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Date : 08/11/2023

Treasury Wine Estates

ASX :

TWE

Market Cap : $8.27 Billion

Dividend Per Share : $0.35

Dividend Yield : 3.05 %

Buy

52 Week Range : $10.471 - $14.687

Share Price : $11.46

TWE's deal to acquire DAOU comes at a good price and enables them to increase exposure to the USA and double down on its premiumisation strategy. We maintain a 'Buy.'

Company Analysis

Treasury Wine Estates (ASX: TWE) is doubling down on its strategic push towards luxury labels by acquiring DAOU, which is a leading US luxury wine brand, for US$900 million, or A$1.4 billion. The deal makes a lot of sense – TWE will increase exposure in the biggest and best luxury wine market in the world, and it perfectly aligns with the company’s strategy of shifting from commercial labels to luxury labels. Once completed, TWE will have the largest market share of the American luxury wine market.

TWE shares were sold off initially but are now tracing their way back to their average trading levels in the mid-$11 range. There are a few reasons for this volatility:

  • TWE is raising equity at $10.80 to partly fund the deal. Normally, the share price reverts to the entitlement offer price briefly.
  • Some Institutional investors have been outspoken regarding TWE’s capital allocation following the acquisition. It is a fair question, considering that exports to China may resume once again. If the tariffs are removed and TWE begins to ship wine into China, capex will certainly increase so that they can service China and the USA.
  • Finally, there is investor anxiety surrounding the acquisition’s integration, given TWE’s track record of failed big-money acquisitions in the past. But TWE is a different company since then and is also run by a different management team.

We think the acquisition of DAOU Vineyards has potential, and it’s a brand that has been performing extremely well in the USA. The $30-$40 wines have shot up in demand and have sustained despite the cost of living crises. While the timing of the deal can be called into question, TWE’s CEO Tom Ford gave a fair and reasonable explanation – “The fact is, deals don’t just magically appear at exactly the time you’d like. When you get a brand that fits within your own portfolio, you have to press ahead even if the timing might not be exactly what you’re after.”


Source: AFR

What does TWE get from DAOU Vineyards?

DAOU is a highly acclaimed luxury wine brand based in Paso Robles, California. Founders Georges and Daniel Daou have a proven track record of success, and both intend to remain engaged and highly involved in the business post completion.

It is the fastest growing luxury wine brand in US Trade over the past year, with an award-winning portfolio focused across five product tiers and luxury price points from US$20-500 per bottle, diversified across multiple sales channels.

Paso Robles is a world-class winemaking region on the central-coast of California, with the two fastest growing luxury cabernet brands in the US, of which DAOU is one, sourced from the region. The Adelaida sub-district is the region’s premier luxury wine producing area, where DAOU has a strong presence. DAOU owns the DAOU Mountain Tasting Room, four luxury vineyards, four wineries and 411 acres of vineyards in the region and will complement TWE’s existing sourcing and production base in Paso Robles.

In CY23, Daou is forecast to generate sales of $US212 million, EBITS of US$63m and an EBITS margin of 30%. DAOU has an outstanding track record of growth, with three-year NSR and EBITS CAGR of 45% and 61%, respectively. 69% of its sales in the $US20 to $US40 per bottle price bracket, which is the best range from a sales growth standpoint. About 13% of sales are for wines priced above $US100 per bottle. Daou generates about 70% of its sales in shops and 30% in restaurants and bars.


Source: TWE

Acquisition will be EPS accretive from the First Year

TWE’s deal is to acquire 100% of DAOU for US$900m, plus an additional earn-out of up to US$100m payable in the event that certain NSR targets deliver growth in excess of pre-agreed thresholds from CY25-27. Completion is expected by the end of CY23, subject to US anti-trust approval.

This acquisition presents significant cash flow benefits stemming from the ability to deduct goodwill amortisation over a 15-year period for US tax purposes. The indicative net present value (NPV) of these cash benefits is approximately US$100 million, with an average annual cash flow benefit of US$12 million.

TWE’s acquisition of DAOU is strategically sound and financially compelling. The implied EV/CY23 EBITDAS multiple of 12.8x is attractive, and considering the NPV of tax benefits and pro-forma cost synergies, this multiple reduces to 8.9x. For comparison, TWE shares currently trade at an EV/EBITDA of 12x for FY24.

The acquisition is expected to have a positive impact on earnings, with pre-synergy EPS accretion and mid to high single-digit EPS accretion (pro forma for cost synergies of US$20 million or more) anticipated in FY25, the first full year of ownership.

This acquisition aligns with TWE’s ongoing premiumisation strategy, with the luxury portfolio now contributing 50% of Group NSR. The acquisition immediately enhances the quality of TWE’s and Treasury Americas operating metrics, positioning the company for continued growth. The combination of Treasury Americas and DAOU establishes a leading luxury wine business in the United States, the world’s largest and fastest-growing luxury wine market. TWE has been quite outspoken and optimistic about the long-term growth prospects for luxury wine in its key global markets, presenting a substantial value creation opportunity.

The Capital Raise

The Upfront Consideration of US$900m or A$1.4b is being funded via a combination of equity and debt:

  • The first is an A$825m equity raising by way of a fully underwritten pro-rata accelerated renounceable entitlement offer with retail entitlements trading at an offer price of A$10.80 per new share, which is ~10% discount on TWE’s share price prior to the announcement. There is not a lot of dilution in this issue, with ~76.4 million New Shares being issued under the Entitlement Offer, which represents around 10.6% of TWE’s existing shares.

The $604 million institutional component of the capital raise has been completed and the retail component has opened as of 8th November 2023. It is expected to raise ~$221 million. Eligible retail shareholders in Australia and NZ can subscribe to 1 New Share for every 9.45 existing TWE fully paid ordinary shares held as of 3rd November 2023.

  • Second is a Scrip consideration – A$157m placement of new TWE shares to the existing owners of DAOU at an issue price of $11.97 per share. 50% of these TWE shares will be subject to a one-year voluntary escrow, with the remaining 50% subject to a two-year voluntary escrow
  • Finally, a new US$350m acquisition debt facility, which, subject to satisfying customary conditions precedent, is available for the purposes of funding the debt component of the acquisition. The term of the new bridge facility is 18 months.

The funding mix has resulted in pro-forma leverage to increase to 2.5x. TWE’s total interest bearing debt will shoot up from $1.38 billion to $1.87 billion. But there is strong cash flow to support deleveraging from 2H24 and the expectation is that leverage will be back within TWE’s target range of 1.5-2.0x by the end of FY25.


Source: TWE

Post the acquisition, TWE will hold $566 million in cash on its balance sheet. Lease liabilities are only expected to see a marginal $11 million increase to $560 million

Investment Thesis

The inference drawn from TWE’s recent performances is that luxury brands are performing well, and commercial brand sales are faltering. The $15 per bottle (or less) price bracket is under the most pressure across the wine industry as households cut back because of cost-of-living pressures and rising interest rates. Trends also suggest that TWE is on the right track. The fundamentals of the Premium and Luxury wine segment are highly attractive.

THe US Market Opportunity is Significant

The USA is the world’s largest luxury wine market and is 3x as big as China. It is a US$4 billion industry. Luxury wine consumption in the USA continues to grow strongly, with the last 5 years seeing a 7.4% CAGR. This is in stark contrast to Premium labels growing just 0.5% and commercial labels declining 3.9% during the same period.

This acquisition accelerates TWE’s focus on luxury-led portfolio premiumisation to approximately 50% of global group revenue, with immediate accretion to key operating metrics. Treasury Americas will make up 53% of the luxury portfolio and 49% of the TWE group revenue. With one deal, TWE has been able to double down on the largest market for luxury wines and diversify its overall business.

Revenue per case from Treasury Americas in FY23 is now expected to increase by 21% to A$181.4, and EBITS margin is expected to expand +1.3ppts to 26.1%. For the group overall, revenue per case is expected to grow by 6% and EBITS margin by 0.7ppts to 24.8%.

Plays into TWE’s long-term Strategy

TWE’s premiumisation strategy has been underway for a few years now. The US$20-40 per bottle segment in the US is valued at US$2.6bn and has grown at a CAGR of 7.2% over 2017-22. For TWE, the acquisition of DAOU fills a key Treasury Americas portfolio gap in the US$20-40 per bottle price point. It strongly complements the existing portfolio in upper-luxury price points where Treasury Americas already has great strength with Stags’ Leap, Beaulieu Vineyard, Beringer, Etude and Frank Family Vineyards. With the luxury segments the fastest growing in the US market, Treasury Americas is well positioned to deliver growth across the portfolio.

Cross Selling Opportunities

DAOU and TWE have operating synergies. Treasury Americas has a deeper luxury distribution footprint across the US, leaving it uniquely placed to drive continued expansion of the DAOU portfolio with an on-premise and off-premise focus. A significant opportunity outside of California also exists, where DAOU has an excellent distribution footprint, and Treasury Americas distribution is deeper than DAOU’s in the top 10 US wine markets.

Within US trade, DAOU has a significant opportunity for distribution growth, with current weighted distribution below that of key luxury peers. Growth plans for the DAOU portfolio will leverage the strength of a leading luxury wine portfolio, and will be supported by RNDC, a highly engaged and vision aligned distribution partner to both Treasury Americas and DAOU.

DAOU’s luxury codes are also known to be similar to Penfolds. This opens up an opportunity to establish DAOU and Patrimony as renowned international brands by leveraging TWE’s global scale and distribution platform.

The one-off integration cost is expected to be ~US$27 million. Full business integration and cost synergy optimisation is expected to commence in FY25, with full run-rate cost synergies of US$20m+ expected to be realised by FY26.

China’s Potential U-turn on Tariffs

Following quite a lengthy period of diplomatic breakdown, Australia and China are finally playing ball. There is a potential reopening of the Chinese market on the cards. Following months of negotiations, the government announced last month that Chinese officials would begin a five-month review of the tariffs.

While the decision here is not in TWE’s control, the company is optimistic about the chances of a revision in policy. Treasury said that it would temporarily delay the process by which it allocates Penfolds to various markets as it waits to see if the recent lifting of tariffs on barley is followed by movement on the wines. This means the company is keeping its options open to take advantage of any potential lifting of tariffs – enabling TWE to quench Chinese demand and capitalise on the boom that usually occurs after an extended cooldown period. To add a bit of perspective to the significance of this opportunity – before the pandemic, Penfolds was exporting $1.3 billion worth into China; therefore, removing tariffs will be a sizeable catalyst.

We do not expect TWE to begin shipping historical volumes to China immediately on reopening, partly because a sub-section of Chinese customers may have moved on to French and Chilean wine brands during the lengthy ban period and partly due to the time it takes to ramp up export. Nonetheless, the EPS boost will be sizeable.

Outlook – 1H24 is Going to Plan

TWE is on its way to delivering top-line growth and high single-digit earnings growth. Trading conditions in the first quarter were consistent with overall expectations, and TWE expects continued strong demand for Luxury wine and resilient category dynamics for Premium wine globally.

In FY24, TWE remains well-positioned to deliver growth in line with its long-term ambition and continued EBITS margin expansion. Group EBITS will be split approximately 45%/55% in 1H/2H, reflecting the planned phasing of Penfolds shipments to retain operational flexibility given the expedited review of tariffs on Australian wine in China. TWE says that the timing, or outcome, of the review is not expected to impact TWE’s full year shipment plan.

That being said, outlook expectations do not assume any incremental earnings from China. The financial boost from the potential reopening of exports to China has also not been priced-in, leaving sizeable gains on the table.

DAOU is expected to contribute EBITS of approximately US$23-25m in 2H24. The earnings expectations assume a completion date of 31st December 2023 and the historical weighting of DAOU sales to the second half of the calendar year.

Our earlier coverage following TWE’s FY23 earnings contains a detailed analysis of its outlook and can be viewed here.

On the valuation front, TWE shares are trading at a P/E of 21x and 18x for FY24 and FY25, respectively. Markets have priced in an increase in revenues of ~8% for FY24 and ~13 for FY25, along with significant margin expansion. On an enterprise value basis, the uplift in luxury brand sales and high margins are also driving the multiple EV/EBITDA lower in subsequent years – 12x and 10.4x for FY24 and FY25.

TWE has said that the dividend policy will remain unchanged following the acquisition. However, the franking is expected to reduce to 70-80%. Consensus expectations are for a 69% payout ratio in FY24. This will see TWE pay out 38.6 cps as dividends – translating to an implied dividend yield of ~3.3% at the current market price.

Recommendation

Treasury Wine Estates is pulling off an acquisition that suits its business strategy and doubles down on its American footprint, the largest market for luxury wines. The deal is coming in at a good price of A$1.4 billion, which is around 12x EV/EBITDA before synergies. The combined entity will give TWE the largest market share in the USA.

The acquisition will be EPS accretive immediately – raising profitability and margins given the higher margin products. TWE can leverage its scale and reach to cross-sell DAOU products, which will bring cost-saving synergies as well. A possible removal of tariffs by China on Australian wines is also looking more likely, which will not just boost EPS but also potentially provide a sizeable catalyst for the share price. TWE’s premiumisation strategy is progressing well, and the DAOU acquisition makes a lot of sense commercially and from a price standpoint. We maintain our ‘Buy‘ recommendation.


Source: Tradingview.com

 

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