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Constellation Brands

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Constellation Brands

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  1. Fuad Fadel Jim Fish Kevin Kaznica Matthew Krajna Constellation Brands

  2. Business Segments • Wine • Spirits • Crown Joint Venture • Key Risks • Health of the Consumer • Joint Venture uncertainty • Financial condition • Corporate governance • Valuation • Multiple Scenario DCF • Sum of Parts • Market Multiples • Sell Recommendation: $17 Price Target Table of Contents

  3. Business Segments Wine Spirits Crown Joint Venture

  4. Constellation • Lags industry CAGR of 3% • Approx. 90% of sales • Overall depletion trends lag industry • Levered to the United States Wine Segment • Industry • Mature industry • EM drive growth • Value Trend • Franzia Winetaps (The Wine Group) has largest market share of 7.9% • Constellation lacks a Top 5 Wine Brand within the industry, by market share

  5. Wine Growth Wine Sales YoY • Forecast • 2.25% growth • -20% Actual 5 Year Wine Sales CAGR • Decreasing CAGR • Lagging industry CAGR of 3%

  6. Constellation • Approx. 10% of sales • SVEDKA double-digit growth • No EM exposure, small market share • Industry • Global competitors • EM driving growth • Driven by flavored vodkas Spirits

  7. SVEDKA Growth • Geographic Reach • SVEDKA primarily U.S. based • U.S. consumer remains fragile

  8. Constellation • Crown Imports ≈ 40% of EPS FY2011 • 43% of EPS FY2012 • No solid commitment from Modelo beyond 2016 • 3% growth in Net Sales Crown Imports • Industry • Craft/Imports are fastest growing category • Social trend away from “traditional” beers

  9. Key Risks Health of the Consumer Joint Venture Uncertainty Financial Condition Corporate Governance

  10. Dependence on U.S. Economy • Not levered to EM or international markets • U.S Economy seen as “fragile” • Outlook for U.S. Economy • PCE & Off-Premise consumption are flat • Source: Bureau of Economic Analysis • FY2012Weaknesses: • Weak consumer not able to trade up to premium • Constellation took pricing on best wine brands • No pricing power • Decreasing volume trends • Increased Marketing Spend • Crown JV sales grew 3%, yet Equity Earnings decreased 6.3% Health of the Consumer

  11. JV does not renew, Modelo imports own brands JV does not renew, Modelo chooses new importer with more scale JV renews Possible JV Outcomes • Key Dates & Outcomes • Modelo must give notice by 2013 to terminate • The current JV agreement expires in 2016

  12. Cash Flows • $500M sustainable • Balance Sheet Quality • High Debt Level • $2.6B on balance sheet • $6B including purchase obligations and leases • Low Times Interest Earned • Poor quality • 50% of assets • Goodwill/Intangibles • Income Statement • Reliance on Crown JV for 40% EPS • No Dividend Financial Condition Highlights

  13. FY12 Earnings Release • Target leverage ratio of 3.0-4.0x • Results in debt level of $2,000M-$2,650M • $2,600M / $664M = 3.92x projection • New $1,000M share buyback • Funded through NEW debt issuance • Could increase leverage ratio • Market will demand higher interest rate Credit RISK

  14. PrivateCompany Characteristics Dual-Class share structure Over 50% of voting rights 11.81% Equity stake Elect majority of Directors Strong resistance to changes in class structure Strong Academic Support Harvard, Wharton, Stanford Entrenchment decreases performance Value Destruction Share repurchases Corporate Governance Source: GMI • AGR: • Aggressive accounting and governance behavior

  15. Value Destruction • Value destruction at all discount rates • ROIC lags cost of capital

  16. $5B in acquisitionssince February 2001 Acquisitions • $3.3B of which was Goodwill/Intangibles • $1.25B in write downs & impairments since 2001

  17. Additional Risk Factors • Private Company Aspect • Governance Risks • Company-specific risk • e.g. JV termination • Mid-Range WACC • 10.41% • Build-Up WACC • 13.97% Build-up Rate Justification

  18. Valuation Multiple Scenario DCF Market Multiples Sum of Parts

  19. 11 Scenarios • Base • Worst • Best • Possible Crown JV Impacts • Efficiency Gains • 5 & 10 Year Valuations • Sensitivity Analysis • 2 Discount Rates • 3 EV/EBITDA Terminal Values DCF Scenarios JV does not renew, Modelo imports own brands JV does not renew, Modelo chooses new importer with more scale JV renews Price Target: $17

  20. Constellation BrandsCanisius College “Base Case” • Net Sales $2,654M $2,661M • EBIT $769M $782M • EPS $2.34 (tax benefits) $1.89 • Tax Rate 17% 35% • Growth -1.0% growth 2.25% growth FY 2013 • EPS $1.89-2.03 $2.09, 10% growth • FCFE $425-475M forecast $440M estimate • Tax Rate 34% 35% FY 2012 Earnings Release

  21. P/CF valuation price target of $16 • P/E valuation price target of $22 • P/E multiple: 10.5 • Projected FY2013 EPS: $2.09 • Measures Constellation value as a whole • Does not discount additional risks Market Multiples Median: 9.38 Average: 11.13 Historical Avg. PE (Restated): 10.5

  22. Valuation • Wine • SVEDKA • Crown JV • 3 Scenarios • Sensitivity Analysis • 2 Discount Rates • Appropriate Scenario • Conservative • Simple Average Sum of Parts Price Target: $17

  23. Price Target Average of all 11 scenarios WACC 10.49%, 13.97% Average sum of the parts valuation $17 $17.10 P/CF $15.60 Price on 4/5/2012: $21.61 SELL TARGET: $17 21.3% downside P/E approach $22

  24. Key Risks • Low growth/mature wine industry • Weakness of U.S. consumer • Corporate governance weakness • Value Destruction • Share buybacks • Crown JV uncertainty • Weak financial condition • Market is inadequately pricing in risks of STZ • SELL Recommendation: Price target of $17 Investment Summary

  25. qUESTIONS?

  26. Appendix • Earnings Release (25) • Price Matrix (26) • Crown JV graph (27) • SG&A / 10yr scenarios (28) • Hispanic graph (29) • Modeled Growth (30) • Margins (31-32) • Diageo (33) • WACC (34-35) • Sum of Parts (36-39)

  27. Price Targets

  28. Crown JV

  29. potential catalysts • Margin Expansion • Through Reduction in SG&A (Project Fusion) • From 20.5% of Sales to 15% over 5 years • We feel this type of efficiency is excessive • Need for increased promo and ad spend • Due to value proposition • Crown JV Continuing for another 10 years • We feel this is unlikely • Modeled 8% Crown Equity Earnings growth • BEST Case Scenario: • 5% Wine growth • 20% Svedka growth • 10% Crown JV growth • Price Target $21, SELL

  30. Opportunity to Grow Crown Earnings • Hispanic population growth is also highly focused in a few key geographic markets • Strategic opportunity for Crown Imports • Increase market share through increased distribution efforts • Key states include California, Texas, Florida, New York, and Illinois.

  31. EPS Growth modeled at 10% • EBIT growth aggressively modeled at 5% • Bucking 5 year negative growth trend REVENUE & EPS Growth Rates

  32. Gross Margin 40.1%, up 420bp YoY Operating Margin 20.3%, up 430bp YoY Upward biased changes due to divestiture of lower margin European and Australian wine business Fy12 Margins

  33. Margins

  34. Diageo: • U.S. Spirits business driven by flavored Vodkas • “[The U.S.] is showing very good signs of improvement. It’s not a snapback…Now the U.S. is not going to offer us the same growth that Brazil can.” • Key takeaway: U.S. does not offer the growth that Emerging Markets offer • Constellation Brands LACKS EM exposure • Thus stuck with 90% of sales from a mature U.S. market • Source: WSJ, March 26, 2012 Competition: Diage0

  35. WACC

  36. WACC

  37. Sum of Parts • Target Price of $17 with Conservative Scenario, using build-up and mid-level discount rates

  38. Sum of Parts • Wine value comes from “Best Case” scenario • PV of wine sales only • SVEDKA purchase price $384 million, adjusted for inflation, and multiplied by 4x to represent case vol growth • Crown valued as the PV of forecasted equity payments

  39. Sum of Parts • Crown value based on PV of future equity earnings • Includes options that will be exercised • Based on build-up method, discount rate of 13.97%

  40. Sum of Parts • Crown value based on PV of future equity earnings • Includes options that will be exercised • Based on build-up method, discount rate of 13.97% • Conclusion: Using both the build-up and mid-level discount rates, an average target price of $17 can be obtained, AFFIRMING SELL RECOMMENDATION

  41. Additional risk Build-up premiums (1-2% per item)

  42. PV of Growth Opportunities • PVGO: The present value of growth opportunities is a tool to extract the market’s expectations on future growth potential for Constellation. • Using the CAPM we determined a cost of equity of 10.41% for Constellation. • PVGO for Constellation under current market conditions is 16.97%. • Peer median of 46.52% • Market does not feel that Constellation has much growth potential. • Given that Constellation has lagged the wine industry growth rate of 3%, the PVGO is justified, especially compared to its peers. Key assumptions: EPS: 1.79 TTM restated Price: 423.62 on 1/12/12

  43. Imported wines ≈ 1/3 U.S. wine sales • USD appreciating against the Euro and Aussie Dollar • Floods market with competitively-priced alternatives • This is a negative for Constellation, as the U.S. consumer is still trending towards value brands Wine Import Data

  44. EPS

  45. STZ • Vincor, Robert Mondavi, Ravenswood, Arbor Mist, and Ruffino • Approximately 90% of sales • Lags the industry growth rate • Sold only 12.7% of the wine cases during 2010 • Negative EPS between 2008-2010 • Negative organic growth in 2011 • Extremely low exposure to emerging markets, leading to lack of revenue growth • Industry: • Smallest segment in the alcoholic beverage industry compared to beer and spirits • 3% CAGR on average • Mature and slow growth industry • Large conglomerates, such as STZ • Competitors are E & J Gallo, The Wine Group, Vina Concha y Toro, and Treasury Wine Estates • 4-6% CAGR prior to the recession • On-premise v. off-premise sales • Larger growth in off-premise sales than on-premise (use graph showing this off Bloomberg) • Value v. Premium Wine Sales • Trend towards value brands continues • Remains to be seen if producers can successfully persuade consumers to abandon value brands for premium • Franzia Winetaps (The Wine Group), a value wine, has the largest market share of 7.9% • High growth seen in developing markets, but mainly China where CAGRs are in the mid-teens Wine

  46. California’s 2011 wine grape crush, from all varieties, totaled 3,342,689 tons, down 7 percent from 2010 varieties accounted for the largest share of all grapes crushed, at 1,917,132 tons, down 7 percent from 2010. The 2011 white wine varieties crush totaled 1,425,557 tons, down 7 percent from 2010. On the price side, record highs were set for both red and white wine grapes average price for the 2011 crop of red wine grapes was $702.70, up 12 percent from 2010, while the average price for white wine grapes came in at $541.11, up 8 percent from last year. The 2011 average price of all varieties reached a record high of $588.96, up 8 percent from 2010 and 3 percent above the previous record high set in 2009. Wine Crush Data

  47. On/Off Premise

  48. STZ • SVEDKA, Black Velvet, & Paul Mason Brandy • Since acquisition, Svedka is quadrupled in case sizes • Approximately 10% of sales • Miniscule market share with many global competitors • Lacks brand recognition that competitors have • Growing at double-digit rate • Driven mainly by SVEDKA • Industry: • 2nd largest market segment of alcoholic beverage industry • Led by vodka and whiskey • Smirnoff, Absolut, Grey Goose, & Skyy • Diageo, Brown-Foreman, & Beam Global & Spirits • Diageo controls the spirits market • Shift towards spirits over wine and beer Spirits

  49. STZ • Crown Imports • Corona, Corona Extra, Corona Light, Modelo Especial, Negra Modelo, St. Pauli Girl, Tsingtao, & Victoria • JV 43.6% of EPS in 2011 • Equity Earnings • No solid commitment from partners beyond 2016 • JV between 2008-2010 was the only positive earnings segment for STZ • Without which, it would not have been able to cover interest payments • Not a beer company • Industry: • Largest market share compared to wine and spirits • Dominated by major companies • Anheuser-Busch InBev, Miller Coors, Crown Imports, • Growing trend towards Imports and Craft Brews in the US • Double digit growth rate compared to stagnant growth for whole industry • 16.4% volume growth compared to -2%; Dollar growth, craft up 17.5% compared to .3% for the industry • Attempt by companies to innovate with new products, such as Bud Light Platinum recently • Strategy: Fast-growing acquisitions by major companies • Ex: SAB Miller’s acquisition of Foster’s • Ex: Major companies acquiring craft breweries Beer