How expensive does Treasury Wine Estates really look?

Having reached innumerable milestones recently, the bigger issue for investors attracted to wine supplier Treasury Wine Estates (ASX: TWE) following its rally to a recent all-time high of $10.36, has less to do with whether it’s a quality growth stock, and more about whether it’s run too hard to justify buying at current levels.

Trading on a price to earnings multiple of 33.16 times – compared to the sector average of 17.2 – a 75% premium to its intrinsic value and well above a median 12 month price target of $9.13, the current share price does appear to be factoring-in a lot of the projected growth Treasury Wine Estates has ahead of it.

To put the magnitude of Treasury Wines Estates’ recent run up in context, the stock is up around 50% since October 2015 on the back of some impressive numbers – including a 72% rise in first-half 2015-16 earnings to $146.8 million, with bottom-line net profit after tax up 42% to $60.6 million, a more than doubling of profits from its Asian business to $46.5 million, plus earnings from the America’s up 67% to $56.2 million – and has outperformed the S&P500 by 41.32%.

Treasury Wines Estates 15 big-hitting, and big-selling wine brands – known as the Priority Portfolio – led by Penfolds, Wolf Blass, Wynns, Beringer, and Lindeman’s now account for 85% of sales, and pulled in 15% more revenue in the half.

But it’s important to remember that having failed to appreciate the full extent of the uptick in performance from the group’s Asia exposed business; the market had underestimated the group’s performance for the six months ending 31 December 2015 by 17%.

The key point is that with exciting developments on so many fronts happening simultaneously across its ever expanding wine empire, the market struggles to digest and make sense of its constant disclosure of good news.

If the gulf in the in the price targets on the stock – ranging from $6 to over $15 – tell us anything meaningful, it’s that analysts differ widely on how they value this stock.

As a result, what remains unclear is exactly how much of the blue sky ahead of Treasury Wines Estates is yet to find its way to the price.

While median price targets may tell us little, some recently revised targets as high as $15.85 suggest that the share price may not be as stretched or exposed as the recent run-up may suggest.

Having successfully turned around its China business, the group is now targeting annual sales growth approaching 20% over the next five years.

Much of this growth will come from the recent launch of Penfolds brands, including Grange Hermitage, in Shanghai and a re-launch of Wolf Blass which are being supported by a tripling of its marketing budged in China.

Assuming this new strategy is successful, Treasury Wines Estates’ China business will, within five years exceed the UK as the third biggest profit contributor for company, behind Australia and the US.

Treasury Wines Estates and its rivals in China are benefiting from rising incomes among the emerging middle class.

While $1.13 per wine case sold has been pulled from out of the supply chain costs, capital expenditure increased $9.1 million to $43.4 million during the period, showing that Treasury Wines Estates is unrelenting on its investment in future growth.

Beyond Asia, one of the great future challenges ahead of Treasury Wines Estates is successfully managing the integration of its $US625 million ($872 million) purchase of Diageo’s wine business, and turning around the fortunes of its previously neglected premium Californian red wine brands.

While Treasury Wines Estates is expected to bundle and sell off some of its commercial wines at some future stage, the stock is also regarded as a potential takeover target.

Having been the subject of two separate buyout proposals from private equity firms KKR and TPG in 2014, it’s likely there will be a future bid for the stock, and this remains another upside for shareholders.

After a bumper 2016 harvest – the best on record – Treasury Wines Estates appears to be on track for rampant earnings in two years’ time, and this has seen some analysts increase their price objective by a little under 20%.

Given that Treasury Wines Estates is on-track to have no debt by 2018 and has pledged to continue driving down costs, further acquisitions from the group are likely, this is also likely to warrant future upgrades.

While both earnings per share (EPS) and return on equity (ROE) have been poor over the last five years, they are both expected to improve; with exceptional EPS growth forecast from $0.30 in 2016 to $0.45 in 2018.

Meantime, ROE which has averaged 3.54% since 2010 is forecast to grow from 6.27% in 2016 to 8.46% in 2018. Equally pleasing, the stock has a total funding surplus of $89.60 million.

Given the very positive momentum on the stock, it seems to be attracting more true believers in the as yet untapped magnitude of its growth trajectory, than those contemplating a shorting strategy.