In some ways, I think Constellation Brands (STZ) is the opposite of Molson Coors (TAP), a stock I wrote about recently. While Molson Coors has largely kept playing the hand it has, hoping to somehow generate better results by repositioning brands in fading categories, Constellation has used aggressive portfolio transformation over the years to give it a dominant position in one of the strongest categories in alcoholic beverages (high-end beer). Where Molson Coors hasn’t seen meaningful volume growth in over a decade, it took a global pandemic to bring Constellation’s string of quarterly volume growth to an end.
I really like the portfolio Constellation has, and I respect management’s willingness to allocate and reallocate capital in response to the changes it sees in the market. Not all of those moves have been the right ones, but I believe they’ve been right more often than not (and where it really counts). The only fly in the ointment is that the company’s success is no secret. While I don’t necessarily think that Constellation is overpriced, the prospective return I see on a discounted cash flow basis is more on the order of a good hold than a new buy.
Growing Through The Downturn
Labor Day Nielsen data was strong for beer, with sales up 7% (11% for beer, cider, and seltzer combined) as consumers continue to buy for consumption at home instead of on-premise consumption at bars and restaurants. Constellation was among the strongest of the larger players, with a nearly 10% increase in beer sales volume versus 7% growth for Heineken (OTCQX:HEINY), 7% growth for Anheuser-Busch InBev (BUD), and just 3% growth for Molson Coors.
Importantly, Constellation seems to be doing a good job of managing out-of-stocks given the pressures on supply created by the pandemic shutdowns (breweries were generally not designated as essential businesses). While distributors reported being placed “on allocation”, it seems that was done largely to prevent any hoarding or inventory-building and to keep beer flowing to the shelves.
Even so, fiscal first-quarter results saw a 7% decline in shipment volume for beer and a reported volume decline of 6% – the first volume decline Constellation has had in its beer business since the Crown Imports deal many years ago. Now, there is an important “asterisk” here – actual consumption (depletion) continued to grow, with depletion of over 5% (7% adjusted for selling days), so consumption volume has continued to grow even through this downturn.
Constellation’s portfolio of Mexican beers has been gaining share for over a decade, and the business has only gotten stronger under the company’s management. While Grupo Modelo was disinterested in supporting can or draft operations, Constellation has fixed that, and it has helped drive a major improvement in product availability (as measured by ACV, or all commodity volume), with Modelo up 15pts in less than a decade.
Constellation has also continued to invest in product development. Corona Premier, a low-carb/low-cal option, has done relatively well, while Corona Seltzer has become the #4 seltzer in only about six months of availability, with about 6% share.
Right-Sizing The Wine Business
Older investors may remember Constellation first for the aggressive M&A program that built it into the largest wine business in the world. Those days are long past, with the success of the beer business and multiple brand sales driving the wine and spirits business to under 30% of revenue and only about 20% of segment profits. With the pending sale of a collection of multiple lower-value wine brands to Gallo for $1 billion, it will soon be an even smaller business and one that is much more focused on so-called “Power Brands”.
Will The Gallo Sale Mark An End To Extensive Portfolio Turnover?
Constellation has been an opportunistic wheeler-dealer over the years; the Crown Imports deal that gave it exclusive U.S. rights to Corona and Modelo is a case in point, as AB InBev had little choice if it wanted its proposed acquisition of Grupo Modelo approved. Management has also been an active buyer and seller in wine & spirits – adding rising brands like High West, Meiomi, Prisoner, and selling less-attractive assets like the Australian, U.K., and Canadian operations.
Not all of these deals have worked out. Constellation bought Ballast Point for $1 billion at pretty much the top of the craft beer craze, and recently sold all of the associated assets for about $41 million. Constellation also bought into the cannabis market when it was frothy, paying $4.2 billion for a sizable stake in Canopy Growth and then adding to it 2018 (exercising warrants for $174 million, building its stake to 38.6%) before taking an impairment of almost $600 million. Canopy Growth’s current market cap is about $5.4 billion.
Still, with the shares up more than 14% annualized over the last 15 years, it’s hard to really complain too much about the net effect of management’s decisions. I do believe that with the latest sale to Gallo, management should be done with large-scale moves. I’m sure there will always be a willingness to buy rising brands in the wine & spirit market (and sell fading brands), but I think large-scale M&A is not too likely.
With about 40% of Constellation’s beer volumes driven by Hispanic customers (50% for the Modelo brand), I still see opportunities to grow the overall share of the business over time. Distribution growth isn’t going to be as powerful of a driver as before (perhaps for some smaller brands like Corona Familiar and Pacifico), but I still volume growth opportunities from effective marketing (Constellation’s marketing productivity is much higher than larger brewers) and new product introduction.
My modeling assumptions for Constellation end up with a long-term revenue growth around 5% (closer to 7% with fiscal 2021 as the starting point). I do believe exiting the lower-value wine business and continuing to leverage the beer and high-value wine businesses will drive improving margins, with around 300bp of operating margin improvement over the next three years and about five to six points of long-term FCF margin leverage, which, in turn, should drive FCF growth around 8-9% over the long term.
The only problem is that Constellation’s share price already discounts a lot of this. I don’t believe that Constellation is overpriced, but the discounted cash flow would seem to support an annualized total return more on the border of the mid-to-high single digits today. Margin- and return-based EV/EBITDA offers a higher potential fair value (in the $210’s). Either way, I don’t dislike Constellation here, but I would rather wait in the hope of a better entry price.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.