Constellation Waits For The Stars To Be Right

By Stephen D. Simpson, CFA | July 05, 2011 AAA

Can the largest publicly-traded wine business regain the shareholder love it once enjoyed? Constellation Brands (NYSE:STZ) rode a heck of a wave as wine consumption took off in the U.S. about 10 years ago and the company acted as a major consolidator. Since then, though, the company has found that its empire hasn't quite validated the debt that underwrote its construction and the stock has not been the winner that its owners may have expected.

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A Sluggish Start to the Fiscal Year
Constellation Brands did not get its new fiscal year off to a roaring start. While reported revenue dropped more than 19%, organic revenue grew about 2%. Shipments fell more than 3%, depletions were down more than 2% and results in wine were generally disappointing. While the company's beer distribution business is doing pretty well, the company is losing some share in wine to the likes of Gallo, Wine Group and Trinchero.

Profitability was a better story, though. Gross margin jumped about five full points and operating income grew 12% from last year's level. Some of this improvement was due to less promotional spending - a mixed blessing that boosts margins but takes a toll on sales growth and market share.

A Crowded Market With Fierce Competition
The major growth in U.S. wine consumption may be over, but it is not as though Americans are going back to teetotaling or beer. Still, that leaves the major players fighting more fiercely for a more limited pool of dollars. While Constellation Brands is certainly the largest pure-play public wine company, it still has to battle with large players like Gallo, Diageo (NYSE:DEO), Wine Group, Altria Group (NYSE:MO), Brown-Forman (NYSE:BF.B), to say nothing of small up-and-comers like Willamette Valley (Nasdaq:WVVI) and a host of small wineries.

Right now, Gallo seems to have the hot hand with its Barefoot brand, and Constellation is trailing with brands like Woodbridge and Robert Mondavi. That leaves Constellation with the choice of fighting back with heavy promotion or preserving margins at the cost of share. In the past Constellation would also fight back with further acquisitions and consolidation but instead of targeting producers like W J Deutsch (with its Yellowtail label) or Jackson Family (Kendall-Jackson), Constellation has been moving the opposite direction. The company has made no major buys in over four years and has instead been making some sizable sales, including the sale of 80% of its UK/Australia wine business to private equity.

Hope in Beer?
Constellation has been doing well in beer and it is worth wondering if the company has any further aspirations here. Modelo can take over this distribution arrangement down the road, but perhaps the company will see this as a possible arena for consolidation or expansion. Molson Coors (NYSE:TAP), Anheuser-Busch InBev (NYSE:BUD) and Boston Beer (NYSE:SAM) could be ripe for a shake-up, but the last wave of IPO and M&A activity in the brewery space in the mid-90s didn't produce much value for anybody but the investment bankers.

The Bottom Line
Constellation has actually done quite well over the past year, rising more than 30% and beating the S&P 500 over that period. At these levels the stock carries a pretty healthy valuation and the balance sheet is still loaded with debt. It may be the case, then, that Constellation still has a few more years of digestion and margin improvement in store before really thinking about a new growth plan.

Constellation is not a bad holding, but the debt largely proscribes hopes for a dividend payment and it's not clear that there's enough underlying growth in the name to make it a really successful stock. Constellation has its fans and supporters, but the stars just don't seem to be right for this name to be a major winner right now. (For additional reading, check out Wine And Chocolate: A Sweet Deal For Investors.)

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