STZ - Constellation Brands Inc. (STZ) Presents at Barclays Global Consumer Staples Conference (Transcript)
2023-09-07 00:29:03 ET
Constellation Brands, Inc. (STZ)
Barclays Global Consumer Staples Conference Call
September 6, 2023 16:30 ET
Company Participants
Garth Hankinson - Chief Financial Officer
Conference Call Participants
Lauren Lieberman - Barclays
Presentation
Lauren Lieberman
Okay, we are going to get started our last session of the day. Really happy to have Garth Hankinson, Constellation’s CFO with us today. So thank you very much for being here. A lot happened this year, but why don’t you just start with the Elliott collaboration agreement that was announced in July. So ours has been sort of a proactive step in terms of governance capital allocation over the longer term rather than something that is intended to be a more proactive effort to come. So I was hoping you could talk a little bit about the nature of the relationship that’s underpinning the agreement that you have come to with them and the types of discussions that you’ve had so far?
Garth Hankinson
Well, first of all, Lauren thanks for hosting us today and thanks for all of you being here. Yes, so as it relates to our relationship with Elliott, I mean, it’s been very, very productive and collaborative in nature. And quite honestly, we have benefited from hearing our perspective. They have shared with us certainly their perspective, which is fairly consistent with the feedback that we have received from and sought out from our other large investors and shareholders as well. The conversations have been focused largely on corporate governance, including board composition. And again, their feedback on that subject or on that topic was similar with what we have heard from other of our large shareholders. Beyond that, it’s similar themes, again, to our other large shareholders. We have got conviction around the beer top line, what the beer margin profile looks like in a more normalized inflationary environment. The drivers in the path forward are getting our wine and spirits business to our stated algorithm of low single-digit top line and high-20s margin – operating margins. And then just to continue conversation as you say around capital allocation and the discipline that Bill and I have, have been operating under for the last several years, but certainly there is still some concerns around some capital allocation decisions that were made in the past. So it’s always been a series of topics that we have had again. It’s very similar to the feedback we have taken from our other investors and clearly on each one of those topics, we will have more to share at an upcoming Investor Day.
Question-and-Answer Session
Q - Lauren Lieberman
So, with the U.S. about transformational change and that more about the growth profile that I would argue undervalued for the growth profile. So maybe we can dig in a little bit into it, but I think it’s pretty solid visibility into their volume growth over the next couple of quarters. In the first quarter, right, trends accelerated and volumes have looked really strong in the tracked channel data. So I guess first thing is a good check in on kind of tracked channels relative to non-tracked overall depletions known historically that kind of relationship between tracked running ahead of depletions have kind of broken down, so we don’t know what to look at the data or not to make of the data. So accelerating trends, that in fact, what you are seeing and how should we think about that relative to depletion?
Garth Hankinson
Well, so first of all, we would agree that we are undervalued relative to our growth profile, but it’s absolutely true that our beer volumes have accelerated – beer performance accelerated through the first half of the year pretty much as expected, as we laid out the year, you will recall that there are two drivers for this and we were pretty open about this as we entered this fiscal year. One was that we expected retailers to roll back the incremental pricing that they took on top of the pricing, our second pricing move in the fall of last year. That largely has come to pass. And so we’ve benefited from that. And then we’ve also benefited from the fact that the cold wet weather that was being experienced in the California has improved. And so obviously, we have seen some acceleration in California, which has helped our overall trends.
As it relates to Circana or syndicated data, the most recent 12-week period, we are running – our beer business is running about 13% year-over-year growth. And the data that we have typically seen between the syndicated data, specifically Circana and depletions, has been more in that low single-digit sort of delta, if you will, that’s increased in recent periods be more in the mid single-digits. And the reason that we are seeing for that is that, that pricing rollback that I referenced earlier, that’s largely taking place with the large chain retailers, where we have seen some slowness in rolling that back has broadly been speaking in the independence. And so we have seen weakness in the independence channel relative to change on a much smaller scale that’s not dissimilar to what we saw during the pandemic, where people migrated away from the on-premise and from independence into chain stores. But so we have seen some of that here in the most recent data. In fact, you have seen in California where the Hispanic consumer, which is important consumer for us, I was actually migrated away from the independent retailer and into the chain. So just further evidence that that’s what we are seeing is a bit of a channel shift, if you will.
Lauren Lieberman
Okay. On the topic of pricing, to me, the big changes in industry, market share dynamics, right, I think you are now probably the leader in the market, someone else was a leader before in typically led pricing, so just kind of your thoughts around industry wide pricing dynamics, how that will change over to a big data unknown because of the type of the sheer shift. But the knock-on effects of industry leadership and who takes the lead on pricing is something that’s sort of yet to be seen. But you have had a very particular stamp on pricing given the premium nature of your portfolio?
Garth Hankinson
Yes, from our perspective, our outlook on pricing, where our methodology just doesn’t change, right. And I have seen some of the speculation that you have referenced around who will be the [Technical Difficulty]. And for us, we are just as I say, we are going to keep that discipline. We take pricing on a brand by brand, market by market, SKU by SKU basis. That’s resulted in us being predictably being able to generate 1 to 2 percentage points of growth, revenue growth every year from pricing. Obviously, the last couple of years, the inflationary environments led to some pricing activity that was in excess in the high-end of our range. But we think that the approach that we take is the right approach. It’s obviously served us well. And clearly what we don’t want to do is we don’t want to take pricing to such extent that it starts to impact our consumer – that impact the growth profile of our business. And so again, we will continue to be very, very methodical and disciplined and intentional around our pricing actions.
Lauren Lieberman
Okay. Thinking about potential growth drivers, shelf resets have been also very topical in the last few months within the industry. Can you tell us that timeline for changes at retail, that kind of process now more in the spring? But just any update on shelf resets?
Garth Hankinson
The most tangible thing we have seen in the short-term by the way has been that we’ve benefited from incremental features and displays. That being said, we are expecting that there will be further shelf resets in the fall not – that’s not dissimilar to what happens every year and that will be followed by more meaningful shelf resets in the spring. Clearly, we think that we will be a beneficiary there in part, because the shift that I think you are seeing between some of our competitors just kind of highlights the fact that the low end of the market really isn’t growing or low end of the category is not growing, yet the high end is. You are seeing some of that acceleration in that premiumization back to more normalized trends. The delta between premium and our high-end and low-end beer right now is back to about 3.1 percentage points. And in wine and spirits, it’s about 5.2 percentage points. So we just think overall you will see we will benefit from the continued premiumization and our leadership position in the high end. More broadly speaking, we are going to continue to execute against the shopper for shelf initiative that we started about 4 years ago. When we initiated or launched this program back in 2019, we were able to about 1,500 shelf resets. And in fiscal 2023, we influenced 17,000. And in the first half of this year, we have influenced 13,000, right. So again we are going to continue to work with our distributor and retail partners to influence shelf resets. We think that a retailer shelf is their most precious asset and they ought to be allocating that to the brands that are showing the most growth, have the highest turns and have the highest profitability and so that is what our brands provide retailers. Even for brands like Modelo Especial, we think that there is a lot of opportunity for continued shelf gains. That’s the brand that in the 10 years that we have owned and has more than doubled in size, growth accelerated right after the acquisition and growth has remained robust. In fact, last year our dollar share growth in Modelo, we led the category in dollar share growth and we outpaced our nearest competitor by 1.5 times. So, clearly a lot of growth in the brand and we think a lot of growth left in the brain, still not a school district, it is brands like Corona Extra even or some of its other competitive set. So, again, we think that there is a lot of opportunity for Modelo Especial, because most of our portfolio, I mean, even Corona Extra was not as distributed as some of its competitive set. And as we focused on other brands, like Pacifico and Modelo Cheladas, still a great opportunity for increased distribution for those brands as well.
Lauren Lieberman
Okay. [indiscernible] It’s still one more month of data right to launch. It also seems like a bit of right time, right place to or some of the changes that have gone in the premium wine segment and we are being a reasonable trade-off for people who prefer to bring that type of beer. So true moment of data under about, what do you think in terms of kind of the core consumer that is coming into the Modelo Oro franchise and where is the brand?
Garth Hankinson
So and it’s still early days, even though we have got a few more weeks and months prior at or about so to speak, but based on what we are seeing, we are pretty positive on what Modelo Oro can be pressed. I mean, it’s already at top 10 in the dollar share gainer in the U.S. And the incrementality has been better than what we saw in test markets. So again, those are reasons for optimism. It does appear to be a bit of a different consumer right now as it relates to other light offerings. And so certainly with Hispanic males, it’s been quite strong, which again you don’t see against other peers and also SKUs are a bit younger and tends to have a little bit resonate well – bit well with females. So, it is – like I said, it’s a bit of a different consumer and for us, for our portfolio, it’s very much a different consumer than what you are seeing for Modelo Especial now or for Corona Light or for Corona Premier.
Again, all of that being said, while we are positive on it, it’s a brand that we are going to have to continue to monitor, we are going to continue to look at consumer takeaway, we will continue to look at incrementality. And then importantly, we look at repeat purchase, want to make sure that, that it’s not just trial that we are getting, but it really is something that resonates with consumers and they come back to it. And so, we are already looking towards next year and what we might do differently next year as you recall this year, we came out with pretty modest plans in terms of total overall volume, but also the number of SKUs that we are offering. We have a 12-ounce, 12-pack and a 24-ounce single serve as to where I think what additional SKUs from a pack size we could be offering next year. But again, I mean, it’s a brand that we feel pretty strongly about. And now with the addition of this, we feel that across our beer portfolio and also wine, I’ll come to that in a second. But across our beer portfolio, we have nice exposure to leveraging consumer driven trends warrants betterment. So obviously there we have Modelo Oro, we have Corona Light and we have Corona Premier, but also in flavors of the strength of Modelo Chelada, which is now the size of Pacifico going growing even double-digits. On the wine side some early win as it relates to betterment, we have a good traction with Meiomi Bright and with Kim Crawford Illuminate. And from a flavors perspective, we have had good traction with our Mi CAMPO High West RTDs as more it’s a bit of a nascent spirits based RTD brand, Austin cocktails.
Lauren Lieberman
Okay, great. Let’s switch to the Corona brand family. So starting with Corona Extra depletion trends originally expected Corona Extra real modestly in fiscal ‘23 I know we have had 4% depletion growth for the year. Depletions have recently a bit slowed to low single-digit and from what we can see tracked channel data as sort of just personal which isn’t about might be the different than what you think? The volumes have kind of been in line with it’s premier category, which is download the requisite. So it’s working through the direction of travel to the brand, what – in terms of marketing, what is in what would you expect in terms of a reasonable volume growth rate for Corona Extra over time?
Garth Hankinson
Firstly, Corona has returned to growth for sure. I mean, it’s still a brand that’s very important to us. It’s a brand that continues to be – win the hearts and minds of the consumer. It’s the most beloved brand in America, whether that’s domestic or imported. And it’s a brand that we are going to continue to invest behind. We have a number of strategic investments, marketing initiatives behind Corona with sponsorships and things like Major League Baseball as well as other large scale marketing investments in live sports and other media, if you will. So, it’s a brand that will continue to be very important for us. Beyond Corona Extra, we think about the Corona brand family. Obviously, this year, we launched Corona NA, we think Corona NA to be a nice distance from portfolio, if you think about the NA segment of the beer category, it’s about 75% incremental to the category in total. And last year, NA was the fastest growing segment within beer grew about 20%. And so, again, we think that this is a new consumer and an incremental opportunity for us and something we are focused on going forward.
Lauren Lieberman
Okay. What about the pros and cons of it? That’s a strong start, but what about the pros and cons if you are sitting in non-alcoholic beer with an existing beer brand versus an even market brand that doesn’t have an alcoholic predecessor?
Garth Hankinson
So look, we firmly believe that innovating and extending off approach from the brands makes a lot of sense. And if you are – if you think about the occasions for why someone might have a non-alcohol variant of a beer, certainly, having that off of an existing beer brand makes sense. That being said, we are exposed to non-alcoholic with other brands in the broader portfolio. We have a couple of venture investments in a non-alcoholic brand called HOP WTR, obviously made with hops. You kind of get the hoppy aroma from it. But it’s non-alcoholic in nature obviously and a bit more seltzer-like and then we have exposure to the functional water space with venture investment called Karma. So, we are not going after that the non-alcoholic agents strictly with the Corona NA. We do think in those instances, those occasions when you are looking at non-alcoholic beer going after the brands like Corona makes a lot of sense.
Lauren Lieberman
Okay. Surprisingly, you said that you are finding it incremental in terms of the consumer, I would expect incremental in terms of the exclusion, but not necessarily the consumer.
Garth Hankinson
No, well, it’s Modelo [indiscernible] 75% incremental for the category.
Lauren Lieberman
Okay, great. Maybe we can talk a little bit about your view on your latest perspective with the U.S. consumer more broadly. Inflationary pressures have been easing on kind of key expenses. I know we have got loan payments about to kick in, but any impact on beer volume behavior, any kind of changes at least and maybe focusing on Hispanic consumer in particular?
Garth Hankinson
Yes, so for everything, we watch this very, very closely Lauren. I mean, everything that we are seeing is the consumer continues to be really resilient and we haven’t seen a lot of impact due to the macroeconomic environment. As I stated previously, we have seen the premiumization trend continue. And we have gotten back to the differences between the high end and low end in both beer and in wine and spirits that are reflective of the historical delta, right. So, that’s very positive. Obviously, I haven’t seen a slowdown in any of the tracked channels programs, which I think is proof positive that the consumer remains resilient. And one of the metrics that we tend to track very, very closely is buy rate and buy rate remains strong across beer and wine and spirits. In fact, we are seeing over-over-year buy rates increase. So, continued growth in buy rate and when we have actually seen that’s true for the Hispanic consumer as well.
Lauren Lieberman
So we might see the upside to demand this year?
Garth Hankinson
We feel really good about – we feel good about being able to deliver on the plan that we set out earlier this year. And the acceleration through the first half of the year gives us conviction that we can meet those targets.
Lauren Lieberman
Okay, great. All the kind of drivers of growth in mind that were just broken through, I just was curious about flexibility in terms of capacity that demand volume growth has been strong. These days keg dynamic has still remained maybe a little bit choppy, so I don’t know how much that’s creating a draw on the non-keg business. So just any update to you in this out of stock the dynamics you are seeing in the marketplace and supply chain development keep up?
Garth Hankinson
Lauren, I mean, we are in the best position we have been in from a supply standpoint since we have owned these beer brands. I mean, as you recall, for the first number of years really, for the first probably 8 years to be on these brands, it’s been hard for us to keep up with demand from a capacity standpoint so much so that we were running these breweries at very high utilization rates. As we announced over a 1.5 year ago, we have made big investments and continue to make investments and capacity in Mexico to support not just the continued growth – strong growth of our beer brands, but also taking some of the capacity. We recall that through the last 4 years we have had some – we have had non-alcoholic documents and things that have resulted in disruption to our operations, one was COVID obviously and then the second was a winter stand in Texas that was up and down for few days. So we have made this investment in incremental capacity. And then we are layering on two main hectoliters of capacity this year 5 and over again that we already commissioned in the first quarter. We have another 5 come on at the end of the year when our ABA facility. So by the end of the year, we have 52 million hectoliters of capacity, which then gives us a lot of optionality to be able to share production to meet any changes that we see in demand.
Lauren Lieberman
What would you say this, you have a target – if you have like a target utilization rate that you want to migrate towards?
Garth Hankinson
Yes. Keeping in mind that again, when we were – when we weren’t able to meet necessarily demand was we are loving, we were going to keep up with demand we are running at over 90% utilization. Basically I have all of our capacity fully up and commissioned. We are going to be more at industry level standards in that 78% range. So, very much more we are running these like you would run a traditional brewery.
Lauren Lieberman
Okay. Great. Just to roundup the discussion, I wanted to just bring up your margins. So, definitely I appreciate you have offered a lot more color on that since you have got 30% margins in fiscal ‘24, but I am just curious will you see the potential for margin improvement beyond ‘24, particularly extended inflationary pressures continued to ease?
Garth Hankinson
Yes. I mean I think as we have included I mean the biggest segment we faced in the near-term was the high rate of inflation, right. We typically plan on inflation in our beer business to be around that 4% to 5%. We have managed that in very – those inflationary pressures in the combination of increased volume, taking price, and then finding operational efficiencies, which were really good. But in the recent years, we have had this accelerated inflationary environment, keeping in mind that 2% to 4% that we typically plan on last year, like in fiscal ‘20, inflation was in the low-double digit range kind of more in 12% to 15% % in aggregate across the portfolio. This year, obviously inflation improved, but we still have – we are still seeing inflation aggregate in the high single-digits. So, that’s what’s got – that’s the biggest driver for us the next few years as keeping inflation back to its more historical level, and some of those input costs rebalancing, if you will. We are doing everything that we can to control the controllables, so to speak. So, again we continue to take our pricing and we will continue to put biometric relatively as we anticipated, we continue to execute our cost savings initiatives. In fact, this year in our first quarter, we have taken man-hours of costs out. So, there is obviously more come to the end of the year. Looking forward a little bit, one of the things we have been pretty clear about for the last several years, too, is that we will continue to face headwinds around depreciation as we layer in this incremental capacity. Obviously, we have planned for and again in a more normal inflationary environment where it’s all set back through the time and the pricing and the cost initiatives. But that’s something that will continue to do – could be a bit of a drag for that for the next couple of years. But again one of the ways that we were managing our depreciation is the very modular approach that we are taking to our capacity expansion. As we have said, we are adding capacity at existing sites, as well as our crews, what we are doing is in a way that we can control some of the timing around the actual spend as well as when capacity comes online, so that we are able to react to any changes, plus or minus in demand signals. And then furthermore, we are identifying, back to the cost savings initiatives, we are identifying ways to make our boys more efficient. We announced last year that we were able to unlock 2.5 million of incremental, just through capacity or just through operational efficiencies. And obviously, that cost is much less than adding incremental brewing capacity.
Lauren Lieberman
Okay. Great. And so as you have heard out saying, right, segments remain challenged. So, kind of what gives you conviction in the outwork for getting to down 50 basis points, up 50 basis points and that’s out reaching 5% asset growth is there?
Garth Hankinson
Yes. So, obviously there has been some headwinds to the overall Wine and Spirits category and more specifically on that mainstream price segment. And so that’s been challenging for our brands [indiscernible] but what gives us conviction that we can overcome some of the category dynamics is really the progress that we have made over the last few years, the strategy evolution. This was a portfolio that a couple of years ago, about 65% of it, 65% of our net revenue 5% above that, that’s now the inverse. And we have seen really good traction with those key brands pricing of dollars, Meiomi, Kim Crawford, The Prisoner, all outpacing their respective 65% price segments, see quick growth that of brands like [indiscernible]. So, again I mean that’s partially what gives us conviction is just the rebalancing of the portfolio and the performance that we are seeing with those brands at the higher end. The other thing what gives us conviction is another key element of the [indiscernible] is we have migrated away also from being almost strictly a U.S. wholesale business and being one that’s more diversified and omni-channel in nature. Obviously, you have heard us talk about the last few years around focusing on higher growth opportunities in international markets, as well as the directions where DTC, we see DTC broadly speaking direct-to-consumer as well as 3G and e-commerce. And those, particularly the DTC is now a faster growing, but it’s higher margin just given the mix of product that runs through that channel, so to speak. So, those are some of the drivers what gives us the conviction that we can hit the high end, as it relates to being able to hit our margin targets, will obviously benefit from all of those things top line driven that I just mentioned the channel shift towards more higher priced higher margin products. Obviously, the other ways we will benefit and see we will continue to take – continue to take price in line. We have talked about this before where we are taking the discipline that we have in pricing and applying that to Wine and Spirits as a category historically, not been very disciplined in pricing, its benefits in those activities. We are continuing to do all of the cost takeout work that we have initiated a few years ago that might have the right product in the right format and the right packaging [Technical Difficulty] have the products in terms of the cost of glass, because in the case of ramping our sales and benefit of great logistics across a number of initiatives on the cost optimization front to the price versus the beer. And then you have always been very, very disappointed on spend in marketing. That being said, as we were clear at the beginning of the year, unlike beer where 55% of our sales will occur in the first half of the year and 45% in the second half in Wine and Spirits were around 55% will occur in the second half of the year versus the first half of the year. And we do think that there is a little bit of a tale of two halves as it relates to our Wine and Spirits business in Q4 or Q1 of FY ‘23, we had a big sort of shipment quarter, and then that happened in Q1 of this fiscal year. And then also last fiscal year in Q4, we did some rebalancing to better align shipments and depletions. And so that will be an easier comp for us in the second half of the year. And then again, through the second half of the year, we will see that continued mix shift towards that – towards the high end. And you have to keep in mind that, this is a fairly normal seasonal year for us. And so you will continue to see that in Q3 is our biggest quarter. So, that’s what gives us conviction, broadly speaking on the turnaround and conviction to be able to deliver the year.
Lauren Lieberman
Okay. And so there has been growth in 28% to 29% margins as well as like longer term benchmarks were there?
Garth Hankinson
We haven’t – obviously, we are going to talk more about both of our businesses in terms of the mid-term outlook. But we haven’t changed any of our algorithm.
Lauren Lieberman
Okay. We still have a few minutes left, so I wanted to sort of end state conversation back where we have started, and that’s on structural changes you have made to build more trust with investors. So, we have added two new independent directors to the Board, sort of broader refreshments and government enhancement process and the single sponshorships, of course. So, are there any more broad changes in the near-term and moving what should investors take away with kind of the [indiscernible] adjustments in particular?
Garth Hankinson
And so first of all, both Bill and with great additions to the Board, obviously, they add significant financial expertise, which is going to be helpful to the Board and we have a transformation to the management as we continue to focus on the long range planning and good capital allocation. After the reclassification occurred, the Board was very committed to performance plus evaluation and as such, engaged with our leading consultant outlook at Board composition, Board capabilities, diversity of thought. And so, there will be more than what come out of that. We want to ensure that we have got – obviously, we have got good governance. We think that there have been a series of things that have happened over the last nine months that you referenced the declassification. Obviously, there has been a change in the Chair, as well as to two additions to our Board. But we will go through this process, again, focusing on what capabilities do we want our Board to have. We want to ensure that we have got diversity of thought. We want to ensure that, we have got a Board that’s focused on the right things, and to an extent that there is any incremental changes, obviously, we will announce those in due course, but it’s a process and it’s underway.
Lauren Lieberman
Okay. Are there any particular capabilities that you can think of you are looking, it’s important to be adding support, so at this point?
Garth Hankinson
The most immediate concern was the one that we already addressed, which was the lack of true financial expertise. We were limited really to kind of one member who really would qualify us having that. And so that was clearly the number one hole in the portfolio. I don’t want to get out to in front of the board process to see like, the next most critical thing is, but suffice to say we are doing a real introspective, again to the extent that there is anything else to share we will share that in due course.
Lauren Lieberman
Okay, great. Right now, more to come this fall.
Garth Hankinson
More to come this fall at Investor Day.
Lauren Lieberman
So, join me in thanking Garth for being here and we will go to breakout afterwards.
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Constellation Brands, Inc. (STZ) Presents at Barclays Global Consumer Staples Conference (Transcript)