EUR 850.00 For Business Accounts Only

Morningstar | Constellation Brands' Shares Pop on Strong Beer Performance and Improved Wine Prospects

Narrow-moat Constellation Brands' efforts to reshape its wine and spirits business (36% of sales), which posted a nearly 8% sales decline in the fourth quarter due to lackluster wine performance, seem to have bolstered confidence in its prospects, sending the shares up roughly 7% on April 4. Also, on April 3, Constellation announced it signed an agreement with E. & J. Gallo Winery to sell around 30 brands from its wine and spirits portfolio (primary at the $11 and below price point) for $1.7 billion. This implies a multiple of around 1.5 times fiscal 2019 sales, by our estimates, which strikes us as reasonable. The deal is expected to close by the end of the first quarter of fiscal 2020, reducing full-year net sales by 25%-30% and operating income by 30%-35%. We think this will sharpen Constellation's focus on the highest-margin opportunities in its wine and spirits portfolio and better position its brand set to benefit from industrywide premiumization trends. Management estimates that retail sales for wine above $11 have grown at a 12% compound rate over the past five years, outpacing the 4% rate for the overall wine category. We think management's decision to use the proceeds from the deal to pay down debt is prudent, as debt/adjusted EBITDA was around 4.7 times in fiscal 2019 and management's target leverage ratio remains 3-4 times.

On a consolidated basis, full-year net sales growth of 7%, a comparable operating margin of 32% (down 40 basis points from the year prior), and adjusted earnings per share of $9.28 compared with our estimates of 6%, slightly below 33%, and $9.25, respectively. As such, we're reiterating our longer-term outlook for 6% sales growth and operating margin in the high 30s in the out years of our forecast. We anticipate lifting our $201 fair value estimate by a low-single-digit percentage as we incorporate these results. We still view the shares as slightly undervalued.

Constellation's beer business (64% of sales) remained the key driver of top-line gains in the fourth quarter, with net sales in the business growing 9% on an 8% increase in depletion volume, thanks to continued momentum in the Modelo and Corona brand families. On a full-year basis, an 11.6% increase in beer sales slightly outpaced our expectation for nearly 11% growth. We were pleased to see strengthened pricing (up 1.8% for the year versus our 1.5% estimate and 1.3% in fiscal 2018), which we view as evidence that the firm's brand intangible assets, which underpin our narrow moat rating, remain healthy. Full-year beer operating margin held steady around 39%, in line with our expectation, as the positive impact from pricing was offset by input cost inflation (particularly for glass and transportation) and an uptick in beer marketing spending (at 9.3% of sales in fiscal 2019, or about 30 basis points over the prior year, and expected to hover around 9.5% of sales in fiscal 2020). From our perspective, management's decision to reinforce investments behind its brands should support its sales trajectory longer term, particularly as it brings new products and packaging formats to market, like Corona Refresca (a flavored malt beverage expected to launch in the first quarter) or a 32-ounce single-serve bottle for Modelo.