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Trade row a 'double-edged' sword for Aussie plays

Glenn Freeman  |  03 Jun 2019Text size  Decrease  Increase  |  
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The escalating US-China tariffs row is a “double-edged sword” for Australian companies doing business with the world’s two superpowers, says Morningstar Australia's director of equity research Adam Fleck.

Treasury Wine Estates (ASX: TWE), A2 Milk (ASX: A2M) and vitamins company Blackmores (ASX: BKL) each count sales into China as a considerable driver of revenue, but Fleck anticipates no long-term negative effects from the escalating trade tensions between the US and China.

"Any slowdown in the Chinese economy because of tariffs would be negative for any company that is garnering a lot of money from Chinese consumers," Fleck says.

"But the other side of that is that if there is a tariff put on goods from the US, it could be a good thing for Australian companies."

The long-running trade skirmish between the US and China has escalated in recent months, stoking fears of a hit to global growth, which could in turn spur a recession. The US has increased the pressure in recent days by announcing punitive tariffs on key trading partner Mexico.

Tariffs a potential positive

In the case of Treasury Wine Estates (ASX: TWE), Fleck notes it has already benefited from a drop in the tariffs China imposes on Australian wine exporters.

Indeed, China's 15 per cent rise in tariffs on US wines may actually make Treasury's product more attractive. However, Fleck notes that given the products tend to be pitched at a wealthier upper-middle class demographic, the impact on individual wine labels of any price increases may be muted.

Fleck describes Asia as Treasury's primary growth engine: "With less than 5 per cent market share in China, the company’s runway remains long, in our opinion."

He says revenue in the segment grew 32 per cent year-on-year in the first-half fiscal 2019 as Treasury further expanded its distribution in the region and concentrated on high-priced luxury and "masstige" wines. The term masstige refers to mass-produced, relatively inexpensive goods that are marketed as luxurious or prestigious.

"Treasury’s distribution and sourcing strategy in China supports its market share aspirations and our forecast growth rates.

“Unlike many competitors, Treasury does not use a national distributor, opting to instead work directly with wholesalers, retailers, and on-premises customers. This enables the company to capture a greater percentage of the end retail price of its wine," Fleck says.

And China is not its only growth engine. Europe is a key market, while the combined Americas and Asia contribute pre-tax earnings of 72 per cent. Fleck expects this to rise to 80 per cent over the next five years.

"Volumes grew faster than market in Australia, tracking our expectations, but were flat in New Zealand following a shift in distribution in the prior corresponding period,” Fleck says.

"However, we expect the top line to rebound in the second half of fiscal 2019 and grow at a mid-single-digit rate over fiscal years 2020 and 2021, while profitability continues to tick up given further favourable product mix developments.”

With a fair value of $12.30, Treasury's share price was $14.58 at 3pm today.

A2 finds formula for growing China market share

A2 Milk has long been linked with Chinese consumers, who have drawn media headlines in Australian for their habit of clearing shop shelves of the company’s baby formula.

But Fleck believes A2 Milk is largely immune from the fallout of trade tariffs chiefly because infant formula tends to be more of a consumer staple than a cyclical product.

"While the company has been wrapped up in the trade narrative, most of their competitors tend to be in Europe," he says.

A2 Milk's market share in China continues to increase, having risen to 6 per cent in key cities across China at the end of March, up from 5.4 per cent in December 2018.

"This supports our February increase in near-term share gains to a forecast 6.7 per cent by the end of June 2019 versus our prior 5.9 per cent," Fleck says.

"We continue to forecast that A2’s Chinese market share can improve to 15 per cent by fiscal 2028, supported by further distribution expansion and solid execution."

A2 Milk's share price closed at $15.80 on Monday – a 15 per cent premium to Morningstar's fair value estimate of $13.60.

Geographical spread drives Blackmores’ earnings resilience

Morningstar senior equity analyst Adrian Atkins says Asia now represents close to 40 per cent of total group revenue for vitamins maker Blackmores.

"We believe the Asian alliance strategy, connecting Asian consumers with Western and Eastern natural health, is the right approach,” Atkins says.

Partnering with dominant traditional Chinese medicine companies and healthcare retailers in China – and a similar approach in Singapore and South Korea – will help grow revenue, Atkins says.

Still, there are risks such as the effects of a potential downturn.

"The vitamin, herbal and mineral supplement market is highly competitive, and an extended economic contraction could test the resilience of company sales revenue that has so far been robust.

"Blackmores needs to balance the protection of margins against the premium status of its brand that commands higher pricing than competitors," he says.

Currency movement also poses a risk as some 98 per cent of Blackmores raw materials are sourced from overseas.

At the close on Monday, the company was priced at $90.90 – an almost 15 per cent discount to Morningstar's fair value estimate of $105.

is senior editor for Morningstar Australia

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

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