STZ - Constellation Brands - Lost Some Of Its Touch

Summary

• Constellation Brands stock has lost some of its magic touch in recent years.
• Growth has slowed down after years of strong growth, as cannabis investments have not worked out at all.
• Valuations look fair at 20 times, amidst high leverage and slower growth.

My last take on Constellation Brands ( STZ ) has been at the time when the pandemic broke out, as I concluded that the Corona crisis was impacting the Corona brewer. The business was a darling at the time, as higher leverage created come uncertainty given the situation at the time, as the developments ever since have not been too spectacular.

A Recap

Constellation Brands has been a huge long term success story, driven largely by its core Corona and Modelo beer brands, causing shares to rise from levels around the $20 mark in 2010 to the $200 mark ahead of the pandemic arriving.

Irony will it that it was the Corona pandemic which hurt the business in such a huge way at the outset of the pandemic. This came as many establishments which served these beers and other liquors brands were closed, as the company had taken on some debt as well.

To isolate the impact of the pandemic I go back to 2019 when Constellation still posted results with were unaffected by these conditions of course. The company only posted a low single digit increase in sales after witnessing a real growth run in the years before.

The company generated $8.3 billion in sales in 2019 on which very fat operating profits of $2.6 billion were posted. Adjusted for some incidental items I pegged net earnings around $1.8 billion, translating into earnings of just over $9 per share based on a share count of 195 million shares.

Net debt was quite substantial however, reported at $12.1 billion, while EBITDA came in at $2.9 billion. This worked down to a 4.2 times leverage ratio, although the balance sheet furthermore revealed $4.2 billion in equity investments carried on the balance sheet. Adjusted for these assets, net debt came in around $8 billion, for a leverage ratio just below 3 times.

While the company would likely still do fine over time, I was cautious given the high leverage situation. Consumption at home went up during the pandemic, as the question was if the same conditions applied to Constellation's brands as well, with some consumers moving to less premium beers and liquors at the time. While the share price levels in the $130s looked interesting enough to gradually pick up a position, the market was moving a lot those days, creating bargains left and right of course.

Recovery And Rebound

Shares of Constellation rose to the $180s in the summer of 2020, to ever since have traded in a $200-$250 range, with shares now exchanging hands at $227 per share.

In April 2022, the company posted its results for the fiscal year 2022. Full year sales rose in a modest fashion to $9.5 billion ahead of excise taxes, or at $8.8 billion on a net basis. The company posted an operating profit of $2.3 billion, or close to $3.0 billion if we add back the impairment charge on a brewery under construction. Net results came in around the flat line following large losses booked on (cannabis) investments.

With a total of 190 million shares outstanding across the dual share classes, earnings (adjusted for special items) would otherwise have come in around $11 per share, amidst modest share buybacks. Net debt came in at $10.2 billion, as this includes a $2.9 billion in equity investments held on the balance sheet. If we subtract this from net debt, I peg adjusted net debt at $7.3 billion, making that net debt is very manageable with EBITDA pegged at $3.3 billion.

For 2023, the company guided for earnings between $11.20 and $11.50 per share, marking modest growth from 2022. With shares trading at $250 at the time, multiples came in at 22 times forward earnings with leverage reported just over 2 times. The company furthermore announced a $500 million accelerated buyback program, executed at prices around $231 per share at the time.

Forwarding through the first three quarters of the 2023 results, the company has grown net sales by 11% to $7.5 billion, with growth slowing down to 5% in the third quarter. Slower growth is disappointing as the company has been suffering from inflationary trends. The company is on track to post operating earnings of around $3 billion, although still accompanied by a net loss. This loss was the result of a $1.95 billion charge taken, relating to Canopy/cannabis investments, creating continued distraction on this front, although the worst risks on this front appear to be a thing of the past now.

Troublesome are the operational trends as actual profits (in dollar terms) are largely equal, with sales having grown in part by inflation. Margins are hurt by notably inflationary trends in packaging, raw materials and logistics.

Net debt has risen to $12.0 billion, with securities and equity method investments having shrunken to less than a billion (following continued impairments of the cannabis investments) making that realistic net debt has risen sharply again this year. Besides investment losses, Constellation has spent a considerable sum to eliminate the dual class share structure.

With comparable earnings now seen at a midpoint of $11.10 per share, the company commands a 20 times multiple. That is a very reasonable multiple, albeit that leverage has risen quite a bit as investors appear tired of the cannabis investments and adventure, detrimental to the business performance here.

Concluding Remark

Right now Constellation seems about fairly valued in my eyes. At a 20 times earnings multiple, the valuation is fair amidst lackluster recent growth and leverage take on, although that the dual class structure has been resolved and that the focus on cannabis seems to be a thing of the past now.

Weighing it all together, Constellation has lost some of that special touch to me, as I see fair value here, but no imminent appeal, although pullbacks to the $200 might start to offer interesting levels to get involved.

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