Treasury Wine Estates (TWE)
Pre-COVID, TWE was one of the ASX’s great growth stocks, delivering shareholders strong returns over many years. In recent years, COVID and the China tariffs on Australian imported wine have knocked the stock for six.
Just when its share price was starting to recover given Australia/China’s improving government relationship and the possibility that the absorbent tariffs could be removed, it announced a big acquisition of Paso Robles luxury wine business, DAOU Vineyards (DAOU) for US$900m (A$1.4bn). While the acquisition is in line with TWE’s premiumisation and growth strategy and will strengthen a key gap in Treasury Americas portfolio, it was much larger than the market was expecting.
Consequently, it required a large equity raising to fund it. It will therefore take some time for this raising to be absorbed by the market. Additionally, there have also been mixed views from some camps on the acquisition given TWE’s chequered history in the US under previous management teams. We take some comfort that its last acquisition in the US, Frank Family Vineyards, has gone extremely, well beating its original business case, albeit it was a much smaller acquisition than DAOU.
Post this transaction, TWE will become the largest player in the US luxury wine market. In the future, TWE will have two luxury wine businesses of scale – Penfolds and Treasury Americas Luxury. Both these businesses which are high margin and high growth, will make up the bulk of TWE’s earnings and will command higher trading multiples. Over time, to focus on its luxury wine businesses and to realise shareholder value, TWE may look to demerge or divest its much smaller Treasury Premium Brands business unit. The key near-term catalyst for the stock is China removing the tariffs on Australian wine imports.
TWE’s FY24 guidance and long-term earnings expectations do not assume any benefits from a positive outcome in relation to the review of tariffs on Australian wine into China. If China tariffs are removed, there is upside to its growth expectations over the coming years. While TWE will report a weak 1H24 result, from the 2H24 onwards it has the drivers in place to deliver solid earnings growth over the next few years. We are therefore taking advantage of recent share price weakness to get set for what should hopefully be a strong rerating over coming years.
Lovisa (LOV)
Although the share price of Lovisa has increased nearly 10x since listing at $2 nine years ago, the ride has never been a smooth one. Before the most recent correction, there have been three periods when the shares have fallen by more than 40% (June 2018 to January 2019; October 2019 to March 2020; and November 2021-June 2022) and, on each occasion, the price has bounced back to a new all-time high.
We’re confident the ~30% fall in the share price since April this year will be no different. To appreciate the reasons for our view, it’s important to understand the causes of this most recent period of share price weakness. One is the broader cyclical move away from consumer discretionary stocks due to concerns about household spending in the context of rising borrowing rates and stubbornly high inflation around the world.
Cycles turn, and when interest rates finally show signs of plateauing and inflation begins to normalise, it is likely investor sentiment towards the sector will warm up and Lovisa shares will be much sought-after as a way of playing the recovery.
A second reason for Lovisa’s recent share price underperformance is the recent move into negative like-for-like sales growth. So far this financial year, sales on a comparable store basis have fallen by 6%. Investors don’t like to see this, but it has been experienced against an unusually strong period last year when like-for-like growth was +16% following an uplift in selling prices. On a two-year basis, growth is still very positive. We expect negative like-for-like sales to be a temporary function of cycling strong comparative numbers and we expect a return to positive growth from around March next year.
Furthermore, the key value driver for Lovisa is the expansion of its global network and we think it should be remembered that Lovisa grew total sales by 17% in the first 20 weeks of FY24, demonstrating the benefit of this expansion. Lovisa recently announced that it will shortly be opening its first stores in mainland China (population: 1.4 billion) and Vietnam (population: 99 million), a development that could lock in substantial network expansion for the future.
Lovisa has proven it can successfully build out its unique brand in many diverse territories around the world on its journey to becoming a truly global brand. It’s at times like these that investors should be getting set to reap the rewards of this strategy over the longer term.
ResMed (RMD)
RMD has lost nearly A$7bn in market capitalisation (more than 1/3 of its total value) in a mere quarter, unprecedented in 24 years of listing, due to investor angst around the potential impact of weight loss drugs, namely GLP-1s (Glucagon-Like Peptide-1), in curtailing the core obstructive sleep apnoea (OSA) addressable market. Hype and hope tend to spring eternal in medicine.
We believe talk of an emerging weight loss drug ‘revolution’ should not feared as an existential threat, but instead as a unique opportunity to buy a quality global franchise at a discounted price, especially considering the impact of weight loss drugs is likely to be fairly limited given the following.
First, it is a mere fallacy to simply assume drugs that reduce obesity will ‘cure’ OSA, despite the majority (~65%) of OSA being linked to excess body weight. Unfortunately, nothing in medicine is ever that simple, especially when you are dealing with a complex, chronic disease that is driven by a myriad of underlying factors. Even bariatric surgery, which is and is likely to remain the most effective intervention for obesity treatment and long-term maintenance of body weight, is not a ‘cure’ for OSA. However, bariatric surgery has been shown to reduce OSA severity, but this has had no discernible impact on RMD’s top-line growth.
Second, weight loss drugs have historically suffered from low adherence and high relapse rates, along with a long and chequered safety profile. We have no reason to believe the latest iteration in this class, which is actually more than 15 years old, should not follow suit.
Third, affordability and accessibility should not be underestimated, as the prevalence of obesity is most acute in lower socio-economic demographics. Recent published reports indicate that ~25% of Americans already have difficulty affording their medications, with ~30% not taking their medicines as prescribed at some point in the past year due to the cost. At an annual cost of US$10-15k, GLP-1s are beyond the realms of affordability for most of the population.
Lastly, OSA represents a large (>1bn) and underdiagnosed (<5%) market for RMD’s gold standard continuous positive airway pressure (CPAP) devices. Even if we assume an aggressive 50% uptake of weight loss drugs, the OSA market for CPAP would remain deeply underserved (<10%). As such, it is really OSA diagnosis and not the potential competitive treatment from weight loss drugs, that is the limiting factor for the uptake of CPAP. More realistically, the weight loss drugs are likely to complement rather than compete with CPAP; ultimately, helping to increase awareness about obesity and opening up the market to more patients who seek treatment.
The bottom line, and in the words of ‘The Oracle of Omaha', “be fearful when others are greedy and be greedy only when others are fearful."
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