Market Overly Optimistic on Constellation Brands
Despite posting fine second-quarter results, the narrow-moat beer- and wine-maker will enjoy above-industry volume gains, but at a slowing rate.
We will likely raise our $117 fair value estimate roughly 5% for narrow-moat Constellation Brands (STZ) after solid second-quarter results and a near-term picture that looks a bit rosier than we had expected. That said, we caution that second-half results still look to slow given challenging comparisons and the lapping of the Ballast Point craft beer acquisition. Moreover, while Constellation’s productivity efforts and higher volumes have led to profit margin improvement ahead of our estimates for this year, we’ve already included rising profitability in our longer-term outlook and note that free cash flow will likely remain limited in the near term. In all, we continue to believe that the firm’s beer business will enjoy above-industry volume gains but at a slowing rate given its larger size and further competition. In our opinion, the market is still pricing in an unreasonably optimistic scenario, leaving shares overvalued.
Constellation’s beer revenue growth remained impressive in the quarter, climbing 20% on 15% organic gains and 5% contribution from the Ballast Point acquisition. But we don’t expect this level of growth to persist, given more difficult year-over-year comparisons upcoming in the second half of the fiscal year, and management’s own outlook for 16% to 17% top-line gains (a tighter range than a prior 14% to 17%) similarly suggests a low-teens growth rate for the next two quarters. Looking over the next five years, we’re still comfortable with our high-single-digit annual forecast--still well above the U.S. beer industry’s low-single-digit rate, but continuing to slow from its current breakneck pace.
We also note that despite better profitability improvement than we had expected, owing to continued volume leverage, strong pricing (in line with our expectations), and increased in-house beer production, Constellation’s free cash flow will remain challenged over the next several quarters as it rapidly expands its brewing capacity.
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Adam Fleck does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.
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