Nicolas Micolani
Overview
My recommendation for Constellation Brands (NYSE:STZ) is a buy rating as the beer segment performance continues to remain solid. I expect this performance to continue through FY25, with a possible chance of outperforming guidance in 4Q24 given the easy comp in 4Q23. Importantly, management has reset expectations for its Wine & Spirits business, which should remove pressure on the stock’s valuation. Note that I previously rated the buy rating for STZ as I believed the near-term headwinds that STZ faced previously were nothing structural. Importantly, the STZ beer segment continued to see positive traction, and the valuation was set to improve as STZ deleveraged the balance sheet.
Recent results & updates
For STZ recent results, the business reported net sales growth of 1.4%, driven by beer sales growth of 4% and wine and spirits [W&S] sales decline of 7.7%. Gross margins did well with an expansion of 53 bps to 51.9%, driven by a beer gross margin expansion of 48 bps and a W&S gross margin expansion of 29 bps. STZ did well in management expenses, with SG&A as a percent of sales declining by 106 bps to 18.7%. All of these result in STZ reporting a strong EPS performance of $3.24.
As I expected, STZ beer consumption momentum remains solid. For the second quarter in a row, STZ’s beer depletions accelerated sequentially, coming in at 8.2%. This performance was actually better than management expectations back in December, where they mentioned actual depletions were running at the high end of the mid-single-digit percentage. The explanation for the better performance was simply because of a strong consumer spending environment during the Thanksgiving season. The strong sell-through performance resulted in retailers restocking. I believe the performance should continue into the following year, as management mentioned that the strong momentum has continued into December. At the current pace, STZ could very well outperform its guided range, providing a high base for FY25 to grow upon. In the quarter, management reiterated its Beer segment FY24 revenue growth guidance of 8 to 9%, and so far, STZ has already achieved 8.9% on a year-to-date basis. Given that 4Q24 is going to be an easy quarter for STZ (3Q24 was an easy comp because of the challenging weather in California and the negative impact of the price increase), I believe 4Q24 could do much better than the past 9 months. The positive implication is that it makes the pricing (low-single-digit percentage) and volume (mid-single-digits to high-single-digit percentage) medium-term growth outlook plausible. Looking ahead into FY25, apart from the continuous demand momentum, I also expect STZ to gain more shelf space (which will improve growth potential) during the spring retail shelf space resets. Retailers are likely to give STZ more shelf space given the strength of consumer demand for its products. Regarding consumer demand, management has specifically highlighted the fact that they are seeing strong loyalty from their core Hispanic consumers and increasing market penetration overall as a result of better marketing and innovation.
Part of that is driven, I think, by a couple of things. One is, we have such a strong base with the Hispanic consumer, where beer remains a critical part of their consumption pattern. Our brands have great brand loyalty. from: 3Q2024 earnings call
On the other hand, STZ’s W&S business continues to severely underperform due to factors like lower consumer spending and aggressive discounting by competitors. To make things worse, this segment is undergoing a management change, which makes the entire situation much more uncertain. That said, I thought it was prudent and sensible for management to significantly lower its guidance for the business, as it helps to reset expectation.
Moving on to the Wine and Spirits business. As noted earlier, our Wine and Spirits business is operating amid a broader marketplace deceleration
More broadly, while we are maintaining a disciplined approach to taking price across our portfolio, the competitive environment is now getting pressure with more aggressive discounting and price points beyond mainstream. from: 3Q2024 earnings call
Valuation and risk
Author’s valuation model
The STZ share price has moved in the same direction as I expected previously, and my model continues to point upside from here. Because of the continued strong performance in STZ’s beer segment, I have increased my growth outlook for FY24 from 5% to 7% and by 100 bps in FY25 to reflect the lower contribution from the W&S segment (the revenue mix is going to be smaller) and the continued momentum into FY25. My margin expectations remain the same, as I expect the positive margin expansion from the beer segment to modestly outweigh the decline in the W&S segment. With management resetting expectations for the W&S segment, I think it has removed the pressure on valuation, which I believe previously existed because of the W&S competition factor and broad market deceleration. As this pressure goes away, I see a clear path for valuation to rerate back to 21x as the market shifts focus to the beer segment. As such, my target price is now $281.
The decline in the W&S segment might be more than what management is expecting. If that is the case, it might drag down the overall performance of the group, despite the beer segment doing very well. This could cause valuations to stay low for the near term as the market awaits further clarity on how bad the situation can get.
Summary
I remain buy rated for STZ as its beer segment continues to demonstrate robust performance, supported by a favorable consumer spending environment. Recent results showcase STZ’s resilience, with net sales growth driven by a 4% increase in beer sales and notable gross margin expansion. While the Wine & Spirits segment faces challenges, the reset guidance should remove the pressure on STZ valuation. With a revised growth outlook, my target price for STZ is $281.
