Constellation delivers beer profits, but weakness in wine prompts a downgrade

Constellation Brands reported an earnings beat on Wednesday that was driven by strength in its beer business. However, shares fell 4% after an initial move up, as investors — including us — remain troubled by continued weakness in the wines and spirits business. Comparable net sales for the three months ended May 31 increased 6% year over year to $2.662 billion, missing Wall Street’s expectations of $2.671 billion, according to LSEG. Adjusted earnings-per-share (EPS) increased 17% compared with the same period last year, to $3.57, a beat versus the $3.46 per share predicted by analysts. Constellation Brands Why we own it : We like Constellation Brands for its beer franchise, which includes popular Mexican brands Modelo, Corona and Pacifico. We would like Constellation to concentrate on beer and divest its wine and spirits business. Competitors : Anheuser-Busch Inbev and Molson Coors Weight in Club portfolio : 2.5% Most recent buy : April 16, 2024 Initiated: May 5, 2022 Bottom line This quarter reaffirmed our belief that Constellation has a great beer business that is weighed down by its wine-and-spirits unit. While overall sales came up short, CEO Bill Newlands said it still beat the overall consumer packaged goods growth by 4.5 percentage points. That outperformance was largely driven by the growth of its beer business, which attained the second largest share gain in the entire beverage industry and the top share gain in alcoholic beverages. We were again pleased to see that the increase in beer sales was driven by strong growth in shipment volume. Remember, the ability to grow sales via increased volume is crucial given the inflationary dynamics we’ve had to deal with coming out of Covid. That’s because consumers are starting to push back on high prices. The ability to grow sales via increased volumes alleviates some pressure on management to take action on prices, a key factor that should help the company continue gaining market share. Operating cash flow came in light, but free cash flow was largely in line with expectations. As members know, cash flow is the key to shareholder returns and indeed, management paid out $185 million in dividends during the quarter, while repurchasing $200 million worth of shares and repurchased another $40 million worth of shares in June. The team continues to target a net leverage ratio of 3 times by the end of the fiscal year. Management said it is working to right the wine-and-spirits business and expects to see improvements in the back half of the year as “operational and commercial execution initiatives” identified in the fourth quarter of the last fiscal year and started in the first quarter of this year take hold. Guidance is in line with the expectation that weakness in the business is bottoming out. We maintain the view that a rebound or divestiture of the wine-and-spirits segment remains key to the stock reaching new highs. While we are sticking with the name given the strength in beer, we opted to trim our position and downgrade the stock to a 2 rating. We want to see actual progress before getting more positive on the trajectory of the stock from here. We are keeping our price target of $300. Quarterly results Constellation’s wine-and-spirits division remains a drag, with net sales falling 7% to $389 million, slightly below Street estimates, while operating income dropped 25% to around $60 million. Operating margin for the segment was down 370 basis points to 15.3%, worse than expectations. The weakness is attributable to lower volumes and higher costs of goods sold, which more than offset the benefits of lower operating expenses elsewhere. Shipment volumes declined 5.1% due to “challenging” market conditions, primarily in the U.S. wholesale channel. Depletions, a key metric that represents how much was product was sold to retailers by a distributor, were down 12.7% from a year ago. “The tactical investments in the 11 brands that represent 75% of net sales and over 80% of volumes for our wine and spirits business in fiscal ’24 are now underway, and we expect to see improvements in this select group of our most scaled offerings over the remainder of the year,” the company said during its post-earnings call with investors. Beer segment results, on the other hand, remain largely positive. Though sales did come in a bit light versus estimates, the result still amounts to 8% year-over-year growth. Moreover, strong profitability led to a beat on operating income despite the topline miss. Operating margin expansion resulted from greater operating leverage (fixed costs were more spread out), along with benefits from ongoing cost-saving initiatives, and timing and efficiencies in marketing investments. Shipments increased 7.6% year over year. Depletions were up 6.4% versus the year-ago period, led by growth in Modelo Especial (11%), Pacifico (21%), and Modelo Chelada (over 5%). Citing Circana channel data, the company said its beer business was the top dollar sales share gainer for the 11 th consecutive quarter and the top volume share gainer in the total beer category in the U.S. Moreover, Constellations beer portfolio has 4 of the top 15 dollar share-gaining brands in the quarter. Guidance Management reaffirmed the guidance it gave in the previous quarter. Net sales are expected to increase 6% to 7%, driven by 7% to 9% growth in beer. Sales of wine and spirits are pegged at down 0.5% to up 0.5%. Enterprise operating income is expected to increase 10% to 12% on a comparable basis, with beer up 10% to 12% and wine and spirits down 9% to 11%. Management expects comparable earnings to be $13.50 to $13.80 per share. Operating cash flow is forecasted to land between $2.8 billion and $3.0 billion, with free cash flow of $1.4 billion and $1.5 billion, after accounting for $1.4 billion to $1.5 billion on capital expenditures, with $1.2 billion of that targeted to support capacity additions to its Mexican beer operations. (See here for a full list of the stocks in Jim Cramer’s Charitable Trust.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust’s portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. 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