STZ - Constellation Brands: Capital Restructuring Can Be Strong Foundation For Growth

• The company has decided to eliminate class B common stock at 26.3% premium as compared to Class A common stock.
• The simplified capital structure can strengthen its corporate governance profile as it has reduced the concentration of voting power, synergizing the decision-making with the company's economic interest.
• The stock is currently trading above its 100-day and 50-day WMA levels which indicates a strong momentum in the share price. Also, the 50-day WMA could soon cross the 100-day.

Investment Thesis

Constellation Brands, Inc. ( STZ ) is a manufacturer and distributor of beer, wine, and spirits. STZ decided to eliminate the class B shares to enhance its capital structure and corporate governance profile. I believe this event can provide a solid base for the company's future growth and align the decision-making with the economic interest of all shareholders, which can give attractive returns.

About Constellation Brands

STZ is a manufacturer and distributor of beer, wine, and spirits operating in the United States, New Zealand, Mexico, and Italy. The company has the third-largest market share among all major beer suppliers and is the biggest beer import company in the United States. The company's product portfolio includes famous brands such as Corona Extra, Modelo Especial, the Robert Mondavi Brand Family, Kim Crawford, Meiomi, The Prisoner Wine Company, and High West. The company reports its revenue through four segments: Beer, Wine and Spirits, Corporate Operations & Other, and Canopy. The company generates 76.6% of its consolidated net sales through beer, while wine contributes 20.6% to total revenue. The spirit is the smallest segment and contributes only 2.8% of the consolidated revenue. The canopy segment gets eliminated in consolidation.

The company has increased its production capacity four times in the last nine years to maintain its leadership in the USA high-end beer market. It is continuously growing and expanding as it has invested $800 million in Mexico Beer Projects in FY2022. It has also completed a significant part of the expansion of Obregon Brewery, which will increase the company's production capacity by 39 million hectoliters. The expansion is supposed to be completed by the end of the current year. From FY2023 to FY2026, the company has planned to $5.0 billion to $5.5 billion in capital expenditure.

STZ's 20% growth is driven by customer demand, while innovation influences 30% growth and 50% is contributed from the space & distribution. For any beer and wine company, the space and distribution strategy plays a critical role, and 50% growth from this component is a sign that the company has an efficient method that has lowered the cost significantly and has the highest margins in the beer industry. To enhance the capital structure and corporate governance of the company has decided to eliminate class B common stock, which can increase the efficiency of capital expenditure.

Elimination of the Class B common stock

The company has decided to eliminate class B ( STZ.B ) common stock, including one owned by the Sands Family. In accordance with the terms of the agreement, each outstanding share of the corporation's Class B ordinary shares will be converted into the option to receive one share of the firm's Class A ( STZ ) common stock as well as cash consideration in the amount of $64.64 per share of Class B outstanding shares, for a total of $1.5 billion. This is a 26.3% premium over the closing stock price of Constellation's Class A Common Stock on August 3, 2022.

The elimination of the class B stock has reduced the concentration of voting power, which has enhanced decision-making. A single voting class stock structure can accelerate the expansion plans, reducing decision-making time. The simplified capital structure can strengthen its corporate governance profile as it has reduced the concentration of voting power, synergizing the decision-making with the company's economic interest. It will also provide a strong base for the organic and inorganic growth of the company as the capital allocation will be efficient, and it will be in the interest of shareholders. This event will also save approximately $15-20 million in operating costs of fiscal 2022 related to executive compensation and benefits. I believe this capital restructuring is a strong base for future growth as it can enhance the decision-making and capital allocation of the company. I think this event might fasten the strategic development and build attractive shareholder returns in the coming years.

What is the main risk faced by STZ?

Huge long term debt liability

As of May 31, 2022, STZ had long-term debt of $10.3 billion. On the other hand, it had cash and cash equivalent of a mere $100 million. This is a big cause of concern for the company and is a big factor in the restricted profit margins of the firm. The interest rate increase by the FED has further increased the problems. High-interest payments affect the cash flows for the company and ultimately lead to contracted margins for any company. The management needs to address this issue to improve the firm's efficiency in the coming years.

Technical Analysis and Fundamental Valuation

STZ has positive technical indicators reflecting a buy rating from current price levels. The stock has strong support at the $240 level, which is its 100-day weighted moving average (WMA) zone. The stock is currently trading above its 100-day and 50-day WMA levels which indicates a strong momentum in the share price. Also, the 50-day WMA could soon cross the 100-day WMA, which might lead to fresh momentum in the stock. The WMA parameter indicates a buy from the current price level. The RSI indicator doesn't reflect any divergence, but the stock is consolidating in the 50-60 RSI band range. This range is generally considered a good buying zone for the stock. I believe the stock could soon test the 70 band levels, reflecting a buying opportunity.

STZ has seen a 10% increase in the stock price over the last one year. The stock is currently trading at a price of $245. STZ is trading at a P/E multiple of 22x with FY22 EPS estimates of $11.02. I believe it is undervalued at current P/E levels when compared to its competitors like Brown-Forman Corporation with a P/E of 37x and The Duckhorn Portfolio, Inc. with a P/E of 30x. Going ahead, the company can trade at a higher P/E multiple given its strong growth aspects and cost optimization. I believe STZ will trade at a P/E multiple of 27x with FY22 EPS estimates of $11.02, giving us a target price of $298.

Conclusion

The elimination of class B stock, which is expected to improve capital governance, will benefit the company's performance in the long term. The operating cost saving expected through proactive measures by the management is another positive factor for the company. It is currently trading at a cheaper valuation compared to its peers, and I believe the company will trade at a higher valuation in the future. I assign a buy recommendation for STZ after analyzing all these factors.

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