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China ban hits Treasury Wine hardest, but value seen

Nicki Bourlioufas  |  16 Nov 2020Text size  Decrease  Increase  |  
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Australian companies exporting to China could face difficult months ahead, with Treasury Wine Estates especially battered by potential bans on imports into China – but analysts say its shares have been oversold.

According to media reports this month, China has ordered importers to stop purchasing at least seven categories of Australian goods, including wine, coal, barley, copper, sugar, timber, wine and lobster. While the Chinese government has denied it would implement such a broad-based ban, the prospects of tariffs being imposed on Australian wine, on top of an existing anti-dumping wine inquiry, has seen shares in Treasury Wine Estates (ASX: TWE) fall particularly hard.

Morningstar analyst Adam Fleck says of all listed Australian companies who export to China, “Treasury faces the most risk of ongoing China-Australian trade tensions”.

The company is Australia's largest wine exporter and owns the Penfolds and Lindeman’s brands, sold in China. Following news of potential tariffs, Treasury’s shares fell to around $7.87 on November 5, their lowest level since January 2016, before recovering to around $9.25 on November 13. This is dramatically down on their 52-week high around $19 in November 2019.

Nonetheless, Fleck believes all the bad news is priced in Australia’s biggest wine producer.

“We think the market is already pricing in this risk [to exports from potential tariffs and blocked imports]. In our note published on August 18, 2020, we peg the downside valuation impact at about 20 per cent, owing to China contributing nearly 25 per cent of the company’s profits in fiscal 2020 by our estimate,” he said.

“As such, [the discount] offered by shares versus our unchanged $12.30 fair value estimate screens as attractive.

“While Europe will likely present a renewed challenge due to reinstated lockdowns, this region makes up only 8 per cent of our forecast earnings for the year. We continue to forecast fiscal 2021 revenue climbing about 5 per cent, with operating margins of 22.7 per cent --still down on fiscal 2019’s 24.1 per cent margins, but improved from fiscal 2020’s 20.1 per cent,” Fleck said.

Treasury said it is examining a range of measures to try maintain its revenue, including passing on the cost of tariffs to Chinese customers, reallocating wine to Europe and the US, and boosting investment in overseas vineyards such as in France, which would be exempt from tariffs. The company has also paused on a sale of the famous Penfolds brands to focus on China’s anti-wine dumping inquiry and boosting its wine operations.

Jun Bei Liu, a portfolio manager from Tribeca Investment Partners, also thinks Treasury has been oversold. While she does expect tariffs to be imposed on wine, Liu believes the bad news has been priced into Treasury’s shares.

wine

“While the share price my fall in the short-term if tariffs are announced, it may not stay there for long. The company will find a way to be able to sell its wine back to consumers elsewhere,” said Liu.

“Once the uncertainty regarding potential tariffs passes, I really think Treasury could head above $20,” said Liu.

Temporary threats to thermal coal

In the resources area, Mathew Hodge, Morningstar’s mining analyst, says the greatest threat is to exports of thermal coal, though any effect is likely to be temporary.

“I see the disruption as most likely temporary. The overall picture for coal demand remains pretty robust – both coking and thermal coal,” said Hodge, notwithstanding threats of bans from China,” said Hodge.

“The prices for both [coal] products in China are significantly higher than global seaborne prices. I think we’re likely to see both a supply response in coal, due to the low prevailing prices, and improved demand ex-China as economies recover from covid-19.”

BHP (ASX: BHP) has confirmed that some of its Chinese customers have asked for deferrals of their coal orders amid reports that China has stopped taking shipments of Australian coal. The company recently said that metallurgical coal production rose 4 per cent in the September quarter of 2020 versus a year earlier, and that its guidance for the 2021 financial year remains unchanged, “although we are monitoring for any potential impacts from restrictions on coal imports into China.”

Looking at all other sectors exporting to China such as The a2Milk Company (ASX: A2M) and Blackmores (ASX: BKL), Liu says Blackmores has not taken a hit on the ASX because its products have not been targeted by potential Chinese bans, says Liu. While a2Milk has fallen, it “is perceived to be a New Zealand product,” so its shares have not been hit as hard as those of Treasury,” says Liu.

Moreover, over the longer term, the trade tensions are not likely to severely damage trade between Australia and China. “China will remain a very important trading partner for Australia. I think whatever is happening now will eventually pass,” says Liu.

“China has a history of political trade tensions with other trading partners such as Japan, South Korea and India over the last three decades. However, those tensions have hardly dented trade over with those countries over the past 30 years.”

is a Morningstar contributor.

Any Morningstar ratings/recommendations contained in this report are based on the full research report available from Morningstar.

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