starting in 2008 are behind the parent’s decision to separate the wine business. All figures are in AUD, although there is a US ADR that trades under TSRYY.
The two economic drags on the stock – strong AUD and wine oversupply – are as transient as the lack of interest due to the recent spinoff. If these factors reverse course or even stabilize, investors are well positioned to profit. The combination of a higher relative interest rate and strong demand for commodities has made the AUD a strong currency, although these things can change. I have a hard time extrapolating the USD weakness and AUD strength into infinity.
Even if the status quo remains as such, the company is conservatively capitalized with a debt/EBIT ratio of 1x and trades at 14x trough fiscal 2010 FCF of $150m using a $3.20/share price and 647m shares outstanding. Trailing 5-year average FCF is $250m. The company trades close to its reported tangible book value of $3.18/share.
The business was spun out with $200m in debt and $60m in cash, so leverage is low, especially for a company that sells alcohol. Debt to tangible equity is 10%. This is appropriate because the wine business can be volatile as the current environment is proving. I would head for the exits if the company levered up even if it was for a buyback or dividends. The company has the cash flow to service the debt as well as pay it off quickly, so bankruptcy risk seems distant.
Five year EBIT, ended June 30th
2010 - $221m
2009- $304m
2008 - $394m
2007 - $431m
2006 - $430m
I use EBIT because that figure is the only one I could pull from past filings with consistency. The 2008-2010 figures include the company’s pro forma projection of what the stand-alone business will generate if they retroactively apply stand-alone costs. If you assume a 10% interest rate on the debt of $200m, pretax income was $200m in 2010 and the business is on track for about $180m pretax in fiscal 2011, which translates into roughly $120 in net income for fiscal 2011.
In the past 3 years depreciation has been $95, $103, and $92 million, while capital expenditures have been $77, $99, and $79 million in 2010, 2009, and 2008 respectively. Disclosure is minimal, but the filings state it was for oak barrels and vineyards, and upgrades to winery and packaging facilities. The fiscal 2011 filing should have more color, but FCF could be a lot higher than net income rather than just a few percent. Maintenance capital expenditures are likely a portion of the whole, which is already less than depreciation.
The company produces wine in Australia (66%), California (32%), and Italy (2%), Where the company produces wine though doesn’t really tell the whole story though, because only 28% of the Australian wine and 10% of the Californian wine is from company owned/leased vineyards. The other portion of grapes that go in their wine is split between third party growers and bulk purchases. While the Australian wine glut has had the effect of lowering prices on wine sales, the company has remained profitable. They don’t have as much capital tied up in land and raw materials as other producers and are able to mitigate the effect of falling grape prices. They did have wider margins prior to the current wine glut, although it is difficult to extricate this factor from the AUD, which is up 30% in the past 5 years. Both clearly play a role, but the company is not on its last legs as a result of the wine glut.
In the demerger documents from Fosters, the company stated it intends to pay out 55-70% of its earnings out in the form of dividends. This should act as a catalyst for the stock when it is announced. This business is not very capital intensive when it comes to growth. It does have half its tangible assets in inventory, but that is a feature of the wine business. A little more than half is classified work in progress, which I interpret as meaning they aren't sitting on a time bomb of unsellable wine - the wine is liquid. Any growth would require additional working capital, but the company will not need additional facilities or farmland. The company should be able to distribute a lot of cash flow.
The long term incentive plan takes into account 2 factors equally – total shareholder return including dividends reinvested over a three year period, and the CAGR in return on capital employed. This bodes well for distributing cash and limiting debt. The company doesn’t indicate if it calculates capital employed with or without goodwill, which may have an effect on management deciding to take a bath on the goodwill. This wouldn’t materially affect the underlying value though. What is interesting to note is that EBITDA or a measure of that sort isn’t included. Maybe they are wise to the fact that this is easily manipulated and a poor incentive, or maybe they realize they will have a hard time manipulating it since it is greatly affected by currency fluctuations.
Fiscal 2011 ended on June 30th, so a filing should be released shortly. There will be continued downward pressure due to the grape glut and strong AUD, but there will likely be additional information for investors to digest. The H1 2011 pro forma EBIT was up 30% YoY excluding the impact of exchange rate movements, which shows how much pressure the AUD is putting on reported results while the actual business remains strong. An investor can't eat - maybe drink in this case - results excluding currency conversions, but it is worth noting.
Looking forward the company is trying to fundamentally improve operations which would further blunt the impact of a strong AUD and/or the supply picture of wine. The company is attempting to move upscale with its brands. I have no particular opinion on how likely this is, but more expensive wine has higher margins and competes for customers that are less affected by a wine glut. They do own the Penfolds brand which sells bottles for several hundred dollars a pop. Operationally, the company built centralized automated bottling plants in 2005 in both Australia and California, which gives them capacity to further expand output. They have opportunities in their distribution in the US that is being revamped. They may also divest lower margin more competitive brands, but that is speculation. They have dropped some lower priced brands into JVs in the past, so it is not wild speculation.
The company appears to be in the fairly valued range based on just using trailing one-year earnings, although on a trailing 5 year basis it is a lot more interesting. A good portion of this is due to currency volatility, Australian wine dynamics, and a weak economy. Using the 5 year average smooths out a lot of this. If the company can benefit from spinoff dynamics such as operational improvements tied to changing incentives and a stronger focus on its core business, the business will increase in value. The business will also strengthen if the AUD and the wine oversupply moderate. A weakening AUD can change the oversupply more quickly as well as boost exports, but a weaker AUD is not necessary for the Australian wine market to return to equilibrium. There have also been rumblings of a buyout, but that would just be a kicker. There are several factors that would cause the market to give TWE a higher valuation, while having downside protection.
(h/t Nate over at Oddball Stocks)
Long TSRYY
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