Last week Treasury Wine Estates Ltd (ASX: TWE) released an announcement informing the market that the company was considering a demerger of its flagship Penfolds business into a separate company listed on the ASX.
According to Treasury Wine, the rationale behind the demerger is that it will allow the company to streamline its internal operations and allow further clarity on expansion if its luxury and commercial portfolios. In addition to a possible demerger, Treasury Wine also informed investors that operations in China are in the process of recovering, with staff in the country returning to work.
So, does the potential demerger and recovery in Chinese operations make the Treasury Wine share price a buy?
Why does Treasury Wine want to demerger its Penfolds brand?
Penfolds is an iconic luxury wine that boasts impressive profit margins and is poised to enjoy significant growth tailwinds in Australia and abroad. According to Treasury Wine management, Penfolds accounts for 10% of the company's wine volume, yet contributes more than 60% to earnings.
Treasury Wine believes that the potential demerger would allow management to add long-term value by focusing on strategic priorities and expanding the Penfolds luxury portfolio. In addition, Treasury Wine would also have the flexibility to restructure and reduce the fixed costs of its commercial portfolio.
According to management, the end result of a demerger would result in more value as the company deletes lower margin brands and improves the cost of goods sold. Under the suggested demerger, exiting Treasury Wine shareholders will own a share in Penfolds in proportion to their existing holdings.
Will a demerger add value for shareholders?
As reported by the Australian Financial Review (AFR), analysts from Citi are of the view that the demerger proposed by Treasury Wine would result in vastly different entities and would not result in immediate value creation for shareholders. If a demerger were successful, analysts predict that Penfolds' cost of capital will be higher and leverage capacity lower than the current combined businesses.
According to the analysts, the timing of a potential demerger also doesn't make sense. Currently the coronavirus pandemic has seen reduced demand for both luxury and commercial items. As a result, without an offset, a demerger will not provide any value for shareholders.
Foolish takeaway
The Treasury Wine share price has slumped more than 33% since the start of the year. Many analysts are sceptical about the potential demerger and fail to see how the strategy could create value for shareholders.
Earlier this year, Treasury Wine revealed an unexpected decline in profits from the US. As a result, the company faces a potential class-action from shareholders who allege that the company breached continuous disclosure laws. Coupled with this is the impact that the coronavirus pandemic has had on demand for Treasury's luxury and commercial wines. China remains the most profitable market for Treasury Wine and a timeline for a full recovery remains uncertain.
Treasury Wine faces multiple headwinds and the outlook for the company remains clouded. Despite the uncertainty, the company does boast premium products that are highly sought after. I think a prudent strategy would be to keep the Treasury Wine share price on a watchlist and wait for clarity before making an investment decision.
