Constellation Brands, Inc. (STZ) Earnings Call Transcript & Summary

Good morning, everyone. I'm Nik Modi, RBC's HPC, Beverage, Packaged Food and Tobacco analyst. And I'm joined by Constellation Brands' CFO, Garth Hankinson. Garth took over as Constellation's CFO in January and has helped the company continue their high single-digit beer depletion growth and recently entered the fast-growing hard seltzer category and helped the company manage through the wine divestiture. It's 4 p.m. somewhere, so grab a glass of Kim Crawford or a bottle of Modelo Especial, and let's get going. Garth, thanks for being here and being part of the RBC conference.

Thanks for having us, Nik.

You bet. So let's just get into it. I mean I know a question on a lot of folks' minds as your beer business is growing more than 35%, and your wine business is growing almost 25% in the latest 4-week IRI channels, both accelerating from their 12-week trends. And while you lost most of your on-premise business, it seems that your Q1 depletion should be fairly solid. Can you just help provide any thoughts around that just to give people some framework to use?

Yes. Great question, Nik. So let me start by saying that we continue to perform relatively well given the current environment, and we are winning in those sales channels that are open. That being said, the performance in IRI doesn't quite tell the complete picture. And while we are seeing accelerated trends in these tracked channels, there are a number of headwinds that will temper our Q1 results. So let me take a minute to try to just level set you on our performance, and I'll start with beer. So as you noted, IRI is showing very healthy growth. But it over-indexes to chains in large-format stores, which are disproportionately benefiting from a shift to consumers to shopping where they can reduce their number of trips, right? So those channels are growing faster than the broader market. And while IRI over-indexes to change large-format stores, it under-indexes to independent markets, such as New York City and New Jersey. So it isn't picking up shopping behavior in those markets, which have experienced the greatest amount of economic disruption related to COVID-19. And keep in mind, our brands are overweighted to some of these hardest hit markets. Additionally, there are a number of other channels of retailers. Think of liquor stores and control states that are captured by IRI, and we know that those channels are growing more slowly than the tracked channels. So while off-premise, in total, is experiencing very healthy growth, what you see when you're looking at the headline syndicated data just doesn't tell the whole story. Then moving to the on-premise. Since the start of our first quarter of fiscal '21, the on-premise has almost been completely shut down. And in order to make up for any loss of the on-premise, we need to grow our off-premise business somewhere in that 15% to 20% range just to breakeven. And then finally, in our fiscal Q1, we have one less selling day than we did last year. In March, we had an extra selling day. April was flat on sale days. And in May, we've had 2 less selling days than we did last year. And as a reminder, when we have a loss selling day in a quarter, that typically equates to roughly 100 to 150 basis points worth of growth on a year-over-year basis. So when you take into account actual on-premise performance -- or off-premise performance, the almost complete shutdown of the on-premise and the loss of a sell day in Q1, we're expecting that our Q1 depletion growth for beer will be in the low single to mid-single-digit range. And that's depletions. And while consumer demand trends remain robust, we are having to balance the demand trends with some supply constraints out of Mexico on select SKUs as we pulled back production in Mexico. So due to the reduced production levels, shipment volume to distributors are expected to decline low single to mid-single digits in our Q1. If I turn to wine, the same dynamics hold true for wine and spirits, strong demand in the off-premise, but the on-premise is all but disappeared. As a result, we're seeing excellent consumer takeaway trends in the off-premise for our wine brands, particularly our power brands, which are growing almost 30% in the latest 4-week IRI channels. And that's inclusive of excellent growth for Woodbridge, Meiomi, Kim Crawford and The Prisoner. And while performance of the remainder of our portfolio target for sale to Gallo has improved, those brands still remain in decline. And then additionally, for our wine and spirits business, we've been impacted by the closure of our tasting and retail rooms throughout the quarter, and the international business we have in this segment was impacted earlier in the quarter due to COVID-19 closures globally. And just to kind of round it out, as I'm thinking about Q1 year-over-year, we've also have the loss of Black Velvet brand in Q1 that we sold in our Q3 of last year. So therefore, we expect to see Q1 wine and spirits depletions down low to single -- low single to mid-single digits for Q1, with sales down around 10%, which is an improvement from the Q1 pre-COVID guidance we gave during our last sales and earnings call. So all in all, we're pleased with how the business is performing during these uncertain times, and we think we remain well positioned for continued success throughout our fiscal '21.

Excellent, Garth. Thank you so much for providing some of that clarity because I know a lot of people have been certainly focused in this area. Now I know the situation is fluid, but can you update us on beer production in Mexico? And has there been -- there's been a lot of press that you're running into -- out of stock. You kind of referenced that shortly in your prepared remarks there, but can you just talk about what's exactly happening? And do you expect to see a catch-up there if indeed production starts on June 1 and kind of how that dynamic will work out?

Yes, sure. So I think you used the right term there, fluid. The situation in Mexico certainly remains fluid, but we're managing through it relatively well, considering the circumstances. Our brewery operations in Mexico, as everyone knows, are at reduced levels and continue to be reduced levels. And based on -- but based on the recent clarity we've gotten from the Mexican government, we do expect that we'll be able to ramp the full production relatively soon in the not-too-distant future. We are currently focusing our production on our most popular and fastest-moving SKUs, many of which are larger pack sizes as this is where consumers seem to be gravitating and seem to be preferring during this COVID-19 period. And with the strong consumer demand we're seeing and with the operation reductions, we are expecting that we will see some select SKU shortages during peak summer selling months. That being said, we fully expect to keep brand Modelo and brand Corona in stock, although some of the pack sizes for these brands might be unavailable for a short period of time. So we believe the actions we took ahead of the production slowed down, along with our focus on producing our core high-volume SKUs, will allow us to continue to meet consumer demand and mitigate any significant disruption at retail. And just to be clear on this point, we will have again some select outages. Those outages, we expect to be for a very short period of time. And we expect consumers to be able to find -- when they want Corona and Modelo, we expect that they'll be able to find it, maybe just in a different pack size than what they were initially looking for. And to the second part of your question there, I think you had there was that we do expect that we will have some of these outages in our first and second quarter. Much of that will come back from a shipment perspective, will come back in the second half of Q2 and to Q3 and Q4. Nik, are we still on with you?

Oh, I might want to hit my mute button again. Sorry about that. So several beverage companies have discussed issues with can shortages. Is this an issue for Constellation?

This is not an issue for us. The aluminum can shortages that you referenced appear to be primarily occurring in the U.S. Cans for us are only about 1/3 of our business, and so we skew a little bit less of that versus our competitive set. And we get our cans from Ball's Mexico facility. And we haven't had any issues getting supplied at this point, and we're not expecting to have any going forward either.

Excellent. Okay. So just to be clear, a lot of the can issues that are happening in the U.S. are due to U.S. capacity, not necessarily international capacity. Is that -- do I have that right?

That's what it appears to be to us, Nik. Again, we've reviewed this with our teams, and no indication that there will be any issue getting aluminum cans for us in Mexico.

Excellent. Excellent. Just wanted to touch on Mexicali. Can you provide an update on what the next steps here are? And I think you mentioned $700 million in CapEx has been spent on the initial site. Any idea on like how we should be thinking about what you'll get back? How much you can repurpose for another production facility? Any clarity around that would be helpful.

Sure. Well, look, we continue to work productively with the Mexican government in evaluating our options to produce elsewhere in Mexico as well as next steps in Mexicali. Our discussions with the government are going well, and we remain confident in our ability to build the capacity needed in Mexico to fuel our long-term success. We've had a positive working relationship in Mexico for more than 30 years, and we fully expect this to continue. And we look forward to being able to provide more specifics when... [Technical Difficulty] Nik, we can hear you.

Oh, okay. Sorry. I lost you guys for a second. My apologies.

Yes. Don't worry.

Yes. Go ahead. Yes.

Where did we lose you, Nik. Should I start from the top?

No, no, please. I'm sure the audience heard you guys. So maybe just a concluding thought on just the production facility?

Yes. So just -- yes, just to wrap that up there, just to remind you and the other listeners, right, that as we're -- as we work through the issues in Mexicali, we have ample capacity based on our current growth forecasts and our production capabilities in Nava and Obregon to meet consumer needs over the medium term. So we're positioned well as we work through what's next.

Great. And just -- and again, feel free to share as much as you care to. But I'm just curious, have you guys specked out other land? Like, how does that process work? Like, do you have other parcels that you're looking at? How long does that take? Any thoughts around that?

Yes. So we're really looking at the full range of options right now, Nik. As you suggest, there's -- in no particular order of preference, there's the ability to perhaps add capabilities at our existing breweries in Nava and Obregon. There's also -- thinking of another third site and even seeing what, if anything, could be done at Mexicali. So the full range of options is still available to us, and we're still working through those. And again, we're working very, very collaboratively with the Mexican government as we assess each one of these options, and we hope to be able to share something with you in the not-too-distant future.

Excellent. Okay. Enough of the operations stuff. Let's talk about products. Obviously, you guys launched Corona Hard Seltzer, tough time to launch a new product given we all got hit with COVID. But how is it doing versus your internal expectations? Maybe just talk about household penetration, repeat, distribution targets? Any metrics would be helpful.

Yes, Nik, you're right. It was a tough time to launch the product, but we're really pleased with how the launch has gone so far, especially given the challenging environment. We've continued to support the launch with strong marketing efforts. And as expected, the halo of the Corona brand, along with marketing support, have really driven good trial for the Corona Hard Seltzer. And the great taste profile that it has, has brought customers back for repeat purchases. In addition, the product profile of having 0 carbs and 0 sugars and only 90 calories really resonates with consumers as well. So between the product attributes, the marketing spend and the halo of the Corona brand, we're really, really positive and bullish around what the opportunity for us is to build to one of the strongest hard seltzer brands in the category. To give some of the market metrics behind it, our performance metrics, from a share perspective, it's already garnered around 4% share, making it the #4 hard seltzer brand. Current ACV for the brand is around 60, and that's really right on par with where we expected to be at this point of our fiscal year. So even in this challenging time in the general environment, we've been able to get the shelf placements that we were expecting to get. Velocity is also very strong and is on par with Truly's #3 variety pack or Truly's variety pack, which is #3 in the category. And repeat purchases, as I referenced early, is also very strong and greater than what the benchmark is. And additionally, we're seeing that Corona Hard Seltzer is penetrating the Hispanic market. So very positive there. And then one final data point is that cannibalization or incrementality for Corona Hard Seltzer has exceeded our expectations. We were expecting that incrementality would be more in line with Corona Premier, which was kind of 75% incremental. And what we're seeing in the early days on Corona seltzer is that incrementality is in excess of 90%. So again, very, very strong performance. And so all of that, all up, all in, we're really, really, really bullish about the opportunity around Corona seltzer and how big that can be over time.

Yes. And just on -- that's Corona. But what about the category? I mean how big do you think this category can get? I mean it just seems like every month that goes by, everyone is just so surprised at how much traction it's getting and how much it's sourcing from all different areas of beverage alcohol. So do you guys have any kind of thoughts? Like, are you more bullish on the seltzer category today than you were when you started the idea of Corona seltzer?

Yes. Well, I'd say we were pretty bullish when we entered into the category, and I'd say we're equally, if not more bullish now than we were then. The seltzer category now represents about 6% share of the U.S. beer category. And it continues to have the dynamic growth that really kind of defies gravity almost. Some of the stuff we're seeing inside the categories, the variety packs, represent about 60% of the overall category. That number would probably actually be a little bit higher, if not for out of stocks that everybody, our competitors, have been experiencing as it relates to variety packs. And then we're seeing that hard seltzers continue to be about 45% incremental to the category. And where it's not incremental, volume is being sourced from domestic premium beers, craft beers and other FMBs. And then quite positively, we're seeing that retailers are carrying somewhere in the neighborhood of 7 to 8 brands. So there's clearly room on the shelf for there to be multiple competitors. And so all that being said, I mean, we think that it's a big category that's getting bigger. And again, probably a little bit more bullish on it now than we were at the beginning of our fiscal year.

Excellent. And just moving on to wine. So recent discussions with my contacts on the industry would suggest that the wine deal could be some kind of an early July type of situation. I know it's taken a lot longer because the FTC has been taking its time. I mean is that consistent with how you guys are thinking about it? And how are volumes trends for the divested brands over the past few months impacted some of the economics you have with Gallo in terms of the earnout?

Yes. So -- geez, there's a lot there to unpack, Nik. So let me start with the transaction in general. So you're right, I mean, the transaction, unfortunately, has taken longer than anyone had expected. But the reworked deal that we announced back in December had a lot of complexity to it around other brands that need to be divested or retained by Constellation. So we continue to work very, very collaboratively with both the FTC and with Gallo to bring this transaction to conclusion. I can tell you that both Gallo and Constellation are absolutely committed to seeing this deal through. And I know that it's been asked before. So Gallo, we know is -- has the funding available to close this transaction even in this current environment. So long story short is we continue to work very, very, very actively and in collaboration with both the FTC and Gallo. And we hope they'd be able to provide clarity or more clarity soon. Then as it relates to some of the brands that were -- that fell out of this that we're keeping, we are keeping both Cook's and J. Roget. Those are relatively strong sparkling wine brands in a strong subsegment of the wine category, being sparkling wine. So we're actually happy to be retaining those brands, and we're just working through what the production plan is with the FTC to make sure that they're comfortable, that we can service those brands going forward. And then I think your final question in there was around the brands that we're selling to Gallo and how they're performing and what that could mean for the earnout. And I will say that those brands, the trends certainly have accelerated as consumers migrate brands that they have a history with and that they're familiar with. So a couple of brands that are performing quite better than their most recent trend -- or their most recent trends prior to COVID-19 are brands like Black Box and Arbor Mist and Clos du Bois. Those are all trending very, very positively. And so we think that we'll transition those brands in a very good position or a very good situation as we divest those to Gallo and should give us the ability to get further -- or to get well into the earnout for sure.

Excellent.

Did I answer everything there, Nik?

Yes, absolutely. That was exactly what I was hoping you would discuss. But just maybe one last tag on to that is, obviously, you've been -- the FTC has requested you keep Cook's and J. Roget on your books. What's the strategy for those brands? Like, how are you going to integrate that back into the portfolio? Like, what role do they play?

So I'll say that Cook's is a really strong sparkling wine brand at its price point. And it's not inconsistent necessary with -- if you look at our portfolio, excluding Cook's, where we have exposure to brands across the price stratification. So this will allow us to play at a pretty big subsegment of the sparkling wine category. It's a brand that is really strong, and so we're bullish on that brand's ability to continue to be a value driver for us going forward. J. Roget, on the other hand, is a brand that is really strong in the on-premise. And it's part of a full package of things that we can go to the on-premise with. So it kind of completes the portfolio of things that we can offer to accounts that are looking for a low-price sparkling wine brand that they can pour by the glass. So it's a brand that not only provides profit benefit on its own, but it also provides a portfolio benefit in that, again, it allows us to go to the on-premise accounts with a complete package of products for them.

Excellent. Thank you for that clarification. Capital allocation. That's been a topic that people have always been focused on when it comes to constellation brands. Maybe just kind of recap review the priorities here, how you're thinking about it. Do you think this environment provides opportunity as things have really been kind of disrupted? Any thoughts around that?

Yes. So first of all, our cash generation profile remains strong. We're fortunate to be in a category that has really strong cash flow generation dynamics as well as we have brands with really high margins that accentuate that cash flow generation. So cash flow is really strong for us. As we continue to move through this year, we will prioritize debt reduction, debt reduction and debt deleveraging in the near term. That's consistent, I think, with what we've said previously. We want to make sure that we're driving our leverage ratio down to the lower end of the range versus where we are right now. Our cash flow generation is such that we're able to prioritize this debt reduction and deleveraging remain very, very liquid and be able to maintain our dividend, which we intend to continue to be able to pay out. And so that's where we are, I think, as it relates to capital allocation. As we discussed on our Q4 earnings call, we'll have to get a little bit further through this year and pay down that debt and then reexamine how we return capital to investors through share buybacks. And so those, again, we'll examine that as we go through the year.

Excellent. Well, we're right about time. I know you got to transition to your next set of meetings. So Garth, I just want to thank you for being part of the RBC Consumer and Retail Conference. And thanks for being with us and providing insight. And thanks, everyone, for tuning in. We'll talk to you at the next fireside chat.

Thank you, Nik. Appreciate it.

You bet. Have a good one.