Treasury Wines delivers shareholder hangover

217779-treasuryThe price of Treasury Wine shares (TWE) fell 15% this week after the company announced $160m in write downs against the US wine business including $40m of stock write downs. This is a significant setback as TWE has climbed over 30% in the last year on expectations that profits in the next few years were looking promising.

Quest has not held Treasury Wine shares post the demerger from Fosters and have watched with interest as the share price soared. We generally agreed with the management strategy including segregating the brands, controlling capital and maximising price on premium products. The problem was valuation: we could not justify the share price. The fanatical support of one senior broking analyst over the last year, which has delivered a lot of buying support, has prompted us to review the valuation on more than one occasion. We are consistently unable to lift our Quest valuation to anywhere near the share price.

The core of our issue was the valuation of the US business. The wine industry has endured another tough period. This is an industry where returns are often below average with high amplitude cycles being common. In very tough times, investors in grapes give up, vines get pulled, capital departs and the cycle starts again. During these cycles consumer taste also varies. The cycle regularly shatters dreams in this industry.

The market optimism toward TWE failed to realise that the last time this business excelled, two things were very different.

In 2000 Berringer had a large and very profitable sweet wine business. Berringer White Zinfandel sold at $1 per bottle more than the competitors. This premium has now been lost. Tastes have changed and TWE will now destroy large volumes of old stock in order to regain the taxes already paid on that stock. Additionally, Australian wine was being sold into US at the same prices as local prices, but one $US then bought two $A, so the profit margin on US sales was much higher. The recent slump in the US dollar is therefore a benefit to TWE.

Currently, Treasury sells Penfolds into China at good margins but volumes into China are far less than 1m cases while US volumes are around 13m cases.

The wine industry has a long history of boom and bust. The industry attracts capital in the good times and supply surpluses usually follow. Logistical challenges in a global business and shifting tastes have combined to confound the herd. Optimism in the TWE share price has out run reality proving that achievable forecasts are always a good place to start when valuing stocks.