Luxury split to decant Penfolds from Treasury Wine

It’s enough to make one feel old – old enough to remember when Foster’s Group spun off its wine business, in the form of Treasury Wine Estates, in May 2011, only four months before Foster’s itself disappeared from the Australian share market, taken over by Anglo-South African brewer SABMiller, which became AB InBev in 2016.

Demergers are meant to unlock value, and Treasury Wine Estates did OK: from an initial valuation of $2.1 billion, the company is now capitalised at $7.4 billion – down from its peak of $13.8 billion in September last year.

Now Treasury Wine Estates itself hopes to unlock some serious value, with its plan to spin-off its luxury wine business under the name of Penfolds, on to the Australian Securities Exchange (ASX), as a stand-alone company, by the end of 2021.

The Penfolds business is Treasury’s crown jewel, generating more than 50 per cent of its profit, despite accounting only for about 10 per cent of volume. The demerger plan would separate Treasury’s high-end brand portfolio from its mid-range, lower-end “commercial” and bulk wine labels, which would stay in the to-be-renamed “New Treasury.” TWE shareholders would own a share in Penfolds and in New Treasury proportional to their existing TWE holdings.

In addition to the eponymous Penfolds and its iconic Grange label, the luxury spin-off would presumably hold the other prestige labels, including Bin 707, Bin 408, Bin 389, St Henri, Wynns and Seppelt, as well as US brands Beringer, Stags’ Leap Winery and Chateau St. Jean.

“New TWE” would most likely include Wolf Blass, Lindeman’s, Squealing Pig, Pepperjack, Matua, 19 Crimes, and Rawson’s Retreat, as well as US brands Blossom Hill, Sterling Vineyards, Beaulieu Vineyard and the US commercial brands, such as Beringer Coastal and Beringer Main & Vine.

According to Treasury, Penfolds was likely to be an ASX top 50-100 company, while “New Treasury” was expected to be a top 100-150 company.

Valuations do not mean much until we see exactly what is apportioned to each company, but the broker most bullish on the plan – Bank of America – estimated prior to the Coronavirus downturn (in early March) that Penfolds could be worth between $10 billion and $14 billion, or $14 to $18 share.

Given that the whole of Treasury is trading at $10.32 and has a market capitalisation of $7.4 billion, that would be a compelling deal.

However, broker Citi – whose preliminary valuation came about a month later than Bank of America’s – estimated a value for Penfolds at about $6.5 billion, and New Treasury at about $2.1 billion. This mark-to-market reflects the halving of the Treasury share price in a matter of eight weeks.

The major rationale for the decanting-off of Penfolds is to give investors a chance to own shares in one of the world’s best-selling high-end wine businesses, without exposure to the fluctuating profitability of mid-range and lower-end products.

Even before the Coronavirus Crash, Treasury Wine Estates had dismayed the share market with a surprise profit downgrade, in January, mainly on the back of problems in its commercial wine business in the US, where it has been hit by a wine glut.

(That downgrade, which caused the share price to slump by about 20%, is now the subject of a shareholder class action, alleging that TWE contravened its obligations of continuous disclosure and engaged in misleading or deceptive conduct in some of its announcements and statements in August 2019 and October 2019.)

Penfolds is the growth engine of Treasury. From its inception in 1844 in South Australia, the label has become one of the biggest-selling in the world – powered by the world-famous Penfolds Grange, which dates from its first vintage in 1951.

More importantly, it represents, in the words of Bank of America analyst David Errington, “close to 100 per cent of TWE’s future growth.”

After years of effort, Penfolds has cracked the Chinese luxury market. Last year, Asia – mainly China – was the second largest region for Treasury Wine Estates’ net sales behind the Americas, with sales up nearly 37 per cent to $748.9 million. And Asia generated more profit than the Americas division.

After a frustrating decade-long fight in the courts against a trademark squatter, Penfolds has finally obtained trademark registration for the brand’s Chinese transliteration, Ben Fu.

In September, the Vinexpo Shanghai exhibition was told that Penfolds is responsible for 66% of all the value growth of the booming $1.2 billion Australian wine market in China.

Treasury has been open about its plans to build on this success, to become the number one importer of French wine into Asia, meaning China, predominantly. (French wine just pips Australian wine for import volume into China).

Last year, the company started buying vineyards in the Bordeaux and Champagne regions: Penfolds from France is likely to be sold in China from FY22. Penfolds has launched a $280-per-bottle French champagne, in a joint venture with family-owned firm Champagne House Thienot.

A Penfolds brandy – placed in barrels in 1990 – has joined the range. Penfolds has also launched into the Chinese market a drink called Lot 518, which is a fortified shiraz infused with Baijiu, a clear spirit that is hugely popular in China.

It was sobering to read that the value of Australian wines exported to mainland China slumped by almost half in March, as the coronavirus saw entire Chinese regions locked down. The $45 billion industry is bracing for more bad news in coming months as similar lockdowns across Europe and North America hit wine sales, but industry body

Wine Australia says there are “early indications of renewed demand for wine” from the recovering Chinese economy.

This growth in the Chinese market – provided it continues – would be a major reason to look at Penfolds stock, as would a trend toward higher-quality wines worldwide. Of course, the market needs to see actual numbers, but brokers generally believe Penfolds will be a high-growth, profitable and high-return-earning business, that would attract a high multiple – as befits one of the world’s great luxury brands.

In contrast, the New Treasury will be a lower-margin, lower-multiple, downsized portfolio, after poorly-performing commercial wine brands are culled. That is not to say it will be a dumping ground: it is expected to be a smaller portfolio of profitable businesses.

Appropriately priced, New Treasury may be a good investment proposition, too: however, we are unlikely to see concrete details of the demerger until at least August.

Drew Meredith

Drew is publisher of the Inside Network's mastheads and a principal adviser at Wattle Partners.