On 17th May 2018, The Australian Financial Review released an article on Treasury Wine Estates (ASX TWE) supply glut in China. The news is troubling, as the supply glut is material but was not announced to the market. Should you buy Treasury Wine Estates shares after this?
Major Supply Glut in Low-End Wines
Treasury Wine Estates is currently facing a supply glut of their own making. The oversupply issue is mainly around TWE’s cheaper brands such as Rawson’s Retreat, Wolf Blass and the cheaper Berringer products.
This supply glut has caused deep discounting in China which has pushed prices lower than Australia despite higher taxes and shipping charges. Some retailers are even giving the cheaper wins away for free, bundled with premium Penfold labels.
According to a number of first-tier wholesalers, Treasury Wine Estates requires retailers to buy the same dollar value in low-end labels as the premium Penfold brands such as Bin 128, Bin 389 and Bin 407.
Whilst Penfold demand remains strong, there was only marginal interest in the low-end labels. Even though the sales strategy has worked in the past for TWE, things are coming to a head as low-end wine stock has built up to the point where there are an estimated 600,000 to 800,000 cases of surplus wine.
Treasury Wine Estates has already booked the surplus wine as profit and it’s estimated this can take 2-3 years to clear. Additionally, top-tier wholesalers are pushing back against TWE’s sales strategy.
Should You Buy Treasury Wine Estates Shares?
In a previous research piece, we were quite bullish on Treasury Wine Estate shares, as they have experienced massive growth in revenue thanks to China. Their popularity with the Chinese market means that growth was exceptional with a CAGR of 11% into 2020.
Their share price has grown strongly as well, from around 5.00 p/s in 2015 to 16.35 p/s as of today.
ASX TWE shares are currently trading at a PE of about 40. Even though this is a very high PE, the price was justified due to the massive growth potential TWE had.
However, the supply glut has changed our view on this fundamentally. TWE has artificially boosted their revenues by booking low-end wine stuck in warehouses as profit. Top-tier wholesalers are starting to fight back which would mean slower growth.
If sales of low-end wine slow due to the glut, we could see ASX TWE shares announce a number of profit downgrades and broker downgrades will subsequently follow.
At this point, the prudent thing to do would be to sit tight as there could be a fair amount of downside from here and wait for the stock to moderate. The current PE I don’t feel is justified considering the lower expected revenue growth going forward. On a technical basis, the stock could pullback all the way to 14.59, which is the next support level formed in mid-January and a previous resistance level made in mid-September last year.
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