Mexican Beer Continues to Shine for Constellation

Nicholas Johnson: We view Constellation Brands, which owns the U.S. rights to Mexican beer trademarks like Corona and Modelo, as an underappreciated gem within the brewing industry. At its core, our job really is to assess two things: a company's competitive position and the intrinsic value of its stock. From our vantage point, Constellation looks stellar in both regards.

As it relates to competitive position, we recently raised the firm's moat rating to wide from narrow. There are common threads that typically run through the fabric of moat-worthy consumer-packaged goods companies. These include broadly resonant brands and massive distribution networks. Constellation's story includes not only these traits, but also a powerful demographic tailwind. Its core consumer base skews towards Hispanics, a sizable demographic whose primacy will only increase over the coming years. We find it fairly intuitive that Hispanics place a premium on Mexican beer, as it speaks in part to a shared culture and heritage, and in our view, these dynamics are at the heart of Constellation's superb operating profile, boasting best-of-breed margins and lower advertising spending than peers.

The shares are trading at a roughly 17% discount to our $230 fair value estimate, as they've been plagued by what we consider noncore issues. The first of these relates to Constellation's investment in Canopy Growth, a no-moat cannabis company that has struggled with choppy product rollouts and limited distribution in Canada following legalization. The second relates to its wine and spirits business, which has had noisy performance as the firm looks to divest some lower-margin brands from the portfolio. Ultimately, we see these issues as transitory, and more importantly, demonstrably outweighed by the growth and earnings power of the Mexican beer business, which represents close to 80% of profits.

Looking ahead, there are numerous catalysts that we think could foster greater appreciation in the market for the Mexican beer assets, the foremost being the launch of Corona seltzer this spring. Hard seltzer is growing at the most torrid pace of all the alcoholic beverage categories, and while we don't expect Corona seltzer to displace incumbents like White Claw and Truly, we think Constellation will garner meaningful growth from this space, which should bolster its already-healthy sales trajectory.