Treasury Wine learns to live without China

A year after tariffs shut the door on Chinese markets, Aussie winemaker Treasury Wine Estates’ pivot to the US is bearing fruit, demonstrating that businesses can learn to live without Chinese markets.

TWE’s earnings in mainland China fell $77.3 million for FY 2021 after China’s Ministry of Commerce slapped a 175.6% tariff on Australian wine. But a pivot to other markets like the Americas, where earnings grew 23%, helped keep overall earnings for FY 2021 flat at $510 million.

The shift was greased by the popularity of high-demand premium brands like Penfolds, says Morningstar equity analyst Angus Hewitt. The vanguard for Treasury’s China strategy, these premium brands have been redeployed to other markets.

“These alternative markets have been starved of high-end Penfolds product under the company’s strategy to limit global production,” he says.

The contribution of Asian markets to total earnings fell 5% to 37% in FY 2021. Australia and the Americas grew their contribution by 2% and 4%, respectively.

Work began after tariffs were imposed last November. This year the winemaker sold four lower-tier US brands for US$100 million. As part of its Investor Day, the company presented its new operating model, talking up US markets and its highly profitable premium brands like Penfolds.

Treasury has notched early successes thanks to the popularity of new premium labels like the Snoop Dogg fronted “19 Crimes” in the US. Margins were up 4.2% as prestige brands took centre stage.

“They’re trying to pivot to higher end wines and not be super reliant on the growth story of one country, which has burnt them,” says Hewitt.

The loss of Chinese markets, which accounted for 30% of earnings in FY2020, was painful. Beyond the immediate hit to earnings, the winemaker is locked out of the demographic growth story that has drawn so many companies to the world’s most populous nation.

In its 2019 annual report, the company had outlined a three-pronged model for targeting the Chinese market, with 40 “priority” cities flagged.

“The growth story for them disappeared overnight. It’s not so much the volume they lost, it’s the potential volume they lost,” says Hewitt.

Hewitt expects the shift to high-end wines and a wider spread of markets will help long term profits, but it’s not enough to earn the winemaker an economic moat in the highly competitive wine industry.

No-moat Treasury Wine Estates closed Friday at $12.37, slightly above the fair value estimate of $11.50.

Sanctioned Aussie exports find new homes

Wine was only one of several Australian exports to bounce back after being slapped with Chinese tariffs.

In late 2020, China imposed tariffs or other restrictions on Australian products ranging from barley to coal.

Most impacted exports found new homes outside China, says Stephen Kirchner, director of the international economy program at the United States Studies Centre at the University of Sydney.

“The general story is similar to wine. Mostly we’ve been able to divert to other markets and the impact has been small.”

Barley producers found new markets in the Middle East and South Asia, while coal exports were rerouted to India, Japan and Korea.

The resilience of Australian exporters comes at a time when tensions are again rising between Beijing and Canberra.

In September, Australia signed up for at least eight nuclear submarines as part of a new defence agreement with the US and UK. China condemned the deal as “extremely irresponsible”.

Iron ore could in the crosshairs if China were to turn to tariffs again, says Kirchner. The crown jewel of Australian exports, it makes up half the trade surplus, with the majority destined for China.

“I wouldn’t be surprised if they hit us on the margin with iron ore,” he says.

Its low cost and importance—about 60% of Chinese iron ore imports are Australian—have kept it off the table so far. Kirchner says Beijing’s crackdown on its technology sector demonstrates a willingness to inflict economic pain for political ends.

But he’s confident Australian iron ore could find a new home in the event of Chinese tariffs. Where Treasury Wine led, iron ore could follow.

“It highlights the long run ineffectiveness of China’s economic statecraft. It paints China as unreliable and encourages the diversification which undermines the tool itself,” he says.