Treasury Wine’s delicate balancing act in China

China has become increasingly important for winemakers, but it is a market with plenty of sharp swings and roundabouts.

Tomorrow’s annual results from Treasury Wine Estates will provide the next window into Australia’s trade with China.

China has become an increasingly important commercial opportunity for Australian wine, but it is a market with plenty of sharp swings and roundabouts, buffeted by tariff changes, consumer shifts, gluts, shortages and supply chain issues, fakes and counterfeiting — not to mention the political tensions between the two countries.  According to Wine Australia, exports from Australia to China, worth $1.12 billion, hit a record high for the year to June, up by 55 per cent. They now make up 40 per cent of the $2.76bn in Australian wine exports.

Australia is the second-largest supplier of wine to the increasingly affluent China market, after France and ahead of Chile, Spain and Italy.

China imported about 106 million litres of wine from Australia in the past year, up by more than 33 per cent, according to data from the General Administration of Customs in China.

This represents just over 14 per cent of total imports into China over the past year of 746 million litres, which was up by 17 per cent on the previous year.

The China Australia Free Trade Agreement, signed in December 2015, has helped the market, cutting tariffs from an initial 14 per cent by 2.8 per cent a year until 2019 when they are set to disappear altogether.

TWE, most famous for its prestigious Penfolds brand in China, reported a 37 per cent increase in net profit in the half-year to December 31, to $187m. Earnings from Asia were a big driver of the increase, with earnings before interest and tax up by 48 per cent over the half-year to $117m.

TWE doesn’t break down sales to China but it is by far the biggest market for the company in the region, representing about 50 per cent of total sales in Asia and by far its strongest growth trajectory.

This was ahead of the $100m in EBIT earned from the American market, almost double the $68.2m earned from the Australia/New Zealand market and the modest $24m made from sales to Europe.

TWE began a distribution deal for China with Baron Philippe de Rothschild in January this year. It also has plans to open a warehouse in Shanghai in October.

The company exports wine to China from Australia, with other brands including Wolf Blass and Rawson’s Retreat, and the US, through its Berringer brand from California’s Napa Valley.

Sales of Penfolds in China have been a major driver behind the big rise in TWE stock over the past five years.

But this year has offered up many challenges for TWE chief executive Michael Clarke, who will need to reassure the market that the group isn’t in danger of becoming another victim of boom-to-bust sales into China.

When a starry-eyed CEO starts talking about there being 1.2 billion people in China and how the company would be happy if only it could get 1 per cent of the market, then it’s time to sell.

No one is putting TWE in that category, given its experience in China and the popularity of its Penfolds brand in the country.

But the market will be looking for a response from TWE to media reports that its cheaper brands are facing an oversupply situation in China.

“The company is comfortable with the sustainability of its operating model in China, to build a portfolio of brands, and its disciplined approach to managing inventory levels with its customers,” the company said. “Discipline and sustainability remain the cornerstone of TWE’s growth in North Asia.”

TWE said it cautioned against “reliance on feedback from selected customers in China”.

It noted it was working with its partners in China to sell a portfolio of TWE brands, suggesting that media reports about a glut of its cheaper wine may have been ­fuelled by those partners in the country who were not doing well out of this strategy.

Then there is the big elephant in the room — any impact from the political tensions between China and Australia.

There were reports earlier this year the company was experiencing a slowdown in clearance of its goods into China.

“TWE confirms that it is also experiencing delays from some of its Australian country-of-origin shipments being cleared by the General Administration of Customs in China,” it said in May.

It appears those issues may have been partly due to political tensions between Australia and China. Whatever the reason, these seem to have been sorted out, although the market will be keen for an update on that situation.

Australia’s strained relations with China took a turn for the better with a much more statesmanlike speech by Prime Minister Malcolm Turnbull on Australia’s long relationship with China at the University of NSW last week.

It is too early to say, but it is widely perceived — in both countries — to have been a big step in the right direction.

There are big incentives for Australia to repair its relations with China, and, for its part, China is now under some pressure to work a little harder to improve its relations with countries other than the US, given the bitter trade war that is showing no sign of abating.

All in all, there are a lot of moving parts that could affect TWE’s sales to China, but the market opportunity is still the biggest single source of future earnings, which makes it well worth the effort.

As long as shareholders are prepared for some twists and turns along the way.