In this article, we’re going to take a look at Constellation Brands (STZ). The company is a business focused on the production and marketing of various types of alcoholic beverages across the world, making what I believe to be a good consumer-defensive investment.
Consumer-defensive investments make up more than 12% of my portfolio – and that has increased since the past year. It makes sense to me, therefore, to establish theses and stances on the most popular of these businesses and start tracking their performance more closely.
That is what I intend to do here.
Let’s get going.
(Source: Constellation Brands)
Company Operations & Performance
Constellation brands is a company in the business of alcoholic beverages.
Over the past few weeks, we’ve seen an increased rotation to what I would consider “conservative” and value stocks. The risk appetite has started to decline – albeit slowly – in light of the FED’s recent stance on interest rate increases.
I myself am a long-term heavy investor of not only US consumer-defensive, but international/European ones as well including Nestlé (OTCPK:NSRGY), Axfood (OTCPK:AXFOY), Kroger (KR), J. M. Smucker (SJM), General Mills (GIS), Diageo (DEO) and many more. In combination with what we’ve seen in terms of sell-off from tech, we’ve also seen people buying more into these companies, and readers asking about them.
That’s why I believe it to be a good time to look at a business such as STZ.
STZ has over 100 brands in its portfolio, and these brands include some of the most popular in the entire world.
Company operations are found not only in the USA, but everywhere STZ has production, meaning the USA, Mexico, New Zealand, and Italy. The company is the third-largest beer company in the USA. This gives them a strong market position with pricing power and a supplier of choice for many consumers and customers.
The company’s customer base is comprised of wholesale distributors, retailers, and on-premise sales locations.
STZ is very active in its portfolio management. Over the past 2 years, the company has divested 3 wine/spirit brands and one beer brand due to margin and performance regions, while investing in 3 wine/spirit brands as well as incrementally investing more in the currently non-profitable Canopy Growth Corporation (CGC).
The company reports operations under four segments – very simple and lacking the need for elaboration.
- Wine & Spirits
While the Canopy investment is exciting many, and the company does expect to see results here eventually, the business is to 65-70% a beer business, especially with Canopy as of yet only generating losses.
Fiscal 2020/2021 net sales give us a picture of this.
(Source: Constellation Brands)
The company has several fundamental upsides speaking for investment and appeal. First, it’s the #1 brewer and seller of imported beer in all of the US, as well as the leader of high-end beer in the nation, including imported craft. The company also has the exclusive right to Corona brands, Modelo and Pacifico/Victoria, all of them out of Mexico.
9 out of 15 of the top-selling beer brands are from this company.
There is no doubt in my mind that such a moat and market share gives the company the right to some premium here in terms of multiples.
The company has tripled its Mexican production capacity since 2012. It’s obvious when looking over the company’s reporting, that expansion and growth as well as rigid portfolio trimming when brands aren’t living up to expectations is part of the management strategy.
STZ is well-capitalized and comes with a BBB credit rating and a sub-50% long-term debt/cap ratio. It has a current market capitalization of $45.4B, and reports annual sales numbers of around $8.6B as of Fiscal 2021, ending in February of 2021.
Company peers and competition are many – and include the following.
(Source: Constellation Brands)
The making of alcohol isn’t a complicated endeavor. What’s complex about the business is making it well while making it a scalable, profitable business and taking market share in a very mature market.
So while there’s plenty of competition, some of these companies aren’t doing as well as STZ.
The production of spirits necessitates simple input/raw material. You need Water, yeast, grain, and packaging material. You need glass bottles, aluminum cans, and steel kegs. The sourcing of these materials where the company does not produce them by themselves is of course subject to inflation, FX, and overall cost increases.
I believe it is fair to say that the company, thus far, has seen a limited impact from COVID-19. The production of alcohol has been deemed an essential business, and the factories have stayed open for the most part.
For Fiscal 2021, the company reported increased sales of beer and flat/slightly negative trends in wines and spirits. The positives in beer came from pricing impacts, product/mix shifts with increased sales of certain products weighing up on-premise keg sales to bars and clubs.
The company’s Canopy interest allows influence but not control, and is accounted for under the equity method in the company. 100% of Canopy results are included and subsequently eliminated in company results for results reconciliation.
(Source: Constellation Brands)
The company expects EPS growth going forward into 2022-2024, based on further margin improvement, favorable volumes, and mean reversion once COVID-19 dies down a little.
The company operates at an impressive income margin for most of its segments.
Beer comes in around 41.5% operating margin, with wine at around 28.1%. On a company-wide gross margin, the company reported 53.1% for FY21 and around 34.3% on the operating margin side. These are numbers that the company has improved over the past years.
On a forecast basis, the company is expected to be able to maintain these excellent margins, with some slight expansion from further efficiencies, price actions, and volume/mix.
Certain of the company’s competitors, such as Anheuser-Busch (BUD) have higher gross margins/better COGS ratios but fail to compare on the operating margin side. Other peers, such as Molson Coors (TAP) have not only worse COGS/Gross margins, but come in at levels of operating margin over 20% below STZ. (Source: Molson Coors 10-k)
Dear readers, STZ is in a difficult industry, and based on straight number-crunching, is doing very well.
In fact, on a high level, I don’t see any worrying or all that negative signs on the financial side of things.
The company also has peer appeal and was chosen by Coca-Cola (KO) to deliver its beverage alcohol. Including the company’s recent 3Q22 beats, we’re talking a very appealing company at a very appealing set of results.
I’m not saying there aren’t challenges. The company’s main ones include the current logistics situation, inflation, and weather.
Still, the challenges couldn’t defeat or drag down good 3Q22 results. The company has chewed off more market shares for its top products, and the recent fiscal includes a guidance increase for the 2022 period.
The company also sees continued potential in its import operations, allowing for increased sales volume through increased investments in capacity and momentum maintenance. The biggest growth driver for sales is currently Modelo Especial (Source: Constellation Brands)
What I wanted to see were improvements in the Wine/Spirits segment of things, and the company is reporting progress here. Increased revenues were reported, and the company is expanding the segment margins, which after all are currently well below the beer segment. It’s unlikely we’ll see significant positives out of Wine/Spirits given YTD performance, but it’s improving. Overall, things in legacy segments for the company are looking good, balancing restocking inventories and fewer sales headwinds than a year ago.
Overall, this is a solid market leader in a recession-resistant business. Exactly what we want in the current market situation characterized by a bit more “risk-off”.
A word on Canopy
I know I’d likely be criticized for not giving Canopy at least some space here – so allow me.
Things are not going that well.
The Canada-based Cannabis business is considered by some to be a bubble, and by others to be one of the best potentials since sliced bread with triple-digit potential capital appreciation.
Me, I see Canopy as an exercise in valuation and fundamentals, namely the following question.
Under what circumstances should you pay 30X Sales for a non-profitable business?
While there might be outlying circumstances and EPS/sales growth numbers that allow for a positive, risk/reward-appealing answer in this (there are always contrarians), my shoot-from-the-hip response would be; Absolutely none – that’s a gods-damned bubble. Not even Tesla (TSLA) is trading at 30X sales.
Yet, at points Canopy traded at 30X sales without being profitable.
As a value investor, I can honestly say I’m somewhat sick of companies pushing fantasy numbers for what they consider to be TAM values (Total addressable markets), overestimating their competitive edge, while underestimating the competition.
What’s more, I really think the entire market is overestimating the number of people who are not using THC/Cannabis only because it is illegal. I don’t believe that the legality of the drug will bring about some Cannabis renaissance/boom – and statistics out of both the USA and Canada support this conclusion, with very little change in the number of people using cannabis to pre-legalization days – not even among teens (Source).
Cannabis has been stigmatized as a drug for so long, that it will take a long time to change people’s minds on it – and that is especially true outside of core NA markets.
I know that my prejudice against fantasy valuations has led me away from some truly terrible investments – as well as missing out on some great ones in terms of short-term returns. I don’t know why I never see these as appealing – perhaps it’s because I’m “too old” and have the mind of an 80-year old stuck in the body of a 36-year old. But given some of the near 100% losses that have been generated by some of these lauded “investments”, I’m fine with this.
Results speak louder than words – so let’s share some actual results.
Canopy reported an operating loss of $1.5B in fiscal 2021, based on STZ results. Its 1-year return is negative 72%, which makes it not the worst investment in the space – but it’s up there.
Recent results have not been better, and the company is struggling to maintain net cash positions following yet another set of quarters of losses. While P/S has dropped to below 10X here and CGC has been trying to “Buy” growth through M&As, none of these deals look really appealing to me.
Back when STZ invested in CGC, the company had a good financial position. That is no longer the case. Sales trends are poor, and current valuations call for a target of below $7/share. This is not a “new company.” Canopy has official financial results going back more than 5 years at this point. At no point has the company reported positive annual earnings.
Yes, there are some excuses for this that are well outside of CGC’s control.
COVID-19 has delayed store openings in Canada – but to my mind, the current trends are mostly due to companies, including STZ, overestimating the ease of entering this market, dominating it, and vastly overestimating the competitive edge of CGC, evidenced by its continued need to buy inorganic growth – the latest of which cost the company near-on $300M.
A disclaimer to this: I’m not a Cannabis investor. In preparation for this article, I did spend time delving into it, but what I came away with was that investors everywhere seem to be overestimating the ease of making money in this market, as well as what should be charged for the companies. Recent results confirm my stance here, but this is not an article on CGC or on Cannabis. If it were me investing, the only way I would go into the space would be using Cannabis-focused REITs such as Power REIT (PW) or Innovative Industrial Properties (IIPR), which are estimated to grow double digits in 2022 (Source: Company forecasts). You could also invest in companies financing the cannabis businesses, such as Advanced Flower Capital Gamma (AFCG). Both of these types of investments are what I would consider more appealing since they don’t carry the direct risk, but are far more senior on the debt pyramid and will be paid before equity shareholders. AFCG’s institutional loans, for instance, are in most cases secured by substantial asset bases.
I’m not saying the appeal couldn’t change. I’m saying that for now, Canopy isn’t that interesting to STZ. And this is reflected by the few sentences management spent speaking about it in the latest quarterly, basically saying “Yeah, it’s doing bad, but we continue to believe in our investment and what it’s doing, here are some great things about the recent M&A they did”.
(Source: Constellation Brands)
Dear readers – focus on legacy here for the time being. That’s undoubtedly where the money is. There might be significant money in Cannabis going forward, but for now, the Canopy investment is a black hole.
Moving on to valuation.
What’s the valuation?
Aside from its venture into Cannabis (which may pay off, who knows!), things are going pretty well for the company.
Recent years have seen a massive multiple expansion for STZ, after over a decade in the sub-15X valuation doldrums. The company initiated its dividend in 2016, and the current yield is a less-than-impressive 1.23%.
The typical 5-8-year average P/E multiple for the company has been a premium of 22.15X. Now, some of you might say that a 20X+ valuation for a consumer-defensive business even with this profile, considering Canopy, is a no-go.
But hold on – give the company a chance, because it might surprise you.
First, STZ has the potential for extreme dips during downturns. Look at the returns you could have made if bought during the pandemic from basically the biggest beer business in the US.
And return potentials are not over. At this point, I believe the company’s premium to be fairly well-established. Also, forecast growth rates have a 10% MoE-adjusted accuracy of 100% – meaning FactSet as well as historical S&P Global targets don’t really miss on a negative basis – in fact, the company beats them half the time.
And, you know, it’s alcohol. People like drinking – it’s not as though sales of beer/wine will go out of style. I consider it far safer than say, cannabis.
So, with that in mind, what happens if the company actually archives its 17% 2023E and 2024E growth rates? Oh, and by the way, I believe that FactSet’s targets are somewhat negative. I’m usually more conservative than this, but I will argue that it’s realistic that the company should reach a $10 EPS based on quarterly estimates and results. Based on such estimates, this company, could at a 21-23X P/E range, bring about an annual RoR of 10-13%.
(Source: F.A.S.T graphs)
Is it a fantastic, undervalued opportunity worthy of massive amounts of investment for triple-digit growth?
No, it’s not. That’s why my stance for the article is actually “Neutral” here. However, to those that say the company is significantly overvalued here, I say that is only true if you consider it wrong to pay for quality.
STZ is by far one of the most profitable and interesting businesses in this entire sector. It “owns” U.S. beer. Its margins are second to very, very few businesses in the same industry on earth. Diageo manages to sort of encroach on the company’s margins, posting better gross/COGS ratios as well as company-wide operating margins currently above the Wine segment from STZ – not the beer segment, and below company-wide margins – and that is an investment I made at a premium as well.
Many readers believe me to be an investor unwilling to pay a premium for quality, because of my near-obsessive focus on valuation. That is false. There are many investments in my portfolio that I paid a premium for, and that I would pay premiums for.
Constellation Brands is one of them.
If the company’s macro headwinds drive this valuation down to 22X P/E, and I see it likely that it might, then I will be investing in STZ. The upside to current estimates at such multiples would be close to 15-16% on a relatively conservative basis (considering company quality), and I would swallow that sub-par yield gladly in such a deal.
Current targets for the company reflect the belief in this premium.
S&P Global guides for an overall price target of $268, based on a range of $213-$310 from 23 analysts. This gives the company an analyst upside of 9.1%. Unfortunately, this comes with the usual exuberance associated with such targets.
Me, I would happily pay a premium for STZ – just not this one. My target reflects a long-term 20-22X P/E and comes to around $219-$240, including the next 2 forecasted annual results – making it the average at $230/share.
Based on this, I see upside at the right valuation for the company – just not necessarily right here.
Constellation Brands has the following current thesis:
- A great company with excellent fundamentals. Even the Canopy Growth investment might be one that eventually delivers some upside to the company. Combine it with a solid portfolio of market-leading brands, and you have one of the most convincing spirits/alcohol businesses available.
- STZ should be accepted at a premium for its moat, its class-leading margins, and its growth prospects both for domestic and import brands. I accept a 20-22X P/E premium for the company and call it fair.
- STZ is a “HOLD” here. A price target that I would consider attractive for investment based on my goals would be around $230/share – though every investor, of course, needs to look at their own targets, goals, and strategies. I would also always consult with a finance professional before making investment decisions such as this.
Remember, I’m all about :
1. Buying undervalued – even if that undervaluation is slight, and not mind-numbingly massive – companies at a discount, allowing them to normalize over time and harvesting capital gains and dividends in the meantime.
2. If the company goes well beyond normalization and goes into overvaluation, I harvest gains and rotate my position into other undervalued stocks, repeating #1.
3. If the company doesn’t go into overvaluation, but hovers within a fair value, or goes back down to undervaluation, I buy more as time allows.
4. I reinvest proceeds from dividends, savings from work, or other cash inflows as specified in #1.
This process has allowed me to triple my net worth in less than 7 years – and that is all I intend to continue doing (even if I don’t expect the same rates of return for the next few years).
If you’re interested in significantly higher returns, then I’m probably not for you. If you’re interested in 10% yields, I’m not for you either.
If you however want to grow your money conservatively, safely, and harvest well-covered dividends while doing so, and your timeframe is 5-30 years, then I might be for you.
Constellation Brands is currently a “HOLD”
Thank you for reading.