CONSTELLATION BRANDS, INC. quarterly report, Q2 FY2020

Business context and reporting period

Constellation Brands, Inc. is an international beverage alcohol company focused on higher-end beer, wine and spirits, with a significant investment in Canopy Growth. This Form 10-Q covers the quarter and six months ended August 31, 2019 (fiscal 2020 Q2); comparisons are with the corresponding 2018 periods. Unless noted, amounts are in U.S. dollars.

Financial performance and condition

• Cash flow: Six-month operating cash flow was $1.419 billion, compared with $1.339 billion; capital expenditures were $355.2 million. Investing used $425.7 million and financing used $1.005 billion. Cash ended the period at $81.3 million.
• Liquidity: Current assets were $3.538 billion and current liabilities $2.196 billion. Available revolving-credit capacity was $1.837 billion at August 31, 2019.
• Debt: Total debt outstanding was $12.947 billion, down $669.7 million from February 28, 2019. The company reported covenant compliance. It issued $800 million of 3.15% senior notes due 2029 and repaid $400 million of 2014 notes; a $491.3 million term loan was also established.
• Dividends and repurchases: Six-month dividends paid were $285 million and share repurchases were $50 million. The board declared a quarterly Class A dividend of $0.75 per share, payable November 22, 2019.

Material changes versus the prior comparable period

• Beer was the principal operating growth driver. Q2 Beer sales rose 7%, with shipment volume up 5.3% and depletions up 6.2%; six-month segment operating income increased 10% to $1.266 billion. Growth reflected Mexican beer volume and pricing, partly offset by higher costs and weaker craft beer.
• Wine and Spirits weakened: six-month sales declined 8% to $1.323 billion and segment operating income fell 13% to $321.2 million. Management cited lower branded volume, adverse mix and higher costs, as well as distributor transition activity ahead of planned sales.
• Reported results were sharply affected by Canopy-related investment and equity-method losses. Six-month income from unconsolidated investments was a loss of $2.255 billion, versus income of $1.053 billion a year earlier. This included a $1.667 billion net unrealized fair-value loss and $590.4 million of Canopy equity-method losses and related activity. The period also included a $1.176 billion unrealized gain from modifying Canopy warrants, which partly offset losses.
• Interest expense rose 29% to $226.2 million for six months, primarily reflecting higher average borrowings associated with the November 2018 Canopy transaction.

Outlook, management commentary, risks and unusual items

• The company agreed to sell about 30 lower-growth wine and spirits brands and related assets for approximately $1.7 billion, subject to closing conditions and regulatory approval, with closing expected by the end of fiscal 2020. Management expects proceeds to be used primarily to reduce borrowings. It now expects approximately $300 million of additional asset write-down loss in the quarter ending November 30, 2019, as part of the consideration may be contingent on future brand performance.
• The Black Velvet Canadian Whisky sale was agreed for approximately $266 million, subject to adjustments and closing conditions, with closing expected in calendar Q4 2019. The company expects a gain of approximately $70 million to $80 million and plans to use proceeds primarily to reduce borrowings.
• Management expects the fiscal 2020 reported effective tax rate to be 95%–97%, reflecting Canopy-related losses and tax effects and assumptions about the planned sales. This estimate excludes future Canopy fair-value changes and certain transaction gains or losses. Separately, foreign tax reform enacted in September 2019 is expected to produce a one-time deferred-tax-asset benefit of approximately $500 million–$550 million in the quarter ending November 30, 2019.
• Management expects the remainder of the fiscal-year shipment timing benefit from beer shipments pulled forward ahead of proposed Mexico tariffs to reverse during the rest of fiscal 2020. The filing does not provide a clear full-year sales or EPS forecast.
• Key risks include volatility in Canopy share prices and valuation assumptions, Canopy operating losses, execution and regulatory approval of the divestitures, contingent sale consideration, leverage and refinancing needs, commodity and foreign-exchange exposure, and changes in consumer demand and shipment timing. Management states liquidity is adequate for anticipated needs and expects operating and financing cash flows to support obligations and investment plans.
• Unusual items included $106.4 million of Wine and Spirits optimization charges for six months, an $11 million Ballast Point trademark impairment, and a $27 million impairment of assets held for sale. A wastewater enforcement action against a subsidiary of a consolidated joint venture resulted in an approximately $110,000 penalty; remediation costs were not expected to be material.

Important facts for investors to verify

• Whether the wine and spirits and Black Velvet transactions close on schedule, their final consideration, and the expected use of proceeds to reduce debt.
• The timing and amount of the expected additional $300 million divestiture-related write-down and the $500 million–$550 million deferred-tax benefit.
• Canopy’s subsequent operating performance and the sensitivity of the company’s reported earnings and asset values to Canopy valuation changes.
• Whether Beer growth persists as shipment timing reverses, and whether Wine and Spirits volume and margins stabilize after distributor transitions.
• Debt reduction, liquidity and covenant headroom, including the effect of planned transactions and ongoing capital expenditures.