Consumers are often willing to pay more for the brands they know and trust, giving companies that have well-known brands pricing power. Better pricing power often leads to better financial performance, which in turn can lead to higher share prices.
Companies in the alcohol sector with well-known brands often offer attractive returns. One of our favorites among alcohol stocks is Constellation Brands Inc. (STZ, Financial) because of its strong brands and dividend growth.
Company background and recent news
Founded in 1945, Constellation Brands produces and distributes beer, wine and spirts. The company has more than 100 brands. It imports and sells beer brands like Corona Extra, Modelo Especial and Pacifico. These brands help make Constellation Brands the third-largest beer company in the U.S. by market share. The company’s liquors include Svedka Vodka, High West Whiskey and Casa Noble Tequila. Its wine portfolio includes Robert Mondavi and Kim Crawford. The company has a current market capitalization of $34 billion.
Constellation Brands announced on April 3 that it would be selling approximately 30 brands from its wine and spirits portfolio to E. & J. Gallo Winery. The deal will net the company $1.7 billion, which it will use to pay down debt. The wine and spirits brands being sold include Clos du Bois, Black Box and Mark West. These brands are priced at $11 retail and under. This divestiture will give Constellation Brands a cash infusion while allowing it to focus on its premium wine and spirits brands.
The company also owns 38% in cannabis producer Canopy Growth (CGC) due to its $4 billion investment on April 15, 2018.Â
Recent financial results
Constellation Brands reported financial results for the fourth quarter of fiscal 2019 on April 5. The company posted earnings of $1.84 per share, which beat consensus estimates by 12 cents but was down 3% from the previous year. Revenue grew 2.3% to $1.8 billion, beating expectations by $70 million.
For the fiscal year, Constellation Brands earned $9.28 per share, a 6.7% improvement from the previous year. Revenue also grew 6.7% to $8.1 billion.
Beer volumes and sales for the fourth quarter increased 8% and 9.3%, respectively. For fiscal 2019, volumes were 9.7% higher and net sales improved 11.6%. Beer was the top contributor to the U.S. market.
Each import brand family experienced record volume levels. The Corona brand shipped more than 150 million cases, while the Modelo brand shipped more than 125 million cases. Constellation Brands is trying to capitalize on the brand’s strength by launching Corona Refresca, which will be the brand’s first non-beer beverage, during the first quarter. The company also expects to increase advertising spend for its top beer products in order to help grow sales, which are expected to increase 7% to 9% in fiscal 2020.
Volumes for wine and spirits declined 9%, while sales were 7.6% lower. For the fiscal year, shipments dropped 0.8%, but net sales were down just 0.2%. One positive sign for this segment was double-digit growth rates in distribution for several brands, such as Kim Crawford, Ruffino Sparkling and Meiomi. Svedka Vodka, the number one imported vodka in the U.S., posted strong sales growth after Constellation Brands launched a new market campaign to improve awareness among consumers.
Constellation Brands expects earnings per share to range from $8.47 to $8.77 in fiscal 2020. Achieving the midpoint of this guidance ($8.62) would represent a decline of 7% from fiscal 2019. Much of this decline can be attributed to the company’s investment in Canopy Growth and an expected 25% to 30% decline in wine and spirits due to the sale to Gallo. The stock finished the trading day up 6.6% after the earnings release.
The company grew earnings per share at a rate of 17% over the past decade. We expect earnings will grow at an annual rate of 10% over the next five years due to continued strength in the company’s premium product categories. If Constellation Brands is able to achieve our expected growth rate, the company could earn $13.88 per share by fiscal 2025.
Recession rerformance
Over the past decade, Constellation Brands has exhibited impressive earnings per share growth, but is the company recession proof? Listed below is Constellation Brands’ performance before, during and after the last economic downturn:
- 2007 adjusted earnings per share: $1.44
- 2008 adjusted earnings per share: $1.60 (11% increase)
- 2009 adjusted earnings per share: $1.69 (5.6% increase)
- 2010 adjusted earnings per share: $1.91 (13% increase)
- 2011 adjusted earnings per share: $2.35 (23% increase)
- 2012 adjusted earnings per share: $2.19 (7% decline)
Constellation Brands experienced a 17% increase in earnings per share from 2007 to 2009, which was a very turbulent period for many companies. Growing earnings is something the company does very well. Over the last 15 years, it has only failed to grow its bottom line twice (2007 and 2012).
Due to its performance during the last recession, we are confident Constellation Brands will be able to continue growing earnings during the next recession.
Dividend history, valuation and total expected returns
Constellation Brands only initiated its dividend in 2015, so it doesn’t have the track record of, say, a Dividend King or a Dividend Aristocrat. That doesn’t mean dividend growth investors should ignore the stock, though. Listed below are the company’s annual dividend payments:
- 2015 dividends per share: $1.24
- 2016 dividends per share: $1.60 (23% increase)
- 2017 dividends per share: $2.08 (30% increase)
- 2018 dividends per share: $2.74 (32% increase)
- 2019 expected dividends per share: $2.99 (9% increase)
As been its pattern, Constellation Brands raised its dividend by 1.5% for the upcoming May payment. This is well below its usual increase. The company had increased its dividend by at least 20% in each of the past three years. Based on the new dividend, shares have a yield of 1.7%, which is slightly below the 1.9% yield of the S&P 500.
Constellation Brands likely kept its dividend increase low due to the amount of its investment in Canopy Growth. Once the debt from this investment is lowered, we expect dividend growth to remain robust.
While the yield is low, the dividend is well covered. Using earnings per share, the average payout ratio is 25% since the company began paying a dividend.
Since dividends are paid from free cash flow, some investors prefer this metric instead of earnings per share to determine dividend safety. In fiscal 2019, Constellation Brands generated a record $1.4 billion in free cash flow. It distributed $558 million of common share dividends over the same period for a free cash flow dividend payout ratio of 40%.
Using either earnings per share or free cash flow, Constellation Brands has a very low payout ratio. It is likely the company can continue to offer compelling dividend growth in future years because of this low payout ratio.
Based off the current share price of $191 and expected earnings per share of $8.62 for fiscal 2020, Constellation Brands has a price-earnings ratio of 22.2. It should be noted the current ratio is only slightly above the 21.5Ă‚ price-earnings ratio of the S&P 500.
We have a 2025 target price-earnings ratio of 18, slightly above its 10-year average. If shares were to revert to this target, total returns could be reduced by 4.1% annually over the next five years.
Total annual returns for Constellation Brands would consist of 10% annual earnings per share growth and the 1.7% dividend yield, offset somewhat by multiple reversion, which could reduce returns by 4.1% per year.
Therefore, we expect shares of Constellation Brands to offer a total annual return of 7.6% over the next five years. If the company is able to produce our expected earnings per share by 2025 and the stock’s valuation shrinks to our target, shares of Constellation Brands could trade for $250 by 2025.
Conclusion
Constellation Brands offers a portfolio of well-known beer, wine and spirits. Corona and Modelo have become very popular with consumers. Bringing a new beverage from the Corona family to market and an increase in advertising should help sales improve for this brand. Constellation Brands is also pruning its less expensive wines in order to focus on its premium lineup.
The company didn’t offer a significant dividend increase, but has shown a willingness to offer high dividend growth in previous years. Once debt is reduced, it is likely the company will return to double-digit dividend growth once again.
Even with a likely multiple reversion, investors buying shares of Constellation Brands are likely to see high-single-digit total annual returns over the next five years due to dividends and expected earnings per share growth.
Disclosure: I am not long any stocks mentioned in this article.
Read more here:
