Treasury delivers a robust, finely balanced result

Treasury is now unrecognisable from the trouble-plagued firm that Michael Clarke took control of three years ago.

Treasury Wine Estates chief executive Michael Clarke.

Treasury Wine Estates is unrecognisable from the trouble-plagued company it was when Michael Clarke became chief executive in 2014. While it remains a work-in-progress, its latest results show that progress is way ahead of even its own schedule.

The result was studded with positives, including a 55 per cent increase in earnings founded on a 19 per cent EBITS (earnings before interest, tax, depreciation, amortisation and SGARA) margin, disciplined cost-of-doing-business outcomes and solid volume growth.

Clarke had targeted EBITS margins in the high teens by 2020. He’s delivered them three years ahead of schedule and has now reset the goal to a margin of 25 per cent “over time.” Four years ago Treasury’s EBITS margin was in the mid-single digits.

Treasury is also delivering on its cost program, with cumulative savings from its supply chain optimisation program of $80 million keeping it on track to achieve $100m in annual savings by 2020.

The result, which represented a return on capital employed of 11.6 per cent (9.3 per cent previously), has enabled Treasury to increase its annual dividend from 20 cents a share to 26 cents a share and announce a $300m share buyback program while saying it remains on the hunt for — and is currently pursuing -- “inorganic” growth opportunities.

Those opportunities — acquisitions — lie primarily in the US, where Clarke bulked up Treasury’s much-maligned operations with the 2015 purchase of Diageo’s US and UK wine operations for $754m and, for the first time in the group’s chequered history in the US, gave it the scale to leverage the Beringer platform acquired in 2000.

The impact of the Diageo acquisition is also showing up across the group in volume growth and reducing costs of doing business.

While the result reflected earnings gains across the regions in which Treasury operates, the performance of the Americas business, which lifted EBITS 43.7 per cent to $189m, and the Asian business, where EBITS rose 47.2 per cent to $150.1m, were the standouts. The Australasian business increased EBITS 24.4 per cent to $111.1m and the European business increased its earnings 0.6 per cent to $48m.

While there are analysts sceptical of Treasury’s ability to sustain the spectacular growth rate it has experienced in China, regarding it as a one-off benefit from the free trade agreement between Australia and China, Clarke himself has responded by saying there is a significant opportunity for continued sustainable and high-margin growth in China as Treasury expands its presence into more regions. He has provided margin guidance of 30 to 35 per cent for the Asia business this financial year.

Treasury has the leading imported wine business in China by value and is aiming to add volume leadership to that ranking as it ramps up its offer of Australian, US and, more recently, French wines.

Treasury is pursuing a “masstige” and “luxury” wine or “premiumisation” strategy that will see it continue to reduce the proportion of lower-margin commercial wine in its portfolio and inventories.

There was an $85.5m increase in its non-current inventories in 2016-17 that the group attributed to the high-quality and high-yielding 2017 Australian and 2016 Californian vintages.

That strategy has enabled a bigger focus on a smaller number of key brands, with more marketing support and stronger distribution channels for that core part of the portfolio. The success of the strategy can be seen in the massive improvement in Treasury’s margins.

The other interesting aspect of the group’s result was the impact of currency fluctuations, which have been a major influence — both positive and negative — over Treasury’s volatile performance in the past. It has been particularly exposed to the Australian dollar/US dollar and Australian dollar/British pound exchange rates.

In the year to June, there was a net adverse impact, after $10m of hedging gains, of $16.4m compared with a gain of $41m from currency fluctuations in the previous financial year so there is still a significant swing factor in the group’s results beyond its control.

As the contributions from its regions become more balanced, and as the regions continue to export to and import from each other, the group will have stronger natural hedges to dampen the impact of currency movements and the seasonal cycles and conditions that are inherent in a business whose ultimate base (albeit one Clarke has been reducing) is agricultural.

There are, therefore, a number of potentially virtuous cycles within the business model Clarke is pursuing.