Constellation Brands, Inc. — Form 10-Q Summary
Reporting period: Fiscal second quarter and six months ended August 31, 2020 (quarter ended August 31); comparable periods are the prior-year quarter and six months. Amounts are U.S. dollars unless noted.
Business context and results
Constellation sells premium beer, wine and spirits, and accounts for its significant Canopy Growth investment separately. Its strategy emphasizes premium brands and portfolio reshaping through divestitures. COVID-19 affected on-premise demand and temporarily constrained Mexican brewery production.
- Second quarter: Net sales were $2.260 billion, down 4%. Operating income was $838.7 million, up 17%; net income attributable to Constellation was $512.1 million, versus a $525.2 million loss a year earlier. Diluted EPS was $2.62 for Class A and $2.42 for Class B, versus losses of $2.77 and $2.52, respectively.
- First six months: Net sales were $4.224 billion, down 5%. Operating income was $1.449 billion, up 8%; net income attributable to Constellation was $334.2 million, versus a $770.6 million loss. Diluted EPS was $1.71 for Class A and $1.58 for Class B, versus losses of $4.08 and $3.71, respectively.
- Margins: Consolidated gross margin was 53.8% for the quarter, versus 50.6%; for the six months it was 52.2%, versus 49.9%. SG&A was 17.7% of quarterly net sales, versus 18.7%, and 17.8% for the six months, versus 19.0%.
- Segment trends, quarter: Beer sales were nearly flat at $1.636 billion; Wine and Spirits sales fell 11% to $624.5 million. Beer shipment volume declined 1.6%, while reported U.S. domestic Wine and Spirits depletion volume fell 3.3%. Pricing and product mix partly offset volume and divestiture impacts.
- Cash flow, six months: Operating cash flow was $1.445 billion, compared with $1.419 billion. Investing used $455.3 million and financing used $872.1 million. Cash increased $123.2 million to $204.6 million.
- Debt and liquidity: Total debt was $11.601 billion, down $584 million from fiscal year-end. Short-term borrowings were zero; current maturities of long-term debt were $533.8 million. The company reported $1.988 billion of available revolving capacity and compliance with debt covenants.
- Shareholder returns: Dividends paid in the six months were $287.6 million. The company declared a quarterly dividend of $0.75 per Class A share and $0.68 per Class B and Class 1 share, payable November 20, 2020. No shares were repurchased in the second quarter.
Material changes versus the prior comparable period
- The sharp earnings turnaround primarily reflects substantially lower losses on Canopy-related investments and equity-method results, not simply improvement in beverage operations. Quarterly losses from unconsolidated investments were $80.7 million versus $1.325 billion; six-month losses were $651.9 million versus $2.255 billion. These items include volatile, largely noncash fair-value changes.
- Quarterly operating income rose despite lower sales, helped by lower SG&A and the prior-year period’s Wine and Spirits transformation and held-for-sale impairment charges. The current quarter included a $22 million impairment recovery; the six-month period recorded a net $3 million impairment charge.
- Beer sales were pressured by COVID-related production disruption in Mexico and the Ballast Point sale, partly offset by pricing. Wine and Spirits sales fell amid lower volume, brands being prepared for sale, and the Black Velvet divestiture.
- Interest expense decreased to $100.2 million for the quarter and $200.2 million for the six months, primarily because average borrowings were lower.
Outlook, risks and unusual items
- Management did not provide fiscal 2021 capital expenditure guidance, citing uncertainty about COVID-19, demand, and project timelines. It expected Mexican beer shipments to outpace depletions in the third quarter as distributor inventories were replenished; inventory levels were expected to normalize by quarter-end.
- Wine and Spirits divestiture transactions, including the revised Gallo sale, Nobilo, Paul Masson, and concentrate business transactions, were expected to close by the end of fiscal Q3 2021, subject to FTC clearance and other conditions. The revised Gallo transaction had an approximately $783 million base price and up to $250 million contingent consideration; Nobilo was priced at a $130 million base. Proceeds were expected primarily to reduce debt.
- COVID-19 effects remained uncertain. The company said its facilities were operating, but on-premise demand and prior Mexican production restrictions affected results. It cited sufficient liquidity from operations, cash and the revolver, while acknowledging that market conditions could affect cash generation and capital access.
- West Coast wildfires threatened grape quality and production. Management estimated unfavorable fixed-cost absorption of $25–$35 million in fiscal Q3 and another $10–$15 million in Q4; it then expected no material effect on customer demand.
- Construction at the Mexicali brewery was paused after a negative public consultation. Approximately $720 million of construction in progress was capitalized, with an estimated additional $200 million committed. Management was evaluating alternatives; future impairment is possible for amounts not recoverable.
- Canopy remained a significant valuation and earnings risk. Its equity-method investment had a market-based fair value $367.9 million below carrying value, but management concluded the decline was not other-than-temporary and recorded no impairment. Exercising all remaining Canopy warrants would require approximately $5.9 billion based on their terms.
- Management reported effective disclosure controls and no material effect on internal financial controls from remote work; implementation of a new ERP system will change controls as it rolls out.
Important facts for investors to verify
- How much of reported earnings and EPS reflects core beverage performance versus Canopy fair-value and equity-method volatility.
- Whether the pending divestitures receive regulatory clearance, close on schedule and deliver expected proceeds and contingent consideration.
- Whether beer shipments and distributor inventories recover as anticipated, and how COVID-19 affects on-premise demand and production.
- Whether wildfire impacts and the Mexicali project lead to additional costs or asset impairments.
- Debt repayment progress, liquidity, covenant headroom, and the sustainability of dividends and any future repurchases.