As the largest multi-category alcohol supplier in the U.S., one would have thought Constellation Brands (STZ, Financial) would have benefitted from Covid-19 pandemic lockdowns with stories of day-drinking and early home-based happy hours. However, the company has a heavy reliance on the bar and restaurant market, so it wasn’t an optimal time for the company. This has kept the stock price depressed, and things aren't getting any better as the economic situation deteriorates.
At first glance, one might think this stock could be avalue opportunity. However, I don't think this will turn out to be the case; the company is not immune to cost issues, and its near-term growth outlook fails to keep pace with inflation, which doesn't bode well for its share price going forward. Additionally, it has another risk in the form of a significant investment in Canopy Growth (TSX:WEED, Financial), which isn't performing that well.
About the company
The business is predominantly driven by the beer category, particularly Mexican beer brands such as Corona, Modelo and Pacifico. It also has a significant exposure to the wine market with leading brands such as Kim Crawford, Robert Mondavi and Meiomi. Liquor brands include SVEDKA Vodka, Casa Noble Tequila and High West Whiskey.
The company imports most of its products after manufacturing them abroad, going to market through independent wholesalers and distributors. It also owns 38.6% of Canopy Growth, a leading provider of medicinal and recreational cannabis products.
The company was established in 1945 by entrepreneur Marvin Sands in New York as Canandaigua Industries, which sold bulk wine to bottlers in the eastern United States. The company was incorporated as Canandaigua Wine Company in 1972 and went public in 1973.
Constellation Brands generated revenue of $8.8 billion in its last fiscal year and currently has a market capitalization of $47 billion.
Canopy Growth investment
In 2017, Constellation Brands made a minority investment in Canopy Growth, purchasing 9.9% stake when the price was 12.98 Canadian dollars ($10.08). The press release stated:
“This investment and relationship is consistent with Constellation Brands’ long-term strategy to identify, meet and stay ahead of evolving consumer trends and market dynamics, while maintaining focus on its core total beverage alcohol business. Constellation has no plans to sell any cannabis products in the U.S. or any other market unless or until it is legally permissible to do so at all government levels”.
Constellation Brands has made two subsequent investments in the company since then. Just under a year after the first investment, Constellation Brands announced its second investment of C$5 billion at C$48.60 per share, just ahead of various states legalizing adult-use cannibis. This investment came with warrants as well that were subsequently amended. The third investment came in May 2020, when Constellation Brands exercised the warrants it had received from its first investment just ahead of their expiration, paying C$245 million to acquire 18.88 million shares at C$12.98.
The investment has not been a successful one as Canopy Growth's stock now languishes around C$7.54 per share which is almost 80% below its 52-week high.
Recent earnings
Constellation Brands' most recent fiscal year ended in February 2022. For the year, shipments grew 2.0%, revenues grew 2.0% and net income grew 5.0%. The beer segment (76% of total revenues) showed strong organic growth of 11%, with international making up for weakness in the U.S. One of the company’s key brands, Modelo Special, became the number two selling brand in the U.S. Although operating margins are still relatively high, they dipped slightly by 110 basis points due to higher input costs and higher depreciation.
In the wine and spirits segment, net sales declined 7.0% due to certain low margin divestitures. However, excluding those brands, organic sales increased 5.0%. Operating margins declined due to higher marketing spend and increased freight and warehousing costs.
Constellation Brands' balance sheet is in good shape, and the company generated strong free cash flow. Free cash flow over the past two fiscal years totaled $1.9 billion and $1.7 billion on a sequential basis..
Valuation
The company expects mid-single-digit revenue growth for the fiscal year ending February 2023, but operating income is expected to be muted by ongoing cost pressures and only grow in the low-single-digit range. Consensus analyst earnings per share estimates for the current fiscal year are $11.19, which means the company is trading at a forward price-earnings ratio above 20. The company also sells at an enterprise-value-to-Ebitda ratio of approximately 16.
The company’s dividend yield is currently 1.28% based on an annualized dividend payment of $3.20, with a payout ratio of approximately of 28%.
All in all, these numbers don't seem great for a company whose growth is failing to keep up with inflation.
Guru trades
Gurus who have purchased or added to their Constellation Brands positions recently include Mark Hillman (Trades, Portfolio) and Diamond Hill Capital (Trades, Portfolio). Gurus who have reduced their positions include Michael Price (Trades, Portfolio) and Steven Cohen (Trades, Portfolio).
Conclusion
Although Constellation Brands and alcohol businesses in general are know to be defensive in economic downturns, this company appears to fairly priced in my view with unattractive potential given its inability to keep up with cost pressures. Particularly in light of global inflation that may last for an extended period of time, I believe a lower price point may be advisable for this stock in order to create a margin of safety.
