EUR 850.00 For Business Accounts Only

Morningstar | Constellation Brands Begins Fiscal 2020 on Solid Footing, Thanks to Momentum in Beer Volumes

Narrow-moat Constellation Brands' beer business (70% of sales) was the highlight of its portfolio in the first quarter, with net sales growth of 7.4% (our full-year estimate is closer to 9%, toward the high end of management's outlook) driven by a 5.4% increase in shipment volume. Performance within the firm's Mexican beer portfolio remains strong, with depletions growing 17% for Modelo Especial and up by a double-digit percentage for Corona Premier and Pacifico. We contend the firm's sustained investments behind its brands, including an increase in marketing spend (up 20 basis points to 11% of sales during the quarter) before the critical summer selling period, will fuel further top-line momentum. We appreciate that management has supported innovation within its brand set; it expects around a quarter of its medium-term outlook for mid- to high-single-digit volume growth (we expect a roughly 7% rate on average over the next five years) to be driven by innovation. For example, the firm launched Corona Refresca in May, which we think will allow it to leverage Corona's brand equity to develop a foothold in the rapidly growing flavored malt beverage category.

On a consolidated basis, net sales increased 2% (our full-year estimate for a roughly 4% decline includes the planned divestiture of around 30 wine and spirits brands in the second quarter) and adjusted operating margin expanded 220 basis points to 33.3% (our full-year outlook incorporates 250 basis points of expansion to 32.4%). We expect to lift our $207 fair value estimate by a low-single-digit percentage to incorporate management's additional detail about the timing of its wine and spirits divestiture but are reiterating our longer-term outlook for mid-single-digit sales growth and operating margin above 34% on average over the next five years. While shares are trading at a slight discount to our valuation, we'd suggest investors keep this name on their radar and wait for a larger margin of safety.

We think management's strategy of reshaping its wine business to focus on higher-growth, higher-margin brands is prudent. Management estimates that retail sales for wine above $11 have grown around 11% over the last three years, while growth in the below $11 price point has been flat over this period. We estimate that the average pricing (as measured by net sales per nine-liter case equivalent) of the business to be divested was roughly 20% lower than Constellation's wine and spirits segment in aggregate in fiscal 2019, suggesting both pricing and profitability will strengthen following the transaction. Management has also identified around $130 million in stranded costs from the divestiture (around 4% of fiscal 2019 sales in the wine and spirits segment) that it plans to extract from its operations over the next two years, which should lead to further margin upside.