Opportunities from Solid Brand Demand Supports Mid-Single-Digit Sales Growth at Constellation Brand

Business Strategy & Outlook:

While Constellation Brands historically made its bones as a winery and distillery, we now view the firm as one of the most stellar brewers across our global coverage. After parlaying AB InBev’s antitrust quandary (allowing it to acquire Mexican brewer Grupo Modelo) into exclusive U.S. ownership rights to brands like Corona and Modelo, we see the firm’s overall Mexican beer portfolio as auspiciously situated at the confluence of unwavering secular and demographic trends. With an enviable growth profile and best of breed margins, we have confidence that the beer business can thrive even amid an evolving industry landscape. The increase in political, social, and cultural clout of the Hispanic population in the U.S. is widely expected to continue, which augurs well for Constellation’s intangible assets. The firm is not resting on its laurels, however, as it continues to expand its addressable market by widening the gamut of categories in which it competes. One of the primary avenues through which it is seeking to do this is innovation, with line extensions like Corona Refresca being a quintessential illustration. Management is looking for 25% of its growth outlook to be driven by innovation, a mark we think is achievable given the broad resonance of its trademarks. Another avenue is through acquisition, currently embodied by its controlling stake in Canopy Growth. Even as the outlook for cannabis in the U.S. remains uncertain, we remain sanguine on the optionality that this investment affords.

The firm’s wine and spirits business should offer some stability, after the divestiture of lower-quality brands, allowing Constellation to place more intentionality behind its “high growth, high margin” long-term strategy. However, in our opinion, the remaining brands (such as Meiomi, Kim Crawford, Svedka vodka, and High West craft whiskey) will still face rife competition. Constellation’s foray into explosive-growth categories like hard seltzer have demanded nontrivial investment, given the competitive intensity and brand equity already built up by the incumbents. Nevertheless, we believe the experience of the management team will allow the firm to navigate these risks.

Financial Strengths:

Constellation Brands’ financial health looks sound to us, and is markedly improved from the precarious positions of the past. Management’s internally calculated leverage ratio (based on adjusted EBITDA) rose to 5 times in order to fund its 2013 acquisition of the perpetual rights to the Mexican beer portfolio, and after steadily reducing it over the next four years, leverage rose again to over 4 times in order to fund the second-round Canopy investment. Nevertheless, we see levels declining to 3.4 by the end of fiscal 2022, thanks to the firm’s robust cash flow, and the prior redemption notes with near-term maturities. Constellation has spun off healthy free cash flow in the low-20s as a proportion of sales on average over the past three years. This is quite the feat when juxtaposed with its hefty capital outlays to solidify and expand its production capacity in Mexico. Capital expenditures have averaged roughly 11% since it purchased the Mexican beer business, versus the 5%-7% that is typical across our brewing coverage. We expect a couple more years of elevation as management makes capital investment to make up for its failed Mexicali expansion, after which normalization (combined with improving margins and working capital management) should support free cash flow for reinvestment and cash returns to shareholders. Given the Canopy investment, management has indicated it plans to avoid transformative acquisitions, but with leverage now at more comfortable levels, we expect cash flow will primarily be deployed toward capacity, share buybacks, and its dividend (instituted in fiscal 2016). There is ample liquidity to fund its operations; in addition to its cash flow and over $200 million in cash as of February 2022, it has access to a $2 billion revolving credit facility.

Bulls Say:

Constellation Brands essentially monopolizes the U. S. market for Mexican beer imports, which augurs well for its positioning given the country’s large Hispanic population.
The ability to parlay the Corona trademarks into different categories is a testament to the broad resonance of the brand and is evidenced by robust initial consumer takeaway of Corona Hard Seltzer.
As we get more clarity regarding what the contours of cannabis legalization will look like in the U.S., the Canopy investment could yield significant upside.

Company Description:

Constellation Brands is the largest multi-category alcohol supplier in the U.S. The business is anchored by a portfolio of Mexican beer trademarks, including Corona and Modelo, for which it acquired exclusive and perpetual U.S. ownership from AB InBev. The latter had to divest these rights due to antitrust mandates as it consummated its 2013 acquisition of dominant Mexican brewer, Grupo Modelo. Constellation’s wine/spirits business has recently transitioned, divesting several lower-margin assets, including myriad wine brands and its Ballast Point craft beer brand. The firm imports most products after manufacturing them abroad, going to market through independent wholesalers. It owns 36% of Canopy Growth, a leading provider of medicinal and recreational cannabis products

(Source: Morningstar)

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