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Constellation Grows By Shrinking
It's not the greatest testament to a business division, when the parent company jettisons it and posts higher profits. Such is the case for Constellation Brands (NYSE:STZ), a company that spent and borrowed too much to expand and is now trying to find a business model that offers better growth and margins for the long haul.
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A Fiscal Q2 Better Than Expected
Constellation's fiscal second quarter results were not great, but they were better than most analysts expected. As-reported revenue plunged 20% (or 21% in constant currency), while organic revenue was basically flat, the difference coming from the divestiture of the Australian and European wine businesses.
Volume was quite mixed. Total North American shipment volume was down almost 2%, as reported, and even worse on an organic basis, which was down almost 4%. Depletion volume, which measures the flow of product from distributors to retailers, was negative in an industry that's showing some modest growth. That said, beer and spirits businesses seem to be doing a fair bit better.
Profits improved quite a lot in the wake of the restructuring. Gross margin improved almost five points, while operating income rose 9% on a substantial, nearly six point, improvement in operating margin. While management has certainly tried to get better about its operating efficiency, these results are also a fairly damning indictment of those Australian and European operations. (For related reading, see Analyzing Operating Margins.)
The Beer World is Changing
Constellation saw its equity earnings from its Crown Imports business drop 4% this quarter, but it was still about 30% of the company's pre-tax, pre-interest income. It's worth wondering, though, how stable this is. The company has a solid relationship with Grupo Modelo, but there looks to be another consolidation wave going through the beer industry.
Right now, companies like Modelo, Molson Coors (NYSE:TAP), Heineken, and so forth, have to be scanning the landscape and wondering if they can be consolidators or brothers-in-arms, or whether they are destined to become part of larger companies like Anheuser Busch-Inbev (NYSE:BUD). There are buyout provisions that give some protection to Constellation, but the company should, nevertheless, have some back-up plans ready. Perhaps Constellation goes back to the M&A well and acquires some brewers or tries to sign up other brewers for distribution agreements.
Wine is Fine, Liquor's Growing Quicker
Right now, the wine business is still in the midst of a major readjustment. Beer has regained popularity and spirit companies like Diageo (NYSE:DEO), Pernod Ricard, Beam (Nasdaq:BEAM), and Brown-Forman (NYSE:BF.B) are more to investors' tastes these days. Given that it has been around for several thousand years, the wine industry is not going away, but Constellation is still going to have to adjust to the new reality of customer tastes and shifting store space, at retailers like Whole Foods (NYSE:WFM) and Walmart (NYSE:WMT).
The Bottom Line
Constellation shares have gotten cheaper lately, but then so has almost everything else. To that end, it doesn't stand out as a must-consider for value investors. There's still turnaround appeal here, though. Management seems to have accepted the new reality and is rebuilding the business accordingly. The process is not over, but this is a business that should be able to produce solid cash flow and decent growth; enough to pay off that huge debt load and maybe someday establish a dividend, like most other respectable adult beverage companies. (Learn the technique that Buffett, Lynch and other pros used to make their fortunes. For more, see The Value Investor's Handbook.)
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A Fiscal Q2 Better Than Expected
Constellation's fiscal second quarter results were not great, but they were better than most analysts expected. As-reported revenue plunged 20% (or 21% in constant currency), while organic revenue was basically flat, the difference coming from the divestiture of the Australian and European wine businesses.
Volume was quite mixed. Total North American shipment volume was down almost 2%, as reported, and even worse on an organic basis, which was down almost 4%. Depletion volume, which measures the flow of product from distributors to retailers, was negative in an industry that's showing some modest growth. That said, beer and spirits businesses seem to be doing a fair bit better.
Profits improved quite a lot in the wake of the restructuring. Gross margin improved almost five points, while operating income rose 9% on a substantial, nearly six point, improvement in operating margin. While management has certainly tried to get better about its operating efficiency, these results are also a fairly damning indictment of those Australian and European operations. (For related reading, see Analyzing Operating Margins.)
Constellation saw its equity earnings from its Crown Imports business drop 4% this quarter, but it was still about 30% of the company's pre-tax, pre-interest income. It's worth wondering, though, how stable this is. The company has a solid relationship with Grupo Modelo, but there looks to be another consolidation wave going through the beer industry.
Right now, companies like Modelo, Molson Coors (NYSE:TAP), Heineken, and so forth, have to be scanning the landscape and wondering if they can be consolidators or brothers-in-arms, or whether they are destined to become part of larger companies like Anheuser Busch-Inbev (NYSE:BUD). There are buyout provisions that give some protection to Constellation, but the company should, nevertheless, have some back-up plans ready. Perhaps Constellation goes back to the M&A well and acquires some brewers or tries to sign up other brewers for distribution agreements.
Wine is Fine, Liquor's Growing Quicker
Right now, the wine business is still in the midst of a major readjustment. Beer has regained popularity and spirit companies like Diageo (NYSE:DEO), Pernod Ricard, Beam (Nasdaq:BEAM), and Brown-Forman (NYSE:BF.B) are more to investors' tastes these days. Given that it has been around for several thousand years, the wine industry is not going away, but Constellation is still going to have to adjust to the new reality of customer tastes and shifting store space, at retailers like Whole Foods (NYSE:WFM) and Walmart (NYSE:WMT).
The Bottom Line
Constellation shares have gotten cheaper lately, but then so has almost everything else. To that end, it doesn't stand out as a must-consider for value investors. There's still turnaround appeal here, though. Management seems to have accepted the new reality and is rebuilding the business accordingly. The process is not over, but this is a business that should be able to produce solid cash flow and decent growth; enough to pay off that huge debt load and maybe someday establish a dividend, like most other respectable adult beverage companies. (Learn the technique that Buffett, Lynch and other pros used to make their fortunes. For more, see The Value Investor's Handbook.)
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by
Stephen D. Simpson, CFA
Stephen D. Simpson, CFA, is a freelance financial writer, investor, and consultant. He has worked as an equity analyst for both sell-side and buy-side investment companies in both equities and fixed income. Stephen's consulting work has focused primarily upon the healthcare sector, while he has also written extensively for publication on topics pertaining to investments, security analysis, and healthcare. Simpson operates the Kratisto Investing blog, and can be reached there.
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