Constellation Brands, Inc. — Q3 FY2023 Form 10-Q
Reporting period: Fiscal third quarter and nine months ended November 30, 2022; comparisons are to the periods ended November 30, 2021. Unless stated otherwise, amounts are U.S. dollars.
Business context
Constellation produces and markets beer, wine, and spirits, principally in the U.S. and Mexico. Its reported segments are Beer, Wine and Spirits, Corporate Operations and Other, and Canopy. Management’s strategy emphasizes premium brands, organic growth, and investment in distribution, digital capabilities, and Mexico beer capacity.
Key financial metrics
| Metric | Q3 FY2023 | Q3 FY2022 | Nine months FY2023 | Nine months FY2022 |
|---|---|---|---|---|
| Net sales | $2,436.5 million | $2,320.6 million | $7,454.8 million | $6,718.2 million |
| Gross profit | $1,226.9 million | $1,225.7 million | $3,807.8 million | $3,574.7 million |
| Gross margin | 50.4% | 52.8% | 51.1% | 53.2% |
| Operating income | $746.7 million | $839.9 million | $2,376.2 million | $1,654.2 million |
| Net income (loss) attributable to CBI | $467.7 million | $470.8 million | $(294.0) million | $(435.8) million |
| Diluted EPS, Class A | $2.52 | $2.48 | $(1.48) | $(2.31) |
| Operating cash flow | Not separately presented | Not separately presented | $2,280.6 million | $2,444.1 million |
- Q3 net sales increased 5%, largely from Mexican beer pricing and shipment growth. Beer net sales rose 8%; Wine and Spirits sales fell 4%, including the effect of the wine divestiture; Canopy sales declined 14%.
- Q3 gross profit was nearly flat, while gross margin declined 2.4 percentage points, principally due to higher material, transportation, brewery, and other operating costs and unfavorable comparable adjustments. Operating income fell 11%.
- For the nine months, net sales grew 11% and operating income grew 44%. The operating-income comparison benefited materially from the prior-year $665.9 million Mexicali construction-asset impairment. Beer sales growth reflected shipment volume and pricing; Wine and Spirits sales were roughly flat.
- Nine-month net loss attributable to CBI narrowed year over year, but remained a loss because of Canopy-related investment losses and a large impairment. The prior year included substantially larger fair-value losses on Canopy securities.
- Nine-month capital expenditures were $683.8 million. Investing cash outflow was $646.6 million. Financing cash outflow was $1,645.9 million, including $1.4 billion of share repurchases, $441.1 million of dividends, and the $1.5 billion Reclassification payment.
Balance sheet, debt, and liquidity
- At November 30, 2022, cash was $185.0 million, current assets were $3,525.9 million, and current liabilities were $2,725.0 million. Inventories were $1,802.0 million, up from $1,573.2 million at February 28, 2022.
- Total debt, including commercial paper, was $12,172.3 million, up $1,755.8 million from February 28, 2022. The balance included $875.6 million of commercial paper and $11,296.7 million of long-term debt including current maturities. Commercial paper carried a 4.6% weighted-average annual rate and a nine-day weighted-average remaining term.
- Unused revolving capacity was $1,361.4 million at November 30, net of commercial paper and letters of credit. The company reported compliance with its debt covenants. Management said operating cash flow, cash on hand, and revolving capacity were expected to support liquidity needs.
- The company issued $1.85 billion of senior notes in May 2022 and entered into a $1.0 billion three-year term loan in August. The latter, along with commercial paper, helped fund the $1.5 billion payment connected with the Reclassification. Net cash declined $14.4 million during the nine months to $185.0 million.
Material changes, outlook, and risks
- Canopy impairment and transaction: CBI recorded a $1,060.3 million impairment of its Canopy equity-method investment in the first half of the fiscal year. Canopy’s operating performance, cannabis-market competition, U.S. federal cannabis legality, and Canopy’s own impairments remain material uncertainties. A proposed Canopy transaction could lead CBI to exchange its common shares for non-voting, non-participating Exchangeable Shares, surrender warrants, relinquish governance rights, and account for the investment at fair value; completion and conversion remained conditional.
- Wine portfolio changes: CBI sold certain mainstream and premium wine brands and related inventory in October 2022, receiving $96.7 million and recognizing a $13.8 million gain. Proceeds were used primarily to reduce borrowings. The company also acquired the remaining interest in Austin Cocktails and acquired Lingua Franca.
- Mexico brewery plans: Construction and design work for a new Veracruz brewery was underway. The Mexicali project remained canceled; its remaining net assets met held-for-sale criteria, and CBI was pursuing possible recovery of costs with Mexican officials, with no assurance of recovery. Management stated existing Nava and Obregon capacity was sufficient in the medium term under normal conditions and current forecasts.
- Reclassification: Completed November 10, 2022, it converted Class B shares into Class A shares plus $64.64 cash per share, totaling $1.5 billion. Governance arrangements changed, including the retirement of the former executive chairman and vice chairman from executive roles and continuing Sands family board-nomination rights subject to ownership thresholds.
- Management outlook: CBI expected its FY2023 reported effective tax rate to be 73%–75%, excluding future changes in Canopy fair value and equity-method results. It expected Beer and Wine and Spirits marketing spend each to range from 9%–10% of segment net sales. For the remainder of FY2023, U.S. Wine and Spirits depletions were expected to exceed shipments; full-year shipment volume was expected to be generally aligned with depletion volume.
- Management expected inflation, supply-chain and transportation costs, reduced consumer discretionary income, and other economic and geopolitical impacts to continue into FY2024. It cautioned that pricing and savings initiatives may not fully offset cost increases. Severe weather, water and agricultural inputs, packaging availability, and global supply disruptions could affect operations.
- A trademark lawsuit challenges use of Corona and Modelo marks on certain hard-seltzer and ranch-water products. CBI said it believed the suit was without merit, but warned that an adverse outcome could restrict marketing of the products or result in damages. The filing also describes risks from Canopy’s regulatory and market exposure and potential volatility in Canopy-linked investments.
Most important facts for investors to verify
- Whether beer shipment and depletion growth, pricing, and margins can withstand inflation and higher logistics and input costs.
- Canopy’s transaction and shareholder-approval status, the accounting treatment of any converted investment, and the potential for further impairments or valuation volatility.
- Debt and interest-cost trajectory after the Reclassification, including commercial-paper refinancing, revolving availability, and covenant headroom.
- Progress, spending, and recoveries relating to Veracruz and the canceled Mexicali project.
- Wine and Spirits shipment trends, divestiture effects, premiumization benefits, and the outcome of the trademark litigation.
- Whether reported FY2023 tax-rate and marketing-spend expectations remain achievable; the filing does not provide a clear overall earnings-per-share outlook.