Constellation Brands: Best margins in class.
Opdateret: 5. apr.
I like companies that have the highest margins in their sector, as it points to the company having a large moat. and could be potential compounders in the long-term. One of such companies is Constellation Brands, which has a higher operating margin in their beer segment than their competitors. In this analysis I will investigate if Constellation Brands should be added to your portfolio and at what 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 shares in Constellation Brands. If you would like to copy my portfolio or see the stock in my portfolio, you can read about how to do so here. I don't own shares in any of their direct competitors either, but I have shares in Ambev, which is a Brazilian brewery. Nonetheless, I will keep this analysis unbiased.
Constellation Brands was founded in 1945 in New York, United States. Constellation Brands is an international producer and marketer of beer, wine, and spirts, 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. While the name Constellation Brands may not be recognizable for everyone, their beer portfolio consists of recognizable brands such as Corona, Modelo, and Pacifico, which means that they have nine of the 15 top-selling imported beer brands in the United States. Their wine portfolio consists of names such as Meiomi and Kim Crawford, resulting in Constellation Brands having nine of the 100 top-selling high-end wine brands in the United States, while their spirits portfolio consists of brands such as SVEDKA vodka and MI CAMPO tequila. These brands are what gives Constellation Brands their brand moat. In fiscal 2022 their beer segment contributed with 76,6 % of their net sales, while wine contributed with 20,6 % and spirits with 2,8 %. Besides their beer, wine, and spirits segment, Constellation Brands also owns 35,7 % of the shares in Canadian cannabis company, 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 being the president of North American at Beam, Inc, which he helped being one of the fastest growing companies in its category. He holds a Bachelor of Science from the Wharton School at University of Pennsylvania and an MBA from Harvard Business School. Bill Newlands also serves at the boards of Hormel Foods, Canopy Growth, and Distilled Spirits Council United States. As a CEO, he has concentrated Constellation Brand's portfolio around high-end brands as it aligns with consumer-led premiumization trends, which should result in higher growth and higher margins for Constellation Brands. I haven't been able to find much about Bill Newlands' management style but according to Glassdoor, he has a 93 % approval rate, which is positive. While we don't have much information about Bill Newlands, it is safe to say that he has a vast experience in the sector, and I like how he has concentrated the portfolio towards high-growth and high-margin products. Hence, I feel comfortable in Bill Newlands leading Constellation Brands moving forward.
I believe that Constellation Brands has a brand moat. Furthermore, I feel confident with the management as well. Now let us investigate the numbers to see if Constellation Brands lives up to our requirements for a strong moat. In case you want an explanation about what the numbers are, you can have a look at "MY STRATEGY" on the website.
The first number I will investigate is the return on investment capital, also known as ROIC. Ideally, you would like to see a ROIC above 10 % in all years. The ROIC of Constellation Brands is underwhelming in most years, as the only manage to deliver a ROIC above the required 10 % in three years within the last ten years. It was a bit surprising to see a 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 rather large debt, which has affected the ROIC. Later in the analysis I will share the ROE (return of equity) for the last ten years, which will be better. Nonetheless, it is slightly concerning that Constellation Brands has a negative ROIC in two out of the last three years, and it is something that needs to be changed moving forward.
The next numbers are the book value + dividend. In my old format this was known as the equity growth rate. It was the most important of the four growth rates I used to use in my analyses, which is why I will continue to use it moving forward. As you are used to see the numbers in percentage, I have decided to share both the numbers and the percentage growth year over year. Up until 2019 Constellation Brands delivered a textbook equity growth as it grew each year. The equity decreased during fiscal 2020, which was the pandemic year, while they had to deal with high input costs in 2022. Overall, I find these numbers encouraging.
Finally, we investigate the free cash flow. In short, free cash flow is the cash a company generates after it has paid for operating expenses and capital expenditures. Levered free cash flow is the amount of money a company has left remaining after paying all of its financial obligations, I use the margin for it to make more sense. Free cash flow yield is the free cash flow per share a company is expected to earn against its market value per share. What springs to mind is that the free cash flow is positive in all years, which is always nice to see. Levered free cash flow is also rather high despite dropping a bit in 2022, while the free cash flow yield is still in the higher tier.
Another important thing to investigate is debt, and we want to see if a business has a reasonable debt that can be paid off within 3 years by calculation long-term debt to earnings. Doing the calculation on Constellation Brands, I can see that Constellation Brands has 5,65 years earnings in debt, which is above the limit of 3 %. In the latest earnings call, management mentioned that they are determined to pay off debt, which is something I would like to see. As mentioned previously, the high debt has affected the ROIC. Below, you can see the ROE in the last 10 years, which will give you an idea of how the debt has affected ROIC.
Like every other investment there are risks when investing in Constellation Brands. One risks is higher costs. Ongoing inflationary pressures on raw materials, packaging, increased logistic expenses because of higher fuel and freight costs are all things that are affecting the results of Constellation Brands. As a result, both gross profit margin and operating margin have decreased. If higher costs of raw materials, packaging and freight continues, it will hurt the profitability of Constellation Brands. Another risk is the 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 large portion of their branded U.S. wine and spirits net sales, while one wholesaler for their beer portfolio represents 20 % of their net sales. If their relationship with any of these wholesalers should come to an end, it will significantly hurt their results.
There are also a lot of potential for Constellation Brands moving forward. Gaining market shares. Constellation Brands continue to win market shares in their beer segment and has done so for six consecutive quarters now. In the latest quarter, their beer business delivered a 3,5 points of share gains year over year. And management believes it is something they can continue to do, as management believes that their brands are still under shares in many parts of the United States. Management stated that growing sales in new markets is a tremendous upside opportunity for their beer segment. Broadening their distribution as a large growth catalyst is something Bill Newland first mentioned when he became CEO and has since repeated several times. Growing their wine and spirit's segment. Management is focusing on high-end brands in their wine and spirits segment, which is improving margins. Furthermore, management believes that direct-to-consumer sales will account for 20 % of their wine and spirits sale over time. If management manage to deliver, it will mean even higher margins as it eliminates the wholesaler on 20 % of their sales. Cannabis. As mentioned earlier, Constellation Brands owns 35,7 % of Canopy Growth, which is one of the largest cannabis companies in the world. The upside in legal cannabis is tremendous as Grand View Research estimates that the global legal cannabis market will grow by 25,5 % CAGR until 2030.
All right, we have gone through the numbers, potential and risk regarding Constellation Brands, and now it is time for us to calculate a price for Constellation Brands. To calculate price, we will need numbers that I have explained in the "MY STRATEGY" section of the website. I do not want to go through the whole calculation here. I chose to use an EPS at 10,48 which is the one from fiscal 2021 (it is lower than both 2019 and 2018, and I have decided that 2022 and 2020 were outliers). I chose an Estimated future EPS growth rate of 8 % (which is the consensus the analysists expected growth rate), Estimated future PE 16 (which the double of the growth rate, as the historically PE for Constellation Brands has been higher) and we already have the minimum acceptable return rate on 15 %. Doing the calculations by using the formula I described in "MY STRATEGY", we come up with the sticker price (some call it fair value or intrinsic value) of $89,48, and we want to have a margin of safety on 50 % , so we will divide it by 2 meaning that we want to buy Constellation Brands at price of $89,48 (or lower obviously), if we use the Margin of Safety price.
Our second way to calculate a buy price is the TEN CAP price, which is also explained at "MY STRATEGY". To do so, we need some numbers from their financial statements, keep in mind that all numbers are in millions. The Operating Cash Flow last year was 2.541,90. The Capital Expenditures was 1.111,9. I tried to look through their annual report to see, how much of the capital expenditures were used on maintenance. I couldn't find it though, so as a rule of thumb, you expect 70 % of the capital expenditures to be used on maintenance, meaning we will use 778,33 in our further calculations. The Tax Provision was 481,20. We have 184,492 outstanding shares. Hence, the calculation will be like this: (2.541,90- 778,33 + 481,20) / 184,492 x 10 = $121,67 in TEN CAP price.
The last calculation is the PAYBACK TIME. I also described in "MY STRATEGY". With the Free Cash Flow Per Share at 8,95 and a growth rate of 8 %, if you want your purchase back in 8 years, the PAYBACK TIME price is $102,81.
Constellation Brands is an interesting company. They have managed to have the highest margins in the sector, which will always make it intriguing. While we don't have much information on the management, I like what they have done, and they certainly have vast experience from the sector. There are some headwinds that will hurt Constellation Brands, as input costs continue to stay elevated, and management has guided for lower margins in fiscal 2023 as well. I don't like the high debt either, but it is encouraging that management is determined to pay it off. I like that they Constellation Brands is continuously gaining market shares in their beer segment, I like that they will improve the margins for the wine and spirits segment, and legal cannabis could be a tremendous upside though it is a speculative bet for the time being. If we see a positive ROIC in fiscal 2023, I will consider opening a position if it reaches the TEN CAP price of $121,67.
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