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Constellation Brands: Best margins in the industry.

Opdateret: for 1 dag siden

I prefer companies that have the highest profit margins in their sector, as it indicates that the company has a significant competitive advantage. and could potentially be compounders in the long term. One such company is Constellation Brands, which has a higher operating margin in its beer segment than its competitors. In this analysis, I will investigate whether Constellation Brands should be added to your portfolio and determine the appropriate price.

This is not a financial advice. I am not a financial advisor and I only do these posts in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.

Since I have attended the workshop with Phil Town, I have decided to change the layout of my analyses a bit. I will do some more calculations and briefly go through why the company has meaning to me. I have changed the format of the analysis a bit to try to make it shorter and with less numbers. If you want to read more about how I evaluate a company, please go to "MY STRATEGY" on my website.

For full disclosure, I should mention that at the time of writing this analysis, I do not own any shares in Constellation Brands. If you would like to copy my portfolio or view the stocks in my portfolio, you can find instructions on how to do so here. I don't own shares in any of their direct competitors either. Thus, I have no personal interest in Constellation Brands. If you want to purchase shares (or fractional shares) of Constellation Brands, you can do so through eToro. eToro is a highly user-friendly platform that allows you to get started on investing with as little as $100.

Constellation Brands was founded in 1945 in New York, United States. Constellation Brands is an international producer and marketer of beer, wine, and spirits, with operations in the U.S., Mexico, New Zealand, and Italy. They are the third-largest beer company in the United States and the largest seller and brewer of imported beer in the U.S. market. Constellation Brands may not be a familiar name to everyone, but their beer portfolio includes well-known brands like Corona, Modelo, and Pacifico. In fact, they own nine out of the top 15 best-selling imported beer brands in the United States. Constellation Brands' wine portfolio includes renowned names like Meiomi and Kim Crawford, making them the owner of nine out of the top 100 best-selling high-end wine brands in the United States. Additionally, their spirits portfolio features popular brands such as SVEDKA vodka and MI CAMPO tequila. These brands are what give Constellation Brands their brand moat. In fiscal 2023, the beer segment contributed with 79,0% to their net sales, while wine contributed 18,2% and spirits contributed 2,8%. In addition to their beer, wine, and spirits segment, Constellation Brands also owns 35,7% of the shares in the Canadian cannabis company, Canopy Growth Corporation. Constellation Brands converted common shares into exchangeable shares in 2022 due to the restructuring in Canopy Growth Corporation.

Their CEO is Bill Newlands. He joined Constellation Brands in 2015 and became the CEO in 2017. Prior to joining Constellation Brands, he held various positions in different wine companies, including serving as the President of North America at Beam, Inc. He played a key role in helping the company become one of the fastest-growing companies in its category. He holds a Bachelor of Science from the Wharton School at the University of Pennsylvania and an MBA from Harvard Business School. Bill Newlands also serves on the boards of Hormel Foods, and the Distilled Spirits Council of the United States. As a CEO, he has focused on consolidating Constellation Brand's portfolio around high-end brands, in line with the current consumer-led trend towards premiumization. This strategic move is expected to drive increased growth and higher profit margins for Constellation Brands. I haven't been able to find much information about Bill Newlands' management style. However, according to Glassdoor, he has a 93% approval rate, which is quite positive. While we don't have much information about Bill Newlands, it is safe to say that he has vast experience in the sector. I appreciate how he has focused the portfolio on high-growth and high-margin products. Hence, I feel comfortable with Bill Newlands leading Constellation Brands moving forward.

I believe that Constellation Brands has a brand moat. Furthermore, I also feel confident with the management. Now, let us examine the numbers to determine if Constellation Brands meets our criteria for a strong moat. In case you want an explanation of what the numbers represent, you can refer to "MY STRATEGY" on the website.

The first number I will investigate is the return on invested capital, also known as ROIC. Ideally, you would like to see a ROIC above 10% in all years. The return on invested capital (ROIC) of Constellation Brands is underwhelming in most years, as they only manage to deliver a ROIC above the required 10% in three out of the last ten years. It was a bit surprising to see a return on invested capital (ROIC) like this, as high-moat companies usually deliver a high ROIC. However, there is an explanation for the low ROIC, and that is debt. Constellation Brands has operated with a significant amount of debt, which has impacted the return on invested capital (ROIC). Later in the analysis, I will share the return on equity (ROE) for the last ten years, which will be better. Nonetheless, it is slightly concerning that Constellation Brands has had a negative Return on Invested Capital (ROIC) in three out of the last four years. This is a significant factor that needs to be addressed and improved in order for me to consider investing in the company.

The following numbers represent the sum of the book value + dividend. In my previous format, this was referred to as the equity growth rate. It was the most important of the four growth rates I used in my analyses, which is why I will continue to use it in the future. As you are accustomed to seeing numbers in percentage form, I have decided to provide both the actual numbers and the percentage growth year over year. Up until 2019, Constellation Brands delivered consistent equity growth, expanding year after year. The equity decreased during fiscal 2020, which was the year of the pandemic, while they had to deal with high input costs in both fiscal 2022 and 2023. Constellation Brands also chose to divest some of their mainstream and premium wine brands in fiscal 2023, which also explains the drop. Overall, I find these numbers encouraging, but I would like to see Constellation Brands grow in fiscal 2024.

Finally, we will investigate the free cash flow. In short, free cash flow refers to the cash that a company generates after covering its operating expenses and capital expenditures. Levered free cash flow is the amount of money a company has remaining after paying all of its financial obligations. I use the margin to provide a clearer understanding. Free cash flow yield refers to the amount of free cash flow per share that a company is projected to generate in relation to its market value per share. What comes to mind is that the free cash flow is positive in all years, which is always pleasing to see. Free cash flow has dropped in fiscal years 2022 and 2023 due to increased input costs. Levered free cash flow is also rather high, despite dropping slightly in 2022 and 2023. Free cash flow yield is the lowest since 2018, which indicates that Constellation Brands is trading at a higher price than usual. However, we will delve into this further in the analysis.

Another important aspect to consider is the level of debt, and it is crucial to determine whether a business has a manageable debt that can be repaid within a 3-year period. This can be assessed by calculating the ratio of long-term debt to earnings. After performing the calculation on Constellation Brands, it is evident that the company has a debt-to-earnings ratio of 5,65 years, which exceeds the 3 year limit. Management has mentioned that they are determined to pay off their debt, which is something I would like to see. As mentioned previously, the high debt has affected the return on invested capital (ROIC). Below, you can see the Return on Equity (ROE) in the last 10 years, which will give you an idea of how debt has impacted the Return on Invested Capital (ROIC).

Like every other investment, there are risks associated with investing in Constellation Brands. One risk is higher costs. Ongoing inflationary pressures on raw materials and packaging, as well as increased logistic expenses due to higher fuel and freight costs, are all factors that are impacting the results of Constellation Brands. As a result, both the gross profit margin and operating margin have decreased in fiscal years 2022 and 2023. If the higher costs of raw materials, packaging, and freight continue, it will hurt the profitability of Constellation Brands. Another risk is debt. Constellation Brands' high debt is affected the return on invested capital, as we saw previously. High debt is a big deal, in his book Rule # 1 investing, Phil Town mentions the following on debt: "A business that is carrying a lot of debt relative to its income has an unpredictable financial future. If there are any problems with the economy, a business with a lot of loans might be in big trouble". As an investor, I don't like unpredictability, and while I don't think that Constellation Brands will go bankrupt, I really don't like to see companies with a debt that cannot be paid off by three years earnings. Reliance on wholesale distributors. In their annual report, Constellation Brands mentioned reliance on wholesale distributors as a risk factor. They mentioned that one wholesaler generates a significant portion of their branded U.S. wine and spirits net sales, while another wholesaler for their beer portfolio represents 20% of their net sales. If their relationship with any of these wholesalers were to end, it would have a significant impact on their results.

There is also a lot of potential for Constellation Brands moving forward. Gaining market share. Constellation Brands continues to gain market share in their beer segment and has done so for several consecutive quarters. As a result, Modelo has become the top-selling beer in the United States. Management believes they can continue to win market share, as they believe their brands still have low market share in many parts of the United States. Management stated that expanding sales in new markets presents a significant growth opportunity for their beer segment. Broadening their distribution as a significant growth catalyst is something Bill Newland first mentioned when he became CEO and has since reiterated several times. Focusing on premiumization. Constellation Brands is focusing on premiumization trends in the United States, as sales for higher end brands are growing faster than lower end brands. It is a trend we see in all Constellation Brands segments: Higher end brand sales in beers has gone from 52% in 2019 to 60% in 2022, for wine it has gone from 31% in 2019 to 41% in 2022, and for spirits it has gone from 47% in 2019 to 53% in 2022. Furthermore, higher end brands have higher margins than lower end brands. Thus, Constellation Brands' focus on premiumization (for instance, by divesting some of their mainstream brands as they have done) could lead to higher profitability in the future. Cannabis. As mentioned earlier, Constellation Brands owns part of Canopy Growth Corporation, which is one of the largest cannabis companies in the world. And while they converted common shares into exchangeable shares, management still has hopes for their share in Canopy Growth Corporation. CEO Bill Newlands expressed his belief in the conversion to exchangeable shares, stating, "We believe that the conversion of our ownership interest will maintain Constellation's ability to realize the potential upside of our investment in Canopy." The upside in the legal cannabis industry is tremendous, as estimated by Grand View Research. They predict that the global legal cannabis market will experience a compound annual growth rate (CAGR) of 25,5% until 2030.

Now it is time to calculate the price of shares in Constellation Brands. I perform three different calculations that I learned at a Phil Town seminar. The first is called the Margin of Safety price, which is calculated based on earnings per share (EPS), estimated future EPS growth, and estimated future price-to-earnings ratio (P/E). The minimum acceptable rate of return is 15%. I chose to use an EPS of 10,19, which is from fiscal year 2021 (EPS was negative in 2022 and 2023, but I see these years as outliers). I have selected a projected future EPS growth rate of 8% (which is the consensus expected growth rate among analysts). Additionally, I have chosen a projected future P/E ratio of 16, which is twice the growth rate. This decision is based on the fact that Constellation Brands has historically had a higher P/E ratio. Lastly, our minimum acceptable rate of return is already set at 15%. Doing the calculations, we come up with the sticker price (some call it fair value or intrinsic value) of $89,48. We want to have a margin of safety of 50%, so we will divide it by 2. This means that we want to buy Constellation Brands at a price of $44,74 (or lower, obviously) if we use the Margin of Safety price.

The second calculation is called the Ten Cap price. The rate of return that an owner of a company (or stock) receives on the purchase price of the company is essentially its return on investment. The return should be at least 10% annually, and I calculate it as follows: The operating cash flow last year was 2.664 and capital expenditures were 1.116. I attempted to review their annual report to determine the percentage of capital expenditures allocated to maintenance. I couldn't find it, but as a rule of thumb, you can expect that 70% of the capital expenditures will be allocated for maintenance purposes. This means that we will use 781 in our calculations. The tax provision was 388. We have 183,259 outstanding shares. Hence, the calculation will be as follows: (2.664 – 781 + 388) / 183,259 x 10 = $123,92 in Ten Cap price.

The final calculation is called the Payback Time price. It is a calculation based on the free cash flow per share. With Constellation Brands' Free Cash Flow Per Share at $9,33 and a growth rate of 8%, if you want to recoup your investment in 8 years, the Payback Time price is $107,18.

Constellation Brands is an interesting company. They have managed to achieve the highest profit margins in the sector, which is always intriguing. While we don't have much information on the management, I appreciate their accomplishments and their extensive experience in the sector. There are some headwinds that will hurt Constellation Brands, as input costs continue to remain elevated. I don't like the high debt either, but it is encouraging that management is determined to pay it off. I like that Constellation Brands is consistently gaining market share in their beer segment. I also believe that focusing on premiumization is a good strategy. Not only are sales of higher-end brands growing faster than lower-end brands, but higher-end brands also have higher profit margins. Their investment in Canopy Growth Corporation has not paid off thus far, and this should not be the sole reason to invest in Constellation Brands. However, if Canopy Growth Corporation manages to execute after their restructuring, it could have some unexpected upside. Nonetheless, I will need to see a higher return on invested capital (ROIC) before investing in a company. Thus, I will not be investing in Constellation Brands at the moment.

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