Constellation Brands, Inc. — Form 10-Q Summary
Business context and reporting period: Unaudited results for the fiscal quarter and nine months ended November 30, 2018 (fiscal 2019 Q3), compared with the periods ended November 30, 2017. Constellation sells beer, wine and spirits, with Beer and Wine and Spirits as its principal operating segments.
Key financial results
- Q3 net sales: $1.973 billion, up 9% year over year. Beer sales rose 16%, primarily on Mexican beer volume and pricing; Wine and Spirits sales were essentially flat.
- Q3 profitability: Gross profit was $970.0 million, up 7%; gross margin was 49.2%, down from 50.5%. Operating income increased 14% to $556.5 million. Net income attributable to Constellation fell to $303.1 million from $492.8 million; diluted Class A EPS was $1.56 versus $2.45.
- Nine-month results: Net sales were $6.319 billion, up 9%; operating income was $1.947 billion, up 10%; net income attributable to Constellation was $2.196 billion versus $1.393 billion. Diluted Class A EPS was $11.21 versus $6.92.
- Cash flow: Nine-month operating cash flow was $1.974 billion, versus $1.468 billion. Investing cash outflow was $4.587 billion, mainly reflecting the Canopy transaction; capital expenditures were $620.3 million. Financing provided $2.661 billion. Cash ended at $130.6 million.
- Debt and liquidity: Total debt was $13.570 billion at November 30, up $3.383 billion from February 28. Current assets were $3.639 billion and current liabilities $3.363 billion. Revolving-credit borrowing capacity was $1.257 billion; the company reported compliance with debt covenants.
- Shareholder returns: The company repurchased $504.3 million of stock during the nine months and paid $417.9 million in dividends. A quarterly dividend of $0.74 per Class A share and $0.67 per Class B and Class 1 share was declared in January 2019.
Material changes and drivers
- Beer led operating growth: nine-month Beer net sales rose 12% and segment operating income rose 10%, supported by Mexican beer volume and pricing. Higher transportation and operating costs, along with increased marketing, partly offset the gains.
- Wine and Spirits nine-month net sales increased 2%, but segment operating income declined 2%. Higher input and transportation costs, mix pressure and planned marketing investment weighed on results.
- Q3 net income was reduced by a $163.9 million unrealized loss on Canopy-related investments measured at fair value, compared with a $216.8 million gain in the prior-year quarter. For the nine months, those investments generated a $786.5 million unrealized gain; the period also included a $99.8 million gain on the sale of the Accolade Wine Investment.
- Constellation completed a roughly $3.87 billion Canopy Growth investment in November, bringing its stake to about 36% and moving the common-share investment to equity-method accounting. The company also holds Canopy warrants and convertible debt securities accounted for at fair value, which management expects to be volatile.
Outlook, risks and unusual items
- Management expected fiscal 2019 Wine and Spirits net sales and segment operating income to decline in the low-single-digit range. It expected U.S. shipment trends to align with depletion trends by year-end, with both down in the low-single-digit range for the fiscal year.
- Management forecast a fiscal 2019 effective tax rate of 16%–17% and expected to return to its targeted leverage ratio within 24 months after the Canopy transaction, while continuing business investment.
- Canopy valuation changes, foreign exchange, commodity prices, interest rates, consumer demand, shipment-versus-depletion timing, raw-material and transportation costs, and execution and financing of brewery expansion are identified areas of risk. The filing also notes that commercial-paper access depends on market demand, although the program is backed by the revolving facility.
- The Canopy purchase was financed with senior notes, $1.5 billion of term loans and commercial-paper borrowings. Total debt rose materially, increasing leverage and interest-rate exposure. Management reported adequate liquidity and covenant compliance at quarter-end.
- Accounting adoption produced significant balance-sheet effects: adoption of income-tax guidance increased opening retained earnings and deferred tax assets by $2.2 billion, primarily related to an intra-entity transfer of imported-beer intellectual property. The company said adoption of new lease guidance was not expected to materially affect results or liquidity, but its balance-sheet effect was still being quantified.
Important facts for investors to verify
- How much reported earnings and EPS depend on volatile Canopy fair-value marks, and how Canopy’s equity-method earnings develop after the accounting change.
- Whether Beer volume and pricing gains persist and whether higher operating, transportation and marketing costs continue to pressure margins.
- Whether Wine and Spirits shipment timing reverses as forecast and whether depletion trends meet management’s low-single-digit-down outlook.
- Progress toward the targeted leverage ratio, debt maturities and refinancing needs, and available liquidity after the Canopy investment.
- The realized fiscal 2019 tax rate and the eventual balance-sheet effect of lease-accounting adoption.