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Edited Transcript of TWE.AX earnings conference call or presentation 28-Jan-20 10:00pm GMT

Half Year 2020 Treasury Wine Estates Ltd Earnings Call

Victoria Feb 10, 2020 (Thomson StreetEvents) -- Edited Transcript of Treasury Wine Estates Ltd earnings conference call or presentation Tuesday, January 28, 2020 at 10:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Matthew John Young

Treasury Wine Estates Limited - Company Secretary & CFO

* Michael A. Clarke

Treasury Wine Estates Limited - CEO, MD & Director

* Tim Ford

Treasury Wine Estates Limited - COO

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Conference Call Participants

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* Andrew J. McLennan

Goldman Sachs Group Inc., Research Division - Consumer and Retail Analyst

* Belinda Moore

Morgans Financial Limited, Research Division - Senior Analyst

* Ben Gilbert

UBS Investment Bank, Research Division - Executive Director and Analyst

* Craig John Woolford

Citigroup Inc, Research Division - MD and Head of Australian Consumer Research Team

* David Errington

BofA Merrill Lynch, Research Division - Head of Consumer Research for Australia and Asia

* Jason Palmer

Taylor Collison Limited, Research Division - Equities Analyst

* Larry Gandler

Crédit Suisse AG, Research Division - Director

* Peter J. Marks

Morgan Stanley, Research Division - Research Associate

* Phillip Kimber

Evans & Partners Pty. Ltd., Research Division - Executive Director of Consumer

* Richard Barwick

CLSA Limited, Research Division - Research Analyst

* Shaun Robert Cousins

JP Morgan Chase & Co, Research Division - Senior Analyst

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by, and welcome to the Treasury Wine Estates F '20 Half Year Results. (Operator Instructions) Please be advised that today's conference is being recorded.

I would now like to hand the conference over to your first speaker today, Mr. Michael Clarke. Thank you. Please go ahead.

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Michael A. Clarke, Treasury Wine Estates Limited - CEO, MD & Director [2]

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Good morning, and thank you for joining Treasury Wine Estate's Fiscal 2020 Interim Results Briefing. Joining me today is Tim Ford, our Chief Operating Officer; and Matt Young, our Chief Financial Officer.

I'd like to start the call today with a conclusion. We slightly missed H1 EBITS versus our expectations, and based on our revised full year forecast, our growth rate in F '20 will be less than previously guided. This is driven primarily by a miss in our U.S. results due to: firstly, unexpected changes in our U.S. leadership resulting in a loss of execution momentum through H1 that will carry into H2; secondly, U.S. market dynamics being that all suppliers are trying to move surplus wine across the market at lower prices resulting in an accelerated growth of private label. Private label is up 15% in a market that is flat to down. This is a massive market shift in a very short period of time, especially after the recent U.S. vintage in October; thirdly, as a result of these market dynamics, we have not been able to recover or offset higher U.S. luxury COGS and higher Australian commercial COGS due to higher levels of discounting being required to try and maintain share across all price points. And also, we walked away from just under 0.5 million cases of commercial volume in the U.S. due to private label growth, aggressive pricing and our higher COGS.

We've looked at whether we can recover this H1 shortfall in H2, but given the continued market dynamics in the United States, we believe that those aggressive one-off recovery activities, e.g., aggressive pricing, would not be repeatable in F '21, and we would rather stay on our journey of growing our company profit each year, but for fiscal '20 and fiscal '21, at slightly lower growth rates than previously expected, and reset the U.S. management team and rebuild momentum in execution, and strategically review how we will manage our U.S. and global wine -- global commercial wine business differently and go into the back half of F '21 and then F '22 stronger.

We'd rather address these 2 setbacks, U.S. management changes and the U.S. market dynamics, while continuing to grow our company profits every year. We have considerably improved the profitability of our Commercial wine business over the last 6 years by rightsizing it and also removing costs and outsourcing supply to third-party suppliers. Given these accelerated market changes, private label, we will now address how we manage this part of our business differently so it continues to support, not drag our premiumization strategy. It should be noted that we pleasingly continue to grow our Luxury/Masstige business across every region: Asia, ANZ, United States and EMEA, and this is a real growing strength of Treasury Wine Estates.

Turning to the results. The quality of our results we are announcing today reflect the fundamental strength of our global business model, which sources multi-regionally, sells multi-regionally and is the most self-distributed wine business in the world. This business model, which we've been progressively strengthening over the past 6 years, has enabled us to continue our journey of delivering sustainable organic growth and in the first half -- in the first half of 2020, against the backdrop of challenging conditions in one of our key markets, the United States.

In the first 6 months ended 31st December 2019, we delivered continuing growth across key financial metrics, driven by the ongoing execution of our premiumization strategy which is gaining momentum in each of our geographies. Headline net sales revenue grew 2% driven by the growth of our Luxury and Masstige portfolios which grew 7% in the first half and now represents approximately 73% of our global net sales revenue, and is reflected in our NSR per case which grew 8% in the half.

Group EBITS increased 6% to $366.7 million and EBITS margin grew 0.9 percentage points to 23.9%.

Net profit after tax before SGARA and material items, was $229 million, up 5%. And earnings per share increased 5% to $0.319 per share.

While we remain very pleased with our performance across Asia, Australia, New Zealand and EMEA, our first half performance in the Americas region has been a setback and is disappointing given the high expectations we have for growth in this important market. Later in this call, Tim will walk -- will talk in some detail to the performance of each region, but ahead of that, I'll now spend a few moments talking about some of the short-term dynamics we have experienced in our key markets which have had an impact on the results and are announcing today.

Starting in the United States, where first and foremost, the recent unforeseen changes in our regional management were a setback for us and led to loss in our execution momentum and, therefore, performance through the half. Exacerbating our own loss in momentum were challenging conditions in the United States wine market which, as we've highlighted previously, is undergoing a period of considerable change. And the pace of this change and its impact on our business has accelerated over the past 3 to 4 months, post-vintage.

The trade war is having an impact on the market, including our partners and competitors, where wine that was going to be sold in Asia is now staying in the United States market. This, along with higher average vintages, has led to higher-than-expected levels of industry supply which have subsequently been discounted in the United States.

Further, the presence of some large market players who are either currently in the process of or are looking to exit their wine businesses is proving to be a significant disruption in the market as price discounting and aggressive investment in promotional support is being used to prop up volume and value share ahead of potential sale.

In response to this, large market players are increasingly moving commercial quality product as exclusives and private label propositions, something which has driven an accelerated structural shift and phenomenal growth in private label despite the broader market declines we are witnessing across commercial price points.

In order to try and maintain market share, we have also invested in promotional support, but this has come at a high cost and has limited our ability to offset the COGS pressures that we previously flagged as something we would need to navigate in fiscal '20.

Across parts of our commercial portfolio, however, we have simply chosen to reduce lower volume commercial volume -- lower margin, sorry, commercial volume, where this has been the most appropriate course of action for us.

On a positive note, our performance across Luxury/Masstige has been strong and had depletions growth of 10% and 5%, respectively, in the half. And we are outperforming the market at these price points.

While the current environment is proving to be a challenge and is going to impact our group performance in F '20 and F '21, we remain very confident about both the market and our long-term prospects in the United States. Our strategy of premiumization, complemented by growing distribution and availability of our focused brands through our optimized route-to-market, is the right one and supports our confidence that we will regain momentum under a new regional leadership team once the market impacts subside.

Turning now to China, where luxury wine consumption remains robust and our portfolio continues to exhibit strong momentum, with our depletions growth tracking at over 40% up in the first half. We continue to perform well ahead of the market and our competitors to grow share in the imported wine market, testament to the strength of our competitively advantaged business model.

In the half, we've continued to observe trends of industry tightening in working capital across the market where our customers have needed to reduce the inventory levels of our competitors' inventory, a trend that analysts who track Chinese customs data and observe declining levels of wine imports into the market will be quite familiar with. This tightening in working capital has impacted one of our largest customers, an exclusive wholesaler of Rawson's Retreat and some of our lower luxury brands, who has needed to restructure their business and reduce their overstocking of competitor brands. Therefore, we have reset our customer partnership model with this partner to better balance distribution of these brands with a broader set of partners, and we expect to get back on track in the second half to ensure continued shipment growth of Rawson's.

Our volume and net sales revenue growth in the region, excluding this one partner, was up 14% and 22%, respectively in the half. Away from the temporary impacts of one customer, our competitively advantaged business model centered on self-distribution and investment in marketing and pull-through programs across our focus brands, is continuing to drive growth in this market and is a reason we are continuing to perform significantly better than all our competitors.

In summary, we're pleased with the continued strong performance of our business in ANZ, Asia and EMEA, where EBITS outside of the United States are up collectively 20%. And whilst we have suffered an execution setback in the U.S. market, our focus on the growing Luxury/Masstige segments, coupled with our optimized route-to-market, which is delivering strong performance in the direct states, supports our confidence that we remain firmly on the right path with this important region.

I'll now hand over to Matt, who will take us through the financial results in more detail.

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Matthew John Young, Treasury Wine Estates Limited - Company Secretary & CFO [3]

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Thanks, Mike, and good morning, everyone.

Our premiumization strategy and global business diversification have enabled us to deliver sustained margin-accretive earnings growth this half despite the setback in U.S. performance. And as always, we've continued to invest heavily in future growth through the key parts of our value chain focused on premiumization, whilst at the same time, maintaining a strong and flexible capital structure.

Looking at our key measures of performance. Group net sales revenue grew 1.9% on a reported currency basis but declined 0.7% at constant currency driven by volume declines across the commercial portfolio where volume was down 10% this half. This impact was partly offset by continued premiumization towards Luxury and Masstige wines which grew 7%, leading to NSR per case growing 5% on constant currency basis and 8% on a reported currency basis to $87 per 9 LE.

COGS per case increased in part due to the premiumization shift but also due to the higher cost of Australian commercial wine as well as U.S.-sourced luxury wines from higher-cost vintages, partly offset by lower COGS on Australian luxury -- Australian-sourced luxury wine. Higher commercial COGS have been difficult to mitigate due to the accelerated declines in commercial category arising from increased promotional activity in the market and accelerated growth in competition from private label.

Cost of doing business margin increased slightly to 20.6% driven primarily by a reduction in NSR. In first half '20, cost of doing business increased due to incremental brand-building investment in Asia and higher promotional activity in the U.S., partly offset by favorable overheads through continued optimization and simplification of our business and operating models.

EBITS increased 6% on a reported basis to $367 million, and EBITS margin increased to 23.9%, moving us closer towards our margin target of 25% and beyond.

Material items of $22 million or $16 million after-tax, in relation to our investment in luxury wine-making capacity in South Australia, led to a slight decrease in reported earnings per share to $0.29. Before material items in SGARA, earnings per share increased 5%.

And finally, ROCE increased 1.1 percentage points to 13.6%, reflecting continued disciplined management of our capital base.

Moving now to the balance sheet, which continues to be efficient and flexible. Net assets increased $69 million driven by an increase in working capital and right-of-use lease assets upon the application of AASB 16. Higher working capital relative to June 2019 reflects the normal operating cycle, with higher receivables driven by the growth in NSR and weighting of Q2 sales ahead of key consumption occasions. Against first half last year, working capital balances demonstrated year-on-year efficiency with debtor days, in particular, showing improvement.

As you all know, AASB 16 leases became effective for TWE first of July 2019, and we've applied this standard on a fully retrospective basis. This has resulted in a grossing up of assets and liabilities on our balance sheet, an increase to EBITS and a decrease to net profit after tax. A full reconciliation of the impact on first half '19 is provided in Appendix 1 to the profit report, and for full year impacts, we presented this in our F '19 full year results announcement.

Turning now to inventory in more detail, which has increased by $50 million to over $2 billion on our balance sheet, valued at cost at the end of December '19. Noncurrent inventory increased $122 million, driven by luxury volume, the result of a strong 2019 luxury vintage in Australia, which was up approximately 10% for TWE on the 2018 vintage. Current inventory declined $73 million, reflecting updated sales volume expectations for the U.S., along with efficient inventory management of bulk wine sourcing arrangements across the Masstige portfolio.

I would make 2 additional points with respect to our inventory balances. Firstly, whilst we have described today some challenges in the commercial-tier market in terms of higher cost of goods and declining volumes, our flexible sourcing model and strong planning processes allow us to effectively manage our inventory holdings to respond to such changes in market demand trends. And secondly, whilst the size and quality of the 2020 vintage in Australia is still to be determined, we remain comfortable that our Luxury and Masstige inventory position is a source of future earnings growth.

Turning now to cash flow and net debt. Operating cash flow before interest, tax and material items increased to $378 million, driven by higher earnings and offset by working capital outflows, delivering cash conversion of 85%. Excluding the net change in Luxury and Masstige noncurrent inventory, cash conversion was 77%. We retain our full year operating cash flow guidance for growth in line with EBITS growth, and therefore, underlying cash conversion to be approximately in line with fiscal '19.

Finally, we have maintained our investment-grade credit profile, with leverage improving to 1.7x in the year. Our liquidity position remains strong, with cash of $336 million and undrawn committed debt facilities of $722 million at the end of December.

Moving over to CapEx, total CapEx for the half was $113 million, of which maintenance and replacement was $51 million. Growth CapEx of $62 million represented investment in luxury wine-making infrastructure in South Australia and France as well as vineyard acquisitions and investment in IT systems. We expect F '20 maintenance and replacement spend to be in line with the previous guidance range of $100 million to $110 million, and growth CapEx of up to $135 million.

The South Australia expansion is progressing to plan and on track to be operational in time for the 2021 vintage.

Thank you, and I'll hand over to Tim Ford to discuss performance of the regions.

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Tim Ford, Treasury Wine Estates Limited - COO [4]

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Thanks, Matt, and good morning, everybody.

A few points I'd like to make before discussing the regional performance in more detail. Firstly, I'll reiterate that we're really pleased with our ongoing performance across the Asia, ANZ and EMEA regions, all continuing to deliver very, very strong results, with their combined EBITS, including corporate, up 20% on the previous half last year.

In addition to this, I'm confident that the issues we are facing in the U.S. market will be turned around and that we will regain momentum in this market to the levels of business and the financial performance we expect driven and underpinned by our focused premiumization strategy.

Ben Dollard, our new Managing Director or President for the U.S. region has hit the ground running early in January, and I'm very confident that under his leadership, with the broader Americas leadership team we have in place, we'll regain this momentum as we move into the second half, but particularly into F '21 and F '22. We maintain our medium EBITS margin target of 25% for this region based on this.

Also, I want to assure you that as an executive leadership team, we are very, very focused on improving the performance of the Americas region and remain committed to the strategy focused on growing our Luxury and Masstige portfolios that we've had in place and remain confident about the long-term prospects, particularly around this portfolio. We will focus on this whilst continuing to build on what was an excellent H1 performance in all of our other operating regions and businesses.

For more detail on America, as we've called out this morning, results were impacted by a loss of execution momentum and increasing challenging conditions in the market. Net sales revenue decreased 4% on a constant currency basis driven by the commercial volume declines and the increased level of trade and promotional spend required to maintain share. This increased investment and lower volume [has] limited our ability to offset the higher COGS per case in the market which increased 3%, and led, when combined together, to a regional EBITS decline of 26% to $98 million and an EBITS margin of 16.1%.

Whilst clearly we are disappointed with the result, what we are pleased about in this half is the continued premiumization of our portfolio, with our Luxury and Masstige depletions, not shipments, in the U.S. trade, up 10% and 5%, respectively, year-on-year. The Luxury and Masstige segments of this market continue to exhibit strong growth for our business, with our strong depletions performance driven by a very focused brand portfolio in Masstige of 19 Crimes, Matua, Beringer Brothers and St Huberts The Stag, and the luxury portfolio led by Stags' Leap wines, Penfolds, Beaulieu Vineyard and Beringer.

Unfortunately, though, this strong performance in the Luxury and Masstige portfolio was not enough to offset the performance in the commercial segment where our depletions volume declined 10% versus the same half last year. Included in this decline has been a conscious decision to walk away from lower-margin commercial-volume opportunities where it was sensible to do so. As we have said many times previously, we will not chase low or no margin commercial volume for the sake of volume growth but focus our efforts on premiumization. However, we also recognize, based on the half 1 results, the need to ensure better balance than we have achieved in this half between value and volume of the commercial portfolio through disciplined optimization of our commercial investment dollars.

As Mike covered earlier a number of factors, including the trade war potential business divestitures and larger-than-average recent vintages, have led to increased levels of supply in the market in the U.S. and, hence, high levels of promotional activity in the U.S. wine market to move that volume.

In response to this, we have seen not only the high levels of discounting discussed but also strong growth in the private label and exclusive label market as large market players increasingly move what is excellent-quality surplus wine as private label propositions. And at present, private label and exclusives outpaced the market in every price point segment except for luxury.

Whilst the level of supply in the market is something that we are confident will rebalance over time, the accelerated trends within the commercial tier are something we need to navigate differently moving forward. In terms of the performance of our new route-to-market model, we remain very pleased with the progress we are making with both our distributor partners and our direct distribution states. Where we have moved direct distribution in Florida, we have outperformed the market at every price point this half, with luxury growth in Florida the highest in the U.S. for our business overall.

In California, shipments grew year-on-year with portfolio premiumization driven by strong Masstige-led growth. But California remains a work in progress, with the mix shift happening at a slower-than-desired rate, particularly our ability to replicate the growth we have seen in Masstige, which is a significant positive across the luxury portfolio, which whilst in growth is not to the level of the Masstige portfolio.

We continue to focus on luxury product availability and distribution in the independent and on-premise channels, in particular, in California and see this as a significant future growth opportunity.

So in summary, despite a setback in the U.S. this half, which we've explained, we remain confident in our portfolio, our people and our business plans to deliver growth in this business into the foreseeable future.

Turning now to Asia, where we again continued to deliver strong earnings growth across both North and Southeast Asia, driven by strong demand and outstanding execution in our key markets. For the Asia region, net sales revenue increased 7%, and EBITS were up 22% to $176 million, resulting in an EBITS margin of 43% for the half. It's worth noting here, we retain our EBITS -- our previous EBITS margin guidance of 35%, which reflects our expectations for growth in the Masstige portfolio moving forward also.

In North Asia, we continue to go from strength to strength. Our distribution business model is providing us the opportunity to outperform versus our competitors who have not invested in people on the ground, or behind their brands like we have over multiple periods. This investment, along with outstanding execution and leadership by the team on the ground, has driven another great result this half.

As you'll recall, we significantly increased our sales force at the end of fiscal '19, and this, along with a focus on building discipline and efficiency across our partner network for us and our partners, has led to meaningful gains in distribution this half.

In China, Luxury and Masstige depletions grew at an impressive 40%-plus versus the previous comparative period.

Growing our distribution breadth and depth remains our key growth strategy and is working. We have previously identified 40 priority cities for distribution depth focus, and pleasingly, we saw our strongest depletion growth come from these focus cities where our investment has been targeted as well as adding an additional 7 new cities this half, bringing our total cities that we distribute within China to 146.

Also pleasing in this period was the fact that growth has been driven not only by Penfolds, but Wolf Blass has shown impressive growth as well as TWE's French portfolio led by Maison de Grand Esprit and the French portfolio under the Beaulieu Vineyard brand, along with new products introduced into the market over the past 12 months, which would include brands like Saltram. The e-commerce channel has also continued to grow in importance with very, very strong growth in volumes and great momentum behind TWE brands continuing over the half.

As Mike highlighted earlier, one of our major customers in China has restructured their business in this first half, which in turn led to us having to restructure our distribution arrangements for Rawson's Retreat and some lower luxury brands. Hence, this period's metrics, including volume, revenue per case and [EBITS] margin, have been temporarily distorted by this change. We expect normal shipping profiles to resume in this half we're in now, and the fact that lower margin volumes were impacted means it was only a small impact on the earnings in the half.

Southeast Asia performance is equally as pleasing in half 1. Distribution gains have been made in several key markets on the back of improved marketing activation and sales execution, focused on the Penfolds and Wolf Blass brand. This is a market we believe will continue to grow. Increased foreign investment into this region, along with increased tourism, makes this an attractive market with a lot of opportunity for growth moving forward, we believe.

I'll now talk about the ANZ business, Australia and New Zealand business, where we remain pleased, again, with the ongoing performance of this business. Net sales revenue declined 2.5%, due largely to reduced commercial volumes, which was driven primarily again by growth in private label and higher cost of goods, which meant we did not pursue some low-margin volume opportunities, where it was sensible not to do so.

As in the U.S., [explained], we will not chase low-margin volume for the sake of volume growth but continue to focus our efforts on a continued mix shift towards Masstige and Luxury. Furthermore, we experienced some temporary changes in buying patterns from our retail partners across parts of the luxury portfolio as a result of changes to their own liquor strategies, which did affect their short-term luxury buy patterns, but as with the discussion around China, has not impacted our profitability.

NSR per case increased 4.2% in the ANZ business, reflecting continued momentum with our premiumization strategy. Favorable cost of doing business reflecting benefits from the establishment of the global business services function, in particular, drove EBITS growth of 14% to $85.9 million, an EBITS margin of an impressive 26.4%. Our key focus brands, including Penfolds, Wolf Blass, Squealing Pig, 19 Crimes and St Huberts The Stag, are driving top line growth across the portfolio and above-market growth rates in their respective categories.

In the on-premise also, the team has successfully secured significant partnerships with customers this half, providing strong brand visibility in key venues and representing great progress in our on-premise growth strategy.

And finally, turning to EMEA, which now includes both Europe and the Middle East and Africa segment. We are pleased yet again with our performance in this market, maintaining their mid-teens EBITS margin in what is a challenging market, as always. Lower NSR for the total region was driven again by reduced commercial volumes, particularly in Middle East, Africa, where we walked away from volume and -- from unprofitable volume within that business.

This was offset by the premiumization strategy as per other regions in the U.K. and the Nordics, in particular, led by the 19 Crimes brand, Wolf Blass and Penfolds. 19 Crimes continues its strong performance across the region, driven by increased distribution in the U.K., along with growth in Continental Europe as well as the Nordics. And Lindeman’s continues to be the #1 brand in Sweden and the Netherlands. Australian-sourced commercial wine COGS are impacting, as foreshadowed previously, so our focus is on controlling our investment levels and continuing to drive the premiumization to maintain a mid-teens margin in F '20.

So I'll now hand back to Mike for concluding remarks.

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Michael A. Clarke, Treasury Wine Estates Limited - CEO, MD & Director [5]

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Thanks, Timothy.

As I said at the outset of this call, the fundamental strength of our globally diverse business model is reflected in our results today, and there are many areas of our business that are performing to expectation, enabling us to continue delivering growth despite the short-term challenges in the United States. However, we recognize that beneath these short-term challenges are several longer-term trends within the commercial tier which are becoming more prevalent and are increasingly impacting both the markets we operate in and our business, and therefore, we will require a refined approach to moving forward.

These trends, which we've touched on during the call today, include continued increases in commercial COGS globally as well as strong growth in private label, now in the United States as well as Australia and the U.K. And rather than just seeing these as long-term negatives, we believe these trends are actually an opportunity for us to accelerate our premiumization strategy, both through the investment we are making in luxury production, as shared at our recent Investor Day, but importantly, also through further changes to drive simplification focus as well as ensuring that we have the right capital and cost structure for the whole business across all price tiers.

Building on work that we have previously completed, we are currently undertaking a strategic review of our internal operating model focused on how we best manage our commercial wine business differently moving forward. As part of this, we'll be exploring a range of options, including refined supply chain structures and operating models, and this would include options such as internal divisionalization but not demerger.

As I said at the start of the call, we've considerably improved the profitability of our commercial wine business over the past 6 years and it is a valuable part of our business. We expect this review to be completed in H2 and we'll provide further details on this in the coming months, including the potential upside to our future financial metrics as a result of restructuring the business.

In closing, the results presented today reflect the momentum behind our premiumization strategy and the strength of our global business model, which has again, delivered sustainable organic growth despite the challenging conditions in the United States market. While we're disappointed with our performance in the Americas this half, we are confident that we have the right strategy and the right team in place to course-correct and return this important region to margin-accretive growth, particularly once market conditions return to a more stable footing and supply is in line with demand.

Looking at the second half, we expect the short-term impact in the United States to persist through the remainder of this financial year and into F '21, and as a result, we're updating our guidance for F '20 reported EBITS growth to 5% to 10%, which is below our previously guided range of approximately 15% to 20% reported EBITS growth.

For fiscal '21, we expect reported EBITS growth of 10% to 15%, which will be driven by continued premiumization of our -- of -- and growth in luxury wine availability, balanced against our expectation that the challenging market conditions in the United States may persist into the next financial year, along with the potential impact to cost of what looks to be a challenging 2020 vintage in Australia.

This guidance for F '21 excludes potential upside from any further restructuring of the business that will accelerate premiumization and address how we run the commercial wine business differently that could deliver meaningful benefits in the future.

I'd like to thank you all for joining the call today and for your ongoing support of our business.

And with that, we'll now open the call for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question today comes from the line of Craig Woolford from Citigroup.

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Craig John Woolford, Citigroup Inc, Research Division - MD and Head of Australian Consumer Research Team [2]

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Just wanted to ask some questions about the U.S. I'm sure you're not surprised by that. The -- in the results, it seems like the NSR result, in terms of revenue growth, was reasonable but the earnings decline, quite significant. So I'm just trying to understand whether there were additional operating costs in that Americas business. And also, was trade spend higher or did it grow faster than sales? In other words, did trend spend to sales ratio rise in that U.S. or Americas segment?

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Matthew John Young, Treasury Wine Estates Limited - Company Secretary & CFO [3]

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Craig, it's Matt here. I might take that one. I think you can -- what you're saying there is right. A couple of things to identify. You can see that volumes are down in the U.S. market. So there is an element of the volumes, which is a mix through the decline in Commercial, offset to some part by the Luxury and Masstige.

The key point you're highlighting is correct, which is what Mike and Tim and we have talked about, the -- whilst there's also been a decline in volume, there has also been an impact of the increased promotional spend required within that market, the level of discounting that is occurring in the market, predominantly driven by higher vintages and also participants looking to exit their wine business. That is driving increased discounting and promotional support in the market. And you can interpret that both at -- through discounts but also advertising, promotion and costs in order to support that business.

The third trend I'd call is also cost of goods, as we've called out before. Higher cost of goods for the Australian-sourced and U.S. luxury wines has been a challenge in that market, which we flagged, but has been harder to mitigate this year when you also overlay the decline in volumes.

So there's a number of trends in there between volume, promotional support and COGS that are driving the -- what I'd call the leverage down the P&L.

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Michael A. Clarke, Treasury Wine Estates Limited - CEO, MD & Director [4]

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If I could build, Craig, in addition to what Matt's just said. On the COGS line, you've got an extra whammy in that, if you walk away from volume that you had planned to sell. So it's an unplanned walkaway from volume. You get an -- if you get an overhead under-recovery within the supply chain. So that's an additional charge in COGS. So you don't get the contribution but you've still got those costs, which therefore, hurt you at the gross profit line. And also in A&P, there's a bigger spend in trade sell. Clearly, with the surplus wine in the U.S. market, there is increased spend in A&P, in trade sell and also in D&R.

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Craig John Woolford, Citigroup Inc, Research Division - MD and Head of Australian Consumer Research Team [5]

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And that walkaway, was that 0.5 million cases just the U.S. or was it also in the other part of the other regions as well?

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Michael A. Clarke, Treasury Wine Estates Limited - CEO, MD & Director [6]

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It's approximately 0.5 million cases in the United States and approximately 0.5 million cases in other parts of the world. But in other parts of the world, we compensate for that by overdelivering on our Luxury/Masstige growth.

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Operator [7]

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Your next question comes from the line of Ben Gilbert from UBS.

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Ben Gilbert, UBS Investment Bank, Research Division - Executive Director and Analyst [8]

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Just interested in just the pace of change that you saw in the U.S. and I suppose how this has all happened so quickly. So if I look at -- I know you've quoted IRI data and we've got Nielsen data [on the table] that's probably tracking down for you guys around sort of 2%, 3% for the last quarter of last year. But if you look at what's implied, it would suggest that the route, which obviously hasn't picked up from this, sort of the on-premise looks like it was probably materially softer. I was just wondering if you could just sort of talk us through the couple of months and how it came on so quickly. And I suppose how you can still -- how you're thinking about the ability to recover this price over time and I suppose sort of potentially pushing out that expectation for 25% medium-term margins in the U.S.

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Tim Ford, Treasury Wine Estates Limited - COO [9]

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Yes, Ben, it's Tim here. I'll answer that first, and then Mike will build, if that's okay. I think there's a couple of aspects that did exacerbate over Q2. I think, firstly, one of those, and I'll start with it is our internal plans. So clearly, with the leadership changes -- the unforeseen leadership changes with the U.S., did lose our momentum in planning for Q2. So that is one component of it that we're not going to walk away from and we face into.

When you then link that with at the end of the California vintage and the commercial wine vintage component of California, in particular, it was sort of September, October completion, there was a realization right across the market which we realized some months before, fortunately, from an inventory balancing point of view but there was a realization in the market that the surplus wine in that marketplace across the industry was more significant than what people would have first thought and other organizations would have first thought. So that surprised all of us. And what they saw then was a significant increase quickly in the activities we've talked about.

I think also on the back of that, as you're trying to move volume and trying to free up space, post a vintage, every organization started discounting much more significantly. And retailers, who earlier in the half had seen the opportunity that private label -- and I'm sure you looked at the numbers over the 26 weeks, the retail partners had seen the opportunity in private label. And once partners and once suppliers also had the opportunity to supply them with more wine at lower price points under exclusive labels, they most certainly expedited their plans around that at the expense of promotional activity and ranging of branded items.

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Michael A. Clarke, Treasury Wine Estates Limited - CEO, MD & Director [10]

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If I can build, just to add 2 extra contexts to that. If you think about what all suppliers have done, including Treasury, but also major suppliers have done in America with the surplus -- industry surplus situation, you've got a couple of choices. You can try and move that -- you can either sit on the inventory, which no one wants to do, or you can actually move it through your own brands but that means you have to discount your brands aggressively or you take it to a retailer and you offer the retailer either an exclusive trademark name and you move the product that way or you put it into their private label brand. And all major players -- if you look at the IRI, Ben, all major players have done this. And this is the thing we hadn't expected. We managed our inventory intake really well, so we've deliberately reduced our inventory intake in October and our inventory situation at the moment in America is actually really good across Luxury/Masstige and commercial, which is great. And as you know, we outsource commercial we buy it in on the bulk wine market. But what we haven't foreseen was that everyone was going to aggressively try and move their inventory, their surplus through exclusives and private label brands. It obviously made a huge amount of sense for the retailers to do this because that now all of a sudden became really good quality juice that was being moved through them at good margins, whereas all the suppliers took discounts to get rid of that inventory, basically. And that's what, from a structural point of view, has driven this change, which we've now realized obviously at the end of the year that everybody was moving their inventory this way. And that led to private label growing at 15% in a market that is basically flat. That is a massive change in the U.S. market.

Now I do foresee that -- this is my personal opinion, I do see that reversing when the industry gets back into balance and demand is in line with supply, that you're not going to have the surplus inventory to try to find a home, and therefore, it will be sold through brands, and therefore, you'll be competition between brands -- more competition, I think, between brands and private label. But in the interim, while there's this continued surplus inventory, which is continuing at the moment from an industry point of view, we believe in the back half of this year and we think into next year, it's going to take another vintage for people to stop doing -- making wine and rather doing almonds or cannabis instead of wine to bring this back into balance, that's when you'll see the normalization take place.

And the final comment, Ben, is Q2, obviously, is a big quarter for us. Q1 is a small quarter for us in America.

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Operator [11]

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Your next question comes from the line of Richard Barwick from CLSA.

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Richard Barwick, CLSA Limited, Research Division - Research Analyst [12]

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It seems like it's been a brilliant time to be a wine drinker in the U.S., from what you've described, there's lots of quality wine swishing around at discounted prices, and yet, the market hasn't seemed to have responded. Volumes still seem weak, notwithstanding some growth at the premium price points. Does this worry you about the bigger-picture view on the U.S. wine market?

And the second part to that question would be you've quoted IRI data and talking about the market being flat to down, and yet, there's some alternative data that would point to, like the Gomberg-Fredrikson, is actually talking volumes up slightly. You've got very strong growth still in direct-to-consumer, and also, the Aussie export data is showing a real bounce back in the value of Australian wine going in.

So there's a bit of, I think, contradictory data floating around, so I'd love to hear your views on that and catch that all in the sort of the shape of -- are you concerned about the longer-term growth in the market given how much has been thrown at it -- well, to the consumer and yet they're arguably not responding?

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Michael A. Clarke, Treasury Wine Estates Limited - CEO, MD & Director [13]

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I'm going to take a bit of time on answering this, and Timothy, jump in and add to where you think you -- I'm missing a point. And I want to take some time because I think it helps for other questions that are going to come, if you guys don't mind.

I would like us to look at the data from an -- we look at IRI, but you could use Nielsen, you could use lots of different data, and I'm pretty sure when I'm finished this, you go back and look at it, I would hope you see the same sort of trends. And I'd encourage you to have a look at the data of what is the private label part of the market and what is the branded part of the market because this shift has driven a very -- a big structural change in the United States. So it's what's the private label and what's the branded. And what you don't see in measured IRI or Nielsen data is Costco, Publics, HEB, a number of these other large players in America that are substantial, who do exclusives and also private label. So if you don't mind, Richard, we're giving our data. And don't forget we have, we think, pretty rich data like on China. We have very rich data on what's going on in the market in America.

But let me now get to that detail. So there's 3 components I've just talked to. Private label measured, branded measured, and private label not measured, and we're looking at that total. You're seeing volume and value growth in the Luxury segments and in the Masstige segments. And that is still an attractive part of the market to compete in for Treasury Wine Estates.

We have outgrown the markets in Luxury and Masstige combined. We have outgrown in value and also in volume. So even without discounting that we've been doing to try and maintain share, which has hurt the P&L, we've not done enough hurt to destroy value. If I can put it that way.

So we've been doing the right things and that's why I've also intimated, we could go even harder in the back half to go even more discounting in Luxury/Masstige to try and get more profit and try and get to the 15% guidance as one metric, and there's other things we could try and do. But then the problem is you'd have to cycle that next year. Now I'm not going to let that happen. And also, the incoming CEO shouldn't want that to happen either. So the 2 of us are completely aligned. We're not going to do that because then you're delaying the problem to next year, where you've discounted your brands aggressively this year, and you now have to try and get the price back next year. So we're not going to do that.

So that's -- that part of the market remains attractive, and that's the priority focus for Treasury Wine Estates. Luxury/Masstige is what we are absolutely focused on.

Second point, if you have a look at the commercial market and I'm going to give a bit of insight on how we do our strategic planning. For Commercial, over the next 8 to 10 years, we have assumed that in the last 6 years, we've taken -- we've restructured the size of our business in Commercial, total company and also in America. We reduced the size, we reduced the cost, we improved the profitability. And so what we were assuming what we would do going forward is to assume a more or less flattish contribution from our commercial portfolio in America and also from around the world, flattish in dollar terms, [think] of brand contribution, can decline, don't have a problem with it declining in line with market decline, but we know that we can compensate for that decline with the upside that we get with the accelerated growth in Luxury/Masstige and the margins you can get. So that's been our business model.

What's thrown a spanner in the works at the moment that's affecting our performance is that with this surplus inventory in the market, so there's a structural issue in the U.S. market, people are, I think, correctly, trying to move this surplus inventory through private label, either as private label brand or as an exclusive. An exclusive could be a trademark owned by a branded company, us and other suppliers. But you give it exclusively to a retailer who's going to take significant quantities. So they create exclusively because they're going to take the quantities and then they move it through effectively like a private label brand in their store. That has been significant. And I think just -- if people just going to have a look at -- 15% growth of that part of the market has been massive from a volume point of view.

So to build on your point, that has been huge. But we're not participating in that from a profit point of view, neither is Gallo, neither is Constellation, neither is Chateau St Michelle. They're moving inventory excess at a discount to the supplier but to -- at a margin for the retailer. So it makes sense for the retailer to move it. That will continue while the market is in surplus but that's volume that the retailer is getting. It's not volume in our brands, if you think about it that way, because we're not making any margin on that.

So I hope that explains the volume and also the dynamic of what's happening between Commercial and Masstige.

As Tim also mentioned, private label growth is not just in Commercial. The private label growth and exclusive growth has been $15 and below. So that's lower Masstige, but there's also been accelerated growth in private label of Luxury. Now they are -- they come from a very small base. And what that is, is we believe, people moving some of their surplus luxury that they didn't want to discount in their brand. We're assuming that's what they've done, is they've moved it through private label, which obviously, if I was a retailer, I'd want to grab it with both hands because I'd like to, as a retailer, grow Luxury/Masstige and Commercial. That's background.

Now let's go forward. What do we want to achieve as a business going forward? We want to achieve a very strong Luxury/Masstige business in America that complements our very strong Luxury/Masstige businesses in every other market around the world where we can, for example, grow Penfolds in every one of those markets. This comes back to the point we've always made about driving apparent scarcity. We've never had the chance historically to grow Penfolds in America sustainably while I've been with this company, firstly, because we didn't have enough inventory and then secondly, because we made more margin in Asia.

But as you go forward, you want to have a diversified business strategy, where you can provide your #1 brand and some other luxury brands, in every one of the markets that you operate in. And the nice thing that we're saying on this call is we are growing Luxury/Masstige profitably in every one of our geographies around the world today, in this first half, including America, and we're outgrowing our competition. So the structure is there to fuel the growth of the luxury portfolio and, in particular, further growth of Penfolds in the future.

What we've got to change now is the fact that there is a structural change in the U.S. market that we hadn't anticipated. Just assuming for the next 8 to 10 years that we can keep our company profit from Commercial flattish is no longer an assumption I think we can live with. That was a luxury maybe we've had in recent years. There is a structural change that we think is going to affect the market in America for the next 2 years, we think, until vintage sizes change. And there's also going to be, with higher COGS on this Australian juice, it's not going to make sense for us to chase that volume with our current business model, today's business model, to chase that volume with the higher COGS with promotional spend, given that there's others in the commercial sector who are also trying to move their Commercial wine. We would rather walk away from that. But if you don't plan that walking away, it hits the P&L because our Commercial business has become more profitable. Whether we like it or not, it's actually a strength of our business because we've improved the profitability.

So therefore, what we have to do going forward now is not admire the structural change issue in America and in other parts of the world, actually just go, we're going to roll up our sleeves and address how do we change the structure of tackling Commercial wine in our business because it is a profitable part of our business. But in the first half, it's been a drag.

And we have, as many of you know, we have run many options. We're always looking at optionality on how we might run different parts of our business differently. We have run the models before. We're busy updating those models at the moment on how we might have a separate focus on Commercial versus Luxury. Tim owns this process because Tim is going to have to live it in future years. I am working on it with Tim. We are owning it. We will ideally just get this done, updated, approved by a Board, come back to the market. My plan, Tim's plan because he's having me work for him on this, is to have this done before I exit the business. So therefore, this is not something that we're going to take time on. We're going to move quickly on this because we've done the work before, we're updating it and we're addressing it.

I apologize to everyone. It's been a long-winded answer, but I want to use that to try and cover a number of different points that everyone gets grounded on what's in Tim's head, Matt's head and Mike's head.

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Tim Ford, Treasury Wine Estates Limited - COO [14]

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So I think you've covered it well. The only other additional point I'll just build on slightly is -- and firstly, I'll reiterate what Mike said, this is a combined plan and we're in alignment with what we need to focus on, particularly in the coming very short period of time to address the challenges, and we will address the challenges and come out of it with a better business model that allows us to do 2 things. One is absolutely remain laser-focused on the growth part of our business that has been so successful to date and will continue to be, which is around the Luxury and Masstige portfolio, but ensuring that we allow the Commercial business to have the right focus to enable that to be a good supporting part of this business going forward and not a drain, as it has been in the first half of this year, by surprise. And when we plan it properly, and I'll link this to the inventory point in a minute, when we plan that business correctly, we know we can run a very, very effective, efficient and profitable Commercial wine business.

Just one build so we're all clear on some of the points we're making around surplus inventory in the market in that business, one example of our planning was we did plan a significantly reduced intake in the U.S. in Vintage '19 just gone. So whilst there is surplus inventory across the market, we are very comfortable with our internal position around our inventory levels and how we're managing those going forward. And whilst we invest in the brands that are working, Luxury and Masstige brands, they're growing across multiple markets, when the structural shift does happen in the U.S. business, we will come out better positioned than others in that marketplace to take advantage of it. That's our plan.

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Michael A. Clarke, Treasury Wine Estates Limited - CEO, MD & Director [15]

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I agree. I'm going to add one extra point. Since we announced the transition back in October from me to Timothy -- and by the way, there's only 2 people in the world that call him Timothy, it's his mother and me. But since we announced that in October, we've been trying to operate that Tim's running the company, and I work for Tim, but I'm going to put a marker down. I'm still the CEO until I depart in Q1. We are going to end up in this business with a much bigger Luxury/Masstige and more profitable Luxury/Masstige business globally in every one of those markets, the U.S., Asia, Europe and also in Australia. We will end up with a smaller, very profitable Commercial wine business globally that will support what we do in the Luxury business, but it will be a smaller Luxury business.

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Tim Ford, Treasury Wine Estates Limited - COO [16]

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Commercial.

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Michael A. Clarke, Treasury Wine Estates Limited - CEO, MD & Director [17]

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Sorry, Commercial business. I beg your pardon. Thank you.

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Operator [18]

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Your next question today comes from the line of Shaun Cousins from JP Morgan.

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Shaun Robert Cousins, JP Morgan Chase & Co, Research Division - Senior Analyst [19]

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Just a question regarding coronavirus. There was no mention of that in your release so far. Can you confirm that there is no negative impact from coronavirus factored into your fiscal '20 and fiscal '21 guidance? And if not, why not? Maybe what are you seeing on the ground in terms of impact so far in terms of China, just given how profitable a region it is for you, please?

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Tim Ford, Treasury Wine Estates Limited - COO [20]

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Yes, sure, Tim here. I -- we haven't built in any impact of the current coronavirus sort of thought process. Clearly, it's top of mind for us at the moment of what the impact's been. And we haven't done so because it's just too early to tell. Our focus in the last, particularly the last 10 days has been around managing our people and ensuring that we have absolute management oversight of what is happening with our teams there in China, particularly over the Chinese New Year period. I'm sure, as you know, there's -- everyone's been on holidays for the last week in there.

So at this point, no, we have not built that into the -- any of our forecasts or plans going forward.

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Michael A. Clarke, Treasury Wine Estates Limited - CEO, MD & Director [21]

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I'm going to build on that. I think it would be premature to start putting that in with certain numbers up, down, sideways. I think it's a watching brief, first point.

Second point is, I think we are definitely -- and as we've mentioned on our existing business today, we're in a better position or a stronger position than most of our competitors in that we are shipping product into China, and we are pulling it through at accelerated depletions rate. So it is moving to retailers and to consumers way better than anybody else's in the marketplace. And a number of you who go and actually data mine the import data into China as well as the consumption behavior in China, will see that consumption continues to grow, especially Luxury/Masstige at mid- to high single-digit growth rates. Yet, if you look at the import data, that has not been the case, and that's because a lot of competitors have shipped product into China and they have not necessarily pulled through with marketing and with local teams and pull-through programs, unlike us. So we're in a better place to drive pull-through.

Another data point I'd share with you is a small percentage of our business is on-premise consumption. And I know that with a potential virus, people may not be able to travel but that's going to affect food, water and wine. And honestly that's a watching brief, we'll just have to keep an eye on it.

The final point that I'd share that it's too premature to make a call on this, is if you look at Hong Kong, for example, a lot of people have said in Hong Kong, with the demonstrations, that businesses will go backwards. We have found that in our business, our business has grown in Hong Kong.

So it's not always correct to just go and join dots unilaterally because of what people are assuming. You need to understand what is the makeup of the on-premise business, what is the makeup of our home delivery business, what is the makeup of the retail business, et cetera, and also how consumers are consuming. They could be consuming at home but not in restaurants, as an example.

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Operator [22]

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Your next question comes from the line of David Errington from Bank of America Merrill Lynch.

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David Errington, BofA Merrill Lynch, Research Division - Head of Consumer Research for Australia and Asia [23]

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This question -- it's a larger philosophical question, but it's got a fair bit of bite in it. Starting off with a statement, I've covered Treasury probably in different shapes and forms for over 25 years and I have never seen this business succeed in the United States, in terms of, one, being able to generate an acceptable return, justifying the method, the amount of money, the amount of man-hours that you put into this business. And I've been skinned and the company has been skinned on setbacks, downgrades, excess inventory, market corrections, you name it. Now my question is, Mike, you say that you want to use this market for multi -- diversification. But why? I mean when you're looking at the Luxury part, the gain that you're going to get is going to be wiped out by the cost of getting it there because this business is largely a Commercial business that's going backwards in a hurry and the cost to restructure another restructure, I mean, a review, what do you need to review? You know the answers, what do you need to review? I mean, if you don't know the answers now, you'll never know.

So I'm asking, why do you need to do the review? What's the review going to say that you don't already know? So why would you persist with this business that's done nothing but offset this fantastic asset that you've got in Australia. This brilliant strategy that you've got leading into growth markets, that sets you aside when you've got competitive advantages. You've never had a competitive advantage in the U.S., I doubt you ever will. So why are you persisting with this? Why do you keep throwing money in it? Why do you keep throwing the best resources that you've had in terms of man people, women people, the smartest minds are in this market, and all it's doing is destroying value.

So why are you persisting with this, Mike and Tim? And you're going to have to own this, Tim. You're on this now, you have to own it. So why should we -- I don't know one person who's investing in this stock that wants to own the U.S. asset from the point of view, we're buying it. We're buying TWE for what you're doing in Australia. Why are you doing this in the U.S.?

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Michael A. Clarke, Treasury Wine Estates Limited - CEO, MD & Director [24]

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Okay, David. I appreciate the question. Timothy would like to go first, he's put his hand up. So he's going to go first and then I'll build on whatever he leaves out.

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Tim Ford, Treasury Wine Estates Limited - COO [25]

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Yes. So yes. Thanks, David. And as you say, I am going to be owning this going forward. So I think it's appropriate I answer first, anyway.

I think the U.S. opportunity and the U.S. business, if we go back and this will disagree with your statement to a point, and I'll start with that point, is we have improved that business over multiple years and particularly over the last 4 or 5 years to the point where, yes, we've had a disappointing result in this half. But if you think about the strengths that we have in that business, and there are a number of strengths, which I'll talk about, and the opportunity from a consumer perspective, the trends that have seen us be successful in other markets around the world, are the same trends that we believe will continue to be there in the U.S.

The first one, the consumer continues to premiumize, which suits and matches our portfolio and our brands. We have invested quite heavily in our Luxury and Masstige brands over the last period of time. We'll continue to do so to take advantage of that opportunity, and we have the asset base behind that to do so. Now I'll use Penfolds as an example, we've talked about that previously. The U.S. market is a significant opportunity to grow our Penfolds portfolio from not only Australia but also from the U.S. and from Napa as we've talked about [proves] we've produced. That is an important growth platform for our business in the U.S. So there is a large component, not of the volume, of the value of the U.S. business that is actually growing and you've seen that with our Luxury and Masstige outcomes and depletions numbers over the last 6 months, albeit [in] a difficult half financially. So that's the reason to believe, right?

And then when you actually get underneath that data and you get underneath that strategy, you compare our ability to execute in that market and what we have done versus what we've started to do. So this is not from now, we have started over the last period of time, particularly the last 12 to 18 months, our distribution gains and our ability to grow distribution in the right accounts with the portfolio that we have is significant.

So this is not new market opportunities, this is not new channels we need to develop. This is getting our fair share of what is a market today, which is a profitable market, Luxury and Masstige, and we believe will continue to be a profitable market going forward.

So that's the reason why I certainly believe in the opportunity that the U.S. does provide us and it's not something that's going to take us another 5 years to get there. We believe it's here and now.

The structural issues that exist in the U.S. will also change. And there is very few of our key competitors in the U.S. who are in the wine business for the long term, we believe. And as we come out the other end of this structural change in the U.S., which could take more than one vintage, hopefully, it's one vintage, and we're planning -- our business planning is around that, we will come out stronger, having invested in the right parts of our business, and we'll be in it for the long-term and it will succeed in my view. That is my belief.

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Michael A. Clarke, Treasury Wine Estates Limited - CEO, MD & Director [26]

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Thanks, Timothy. If I could just build and clearly, Tim and I are quite aligned, and I'm in the role of supporting Tim now as we go forward. I think, David, I want to react to a couple of comments, and I can appreciate someone who's been on the journey for 25 years, i.e., you, versus some of us who have maybe been on the journey for 6 years thus far, and some of us who are going to continue.

I'm going to be quite controversial. It would have been fantastic if the people before Tim, Matt and Mike would have actually rolled up their sleeves and actually fixed America prior to us doing our jobs. That would be nice. That's a wish. The reality is, we're in charge of running this business, delivering value for shareholders, and we inherit this business the way it is. And we have, I think, focused on how we optimize that business over the last 6 years and also how we want to optimize the business as we go forward without destroying shareholder value. And I think we've improved shareholder value over the last 6 years and we have hit a speed bump at the moment in this year and we are going to address that. That's the first point.

You've already heard me and Tim say why we think the U.S. is important from a Luxury/Masstige portfolio point of view, having a Luxury/Masstige profitable business, where we can sell our U.S. Luxury brands, and we are outgrowing our competition in Luxury/Masstige, even in a challenging time, and that's a good sign for us, so we're getting traction and we've done this in the past 6 months without a full team in place. We have a guy who we all love in Angus, who was not able to move to America. He was well loved by the people in America and for personal reasons, he is not moving to America. We're not going to get into that detail, but we've got an equally great guy in Ben Dollard and a strong team around him who can drive this accelerated growth in Luxury/Masstige, which will also sell Penfolds.

Penfolds does well with apparent scarcity. And I promise you if any day you have a problem or we have a problem with apparent scarcity of Penfolds, it's going to be an issue. And so therefore, if you limit the number of markets or platforms that you can sell Penfolds in to drive apparent scarcity, I think you're in, over time, limiting what the future potential of the brand is. And America does need to be a platform to sell Penfolds and the U.S. Luxury portfolio.

The next piece that you mentioned is that we know the answers. You're correct. We do know the answers. Unfortunately, under Australian Stock Exchange regulations, as soon as you change your guidance, you have to go and tell the market immediately. And we have not had the time to finalize the plans that Tim, myself, Matt and his leadership team, know infinitely well what we're going to do. We just can't talk about it publicly at the moment today because we haven't finalized the work and we haven't finalized reviewing it with our Board. There are governance requirements that we need to go through to review this with this Board.

There is a unanimous approach from the leadership team on what we need to do to go and address Commercial. It's something we've been looking at in the past, and we didn't do it in the past because we prioritized driving Asia, we prioritized going direct in America and other things that were more important for us in the last 6 years. It has now got to the stage where, just relying on -- of our Commercial business, just ticking along nicely without any significant changes in profitability was -- is something that's not going to happen and therefore we have to go and address it, which means we change the size, we improve the profitability, and it's not a distraction.

I would put to you, David, that if we were presenting today and there was no structural change in the market with surplus inventory in the United States, with private label growing at 15% and if Angus McPherson was in the market and we reported Luxury/Masstige growth and we didn't even comment on our Commercial business, everyone would be very happy because strategically it made sense.

Unfortunately, and I like the challenge from you, by the way, strategically, Commercial is a challenge, and we're going to have to rightsize Commercial even more. We're going to have to run it differently. I would put that there's a mindset that as this business continues to grow, the Luxury part of the business, a mindset creeps into the people in our business, they're not wrong, they are humans, but the mindset that creeps in is I can make more profit number by selling more Luxury, and I don't have to worry about the Commercial. That has proven now you cannot operate like that. We need a separate focus on Luxury and a separate focus on Commercial. And Tim and I are absolutely aligned that is the right thing to do for this business going forward. And as we said earlier, we're going to get this done before I go.

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Tim Ford, Treasury Wine Estates Limited - COO [27]

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And the last point I'll make is, and not just in America but globally.

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Michael A. Clarke, Treasury Wine Estates Limited - CEO, MD & Director [28]

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Correct. The fact that we can tell you we've walked away from volume in Australia, we've walked away from volume in China, but more because of a customer change but also, we've walked away from volume in Europe, and that hasn't [detracted] Commercial volume. And that wasn't planned, and that's just under 0.5 million cases, and that hasn't hurt the profitability of those businesses outside of America, we've hit 20% EBITS growth across those businesses, shows you that when a business is fixed in Luxury/Masstige, we can cover 4 issues. The problem is we haven't finished fixing the U.S. business, we will get it fixed.

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Operator [29]

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Your next question comes from the line of Larry Gandler from Crédit Suisse.

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Larry Gandler, Crédit Suisse AG, Research Division - Director [30]

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I might try and finish the call with maybe a positive note. The -- I think the most redeeming feature in the result was the 40% depletions in China. It would be very important, I think, if you can give as much color as you have to that, as you have to the U.S. issues.

Some areas to address in your answer, as you described how 40% growth in depletions was achieved was -- here are some points: were shipments at a similar rate for Luxury depletions in China? Can you talk about some of the brands? Bin 389, pricing has been weak, but that clearly has not impacted your volumes. Lot 518, how is that new brand evolving? Bin 407 has always been on short supply, have you been able to increase that? Comment on some other brands.

Point three, if you could touch on your answer, allocations in the coronavirus. Often you try and have your customers purchase their allocations by March. Will you delay that given the coronavirus?

New warehouse, you've got that up and operating. Is that going to be 100%?

And then 146 cities you mentioned, where was that last year? Can you talk about your progress in penetrating Tier 2 and Tier 3 cities?

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Tim Ford, Treasury Wine Estates Limited - COO [31]

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Larry, firstly, thank you for the positive question. I appreciate that. It's -- and secondly, I'm sure with numerous discussions over the next couple of days, we can -- we'll cover as a team all of the answers to those specific questions. But I'll try and keep it broader, if I can, just in the interests of time.

First thing is your point, and it's one of our most pleasing aspects of this result and it's worth calling out, depletions rate year-on-year for the half for China across our total portfolio, yes, it is plus 4 -- it's 40% plus.

The most pleasing part within that for me is a couple of aspects. One is, it is the depth of distribution that is driving that growth within our 40 key cities that we're focusing on. What that means is we are getting better at allocating and getting value for our investment dollars within those cities. Those cities also have been the focus of our resourcing increases with the sales team, et cetera, as well. So the information we have and we track very, very closely certainly suggests that albeit we are well distributed across multiple brands in these priority cities, we still have an opportunity for increased growth from a depth of distribution point of view. So that's number one, the most pleasing part.

The second part is with our partners in these regions, we have spent a lot of time building disciplines around partner selling territories, how we sell our brands in specific territories with partners and how we support those with the brand investment. And I believe our partners are responding very, very positively to that as we continue to build plans with them together as well. So from that perspective, the growth that they are seeing and the translation of inventory into cash quickly for them, based on the pull-through programs, is very, very successful for the majority of our partners in China at the moment, as I'm sure those that are close to the market are getting that same feedback as well.

The broader portfolio, again, is working well. You touched on some of the specific SKUs within Penfolds, and I won't go through each of those SKUs, if you don't mind, in the interests of time, but I will say is one of the more pleasing parts of it is we are starting to see depletions growth where we want it to be across brands, not only in the Luxury or the core part of Penfolds, but within brands like Koonunga Hill and the French portfolio, et cetera, as well. So the brand portfolio is important to have as a selling tool more than just core Bins within Penfolds for us in China.

So those 3 aspects are the most pleasing. We have mid-Autumn festival period and we had Chinese New Year festival periods, which we are very, very pleased with our performance across the board.

So hopefully, that gives enough color in terms of the 3 or 4 specific reasons why it's working that way. And clearly, we can go into more detail in future discussions, if that's okay. Yes.

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Operator [32]

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Your next question comes from the line of Andrew McLennan from Goldman Sachs.

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Andrew J. McLennan, Goldman Sachs Group Inc., Research Division - Consumer and Retail Analyst [33]

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I just want to follow-on from Larry's question, again, focusing on China. Obviously, it's a tough environment. And Tim, the explanation you provided there is similar to what we've been hearing. So it's good to hear that kind of execution improvement coming through higher A&P spending. But -- so when we just sort of look through the issues, there is excess inventory in the channel, not necessarily of Treasury's products. You've obviously been fixing up your agreement with Costco. You've also lost Mouton Cadet, which I think is going to be a second half impact, whether it's significant, I'm not sure. But you really have, I guess, been able to rely on a high proportion of Penfolds sales from what we're hearing, which is a good thing to be able to rely on. But it does suggest to some degree at least that there's an unanticipated buildup in non-Penfolds Luxury and Masstige inventory. But also, at the same time, we are seeing, as Larry alluded to, a deterioration in some price points for a number of Penfolds products, it's not across the board but Bin 389 is an example.

I'm just wondering, first -- firstly, how do you resolve these price declines that you're seeing in products like Bin 389? And also secondly, can you just confirm your confidence around your inventory position and whether there's anything that's built up that needs to be cleared out in time?

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Tim Ford, Treasury Wine Estates Limited - COO [34]

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Yes, sure. Thanks for that one. The first point I'll talk about pricing is, I touched on it around our partners. We work very, very closely with our partners to ensure that the disciplines in the market, not only where they sell the product, but also the pricing they're selling our products are exactly where we want them to be. And as I say, there's not instances of behavior that change it, no. There is instances of behavior that we're very clear on and very much across, and we deal with it with those individual partners on a case-by-case basis.

I do not believe and from the information I have and see, which I think is pretty broad and pretty detailed, that we have a structural pricing issue across any portfolio -- part of our portfolio across China at this point of time across any of the channels. Isolated instances, yes, absolutely, and we deal with those, and we continue to have those management mechanisms, which I actually think is a real strength in having more of our sales team on the ground, dealing with partners, et cetera, because we can deal with those and get that insight ourselves as opposed to, I guess, believing the feedback you get sometimes from different parts of the market. So that's point one, how I'd respond to that.

Secondly, around inventory, we are very comfortable with our inventory levels that we have within our partner network within the business in China. Year-on-year, the actual days cover -- the forward days cover across our portfolio was down on what it was the same time last year. And we do look at it, and I'm not going to go through the specifics here, we look at it SKU-by-SKU, month-by-month as a leadership team and then with the management team in China as well to ensure that we're balancing shipments with depletions, not only with Penfolds, but across the total portfolio.

So from that perspective, I'm very comfortable with our levels of inventory, not only to support the growth of the channel there, and it is a growth market, so we will be shipping more inventory in year-on-year because we're growing that business. But in terms of the balance of depletions, I'm very comfortable where it sits at the moment.

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Michael A. Clarke, Treasury Wine Estates Limited - CEO, MD & Director [35]

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Two quick builds on the -- on what you just said. BPhR, we've aligned that we will not distribute their brand going forward and -- or Mouton Cadet, sorry, and we will focus on distributing our own French portfolio. I think that's quite obvious for everybody why we've done that. And the -- I don't think you should worry about the P&L from that point of view. We cover that within our ongoing business.

Secondly, just to give a bit of texture on this question on 389 as an example. Tim answered it by saying [there sometimes] can be flash points, but it's not ongoing. I think the key thing you need to realize is, sometimes what happens is a particular retailer, and let's just say, it could be e-commerce, is trying to drive a big program. It could be around Singles Day and they're wanting to get more of a particular SKU than what has been allocated to them, either by us or by anyone else that is selling to them. And what they will sometimes do in order to drive an attractiveness to their site is they will go and try and mop up from others, the inventory, and consolidate it and then go and do a price blaster for a particular event in China.

By the way, this happens in other markets around the world. You will see this with other major retailers here in Australia where you live, you'll see it with retailers in the U.K., you'll see it with retailers in the States. Retailers do this all the time. So it's not just a China phenomenon, it happens in other markets around the world. However, when it happens in China, people tend to focus on that and latch on to it versus latching on to it in, let's say, the U.K.

What we have done with those partners is we sit down with them, and we plan better as we go forward because this is a learning for our organization and trust me, this is a market that is growing at a fast pace and where all our partners that work with us are operating dynamically, they're not slow moving. And so the dialogue that takes place with our partner is rather tell us what you're trying to do, we can look at how we can help you. There's no need to discount it because there's value for everyone if you get the right price. And then we also have a conversation with those parties who have sold it to that retailer. And the question is, well, clearly, you didn't need to sell that yourself in your region. You decided to sell it and become a distributor for us and sell it to that particular retailer, in which case, your allocation goes down in the next financial period.

You have to keep doing this, not just in China, but you do it in Australia, you do it in America and you do it in the U.K. Just to add some extra build.

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Operator [36]

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Your next question comes from the line of Phil Kimber from Evans & Partners.

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Phillip Kimber, Evans & Partners Pty. Ltd., Research Division - Executive Director of Consumer [37]

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The question I had was just around the comments you made around Asia, where I think you said volume was down 10%, but it would have been up 14% if it wasn't for that one customer issue. When I did the numbers on that, that sort of worked out to be about 500,000 cases, is -- have I got that right? That just seems an awful lot to be going through one customer and largely one brand to have such an impact. So any sort of additional color you can provide around that would be great.

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Michael A. Clarke, Treasury Wine Estates Limited - CEO, MD & Director [38]

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I think the additional color we will share is we did mention that, that was an exclusive relationship with that one customer, and that is now no longer an exclusive relationship. So that customer was distributing over a broad number of territories in China. We now go directly to other Tier 1 wholesalers that we work with. So we don't go through that partner. And there's an obvious reason why we only mentioned the restatement of the volume in the NSR. We were not going to -- we didn't feel a need to quote what the adjusted profit number would look like.

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Operator [39]

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Your next question comes from the line of Belinda Moore from Morgans.

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Belinda Moore, Morgans Financial Limited, Research Division - Senior Analyst [40]

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Look, I recognize it's sort of early days and difficult to quantify, but just given it's topical at the moment following the tragic bushfires, can you sort of talk about the process that you're testing for smoke taint? When could you update us? And sort of how we should think about if it occurs, the implication on earnings over future years and maybe what you've built into guidance?

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Tim Ford, Treasury Wine Estates Limited - COO [41]

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Belinda, yes, sure. So fortunately, for us, and I think we've said this, but I'll add a little more color. Fortunately for us, our asset base was untouched from the broad bushfires around the country. So we were very lucky from that perspective. There was a number of our growers in the Adelaide Hills region, which is a very small percentage of our intake that unfortunately were not so lucky.

So from an intake plan point of view, the bushfires themselves, certainly had very -- almost a 0 impact other than the growers. And I don't want to downplay the impact on those growers by that statement either.

The -- in terms of the smoke taint, so other things, so you think about how we -- at our different sourcing regions, smoke taint is something we believe will have -- will not have a major impact at all on our intake or the quality of our intake. We are testing for that. What we are testing for is a very small component of what our intake would look like because of the regions and the multiple different regions that we source from, whether that be the Southeast, McLaren Vale, Barossa Valley, et cetera.

So most of the potential impact of smoke taint will come from surrounding Adelaide Hills areas, which again, is very small. So our multi-regionally sourced footprint is a significant advantage in examples such as this, but we're also fortunate that where the bushfires did take place, the smoke taint impact, we believe, and we're still going through the testing process, so I'm not categorically stating,, but we certainly believe it will be very, very minimal, if at all, across our intake.

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Michael A. Clarke, Treasury Wine Estates Limited - CEO, MD & Director [42]

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And to build, Tim, to what you've just said is the comment that I made about cost on the vintage is more a comment towards Commercial Australian juice in this vintage. Given the heat spikes and given what we think the volumes are going to be in the market with regard to the commercial vintage, there is a likelihood that Commercial wine from Australia will continue to have higher COGS. And clearly, we're factoring that into how we're looking at how we'll run the Commercial wine business differently.

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Tim Ford, Treasury Wine Estates Limited - COO [43]

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Yes. There's 2 dynamics that are underpinning our point on that. And it's important to understand when we're talking about COGS, it is the cost of the vintage upcoming, and we certainly believe and have confidence in the Luxury intake we're getting. Our Commercial wine intake for this vintage is going to be higher-priced, with the market rates for Commercial wine are higher than what they were in Vintage '19. Yes, that's common knowledge within the -- within grape growers, et cetera. So that is going to be an impact.

And secondly, based on the heat spikes that we have seen, the use of water and water at the moment, per gigaliter, is at the highest price than it's been in a long, long time, is going to have a cost impact on the vintage. So that's just what we're calling out underneath that, not to make the point around we believe the Luxury intake, et cetera, will be significantly impacted over the next 3 or 4 months as we finalize vintage.

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Operator [44]

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Your next question comes from the line of Jason Palmer from Taylor Collison.

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Jason Palmer, Taylor Collison Limited, Research Division - Equities Analyst [45]

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My question is in respect to the U.S. What gives you confidence that the brands like Matua, in particular, 19 Crimes, which have been band-aiding the results of that business for the last 2 to 3 years will hold up through this potential recovery that you were talking about as supply normalizes in that market?

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Tim Ford, Treasury Wine Estates Limited - COO [46]

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Yes. I think I'll talk about those 2 brands in particular, because they're good examples to talk through. The work -- and we've talked about this previously around 19 Crimes. The market activation and the brand planning work that we are now putting in behind a brand like 19 Crimes going forward, it does give us a significant amount more confidence.

The second part is when you get underneath the detail of 19 Crimes, it is a brand that is still growing. You've seen in the data in the last couple of months in particular, as we have activated better marketing programs than what we had over the early part of the first half but also in the back half of last year. So our programming, our focus on execution and our brand-building activity, yes, we're very, very happy with what that looks like, both now and going forward as well.

The second part of 19 Crimes is when you get underneath distribution -- and I keep coming back to distribution because it is the key. 19 Crimes as a brand is heavily distributed across distribution points in the U.S. The portfolio of 19 Crimes and the number of SKUs underneath that brand, the opportunity is still significant from a distribution perspective as we sell our portfolio and we get that brand back into the growth that we believe it can achieve. It certainly grew, for the half, slightly in the last 3 months, it grew much higher numbers from a depletion point of view, and it is still a profitable brand for us, notwithstanding the COGS impacts we've talked about.

Matua is slightly different, I believe, in terms that it is growing 30%-plus depletions. And you can see that in any of the IRI data, has consistently done so. The category around Sauvignon Blanc it's not about New Zealand Sauvignon Blanc, it's about refreshment. It's a consumer need that is going to continue to grow in the U.S. market as it is globally. So as we tailor that brand and the activation of brand activity, but also the execution in-store around Matua, which we are going to do a much better job of, we have a significant belief in the growth of that because of the consumer need, not just because we like the brand or think it's about New Zealand Sauvignon Blanc.

As well as that, you look at some of the competitor activity of what might be coming up within the U.S. businesses, brands change hands, et cetera, here is a huge opportunity for us with specific brands, and I'll use Matua as one, to take share off people that are -- have that share today with their brands and off our competitors.

So a number of factors in there, but doing a much greater investment behind a brand like Matua with a consumer-driven approach that meets that need is an upside for us, we believe.

I think the other part, just on the U.S. brands, we talked about the Masstige brands there, and they're both the imported brands. But if you have a look through some of the data and some of the U.S.-produced Masstige focused brands around St Huberts The Stag, around Beringer Brothers as well, smaller bases, but their growth is significant. And again, it comes back to distribution and execution of programming that we believe we are much better placed to implement. We lost some momentum with the management changes in half 1, but we are in a much better place than where we have been previously.

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Operator [47]

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Your final question today comes from the line of Peter Marks from Morgan Stanley.

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Peter J. Marks, Morgan Stanley, Research Division - Research Associate [48]

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Just another one on China. I did the same math that Phil did on the 500,000 cases of Rawson's Retreat. So I'm just wondering if your partner there still has inventory to work through. And if they do, do you still have a good working relationship there?

And then secondly, you're saying it's a temporary impact there, are you confident you will still be able to sell the same number of cases of Rawson's Retreat going forward? And then -- so we should see a bit of a volume recovery in Asia in the second half? And I'm just wondering, did you sell any Rawson's Retreat in the first half because that seems like a big volume decline?

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Tim Ford, Treasury Wine Estates Limited - COO [49]

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So 2 words I'll use when we talk through this is depletions and shipments. So certainly -- and I think it's important to understand that we have worked together with the partner -- our major partner here in China, in terms of a transition as they restructure their business, we -- and together with them, so we are continuing to work with them and work collaboratively, and we'll continue to work with them going forward. So that's an important point to make, I believe, because they are an important partner to us.

Secondly is the inventory levels that you referred to are a big part of the transition plan that, again, we've worked together on with that partner and with our new route to market partners, which is our existing wholesalers.

So the transition of inventory within the market has been well thought through, well executed, it has impacted shipments for the first half, but our depletions are still continuing to get back on track, particularly over the pre Chinese New Year period.

So our belief and our forecast for the brand are still very strong into the second half. But you rightly point out, there is a shipment decrease, which is temporary, in the first half that we believe will be corrected as we go forward in China.

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Michael A. Clarke, Treasury Wine Estates Limited - CEO, MD & Director [50]

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And the transition from one partner to multiple partners has been done in a very collaborative way between all parties.

I think that's the end of the call, and I want to thank everybody for joining us at short notice for the call this morning. Thank you very much.