Constellation Brands, Inc. — Fiscal 2019 Form 10-K
Reporting period: Fiscal year ended February 28, 2019. Although the request metadata refers to 2018 Q4, this filing is an annual report for fiscal 2019; quarterly results are included but are not the filing’s reporting period.
Business context
Constellation produces and markets beer, wine and spirits, principally in the U.S., with operations in Mexico, New Zealand, Italy and Canada. Its strategy emphasizes premium brands and growth in higher-end categories. Beer represented 64% of net sales; Wine and Spirits represented 36%. In November 2018, the company expanded its investment in cannabis producer Canopy Growth and began accounting for its common-share investment under the equity method.
Financial results and liquidity
| Metric | Fiscal 2019 | Fiscal 2018 | Change/comment |
|---|---|---|---|
| Net sales | $8.116 billion | $7.580 billion | Up 7% |
| Gross profit / margin | $4.080 billion / 50.3% | $3.813 billion / 50.3% | Profit up 7%; margin flat |
| Operating income | $2.412 billion | $2.280 billion | Up 6% |
| Income from unconsolidated investments | $2.102 billion | $487 million | Includes $1.971 billion unrealized gain on Canopy securities and $99.8 million gain on the Accolade investment sale |
| Net income attributable to CBI | $3.436 billion | $2.303 billion | Increase largely reflects Canopy fair-value gains |
| Diluted EPS, Class A | $17.57 | $11.47 | Reported EPS was materially affected by investment gains and tax-period comparability |
| Cash from operations | $2.246 billion | $1.931 billion | Up $315 million |
| Capital expenditures | $886 million | $1.058 billion | Primarily beer capacity expansion |
| Total debt outstanding | $13.617 billion | $10.187 billion | Increase primarily funded the Canopy transaction |
| Cash and cash equivalents | $94 million | $90 million | Revolver availability was $1.197 billion at year-end |
Segment performance: Beer net sales rose 12% to $5.202 billion, driven mainly by Mexican beer volume growth and pricing; shipment volume increased 9.7% and distributor depletion volume 8.8%. Wine and Spirits net sales were essentially flat at $2.914 billion, as pricing offset lower volume and unfavorable mix; segment operating income fell 3% to $771 million. Beer operating income rose 11% to $2.043 billion.
Interest expense increased 11% to $367 million, mainly due to higher average borrowings. The reported effective tax rate was 16.5%, compared with 1.0% in fiscal 2018, which included a $351 million benefit related to U.S. tax reform. The filing reports no material off-balance-sheet arrangements. The company was in compliance with debt covenants at year-end.
Material changes and unusual items
- Canopy-related fair-value gains were a major contributor to reported income: the $1.971 billion gain was unrealized and subject to market volatility. The company held a 36% Canopy ownership interest at year-end.
- Beer shipment growth exceeded depletion growth due to timing; management expected this benefit to reverse in fiscal 2020. Wine and Spirits shipments also differed from depletions, with the company expecting a timing-related decline in first-quarter fiscal 2020 net sales.
- The company recorded a $108 million impairment of the Ballast Point trademark, citing negative trends in craft beer and a strategy change. It also recorded a $20.6 million total write-down for California wildfire smoke damage to bulk wine inventory; insurance recovery was uncertain.
- Revenue-recognition guidance was adopted retrospectively. Management said the adoption did not materially affect sales recognition overall, but it shifted some incentive-related revenue timing and reduced opening retained earnings by $49 million, net of tax. A separate tax-accounting adoption increased opening retained earnings and deferred tax assets by approximately $2.2 billion.
- In April 2019, after year-end, the company agreed to sell approximately 30 lower-growth, lower-margin wine and spirits brands and related assets for about $1.7 billion, subject to adjustments and regulatory approval. It expected to close around the end of fiscal 2020’s first quarter, use net proceeds primarily to repay debt, and incur a restructuring charge.
Outlook, management commentary and risks
- Management expects fiscal 2020 capital expenditures of $800–$900 million, including about $750 million for Mexico beer expansion. It is targeting approximately 10 million additional hectoliters of Mexican beer capacity over the next four fiscal years.
- Management expects a fiscal 2020 effective tax rate of 16%–18% and said it expects to return to its targeted leverage ratio within 24 months after the November 2018 Canopy investment.
- Management expects first-quarter fiscal 2020 Wine and Spirits net sales to decline 10% year over year, principally because of shipment/depletion timing. It also expected the fiscal 2019 beer shipment timing benefit to reverse.
- Key risks include high debt and financing needs; dependence on Mexican beer brands and a limited number of breweries and glass suppliers; execution, timing and cost risks in brewery construction; water, agricultural-input and packaging supply exposure; distributor and major-customer concentration; Canopy’s cannabis legality, market prospects and volatile valuation; and competition, regulation, taxes, cyber/ERP implementation and climate or natural-disaster risks.
- The company disclosed ordinary-course litigation and regulatory inquiries; management did not expect pending matters to have a material adverse effect but said outcomes could not be predicted. Management and KPMG reported effective internal control over financial reporting as of year-end.
Important facts for investors to verify
- How much of reported earnings and EPS growth reflects recurring operating performance versus Canopy fair-value gains, the Accolade sale gain and tax items.
- Canopy investment valuation, warrant modification approvals and accounting effects, and the potential impact of cannabis regulation and market developments.
- Debt reduction progress, leverage trajectory, refinancing needs and the effect of the proposed wine and spirits sale on debt and remaining-business profitability.
- Whether beer depletion trends sustain growth as shipment timing reverses, and whether planned Mexican brewery expansions stay on schedule and within budget.
- Execution of the wine and spirits divestiture, closing conditions, final proceeds and adjustments, restructuring costs, and the forecast first-quarter sales decline.
- Ballast Point recovery plans, further potential brand impairments, wildfire inventory insurance recovery, and exposure to supplier, water and customer concentration.