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Stock Analyst Update

Can Constellation Brands' Pricey Purchase Pay Off?

While the price paid was excessive, we're constructive on the longer term opportunities the investment in leading cannabis firm Canopy Growth could yield.

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We're not anticipating a material change to our $199 fair value estimate for narrow-moat  Constellation Brands (STZ) after evaluating its increased equity stake in Canopy Growth, a leading cannabis firm. Constellation had taken a nearly 10% ownership stake in Canopy in October 2017 for CAD $245 million and now plans to raise its stake to roughly 38% ownership for around CAD $5 billion, or a 38% premium to Canopy's five-day volume weighted average price. The transaction is expected to close in October, and will also provide warrants that, if exercised, would lift Constellation's ownership to more than 50% in the three years after closing.

Shares pulled back by a mid-single-digit percentage on the announcement, and we suspect this reaction was due to concerns around capital allocation, given the lofty premium paid for shares and higher risk inherent to the cannabis space (which is not legal on a federal level in the U.S.) relative to Constellation's core beer and wine portfolio. While we concur that the price paid was excessive, we remain constructive on the longer-term opportunities this investment could yield and appreciate the firm's efforts to be an early mover into this developing category. Further the deal will allow Constellation to nominate four directors to Canopy's seven-member board; we'd expect this increased control to come at a premium. We're reiterating our longer-term outlook for the company, which incorporates around 6% revenue growth and mid-30s operating margin on average over our forecast. While shares are now trading in line with our valuation, we'd suggest investors wait for a wider margin of safety.

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Sonia Vora does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.