Jun Bei Liu: A defensive staple trading at an attractive discount

Today’s strong result from the company behind some of Australia’s best-known global wine brands has beaten the odds in at least a couple of ways. Posting a net profit of $263.2 million for FY2022 – up 5% on the 2021 result – it’s clear management is doing something right.

Perhaps most notably, there’s the China angle. The tiger economy used to make up around 45% of Treasury Wine’s ASX:TWE group earnings. The sharp increase in tariffs imposed by China in November 2020 – up to 175.6% – prompted a huge shift. Then-new CEO, Tim Ford, had to steer around a massive hole in earnings. Sales into China brought in only $2 million in the six months ended 31 December 2021 – down from more than $78 million a year earlier.

And then there’s the global economic environment, as rising inflation has seen spending on luxury and non-essential items pull back. It’s at this point that it becomes clear that Treasury sits somewhere between the Growth and Value styles, probably more accurately described as a Quality stock.

In the following interview, Jun Bei Liu, lead portfolio manager at Tribeca Investment Partners, discusses Treasury’s earnings result and her broader outlook for the company.

Note: Treasury Wine has been a top holding of the Tribeca Alpha Plus Fund for several years. This interview took place on Thursday 18 August 2022.

Key results

• Revenue of $2.53 billion, down 5.7%
• Underlying NPAT of $263.3 million, up 5.3%
• Underlying EBIT from continuing operations up 3% to a $523.7 million
• Earnings per share up 5.2% to 36.5 cents
• 16 cents a share final dividend, payable on 30 September.

What were the key takeaways from this result? What surprised you the most?

It was roughly in line with expectations. The key takeaway is that EBIT across most regions of the business was up very strongly. And particularly in the market for its Penfolds premium brand, it’s now adjusted for China, where earnings grew 25%.

That is incredible because there was so much scepticism and fears the China market was not coming back. It just seems they really have found a life and have successfully grown in those other markets. And in terms of the outlook, we were very impressed with the very robust outlook, despite higher supply chain costs, higher cost inflation, and other challenges. The company's got so many levers to pull and the demand environment is incredibly strong for this business.

The balance sheet's very strong, with less than 1-times gearing expected by next year and management is talking about potential capital management next year. The dividend this year is also pretty good too.

What was the market’s reaction to this result? Was this an overreaction, an under-reaction or appropriate?

The share price actually declined around 4% when the result came out, really on the basis that it performed very well ahead of the result. It’s almost like there's an endless search by some investors for negatives and trying to second guess management's outlook.

There was a bit of market misunderstanding about what a strong result for Treasury looks like – is 20% strong or not? But once the conference call started at 10 am, you could see the share price movement started turning positive. And now it's up around 2%.

That’s absolutely an appropriate reaction and, if anything, we might see earnings upgrade further overnight.

Would you buy, hold or sell TWE on the back of these results?

It’s a Buy. TWE is very cheap, trading on less than 19 times earnings and will deliver growth of more than 20%. Compared to other consumer staples, defensive businesses, such as Woolworths ASX:WOW and Endeavour ASX:EDV , they're both on 30 times earnings and will probably deliver very small growth for the next year, if not negative. On that basis, TWE looks very cheap and earnings are very defensive. It's very well positioned for further upside.

What’s your outlook on TWE and its sector over FY23?

I'm very positive. Management doesn’t normally give guidance, but they do provide more colour throughout the year and are actually quite transparent. TWE is on a very cheap valuation, and further growth doesn’t require any improvement in economic activity, China stimulus, or any other external events. It provides very defensive, structural growth and is also a very strong brand.

Also supporting the outlook for further earnings growth is the mix shift into that premium label, Penfolds. The company has also put through price increases because there's so much demand for their product within the premium and luxury end.

Are there any risks to this company and its sector that investors should be aware of given the current market environment?

The potential for mismanagement of brand labels is a risk for Treasury Wine. Anything detrimental to the brand would be catastrophic for the company. But aside from that, this company has really removed a lot of operational risks. In the last few years, China was a big risk but it has found a life outside of that market. China is still doing well for Treasury and it is now really going global.

Treasury sits in that consumer staple space but it has never really traded like a defensive stock. It was a Growth company – something like Domino’s ASX:DMP  – but then China happened and it suddenly traded like a Value company.

Now, it is essentially just trading on the company's fundamentals. And its earnings also have an element of the reopening trade, because hotels and restaurants were shut. These are high-margin products and as we return to normal, that will come back, which is yet another way it’s well positioned.

From 1-5, where 1 is cheap and 5 is expensive, how much value are you seeing in the market right now? Are you excited or are you cautious about the market in general?

Rating: 3

Some parts of the market are now trading at around 18-times earnings, which is in line with the historical average. So, to me, the market looks quite neutral – it’s not cheap, but it’s not over-expensive.

But some sectors do look cheap, such as resources. Some Growth companies will see a bit of pullback, particularly if they don’t have the fundamentals to support those valuations. The re-valuation is done for all those volatile names and from here on, they must have earnings growth to underpin their path.

We’re probably looking at mid-single-digit returns underpinned by good dividends because corporate earnings are still doing okay. Net-net, we still think the market will deliver positive returns this year and within that, you can always find companies that will generate so much more return. In addition to companies like Treasury, the healthcare sector also looks interesting. Overall, you need to be cautious and stay defensive and drill down to the individual stock level.

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