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Balanced Risk-Reward for Constellation Brands: Stock Rises

Zacks Equity Research

Constellation Brands Inc. STZ has displayed positive momentum, driven by strength in its beer business that stems from higher shipment volume and depletions. Additionally, the company is poised to gain from constant brand-building efforts, innovation pipeline and the Canopy Growth CGC investment. These factors have not only aided its quarterly outcome but also boosted the share price, with gain of 24.4% recorded in the past six months. This performance is well ahead of the industry’s growth of 11.5% for the same period.

However, Constellation Brands continues to grapple persistent softness in its wine & spirits segment. A soft view for the segment due to impacts of the sale of its 30 brands to Gallo is concerning. Further, higher interest expense projections for fiscal 2020, including $105 million related to the financing of the Canopy deal, may hurt the company’s bottom line. With these headwinds, let’s see how this leading beer, wine and spirits company will retain stock momentum.

 


Factors Favoring the Stock

Strength in the beer business over the years has been the key highlight of Constellation Brands’ growth story. In first-quarter fiscal 2020, sales at the beer business improved 7.4%, marking the 37th straight quarter of growth. This growth story is mainly supported by strong shipment volume and depletions growth trend. Strength in the Modelo and Corona brand families are mainly driving the company’s solid portfolio depletions and market share gains.

In fact, its beer business was the most significant contributor to the U.S. beer market, courtesy of gains from Modelo Especial, Corona Premier and Corona Refresca. Furthermore, management anticipates net sales and operating income for the beer segment to increase 7-9% in fiscal 2020.

Additionally, Constellation Brands’ consistent focus on brand building and initiatives to include new products are its key revenue drivers. These endeavors are largely contributing to the company’s market share gains, especially in the U.S. beer category. Its recently launched Corona Refresca in the Corona brand family is witnessing positive response and is poised for growth in the flavored malt beverage category. Some of its previously launched innovations, including SVEDKA Rose, Robert Mondavi Private Selection, Rum Barrel-Aged Merlot and Crafters Union, are also witnessing favorable trends.

Looking ahead, management will continue enhancing its Bourbon Barrel Aged innovation program, which sold more than 1 million cases in the first two years. The company has strong innovation pipeline for fiscal 2020, with planned launches for Woodbridge Rose and Robert Mondavi Private Selection. Further, it expects to expand consumer marketing efforts in fiscal 2020, with new sponsorship opportunities. These will include sponsorships for the PGA, the U.S. Tennis Association and several NFL teams for Meiomi, Kim Crawford and Woodbridge brands, respectively.

Moreover, Constellation Brands focuses on expanding operations to achieve business growth. In the beer segment, the company’s expansion plans are anchored by the Funky Buddha Brewery buyout; the addition of Fathom IPA by Ballast Point Brewery; and expansions at the Nava, Obregon and Mexicali breweries. Further, it is poised to gain from investment in Canopy Growth, which provides it a single platform for growth in the cannabis market. The company sees strong consumer demand in the Canadian recreational cannabis market. Further, it notes that the recently passed U.S. Farm Bill has legalized the production of industrial hemp, including CBD, a non-psychoactive cannabis compound with significant medical benefits. This provides further growth opportunity for the company.

Meanwhile, it remains keen on reviving the performance of the wine & spirits business. As part of its efforts, the company agreed to sell nearly 30 low-end brands from the wine & spirits portfolio, which are priced at or below $11 per bottle, to E. & J. Gallo Winery for $1.7 billion. Moreover, the deal also includes the divestiture of related facilities in California, New York and Washington. The transaction is expected to conclude by second-quarter fiscal 2020. The sale of these low-end brands will help it concentrate on more lucrative premium wine & spirits brands, which should enhance returns and shareholder value. The company expects to use proceeds from the transaction to reduce debt.

Factors Hindering Growth

Though the aforementioned factors keep us optimistic about the stock’s potential, there remain some hurdles in its growth path. The most prominent among these is the persistent softness in the company’s wine & spirits business.

In first-quarter fiscal 2020, net sales for the wine & spirits segment declined 7.8%, owing to an 8.1% fall in shipment volume and a 0.7% dip in depletions. While the company’s divestiture plans for wine & spirits brands look promising, net sales (on a reported basis) for this business are estimated to decline 20-25% in fiscal 2020, with operating income likely to fall 25-30%. The guidance for the wine & spirits business includes impacts of the sale of its brands to Gallo.

Constellation Brands also issued a bearish outlook for fiscal 2020 due to impacts of the adjustments related to loss from the Canopy Growth deal (mostly higher interest expenses) and other activities in addition to wine and spirits divestitures. For fiscal 2020, interest expenses are expected to be $425-$435 million, up from $420-$430 million mentioned previously. This view includes incremental interest of $105 million related to the financing of the 2018 Canopy investment. This might weigh on the company’s bottom line.

Wrapping Up

The above discussion clearly shows that Constellation Brands has balanced risk-reward, with growth efforts likely to offset hurdles. Further, the Zacks Rank #3 (Hold) company’s expected long-term earnings growth rate of 8% and a Growth Score of B speak well of its growth potential.

Though the company provided soft guidance for the wine & spirits business for fiscal 2020, it targets achieving mid-single-digit power brand depletion growth due to gains from wine and spirits transformation strategy. In the long run, the business is anticipated to generate mid-single-digit net sales growth, with operating margin of 30%.

Don’t Miss These Better-Ranked Alcohol Stocks

Anheuser-Busch InBev SA/NV BUD has a long-term earnings growth rate of 9.1%. The stock presently carries a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

The Boston Beer Company, Inc. SAM, with long-term earnings per share growth rate of 10%, currently carries a Zacks Rank #2.

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