This is an expansion of a former post I had on Constellation Brands. Sorry for the repetition but this is a more thorough analysis. Promise, no repetitive posts in the future! :)
Constellation Brands (STZ) is a Fortune 500® company and a leading international producer and marketer of beer, wine and spirits with operations in the U.S., Mexico, Canada, New Zealand and Italy. Constellation is the third-largest producer and marketer of beer for the U.S. market. The company’s high-end, iconic imported brands include Corona Extra, Corona Light, Modelo Especial, Modelo Negra and Pacifico. The portfolio also includes Ballast Point, one of the most awarded craft brewers in the U.S. In addition, Constellation is the world’s leader in premium wine, selling great brands including Robert Mondavi, Clos du Bois, Kim Crawford, Meiomi, Mark West, Franciscan Estate, Ruffino and The Prisoner. The company’s premium spirits brands include SVEDKA Vodka, Casa Noble Tequila and High West Whiskey.
The company’s fundamentals are strong! As of the most recent quarter, the company’s market cap is $42.57 billion with a forward P/E ratio of 23.57 (A good sign; level P/E ratios common in mature industries like this; Beta of -0.01) compared to an alcoholic beverage sector average of 23.27 and an S&P 500 average of 23.28. Their revenue amount to $7.46 Billion. Organic net sales rose 8% to $2.07 Billion, beer segment sales increase 12.8% to 1.38 Billion, wine and spirits sales fell 11.7% to 705.6 Million, and they improved adjusted earnings guidance to $8.25-$8.40 per share from $7.90-$8.10. This is their 12th straight earnings beat and 17th consecutive quarter of year-over-year improvement (40% increase at $2.47 per share). So how does STZ square up to competitors? For this analysis, I will be looking at Constellation Brands (STZ), Diageo (DEO), Brown-Foreman (BF-B), Molson Coors Brewing Company (TAP), Anheuser-Busch InBev (BUD), and The Boston Beer Company (SAM). I will also very briefly mention Campari (CPR-MI), Remy Cointreau (RCO-PA), and Pernod Ricard (RI-PA) for further comparison within the industry.
Constellation Brands is most efficient in its operations, effective in management, and consistent in performance. Let’s first look at each company’s revenue per employee (independent variable) and operating margin (dependent variable) …
STZ: Revenue per Employee - $828,418 Feb 28, 2017 (Operating Margin = 33.76% August 31st, 2017) DEO: Revenue per Employee - $489,858 June 30, 2017 (Operating Margin = 29.50% June 30th, 2017) BF-B: Revenue per Employee - $630315 April 30, 2017 (Operating Margin = 33.34% July 31st, 2017) TAP: Revenue per Employee - $368679 December 31, 2016 (Operating Margin = 36.60% September 30, 2017) BUD: Revenue per Employee - $258,383 December 31, 2016 (Operating Margin = 28.92% September 30, 2017) SAM: Revenue per Employee - $617,890 December 31, 2016 (Operating Margin = 15.43% September 30, 2017)
Source: Y Charts
Although TAP’s operating margin is superior to the rest of its competitors with data given so far, STZ maintains the lead in terms of superior operating margins in correlation with revenue per employee (BF-B comes close but revenue per employee falls short while SAM’s operating margin is the worst in comparison even though revenue per employee is close to that of BF-B). This illustrates that STZ’s labor and operations efficiency is the highest. It is worth noting that operating margins for Campari, Remy Cointreau, and Pernod Ricard also fall short of STZ and even that of BF-B so these are not in consideration (especially taking into account that they trade on European Stock Exchanges and are subject to currency exchange risk; DEO is subject to these risks as well but the security is traded on US stock exchanges). Let’s now look at revenue and earnings of each company…
Constellation Brands (STZ) 2015 - Revenue: 6.03 Billion, Earnings: 839.30 Million 2016 - Revenue: 6.55 Billion, Earnings: 1.05 Billion 2017 - Revenue: 7.33 Billion, Earnings: 1.54 Billion Diageo (DEO) 2015: Revenue: 17.01 Billion, Earnings: 3.88 Billion 2016: Revenue: 14.02 Billion, Earnings: 3.16 Billion 2017: Revenue: 15.65 Billion, Earnings: 3.60 Billion Brown-Foreman Corporation (BF-B) 2015: Revenue: 3.13 Billion, Earnings: 684 Million 2016: Revenue: 3.09 Billion, Earnings: 1.07 Billion 2017: Revenue: 2.99 Billion, Earnings: 669 Million Molson Coors Brewing Company (TAP) 2014: Revenue: 4.15 Billion, Earnings: 514 Million 2015: Revenue: 3.57 Billion, Earnings: 359.50 Million 2016: Revenue: 4.89 Billion, Earnings: 1.98 Billion Anheuser-Busch InBev (BUD) 2014: Revenue: 47.06 Billion, Earnings: 9.22 Billion 2015: Revenue: 43.60 Billion, Earnings: 8.27 Billion 2016: Revenue: 45.52 Billion, Earnings: 1.24 Billion The Boston Beer Company (SAM) 2014: Revenue: 903.01 Million, Earnings: 90.74 Million 2015: Revenue: 959.93 Million, Earnings: 98.41 Million 2016: Revenue: 906.45 Million, Earnings: 87.35 Million
Source: Yahoo Finance
The only company to maintain a consecutive uptrend in BOTH revenues and earnings is STZ. In fact, in the past five years, STZ's stock price has failed to increase, per quarter, only three times. TAP is the only company on the list that ends up at a higher revenue and earnings level compared to the first year but considering that it has no consecutive earnings beats compared to STZ whose beat earnings 12 times in a row, consistency comes into question. Finally, let’s look at 5-year stock performance…
STZ: 518.39% DEO: 16.94% BF-B: 67.68% BUD: 33.64% TAP: 92.16% SAM: 57.30% RI-PA: 48.92%
Source: Y Charts
Evidently, Constellation continues to outperform all its competitors for the past five years and beyond. Many comparisons between STZ have been made against DEO and BF-B but from the data above, DEO seems to be sluggish and inefficient based on its operating margins and revenue per employee while BF-B, although a close contender, lacks consistency in performance (BF-B's stock price has fallen eight times in a quarter-to-quarter comparison in the past five years). But what could explain STZ’s superior performance and growth?
Looking at the 10-year chart, STZ (excluding SAM) breaks out from the rest of the companies in comparison around 2013 with the pace quickening near the end of the 1st half of the year. Around that time, the company completed its acquisition of Grupo Modelo’s U.S. Beer Business from Anheuser-Busch InBev for approximately $4.75 Billion. The acquisition nearly doubled company sales and significantly increased EBIT alongside free cash flow, helping solidify Constellation's position as the #1 multi-category supplier for beer, wine and spirits in the U.S. at the time of the acquisition. Furthermore, Constellation entered the tequila game early with its acquisition of Casa Noble Tequila in 2014 for only $30 Million. Compare this with DEO’s later acquisition of George Clooney’s Casamigos Tequila brand (respectable brand but not on the level of Casa Noble and a little late not to mention expensive; makes STZ’s tequila play a massive bargain in comparison) for approximately $1 Billion earlier this year and one can see why STZ is where it is now. These are arguably pivotal moments in the company’s history as their blockbuster Corona franchise is America’s best-selling premium import and the company alone was responsible for the 60% of the growth in the high-end beer category last quarter (this segment expanded by 9% over the past six months). Furthermore, Modelo, not Corona, led the beer portfolio higher by posting a 20% spike in consumption for the last quarter.
There is reason for concern when considering their wine and spirits segments, however, and recent acquisitions in the craft beer space. According to the company, wine and spirits sales fell 11.7% to 705.6 Million which is worrying especially considering the company’s recent acquisitions of Charles Smith and Prisoner wine brands. These acquisitions are further put into question with the acquisition of Ballast Point in 2015 for $1 Billion and expansion into craft beers (to make matters worse, the company alongside others making similar moves such as BUD are facing negative sentiment from the craft beer community). For example, after BUD’s purchase of Wicked Weed Brewing, many brewpubs and craft beer festivals cut ties. Furthermore, negative trends in the craft beer space led STZ to take a $86.8 Million impairment charge on the Ballast Point’s trademark value to $136 Million and the need to further write down the value more and more could grow. In other words, it looks like the company overpaid for Ballast Point, especially considering that the acquisition of Grupo Modelo only a few years ago cost approximately $4.75 Billion and the return on that investment has proven life-changing for STZ. However, despite these facts, the fact that Charles Smith alongside other new brand launches including Buddha Funky Brewery, acquired this past August, helped contribute to the most recent earnings beat and raised the bottom line is encouraging. Regarding their acquisitions in the craft beer space, although the price tag for Ballast was a little high, the move marks STZ’s overall strides to expand their presence in the high-end beer market and although their focus should be more on Corona, etc., this seems to have been a necessary move. Acquisitions to fuel strategic growth is a strong characteristic of the company and so far, they have been making the right moves for the most part and will do so going forward. But what is there to prove that they are making the right moves? Their debt-management.
A major concern for the company is their debt load and just recently, STZ priced in $2 billion in new debt as of Oct 31st, 2017 which closed on November 7th. So evidently, debt-management comes into question. Okay, so at first glance the debt situation looks bad but let's dig a little deeper...
So, although STZ's debt is rising, their debt-to-equity ratio is decreasing. Back in 2015 around the beginning of the second half, it was about 1.224 and now it's resting at about 1.129. In short, their equity is rising faster than their debt can keep pace and instead of focusing on dividends and distributions back to shareholders, they're keeping profits on the balance sheet. And their management under Rob Sands is excellent so these profits are getting reinvested to fuel smart and strategic expansion of potential economic profits. The style of debt they're using is old-fashioned, but it is working for them. The share price is a testament to this superb management and a result of the company putting its profits to work. Take another look below…
2015: Net Margin % - 13.92% | Financial Leverage - 2.62 | Return on Equity 15.61% 2016: Net Margin % - 16.11% | Financial Leverage - 2.59 | Return on Equity 17.11% 2017: Net Margin % - 20.94% | Financial Leverage - 2.70 | Return on Equity 22.83%
Source: Edgar Online Database
The reason for the overwhelming rise in equity is due to improving net income margins. While many companies are achieving this at the expense of increasing leverage and thereby risk, STZ has made improvements in the right areas. According to the data above, financial leverage for STZ increased by just 3% in three years and was not a significant contributor to the increase in return on equity. Compare this with its peers and STZ’s results look even more impressive. For instance, in the case of Anheuser-Busch (BUD), the return on equities has dipped despite an increase in leverage and risk. Therefore, excess returns from higher return on equity with minimal increases in risk (leverage), when peers are failing to do that, should support further expansion in STZ's earnings multiple. So, knowing the story behind this debt alleviates any concern regarding the company’s debt and, in fact, recent news of more debt is encouraging with management intact.
Now that the case for STZ against its competitors is made, let’s evaluate the intrinsic value of the company. For this analysis, a discount rate of 8.49% 5 Year Cash Flow Forecast
Levered FCF (USD, Millions) 2017 - $776.90 (PV $716.08) 2018 - $901.10 (PV $765.53) 2019 - $1,520.55 (PV $1,190.65) 2020 - $1,848.81 (PV $1,334.35) 2021 - $2,145.00 (PV $1,426.92) Discounted (@ 8.49%)
Present value of next 5 years cash flows: $5,434
Terminal Value
Terminal Value = FCF2021 × (1 + g) ÷ (Discount Rate – g) Terminal Value = $2,145 × (1 + 2.47%) ÷ (8.49% – 2.47%) Terminal value based on the Perpetuity Method where growth (g) = 2.47%: $36,487 Present value of terminal value: $24,272
Equity Value
Equity Value (Total value) = Present value of next 5 years cash flows + terminal value $29,706 = $5,434 + $24,272
Value = Total value / Shares Outstanding ($29,706 / 172)
Discount to Share Price Value per share: $172.71
Estimate of Discount Rate
The discount rate, or required rate of return, is estimated by calculating the Cost of Equity. Discount rate = Cost of Equity = Risk Free Rate + (Levered Beta * Equity Risk Premium) Discount rate = 8.49% = 2.47% + (0.8 * 7.53%)
Estimate of Bottom Up Beta
The Levered Beta is the Unlevered Beta adjusted for financial leverage. It is limited to 0.8 to 2.0 (practical range for a stable firm). Note the market value of equity is used not the book value ($43,044,787,154).
Levered Beta = Unlevered beta (1 + (1- tax rate) (Debt/Equity)) 0.608 = 0.531 (1 + (1- 30%) (20.79%)) Levered Beta used in calculation = 0.8
It is important to note that any type of DCF calculation is subject to significant variance depending on discount rate and growth rate. The discount rate is based on the cost of equity since the perspective is from the viewpoint of a potential investor so cost of capital (Weighed Average Cost of Capital/WACC), which accounts for debt, is not used. So clearly the intrinsic value is not up to par with my bull thesis of the stock. In fact, for the past two years I’ve been analyzing the stock, the DCF model has concluded STZ is overvalued yet the stock has continued to climb. I believe this is the case because DCF is a highly quantitative technique and therefore does not fully reflect changes in non-financial information. The company is simply making too many moves that the valuation can never keep up and full current potential is not being realized. So, what does the company have going for itself moving forward that is justifying further upside?
First, CEO Rob Sands makes it clear in the most recent earnings call that distribution growth is anything but at its highest potential due to retailors dedicating too much shelf space to low-margin, low-growth brands. Evidently, the velocity on STZ products are much higher than its competitors in terms of the high-end beer market and therefore the point Sands made in the call was that retailers are beginning to assign more shelf space to Constellation’s portfolio as they realize higher margins and growth can be unlocked, benefiting both sides. With that said, the full potential of STZ is yet to be realized implying further growth ahead.
Second, the company is beginning to reap the financial benefits from its multiyear investments aimed toward boosting Mexican brewery capacity and added efficiency to its glass production, spending which peaks over $1 Billion this year, as part of an $4-billion-plus total investment. Capital spending should slow significantly from here, though. Constellation Brands is expecting over $1 billion in annual free cash flow beginning next year, compared to the $775 million it expects to generate in fiscal 2017. That will result in larger amounts of free cash flow that can be directed toward bigger beer and wine brand acquisitions, accelerated share repurchases, and a rising dividend. This increase in growth and repurchasing of shares should point further upside while attracting more equity as the stock brings in more income investors with a higher dividend.
Third, STZ announced plans to debut its newest additions to the Corona franchise this upcoming February: Corona Premier (domestic markets) and Familiar (all major Hispanic markets). This is an excellent move for two reasons: 1) 66% of net sales consisted of beer segment sales which increased 12.8% to 1.38 Billion with Mexican beers leading the charge behind this massive growth and therefore makes the focus on Mexican beers like Corona paramount, and 2) the company states that 55% to 60% of all beer sales occur during the first half of the year so the fact that the new beers will debut near the beginning of the first half is optimal. With the Corona franchise already exceeding expectations and test markets showing approval so far, expect further growth and dominance in the high-end beer market, arguably their strongest segment.
Fourth, a recent 9.9% stake purchase (~$195 million) in Canopy, a world-leading provider of medical marijuana is another effective and early move reminiscent of STZ’s moves into the high-end beer market through the Grupo Modelo acquisition and tequila through Casa Noble. Both those acquisitions have paid off immensely and no doubt this move into the weed industry will prove successful as well. And although this initial investment may seem small, the company has options to buy more shares at a later time. This move comes at a time when approximately 27% of beer drinkers have already substituted beer with cannabis while BUD and TAP are already trying to secure sole licensing rights in Nevada to distribute cannabis. The move by Constellation therefore is clearly an effort to secure Canadian distribution before legislation is passed requiring cannabis be sold and purchased through a government licensed distributor which would cost significantly more. But legalization is the trend with recreational marijuana already legalized seven states (Alaska, California, Colorado, Maine, Massachusetts, Nevada, Oregon, Washington) alongside Washington, D.C. Increased legalization of recreational marijuana will equate to lower beer and spirits sales, so this is a smart move. The question of legalization is not “If” but “When” and soon, many if not all, of the other states will follow and the cannabis market is expected to hit a lofty $50 billion by 2026, according to Cowen. More importantly, Constellation is going to work with Canopy Growth to develop cannabis-based drinks for its customers who already purchase wine, beer and spirits made by the company. In states like Colorado where recreational use is legal, cannabis-based drinks are booming. By working with Canopy Growth, Constellation goes from a triple threat (beer, wine, spirits) to a quadruple threat. This investment should continue to fuel STZ’s growth as it enters a potentially explosive market in the coming years.
Finally, Senate Republicans are proposing significant excise tax reductions for wine, liquor, and beer. Only downside is it would only last two years, so the Republicans are proposing extensions (Would begin December 31, 2017 to December 31, 2019). This would be the first distilled spirits tax reduction since the Civil War if approved. Some examples of how reductions would work (Potential $130 million generated from this throughout the industry, will be reinvested back into businesses which is good for investors) …
Beer: $16/barrel – First 2,000,000 barrels, $18/barrel - 2,000,000+ Small brewers: $3.50/barrel - First 60,000 barrels, $16/barrel - 60,000+ Spirits: $2.70/gallon – First 100,000 gallons, $13.34/gallon – between 100,000 and 22,130,000 gallons, $13.50/gallon - 22,130,000+ Wines: $1.07/gallon -14% alcohol content, stronger wines increase with alcohol content, $13.50/gallon - 24% alcohol content (Sparkling wine at $3.40/gallon) Increases lowest taxable increment of wine from 14% to 16% (Sparkling wine will be taxed in line with still wines) Reduce Excise Taxes: $1/gallon – First 30,000 gallons (produced or imported), 90 cents/gallon - next 100,000 gallons, 53.5 cents/gallon - next 620,000 gallons
Source: CNN Money
Although this is more speculative and there is no guarantee that this proposal goes through, if these tax reductions are realized then the potential for additional upside would increase as this is not necessarily priced into the stock itself. To put this into perspective, STZ paid approximately $730.1 Million in excise taxes for the fiscal year ended February 28, 2017 so any savings that can be realized from excise taxes would be a boon to not only STZ but the alcoholic beverages industry. But under superior management and efficiency in operations, this tax relief should be of more benefit to STZ than its peers.
I will not provide a price target as such is not in my nature to do so. And statistically, this stock would not count as an undervalued security as the relevant P/E and P/BV are not below 15 and 1.5, respectively. Furthermore, the DCF model shows that STZ is overvalued but considering all points mentioned and that the stock has continued to steadily rise over the years above its peers, I am expecting further upside fueled by its promising future growth prospects.
Thoughts?
If you would like a more brief analysis of the security and other insights, please check out my YouTube channel/Seeking Alpha Blog.
YouTube (I am still experimenting with my videos but I will try to include more significant analysis in my videos as the opinions of this subreddit are valuable) https://www.youtube.com/channel/UCG419gTxWVs1f0C1qjRD-XQ
Submitted November 28, 2017 at 04:57AM by seoul_investor http://ift.tt/2AF1pXx
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