Clarke's running out of time on Treasury Wine

While Treasury Wine's result may not look so encouraging at first glance, there are signs that Michael Clarke’s strategies are gaining traction. His biggest problem now is a lack of time.

If he weren’t being stalked by two giant private equity firms, Michael Clarke might feel encouraged by his first few months as chief executive of the perennially-challenged Treasury Wine Estates.

With Kohlberg Kravis Roberts & Co and, reportedly, TPG both in its data room undertaking due diligence for potential $3.4 billion-plus bids for the group, however, Clarke may not be given the time to realise the latent potential in the business.

At face value the result announced today doesn’t look encouraging, with Treasury reporting a statutory after-tax loss of $100.9 million against the $47m profit of the previous year, mainly because of largely non-cash significant items of $280.6m.

Earnings before interest, tax and the wine industry inventory accounting treatment were $184.6m and, on a currency-adjusted basis were $193m and within the guidance range the group provided earlier this year.

Beneath the financial numbers, however, there were some positive signs that Clarke’s strategies for the group are starting to gain traction.

While sales volumes were down 6.4 per cent the group’s net sales revenue per case was up 7.9 per cent -- Treasury might be selling fewer cases but it is achieving improved margins from the volumes that it is selling.

There are some legacy issues affecting the volume/margin mix. Treasury had a well-publicised (and costly) inventory problem in the US which cost former chief executive David Dearie his job, generated some very substantial write-downs and led to the bizarre outcome where Treasury was forced to destroy old and obsolete stock.

While the group has almost completed that realignment of inventories in the US, the response to the problem has involved reducing shipments of wine into the US system. Clarke said today shipments would continue to be lower than depletions in 2015.

Clarke is committed to a strategy of “premiumisation” that would see less focus on the volume of wine sold and more on the margin achieved as Treasury focuses more -- and spends more of its marketing dollars -- on its “masstige” and luxury wines and manages its commercial wine portfolio at arms-length from the premium brands.

There is significant latent profitability tied up in the relationship between the subtle shift in strategy and Treasury’s inventory position, something that wouldn’t have escaped the private equity firms.

At the end of the latest financial year Treasury had total inventories (at cost) of $1.23 billion, slightly up on the previous year’s $1.16bn. About 90 per cent of those inventories are masstige and luxury wines -- 42 per cent, or $517m, are luxury wines and about 42 per cent ($525m) of the total inventories are classified as “non-current”.

With Clarke’s focus on Treasury’s premium wines, including a big increase in  marketing support and a radical change to the release schedule for Penfolds products, that non-current inventory represent a pool of future profitability within an industry context of improving supply/demand equations and increasing demand at the higher price points.

Clarke is particularly optimistic about the fundamentals of the US market -- that has been a particular source of problems for the group -- and Treasury’s improved ability to supply it with premium wine. Earnings from the Americas business rose 12 per cent.

There are some challenges in the group’s home market, with earnings in Australasia down 31.8 per cent, but the success of the Penfolds’ wine cabinet promotion towards the end of the financial year, changes to its release schedule and planned increase in promotional spending provides some upside.

Treasury was also hit by the crackdown on conspicuous consumption in China, with earnings in Asia down 12.5 per cent. Clarke said, however, depletions in Asia ran well ahead of shipments, sales had grown and the outlook was positive.

He describes the 2014 financial year as a “re-set” year and believes the group is now about to return to growth as it invests more heavily in its key brands, continues to reduce costs and put the excess US inventory position behind it.

Whether or not he gets the opportunity to capitalise the outcomes of his strategies in a listed company share price, however, is dependent on the outcomes of the due diligence investigations now being conducted by the two private equity firms and whether not they follow through with their foreshadowed offers of at least $5.20 a share.

Treasury’s chequered history probably means that an offer at or above that level will probably succeed, despite Clarke’s confidence that he can significantly improve Treasury’s performance and end the cycle of disappointment that has been a feature of its performance since it was put together by Foster’s a decade and a half ago.

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