Constellation Brands, Inc. — Q1 FY2020 Form 10-Q
Reporting period: Three months ended May 31, 2019. Unless noted otherwise, amounts are in U.S. dollars. The company sells premium beer, wine and spirits and holds a significant equity-method investment in Canopy Growth Corporation.
Financial performance and position
| Metric | Q1 FY2020 | Prior comparable period |
|---|---|---|
| Net sales | $2,097.2 million | $2,047.1 million |
| Gross profit / gross margin | $1,028.7 million / 49.1% | $1,048.6 million / 51.2% |
| Operating income | $622.7 million | $625.4 million |
| Net income (loss) attributable to CBI | $(245.4) million | $743.8 million |
| Diluted EPS, Class A | $(1.30) | $3.77 |
| Cash from operating activities | $593.1 million | $504.0 million |
| Capital expenditures | $155.7 million | $168.2 million |
- Net sales rose 2%. Beer sales increased 7% to $1,477.4 million; Wine and Spirits sales decreased 8% to $619.8 million. Beer growth reflected volume and pricing; Wine and Spirits weakness reflected lower branded volume and unfavorable mix.
- Operating income was nearly flat. Gross margin fell 2.1 percentage points, substantially affected by a $70.9 million unfavorable year-over-year swing in comparable adjustments, including strategic business development costs and commodity-derivative settlements.
- The company recorded an $827.5 million unrealized loss on Canopy-related securities measured at fair value and $106.0 million of equity-method losses from Canopy. These investment results were the principal driver of the reported net loss; operating income remained comparatively steady.
- Operating cash flow increased $89.1 million, helped by strong Beer performance, lower income-tax payments and the timing of Wine and Spirits receivable collections. Investing activities used $213.5 million; financing activities used $374.4 million. Cash ended at $98.7 million.
- At May 31, total debt was $13,397.6 million, including $586.4 million of short-term borrowings and $12,811.2 million of long-term debt, including current maturities. Cash was $98.7 million. Available revolving-credit capacity was $1,400.6 million; the company reported compliance with debt covenants.
- Current assets were $3,580.9 million and current liabilities were $2,939.3 million. The filing reports adequate liquidity and expects operating cash flow and financing capacity to meet obligations and planned spending.
Material changes and significant developments
- Beer volume and pricing supported growth: Beer shipment volume rose 5.4%, and depletion volume rose 6.6%. Management said shipments were accelerated ahead of proposed tariffs on Mexican imports and now expects that timing benefit to reverse during the remainder of Fiscal 2020.
- Wine and Spirits shipment volume declined 8.1%; U.S. Domestic Power Brand shipments fell 15.1%. The company is shifting the portfolio toward higher-margin, higher-growth brands.
- In April 2019, CBI agreed to sell about 30 lower-growth, lower-margin wine and spirits brands and related assets to E. & J. Gallo Winery for approximately $1.7 billion, subject to closing adjustments and regulatory approval. Closing was expected in the second half of calendar 2019; proceeds were expected to be used primarily to repay borrowings. Net assets held for sale were $1,560.4 million. No impairment was identified as of May 31.
- Wine and Spirits optimization charges totaled $61.2 million for the quarter, including inventory write-downs, contract terminations, employee termination costs and other costs.
- CBI increased its ownership of Nelson’s Green Brier Distillery to 75% in May and began consolidating it; the transaction produced an $11.8 million remeasurement gain.
- Lease accounting adoption on March 1, 2019 added operating lease right-of-use assets of $592.5 million and liabilities of $619.9 million, with no material impact on results or liquidity.
Outlook, risks and contingencies
- Management forecast a Fiscal 2020 reported effective tax rate of 6%–8%. The estimate excludes future Canopy fair-value changes and equity-method results, any gain or loss on the wine and spirits sale, and the expected gain from the Canopy warrant modification. A potential $500–$600 million one-time deferred-tax benefit from proposed foreign tax reform was also excluded.
- Following June 2019 modifications to the Canopy warrants, management preliminarily expected a material gain in Q2 Fiscal 2020 and cautioned that warrant fair values and Canopy earnings could be volatile. The warrant modification was linked to Canopy’s proposed acquisition of Acreage Holdings upon U.S. federal cannabis legalization, subject to conditions.
- CBI’s Canopy investment was valued at $2,409.5 million for fair-value-measured securities at May 31; a hypothetical 10% adverse move in Canopy’s share price would have reduced their fair value by an estimated $352.8 million. Exercising all warrants outstanding at May 31 would have required approximately $5.6 billion in cash.
- Key risks include Canopy share-price and earnings volatility, execution and approval of the wine and spirits divestiture, reversal of beer shipment timing, tariffs or other trade measures affecting Mexican imports, foreign-exchange and commodity-price movements, and interest-rate and refinancing exposure. The filing states the company was in compliance with covenants at quarter-end.
- The board declared a quarterly dividend of $0.75 per Class A share and $0.68 per Class B and Class 1 share, payable August 27, 2019, subject to the stated conditions and board approval.
Investor verification checklist
- Track Beer consumer depletions versus shipments and whether the anticipated shipment-timing reversal occurs.
- Verify the wine and spirits sale’s closing, final proceeds, regulatory approvals, and use of proceeds to reduce debt.
- Reconcile ongoing Wine and Spirits volumes, margins and optimization costs against management’s portfolio-transition plans.
- Monitor Canopy’s market value, equity-method results, warrant-modification accounting and the expected Q2 gain.
- Assess debt reduction, borrowing capacity, covenant compliance and progress toward the company’s targeted leverage ratio; the filing does not state a specific target ratio or return date.
- Compare the 6%–8% tax-rate outlook with subsequent results and any enactment of foreign tax reform.