Treasury Wine's glass is half full

A sliding Australian dollar and the burgeoning strength of the US economy add a positive dimension to Treasury Wine's recovery.

One of the more interested observers as the Australian dollar continues to slide would be Treasury Wine Estates’ Michael Clarke, given that the big change in currency relativities adds an increasingly positive dimension to his strategy for revitalising the perennially disappointing group.

While he has been cautious about the extent to which he has provided guidance for this year, preferring to deliver rather than promise, there is little doubt that Clarke, having seen off approaches from two private equity groups last year, is aware that Treasury needs to demonstrate a structural improvement in its performance.

He has completed the first part of his strategy (and the one over which he has had most control), lowering Treasury’s cost base and realigning inventory levels in the difficult US business by maintaining shipments of wine into the US at levels below depletions.

He has also increased the marketing spend on core brands and introduced some innovative approaches to marketing, including the controversial and potentially risky (but apparently successful) rescheduling of the release dates for his key Penfolds brand.

Those are changes within his control, as is the shift towards the much-talked about but never implemented strategy of 'premiumisation' and the rationalisation of Treasury’s sprawling portfolio of commercial wines to focus on its key 'masstige' brands in Australia and the US.

Something that will presumably be clearer as this year progresses is how Clarke plans to exploit the big store of latent value Treasury has built within its inventories, which include more than $500 million of 'luxury' wines.

One of the more potentially controversial elements of the strategy Clarke has outlined relates to acquisitions in the US, a business that Treasury shareholders have been urging over the years should be sold.

Clarke told last year’s annual meeting that the group doesn’t have sufficient scale in the US to win its fair "share of mind" with US distributors and also that Treasury’s supply constraints weren’t allowing to fully participate double-digit volume and value growth being experienced in that segment in the US.

Over the decade and a half that Foster’s has had a platform in the US since acquiring the Beringer business it has looked at acquisitions. These have included Robert Mondavi, Brown-Forman and Kendall-Jackson at various times. That was a recognition both that it was sub-scale in the US and that the price it had paid to enter the market could only be justified by the synergies from subsequent acquisitions.

Clarke isn’t looking to buy brands. He wants more secure access to more high-quality grapes to better utilise the existing production platform he has in the US, to give the business the scale he seeks and to enable it to reduce its commercial portfolio. That’s a lower-cost and lower-risk strategy for improving the group’s business model in the US.

It is worth noting that the private equity players, Kohlberg Kravis Roberts & Co and TPG, were so impressed by Clarke’s plans during their due diligence programs last year that they ditched their own plans for the business to embrace his.

If the core of Clarke’s approach is to shift the volume/margin mix to focus more on higher-value and margin brands margin than simple volume, the falling Australian dollar ought to provide a meaningful bonus during what he has quite candidly described as a 're-set' year for the group.

Treasury, with its largest production base in Australia and its two big offshore markets the US and UK, is sensitive to currency relativities.

A year ago the Australian dollar was trading around US90c and six months ago it ended the financial year at US95c. A year ago it bought about 55p and it started this financial year around that same level.

Today the Australian dollar, as a result of the combination of the strength of the US dollar, the growth in the US economy and the collapse in commodity prices, is trading at five-year lows against the US dollar at just over US80c and has slid slightly against the pound.

Earnings from its exports from Australia will be enhanced and there will be a material translation benefit from its US earnings. In the post-financial crisis era, the currency has been a drag on Treasury’s performance.

The other big drag, of course, has been the state of the US economy for most of the post-crisis period. But it is now displaying signs of gathering momentum to the point where US interest rates are expected to start rising around mid-year as the US Federal Reserve Board begins normalising monetary policy settings.

Stronger US confidence and demand and a continued strengthening of the US dollar against other currencies would help support Treasury’s recovery. These factors could give Clarke a windfall that he could either reinvest in the business to support its longer-term prospects or that he could allow to fall through to the bottom line.

Treasury is a business that could do with a bit of external help -- it hasn't had much luck from those external settings over the past decade and a half. Now it might finally be experiencing some.

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