Constellation Brands named top pick at Credit Suisse — analyst explains why

Credit Suisse analyst Kaumil Gajrawala joins Yahoo Finance to discuss the latest ranking for Constellation Brands, the reasoning behind why the company took top honors amongst alcoholic beverages, and the challenges the company can expect moving forward.

Video Transcript

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JULIE HYMAN: Constellation brands shares have been hit as of late, in part because hard seltzer just isn't what it used to be, I guess, last summer. However, the stock is being named a top alcoholic beverage pick over at Credit Suisse. And Kaumil Gajrawala, the analyst over there who covers the stock, is joining us right now. Kaumil, thank you for being here.

You say the hard seltzer challenges might be temporary. And in any case, beer is going to have a comeback. Walk us through your thesis here.

KAUMIL GAJRAWALA: Yeah, remember, we're seeing a slowdown in seltzer. We're not necessarily seeing a decline. And I think a lot of the buzz over the last 20 months really have been about seltzer. And companies like Boston Beer and Marc Anthony Brands, which owns White Claw, have done extremely well.

I think the expectations for how much growth there was going to be in seltzer were out of line. And that's starting to reset itself. As it has, the way we're looking at the beer industry, the stocks in the beer industry is Constellation Brands is a company that didn't really ever have a lot of exposure to seltzer. And as we start to go to maybe more normalized growth, slower share gains of seltzer, now you're likely to see them outperform many of their peers.

BRIAN SOZZI: You write a little bit in the note this morning about their success, Constellation Brands that is, with Modelo. We have talked to Constellation Brands consistently. And they are highlighting this as well. Why is this brand so hot? It's not a new brand. It just seems as though that strength has come out of nowhere.

KAUMIL GAJRAWALA: Yeah, it feels like it's come out of nowhere, but the brand's been around for a long time. And originally, for many decades, Constellation was in a joint venture, a joint venture in the United States. Once they eventually had complete control in the United States for the whole Modelo portfolio, with Modelo, of course, being the kind of crown jewel of a brand, is when you really started to see the brand unleash itself, when the marketing really started to kick in, when distribution started to increase.

And it's very favorable demographics. And while it's done very well in the recent five, seven years, it still skews very heavily to certain markets. And so we continue to expect the growth as it becomes more mainstream of a beer and starts to gain share, similar types of share in states where it's maybe 1/3 of the share, as it might be in Southern California and some other markets.

BRIAN SOZZI: One part of the business that hasn't done well for Constellation in some time is the wine business. Do you see that business turning around?

KAUMIL GAJRAWALA: We're starting to see it. It required a pretty complex restructuring. Their wine business used to have-- a very large piece of their wine business used to be in what they would call lower-end or popular priced wines, really kind of $10 and below, on average. It's very difficult to make money in the wine industry, I think, at those price points.

As you move slowly up the value ladder, then it's easier to build brands. It's easier to market. And obviously, at a higher price, you have the opportunity to capture higher margins.

And so we've gotten to the place-- now that they have sold off some of that portfolio, the remainco should indeed grow much more quickly than Constellation's wine business has grown in the past.

JULIE HYMAN: And Kaumil, I want to pick up on the margin discussion but on the beer side. We had a full screen up before showing your estimate for beer margins, if we can pull that back up, because you say the margins are likely going to be better than the company guided, that 41% in 2022, in fiscal '22, and 41% this year as well.

Margins have really been a challenge across industries. We've been hearing a lot about companies, from Nike to other types of manufacturers. What is going to help Constellation in this case? I assume in the case of Constellation, they don't have to ship their beer from Asia. So you don't have to worry maybe as much about the shipping question. But talk us through it.

KAUMIL GAJRAWALA: Yeah, so it's one of the few companies-- we cover the whole of the consumer space. And almost every company is dealing with cost pressure. And Constellation is dealing with it but not in the same sense. As you mentioned, they don't have to worry about ocean freight and the port shortages, particularly on the West Coast. They don't have to worry about resin prices and plastic prices in the same way that some of the other names, some of the other companies that we cover are struggling with.

However, when you think about their margin story, demand is very strong. We expect demand to be quite strong. We just had a conversation about Modelo. Beer is an industrial business. And industrial businesses, when you have accelerating volume, they generate a lot of operating leverage.

They call them golden cases. Once you've covered the cost of your facilities, all the incremental cases are very highly profitable. So we expect demand to come in a little, as demand continues to be strong, and we expect it to stay that way. We also see them shipping more into the channel because they're light on inventories. That combination should drive enough operating leverage to more than offset any incremental costs and to likely deliver numbers that are better than where they've guided.

BRIAN SOZZI: I've been really blown away the past six months on how strong the whiskey and tequila markets are. And Constellation has a great balance sheet. I mean, do you think they start venturing outside of beer and maybe make a play for some upstart tequila brand?

KAUMIL GAJRAWALA: We don't think so. The company has done a series of deals over the last two decades, some which have worked out, others which have not. At the moment, given how well beer is growing, I think the focus for the company is to build new breweries. They're looking for a new location to build a brewery in Mexico. And just continue investing in kind of the core of their portfolio--

Like we mentioned about wine, they've actually been a net seller as opposed to a net buyer of late. Could there be some small bolt-ons, maybe a tiny brand that really shows the ability to scale? Possibly, but I don't expect anything large-scale.

JULIE HYMAN: All right. Kaumil, interesting call out today. And great to talk to you and break all of this down. Kaumil Gajrawala is with Credit Suisse. He's an analyst and has Constellation Brands as a top pick in alcoholic beverages. Thank you, Kaumil.