In February of this year, I believed that shares of Constellation Brands (NYSE:STZ) lost some of its touch. Growth slowed down after a few very strong years, as cannabis investments have not worked out at all. Trading at a 20 times earnings multiple, amidst higher leverage and slower growth, I believed that valuations looked largely fair.
The company has seen modest growth this year and benefited from the mishaps by Bud Light, making shares trade range bound. Quite frankly, I have no interest at current levels, certainly now with a de-premiumization trend on the horizon with consumers feeling the pain of higher interest rates and higher gasoline prices.
A Long-Term Success Story
Constellation Brands has been a huge long term success, driven by the core Corona and Modelo beer brands which send shares a factor of ten times higher in the 2010s, as shares rose from levels in the $20s in 2010 to the $200 mark ahead of the pandemic.
Irony is that it was the Corona pandemic which hurt the business, as investors were digesting lower demand while the company was quite leveraged. The company posted sales of $8.3 billion in 2019, on which very strong operating profits of $2.6 billion were reported, with realistic earnings of $1.8 billion coming in at $9 per share based on a share tally of 195 million shares.
Net debt was substantial at $12.1 billion and with EBITDA reported at $2.9 billion, leverage ratios were high at 4.2 times, although that the balance sheet revealed over $4 billion in equity investments as well, with leverage much lower if we adjust for those investments.
After shares traded in the $100s following the outbreak from the pandemic, they have traded in a $200-$250 range ever since, trading at $227 per share in February. For the fiscal year 2022, as reported in April that year, the company posted net sales of $8.8 billion (after excise taxes) with operating profits reported at $2.3 billion, or $3.0 billion if we add back an impairment charge, with adjusted earnings coming in around $11 per share.
Through the first three quarters of the fiscal year 2023, Constellation saw sales up 11% to $7.5 billion, although that growth slowed down to 5% in the third quarter. The company was on track to post operating earnings of around $3 billion, although no GAAP losses were seen due to writedowns on the Canopy/cannabis investments, although the worst risks on these investments appeared to be a thing of the past.
Net debt rose to the $12 billion mark, due to some share buybacks, as securities and equity method investments having shrunken to less than a billion due to impairments on the cannabis investments. With the business on track to earn $11 per share, the resulting 20 times multiple looked reasonable, although that leverage has risen, and investors are tired of detrimental investment outside the core areas of the business.
That said, these investments appeared to be a thing of the past, as the company furthermore resolved the complication of the dual class share structure, creating some positive developments as well.
Range Bound
Since February, shares of Constellation Brands have traded in a $210-$270 range, now trading right in the middle of the range at $241 per share. In April, Constellation posted 2023 sales which rose from $8.8 billion to $9.5 billion, although that fourth quarter sales fell 5% to $2.0 billion. The company saw full year operating earnings fall from $3.0 billion to $2.8 billion as losses on investments made that a GAAP loss was reported. Adjusted for these items, losses rose by forty-one cents to $11.40 per share.
Net debt ticked up to $12.3 billion with investments now falling below the billion mark. Excluding the impact of Canopy, the company guided for modest growth in 2024 with earnings per share seen between $11.70 and $12.00 per share.
Despite the troubles, Constellation announced two bolt-on deals. In May, Constellation acquired a minority stake in Tost, a flavor and alcohol-free sparkling beverage brand. In June, Constellation acquired luxury Napa Valley wine brand Domaine Curry, with again no financial details being announced.
The company lost Chairman of the board Rob Sands over the summer in his capacity as chair, although he will continue to hold a board seat, as Mr. Sands has been instrumental in the success of the firm, having taken the top reign from 2007 to 2019. This decision is part of a wider shake up of the board.
The company saw growth return in the first quarter of 2024 as reported in June. First quarter sales rose by more than 6% to $2.5 billion. While comparable earnings per share fell by thirteen cents to $2.91 per share, GAAP earnings fell to just $0.74 per share due to major losses and non-consolidated entities (read Canopy).
Second quarter sales rose by 7% to over $2.8 billion as net debt ticked down to $11.6 billion. Comparable earnings were still down ten cents to $3.70 per share, with reported GAAP earnings being in line as the bottom line was not hurt by another investment loss. Growth is really driven by the beer business, up 12% to nearly $2.4 billion, while the wine and spirits business posted a 14% fall in sales to $444 million.
Like other peers, the business benefited from the woes at Bud Light, of course owned by Anheuser-Busch InBev (BUD), after its marketing mishap. This makes that comparable earnings are now seen between $12.00 and $12.20 per share.
What Now?
The reality is that shares of Constellation continue to muddle through. With earnings power around $12 per share, the company still trades at around 20 times earnings, as the positive is that leverage has come down a bit, now equivalent to 3.2 times EBITDA.
The bigger concern is that of a potential retreat in demand as consumers are strapped here and all the consumer food companies are under pressure. This came after 2022 was already a year of volume declines for the sector at large. This decline, in combination with larger price hikes, resulted in overall growth, but the composition of growth for the wider industry is poor.
By now, higher interest rates and gasoline prices hurt consumers, as demand might retreat and a de-premiumization of brands might happen here, resulting in potential less demand for premium beers/brands like the ones owned by Constellation.
Given this backdrop, I am refraining from getting involved here just yet, although I will be keen to keep a close eye on any dip towards the $200 mark.
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