Constellation Brands, Inc. — Form 10-Q Summary
Reporting period: Quarter and six months ended August 31, 2018 (fiscal 2019). Dollar amounts are U.S. dollars unless noted. The filing was signed October 4, 2018.
Business context
Constellation sells high-end imported and craft beer, wine, and spirits. It reports Beer, Wine and Spirits, and Corporate Operations and Other segments. Management’s strategy emphasizes premium brands, organic growth, production expansion, and targeted acquisitions.
Financial performance
| Metric | Three months ended Aug. 31, 2018 | Three months ended Aug. 31, 2017 | Six months ended Aug. 31, 2018 | Six months ended Aug. 31, 2017 |
|---|---|---|---|---|
| Net sales | $2,299.1 million | $2,087.9 million | $4,346.2 million | $4,016.4 million |
| Gross profit | $1,168.2 million | $1,068.7 million | $2,216.8 million | $2,057.0 million |
| Operating income | $765.0 million | $717.3 million | $1,390.4 million | $1,278.4 million |
| Net income attributable to CBI | $1,149.5 million | $501.6 million | $1,893.3 million | $900.1 million |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $1,338.5 million | $1,102.9 million |
- Quarterly net sales rose 10% and operating income rose 7%. Six-month net sales increased 8% and operating income increased 9%.
- Gross margin was 50.8% for the quarter versus 51.2% a year earlier, and 51.0% for the six months versus 51.2%. Wine and Spirits faced higher grape, bulk-wine, vodka, and transportation costs; beer pricing and volume helped offset pressure.
- Beer six-month sales grew 11%, with segment operating income up 8%, supported by Mexican beer volume and pricing. Wine and Spirits sales increased 3%, but segment operating income fell 5%.
- Reported net income included a $692.1 million quarterly and $950.4 million six-month unrealized gain on Canopy Growth-related securities. Six-month results also included a $99.8 million gain on the sale of the Accolade Wine Investment. These non-operating items substantially explain the rise in reported net income.
- Cash and cash equivalents were $206.1 million at August 31, 2018. Current assets were $3,585.5 million and current liabilities $2,162.5 million.
- Total debt was approximately $9.9 billion, down $263.1 million from February 28, including a $248.4 million noncash conversion of debt to noncontrolling equity. Long-term debt, including current maturities, was $9,206.5 million; short-term borrowings were $717.1 million.
- Six-month capital expenditures were $370.6 million, versus $505.1 million a year earlier. Financing cash outflow was $832.9 million, including $504.3 million of share repurchases and $279.1 million of dividends.
Material changes and notable items
- Quarterly beer shipment volume increased 8.7%; beer depletions increased 10.1%. Wine and Spirits shipments rose 8.8%, while U.S. domestic depletions were nearly flat.
- Management said Wine and Spirits shipments were accelerated ahead of anticipated third-quarter logistics and transportation constraints, and expected most of that timing benefit to reverse in the third quarter.
- In July, the company acquired Texas craft brewer Four Corners. Subsequent to quarter-end, it acquired an Italian wine business, primarily to add production and sourcing capacity.
- Accounting adoption effects included a $2.2 billion increase in opening retained earnings and deferred tax assets from the new intra-entity tax-transfer guidance. Revenue-recognition guidance had no material effect on sales recognition overall, but changed the timing of sales-incentive recognition and reduced opening retained earnings by $49.0 million, net of tax, at March 1, 2016.
Outlook, financing, and risks
- The filing provides no specific full-year earnings or sales guidance. Management reiterated its long-term aims of sales growth, margin expansion, increased cash flow, EPS growth, targeted leverage, and quarterly dividends.
- In August, Constellation agreed to invest approximately C$5.1 billion (about $4 billion) in additional Canopy shares and warrants. It expected to own approximately 37% of Canopy after closing and anticipated completion around October 31, 2018, subject to regulatory and other conditions.
- September financing arrangements included $1.5 billion of delayed-draw term loans and a C$3.143 billion (about $2.4 billion) bridge facility. The company said it did not expect to draw the bridge facility, anticipating other debt issuance, commercial paper, and available cash for remaining funding.
- Management expects to limit share repurchases and certain acquisitions after the Canopy transaction until it returns to its targeted leverage ratio, which it targets within 24 months of closing. It stated that cash flows and financing activities should provide adequate liquidity, subject to market conditions.
- Key risks include transaction approval or completion failure; substantially higher leverage and financing costs; Canopy’s volatile valuation and uncertain market prospects; cannabis legality and regulatory developments; and the company’s reliance on Canopy’s controls despite not controlling its operations. A failure to make required legal-compliance certifications could also affect financing arrangements.
- Other pressures include higher transportation and raw-material costs, planned marketing and growth investments, foreign-exchange and commodity exposure, and possible adjustments to provisional tax accounting. Management noted that Canopy investment fair values may be volatile.
Investor verification priorities
- Separate operating performance from the large, unrealized Canopy valuation gain and the Accolade disposal gain when assessing earnings quality.
- Check whether the Canopy transaction closed on expected terms, its final financing mix, and the resulting leverage and path back to targeted leverage.
- Track Wine and Spirits depletions against shipments, the expected reversal of shipment pull-forward, and ongoing logistics constraints.
- Monitor beer expansion spending, transportation and input costs, and whether volume and pricing continue to offset margin pressure.
- Review Canopy fair-value assumptions and regulatory developments, and confirm future tax adjustments and liquidity/covenant capacity.