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

They're still ongoing in their development. But -- as you point out, there's a port that's very close to the Veracruz facility that would feed right up to the East Coast. It probably will mean different mode of transportation, which will be different for us. We've mainly used rail out of our other 2 facilities. But we're still getting our feet wet, if you will, no pun intended, about how we will take product out of that port. What we probably will do, given it will be a little bit more logistically [ challenging ] to what we've had is we do very efficient SKUs in that plant. Large long run SKUs to be much more conducive to that mode of logistics and shipping them to have a wide array of products, even though it's very efficient. A wider array of products that we have at the other 2 facilities.

All right. And then maybe a final question here on the beer portion of the business. There was one resounding question I've had year-to-date, time and time again, probably for many people in the room, which is what is going on with U.S. alcohol consumption? So U.S. beer, in particular, I mean, has been especially weak over the last 18 months. It's been an exceptional time. So what do you believe, let's just stick first with the overall industry or the fundamental factors driving the sweetness?

I think there are a lot of factors involved. First of all, we don't see too much of that with our brands. I think the consumer is a bit more brand-specific, and brand loyalty is as important as it's ever been. And fortunately, we have a lot of brand loyalty within our brands, so that's very positive. I do think there's some evolution of what some consumers are looking for. Some consumers, they're looking for things like more flavor for Betterment. It's a great example of why Corona nonalcohol is helpful in its inception year. But I think we need to be careful and not look at too small and discrete periods of time. It's been a little [ squirly ] this year with the weather at times, and there's direct correlation with our beer business and how is the weather? Is it cold, rainy or is it nice, hot and sunny? So you can see some of those characteristics. I wouldn't be overly concerned about long-term trends at this point in time. But as Garth pointed out earlier, it's certainly something we're keeping our eye on.

So if I just push that a little bit further. If we look back at history, U.S. beer has historically been a plus or minus 1 volume. From your answer, it sounds like you think we will revert back to that on a medium to long-term basis, and you're not overly concerned about structural factors. Would that be a fair way to put it?

Yes, I'm not overly concerned about structural factors. I mean, we've spent most of our time worrying about ourselves rather than the broader category. Although, obviously, it's in everybody's interest if the broader category is helping. As you've seen, we tend to do very well, and we continue to take share. We took 2 share points last year of the category. It was the biggest we've ever done in our history, and we're compounding that this year with 1.2 to 1.4 period after period. If the category was a little healthier, those numbers would be a little bigger, and that would be nice. But I think some of the things that we need to do as a category, we're doing the nonalcoholic, higher flavor, the Sunbrew as the example, making sure your brands have authenticity. All of those things are, at least, as important as they've ever been.

So anything that ties back to brand health?

Yes, I think that's really important.

Now if I play devil's advocate, which is probably what many people in the room are thinking, brand health is fantastic, but there are 3 sort of factors I have been hearing over the last 6 to 9 months. This GOP one, I saw an ad for it in my cab here on the way to the airport, the rise of legal cannabis and also the potential for younger consumers to be drinking less. Now I fully appreciate your view here that brand health is paramount, and that's the first and most important thing to focus on. But how do you consider these potential long-term headwinds to the industry?

Well, let's take the GOP diet scenario first. And we said this at Investor Day, Garth, if you remember, we have seen almost no evidence that, that has any impact on our business. And we've listened to millions of conversations with consumers, and it literally comes up about 2% of the time. It's just not a factor. Similarly, when you think about cannabis, we've studied many of the markets where cannabis has been legal for a longer period of time and have seen, again, very little to no impact across it. My guess is you've seen some people that have actually consumed more who are cannabis users, meaning more alcohol beverages, and then you've seen probably some who have done less. It washes out. So that has been a relatively unimportant factor. And we've been fortunate that we continue to bring legal drinking age, newer consumers into our marketplace. Again, we're somewhat [ debited ] by that because of our heavy SKU to Hispanic consumers. The Hispanic consumer and the Hispanic culture tends to be more beer-oriented, and we are way overdeveloped with that particular marketplace. So some of those factors just don't seem to be big issues as far as it relates to us.

Just since you mentioned the cannabis, I think because it was 1.5 years in the making, it's worth noting that in Q1, we did move from common shares to exchangeable shares in Canopy Growth. I think that's important for the audience because that now means that beyond Q1, you will not see any impact from Canopy Growth in our EIE numbers. So as we move forward, reported [indiscernible] results will be more in line with the [indiscernible]. Importantly, while we moved to exchangeable shares, and this won't be a factor from us from a reporting perspective anymore, we still do have exposure to what is an interesting and dynamic category that's unfolding here, and we'll have to see what happens from a regulatory environment for certain. But -- so not only do -- not only do we benefit from being an exchangeable shares, but Canopy does as well, because it allows them to be maybe a little bit more aggressive in how they attack the all-important U.S. market.

Got it. And then just coming on to that legal drinking age consumer point you mentioned, about how that is still a very dynamic consumer for you, is what you're saying that the rate at which 21-year-olds today are drinking more product is the same, at or greater as what they were drinking than previously? Or is it that...

Yes, our [ bottle ] rates have been very strong with that consumer.

So let's move on to Wine and Spirits. So last time you were here on the stage, I asked you if you would consider divesting your wine business. And your response was very honest, and I quote, "There are no sacred cows in our business. There might have been at one point, but there are no longer." And so here, 1 year on, what is your view on the role of the wine business in your portfolio today?

Well, certainly, Nadine, we expect all of our businesses to perform. And frankly, we've had some challenges with our wine business. So we have put a fair amount of work into it. What I would say is the business is very different. We -- from -- if you think about what it was, say, 5 years ago, we've got 1/10 of the amount of mainstream brands that we had 5 years ago. So we've pretty radically addressed what our portfolio looks like, moving a disproportionate amount of our business to the higher end, where there's better growth, better margins and certainly a more strategic play. With that said, we still have a fair amount of presence in the mainstream segment because of Woodbridge and SVEDKA in particular. So that -- I would say, my comment from a year ago hasn't changed any. But what I would say is look at our track record. This company has historically always challenged itself to make sure that we are doing what is in the best interest of our shareholders, and we're going to continue to do that.

So still no [indiscernible] I'll ask again next year.

Okay.

Now let's stick to wine here. I think everybody appreciates the efforts to turn around brands, investing in brand building for the core brands in the business. But this is all against a wine business that is, for the industry as a whole, a very challenging time. So if we cast our minds beyond just this year, which you provided guidance for, and we look out over the next couple of years, how do you see the potential for that business sort of a normalized run rate, if you will, considering the challenges the industry faces today?

Well, as you've seen, and we said at Investor Day, we believe that, that category can be sort of a low single-digit growth category, driven by the higher end of the business, not by the lower end of the business, which has been very challenged, as you point out. Here's what I'd say. We went in -- and as you know, we had a change of management in January. We went in and looked very carefully at everything we were doing. And there were a few things that we felt were critically important. One is we had peanut buttered our spend a bit too broadly. We've got 10 or 11 brands that really matter, including the 2 at the low end of the mainstream segment, which we needed to shore up. So that's one. So we focus much more attention on the brands that matter. Secondly, some of that business is tactical. We had probably gotten away from some of the key tactical work that needed to be done. So we put more focus on tactical work with some of our brands, particularly those that play in the lower price points. Third, we think the cost structure had gotten a bit out of whack. And a bit of what we've done this year is put some very aggressive cost approaches in that business. For instance, Garth mentioned earlier about the procurement and logistics capabilities that we brought into our beer business. The gentleman that has overseen that is now working with our Wine and Spirits business as well, and we think that's going to provide some strength on the cost side of that business. We continue, though, to think about it on a consumer basis. Consumers, 9 out of 10 alcohol beverage consumers, drink beer, wine and spirits. And those who do spend 6x as much as somebody that just drinks one category. So by playing in all those categories, it allows us to reach more consumers and more consumer occasions. And we think that's important over the longer run. Anything you want to add?

Yes, maybe to [ practice piling ]on a little bit. I mean, so obviously, the guidance provided for FY '25 is not in line with what we laid out at Investor Day. That being said, we are still committed to the longer -- to the midterm algorithm that we did lay out at Investor Day, meaning we do believe we can achieve 1% to 3% top line growth and 25% to 26% operating margins over the medium term. The deep dive that Bill and I have been performing with the team really has given us greater conviction that the strategy that we have in place is still the right strategy. Continuing to lean into the premiumization trends that have been ongoing for a long period of time and show every sign that they will continue, that's the right strategy. Diversifying our business away a little bit from the U.S. wholesale into DTC and to the international -- select international markets is the right approach. And so we think we'll see improvement. Again, the guidance for this year is not where we would have I liked it to have been. That being said, we are expecting to see sequential improvement as we move through the year. Similar to our beer business, not every quarter is going to look the same. We would expect to see improvements in both the top and bottom line sequentially as we move through a number of the initiatives that we reviewed with the team and have been put in place. We'll start to show dividends, if you will, through most of the year and keep that business a little bit different than our beer business, which, in beer, we do about 55% in the first half and 45% in the second half versus Wine and Spirits. So we do expect to see, as we move through the year, that, that business will improve.

Okay. And then in terms of CapEx, longer term, how should we be thinking about CapEx for that wine business, in particular, especially when we place that in context of overall Constellation?

Well, let me just start with overall Constellation and then we can go specifically. I don't want to spare us, but overall constellation, we've been investing a lot in CapEx, mostly in our beer business. And this is actually going to be our high watermark for CapEx as an enterprise. This year, we're going to spend about 13%, 13.5% of net sales on CapEx. Again, the vast majority of that in Mexico. And we see over this medium-term period that coming down in our fiscal 2028 to be in the 4% to 6% range. So that's a real inflection for us as [ advised ]. There hasn't been as much variability in Wine and Spirits as there has been in beer. That being said, we're a little bit of a high watermark right now in Wine and Spirits as well. Now a lot of that, I would tell you, is sort of catch-up CapEx because we probably underinvested in the last 5 to 7 years, and so we've had to spend a couple of years [ over ], I think. But the target rate for CapEx for that business, on a more normalized basis, is right in that 4% to 5% of net sales range.

Perfect. And then finally, just a question on spirits, in particular, to round out our conversation for this segment. So the spirits category, as a whole, in the U.S. has been the biggest share, sort of, gainer over the last 15 years. Is Constellation interested in growing its presence more meaningfully in spirits? I know you've spoken about your string of pearls approach to M&A. Is that an area of focus for you?

Yes. But the reality is there's probably limited amounts of what we can do. We bought High West. That has performed extremely well and outperformed its acquisition case. We built Mi Campo from scratch, and that has done extraordinarily well for us. We also have, in our venture arm, a couple of investments in the spirit arena. I don't know that we're going to substantially change the profile and the size of that section of the business. But I'll give you an example. We've done ready-to-serves now that are doing extraordinarily well from High West, which puts us in a different sort of piece of the business and a piece of the spirits business that's performing very well, utilizing the brand that we already own, High West. So would we like to continue to see that be an important part? Yes. I don't think you're going to see it be substantially different than where it is today.

I mean the only thing I would add to that is, to the extent that there is something that we want to take a look at, we'll use this team's, sort of, rigorous strategic assessments that we always do. We'll apply the same rigorous financial discipline. There's a whole sort of list of criteria that has to be met in order for us to consider an M&A transaction, whether that's in the spirits or the wine space, for that matter, even in the beer space. Some of those are the fact that they have to be accretive to both our top and bottom line, they have to have the ability to scale. And importantly, they have to be accretive to our enterprise-wide ROIC. So we'll apply that same discipline, regardless of the opportunity.

Now with the time we have left, I'd like to shift back to the overall strategic focus of Constellation as a whole. So capital allocation is something that's got a lot of air time when it comes to you guys. Could you just remind us what are the priorities today? And I'm going to preempt the question that will come from the audience, probably, which is, many investors ask, when we can expect very fruitful share buybacks again?

Well, I'll let Garth give the big answer to that. But I think you should keep in mind, we said we were going to do $5 billion of returns between dividends and share buybacks, and we far exceeded it. In fact, Joe Suarez, who's sitting here often, says it's the one place where we've gone beyond what we said we were going to do on a capital basis is on that. You should also keep in mind, we have almost $2.5 billion authorized by our Board for share buybacks that's still existing. So share buybacks and returning dollars to shareholders has been a critical part of the overall capital allocation approach that Garth and I have been doing for the last several years. And I think our capital allocation hasn't changed in years.

Yes. I mean, look, I think that's an important point for the last 5 years. We've been very consistent with what our capital allocation priorities are, and we've done what we said we were going to do. As a reminder, our capital allocation priorities are, first, to maintain our investment-grade rating. This is something that when Bill and I took over, Bill took over a little bit before me, but the leverage ratio was about 4.5x. We got that down to near 3x, 3.1x before the share collapse transaction, and that took it back up to 3.5x. We ended fiscal 2024 at 3.2x, and we expect to be back at 3x in this fiscal year. Second priority is to maintain our 30% payout, dividend payout. Clearly, that's important for our shareholders. We think it's an important element of our capital allocation strategy. Third is we're going to continue to invest in the growth of our business, most notably production expansion, capacity expansion in Mexico. Fourth is we'll continue to provide our return capital to shareholders for share repurchases. As Bill said, we significantly overdelivered on our commitment over a couple of years ago, and we've continued to be opportunistic when we've seen dislocations in the marketplace. And then fifth and finally, we'll do some select bolt-on M&A transactions, again, using that rigorous financial discipline that we outlined a little bit a few minutes ago.

And something else that we've seen a lot of change when it comes to completion is corporate governance. I know we've spoken about this a number of times. There have been a number of changes over the last couple of months and years. I think it would be helpful maybe for those in the audience to hear some practical ways that that's changed the day-to-day of the business. And maybe some examples of how the corporate governance changes have led to some actually more tangible changes that we could imagine. Is there anything else that you could add on corporate governance?

Well, I think we've done a lot of things. Obviously, Garth mentioned the collapse of the B shares, so that we're now single-class shares. I think a lot of investors were anxious to see that happen. And while it was an expensive transaction, it certainly is one that I think everybody is pleased it exists today. Second, we've added multiple directors to our Board with stronger financial acumen, which we thought is an important thing that we need to do. And we've just had a new chair of the Board this past, what, like 2 months ago, 3 months ago at this point, who we're very pleased with. Strong outside perspective, strong consumer perspective, I think that's been a real positive addition to what we're doing as well. We operate much more consistently now, as you would expect, a normal publicly traded company to be. And I think a lot of our investors were looking for that sort of [indiscernible] approach.

And one of the most frequently asked questions I get on Constellation, it's the level of concentration in your portfolio. Now obviously, given that your core beer brands were growing so strongly, that concentration is a very good thing at the moment. That will translate both at the group level as well. But obviously, some people will push back on this concentration geographically especially. So to those investors who are in the audience today or listening and who have those concerns at the back of their minds, what would you tell them?

I'd say, if I was -- wanted to be invested in one market in the world, the highest profit market in the world is in the United States. So if you wanted to be in a position where you're overskewed to a particular place, this is by far is best place to be overskewed. I would also say, you often see more risk in international markets than you do in the United States on an ongoing and long-term basis. I mean you've seen many competitors have pros and cons that go on as markets around the world changes or governments around the world change, lots of things can be variable. So while certainly, there's a concentration in this market, and that's a statement, I can't think of a better place to be overinvested than in the United States.

And I'll ask you the same question, but at a concentration level in terms of category exposure, what would you say to that investor?

Well, I think beer business is a huge business, and it represents 85-plus percent of our total profit today. So it is a category that has -- it is huge. There's still tremendous opportunity for us to take share as well as grow in usage occasions and consumer occasions, which is what we're doing with many of the things that we've added into our portfolio, the Cheladas and the Sunbrews and Aguas Frescas and those types of things. So I think we're in a position where we are actually broadening our consumer reach as we go forward, and I think that's going to be good for investors.

All right. Well, with the 1 or 2 minutes that we have left, I'd like to end with a question that I ask all our management team, which is what is the one thing that you believe is underappreciated or misunderstood about Constellation by the capital markets today?

Shall I?

You go first, and I'll follow up.

Look, I am always perplexed by why our -- we don't get a better valuation on our stock. We have said year after year after year what we're going to do. We've been judicious in our capital allocation approach the entire time that I've been in the seat. We've said what our growth profile is going to be, and we've hit it consistently, and with additional ups and downs that periodically occur in any business. So 5 of the last 7 years, we have been the #1 large-scale growth company in Circana, 5 of the 7. Meanwhile, everybody asked every year when Modelo is going to slow down. So -- and acknowledging, I didn't bring it up, but -- and acknowledging the last year or 2, we've had some challenges in our wine business, to be fair. So I would argue, we are very undervalued, frankly, an opportunity and a nuance at the management level.

Yes. I mean, just to follow on some of that. I mean, I'm not concerned that everyone appreciates or digested what we shared at [ Investor Day ]. I mean from an enterprise-wide basis, right, we're going to grow the top line 6% to 8% over the medium-term period. We're going to deliver 35 -- 33% to 35% operating margins. We're going to deliver low double-digit EPS growth. That's all going to then result from FY '24 to FY '28, in aggregate, about $15 billion to $17 billion worth of operating cash flow. And I already touched upon the big inflection point from a CapEx perspective. So that's going to result in much improved free cash flow generation. So we took those metrics, and we looked at a host of companies that are really similar-facing, if you will. And across the universe of consumer-facing companies, if we -- if you look for companies that have at least the growth rate in the top line growth rate that we have, the earnings growth rate that we have and the dividend payout that we have, there's like 7 companies that follow within our universe, 6 of which have a higher multiple than we do. So clearly, we believe we're undervalued. And we think with our track record of result delivery and the future growth that we have ahead of us, the outlook we have ahead of us, we certainly deserve a higher valuation than we have today.

Well, I think that's a great place to end. Bill, Garth, thank you for joining us. Thank you, everybody.

Thanks for having us.