Our current investment themes are:
- Constellation Brand (NYSE:STZ) operates a range of leading brands including Corona, Modelo and SVEDKA. The company’s marketing and industry penetration efforts have been successful, maintaining its leadership position in the business.
- Industry trends such as premiumization are good for STZ, helping to boost growth and profits. The business has good visibility in both beer and spirits compared to its peers.
- Compared with its peers, STZ’s performance is average, with higher profit margins but lagging growth. When considered in conjunction with its trading multiple, we don’t think there’s enough upside.
Constellation Brands operates a multi-category alcoholic beverage business. Its business model involves the production, marketing and distribution of various alcoholic products. The company’s product portfolio includes well-known brands such as beer (e.g. Corona, Modelo), wine (e.g. Robert Mondavi, Kim Crawford) and spirits (e.g. SVEDKA Vodka).
STZ’s share price performance over the past decade has been impressive, clearly outperforming the market. This is driven by Shrew management, with continued commercial development delivering substantial financial returns.
The above describes the financial performance of STZ.
Revenue and business factors
STZ’s revenue has grown at a healthy 8% CAGR over the past decade, with relatively stable year-over-year growth. This is supported by mergers and acquisitions and healthy organic growth.
STZ has a diverse portfolio of well-known brands in different alcoholic beverage categories. These include beer brands such as Corona, Modelo and Pacifico, wine brands such as Robert Mondavi and Meiomi, and spirits brands such as SVEDKA vodka. These brands occupy an important position in the global market, especially in the Western market.
Continuous investment in brand development, especially through innovative marketing strategies, is critical to growing your customer base. Consumers are often loyal to their favorite beverages, which is why winning more customers among your peers can be very profitable.
STZ has a strong distribution network covering various regions and is able to penetrate deeply into the national market. Similar to the importance of effective marketing, reaching consumers through “shelf space” (stores and social venues) is critical to maintaining and developing market-leading products. Underpinning this is a diversified global supply chain that will continue to improve margins as scale expands.
As shown below, management has successfully executed on its strategic mission, resulting in 50 consecutive quarters of consumption growth.
The company has entered into strategic partnerships with other beverage companies, allowing it to expand its product portfolio and distribution reach. The biggest example is its partnership with Grupo Modelo, which gave it exclusive rights to import and sell Corona and other Modelo beers in the United States. After the Bud Light scandal, Modelo Especial takes the top spot in the U.S. beer market (May 23).
STZ has made strategic acquisitions and investments to expand its product portfolio, primarily to fill gaps, increase exposure to certain markets and enter emerging beverage categories. Industry trends have the potential to negatively impact STZ’s brand, but we are not overly concerned as it always has M&A options. Most recently, the company acquired My Favorite Neighbor and Lingua Franca.
The alcoholic beverage industry is highly profitable due to the large number of people drinking. Therefore, the market competition is fierce, but for well-established brands, the returns are equally high.
Although the industry has matured, it has grown well over the past decade, with leading brands recording a CAGR of over 3%. We see no reason to move below this level over the next decade, meaning the current trajectory is likely to continue.
STZ faces competition from other global alcoholic beverage companies including Anheuser-Busch InBev (BUD) , Diageo (DEO) and Pernod Ricard (OTCPK:PDRDF) . Competition is based on brand strength, product quality, innovation and distribution capabilities.
The alcoholic beverage industry has experienced a trend toward premium products as consumers seek higher quality, new experiences and premium brands. This is due in part to specific growth in craft beer, premium wine and craft spirits, with strong innovation attracting consumers looking to try something new. STZ has a strong presence in the upper and premium segments of the alcoholic beverage market, positioning it to capitalize on this growth.
As shown in the figure below, the high-end segment has significant incremental growth advantages, which is one of the key reasons why STZ has been able to achieve strong growth in recent years.
This resulted in an aggressive shift in the revenue sales mix towards the higher end of the market. We expect this trend to continue, or at least remain strong, as demand becomes sticky once consumers find a product they like.
Looking ahead, management believes the following are key growth opportunities:
- Growth in the “better for you” segment (3-year CAGR of 25%) – As consumers become increasingly health-conscious, we see this as another key value driver.
- Growth of flavored products in alcoholic beverages (three-year CAGR 22%) – This is partly a premiumization trend, but it is also an opportunity offered through partnerships. We recently released Jack and the Coke Can, as well as Coco Vita Morgan Mojito Captain. Through these partnerships, we see real opportunities for brand growth.
- E-commerce beverage sales growth (3-5x L3Y) – The company’s efforts to expand its online presence and direct-to-consumer sales channel have enabled STZ to improve its unit economics, consistent with the channel’s impressive growth. It’s a win-win situation for STZ, and we suspect e-commerce could outperform further, just like the rest of the retail sector.
Economic and external considerations
Current economic conditions may impact sales as financial difficulties result in less discretionary activity. Growth in STZ’s latest quarter has been generally good (+6.4%), suggesting resilience so far. Nonetheless, we remain cautious given the uncertainty.
STZ’s profit margins have trended upward over the past decade but remain below the heights reached during the post-pandemic peak. This improvement was driven by the premiumization trend, resulting in increased sales of high-margin beverages. The recent weakness reflects demand and inflationary pressures on costs, although quarterly data suggest this has stabilized (OPM – Q2’22 31.8%, Q3’22 30.4%, Q4’22 26.5% and Q1’23 31.0%).
Balance Sheet and Cash Flow
We believe STZ’s debt levels are above optimal, with an ND/EBITDA ratio of 3.4x. This has resulted in interest payments of 4% of revenue, and it has also recently raised a significant amount of debt.
The decision appears to be an attempt to maintain its aggressive distribution strategy, a worrying choice given the lack of sustainability in this approach. We suspect there may be a slowdown ahead, at least on the repurchase side at current rates.
The above is Wall Street’s consensus for the next five years.
Analysts forecast growth of 6% in fiscal 2028, with margins rising slightly. We believe it is a reasonable estimate that STZ will continue on its current trajectory, given the financial improvements achieved to date and the likely weakening of inflationary pressures.
Above is how STZ’s growth and profitability compare to the industry average as defined by Seeking Alpha (6 companies).
STZ’s performance is respectable relative to its peers. The company lacks growth and lags behind its directly comparable peers. That’s an impressive performance, especially since both Diageo and Pernod Ricard outperformed the business. This is likely due to its reliance on beer, while the spirits industry (and compared to peers) has performed better.
STZ’s main advantage is its profit margins. The company’s EBITDA-M and FCF are both positive incremental and at levels where losses are unlikely. This profit advantage is far more impressive than the industry’s growth, given its maturity.
STZ currently trades at 18x LTM EBITDA and 16x NTM EBITDA. This is above its historical average.
We believe the premium to historical averages is difficult to justify. The business has grown well over the past decade but has not exceeded expectations at any point. Its profit margins and growth were broadly in line with the average for the period.
Furthermore, a small premium relative to the industry average seems to be a reasonable upper limit. This is due to its profitability premium and comparable size to larger market players. STZ is currently trading at a 1.1% discount, but if you exclude Brown Foreman (which is trading at a uniquely high level), STZ is actually trading at a premium.
Based on this, we do not believe that STZ has any clear advantages. The below-average NTM FCF yield (-1.1 percentage points) confirms this view.
STZ is an attractively positioned beverage company. Unlike many of its peers, it has adapted well to the premiumization trend while maintaining a good balance between beer and spirits. With its many leading brands and quality strategic direction, we believe a continuation of its current trends is reasonably expected.
We believe the business is currently priced with no upside compared to its peers and its historical performance.
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