Take a Sip of Undervalued Constellation Brands

Shares of narrow-moat Constellation Brands STZ fell around 12% after the firm reported third-quarter results, which included sales growing 9% and operating margin expanding 100 basis points to 28%. We primarily attribute this reaction to weak performance in the firm’s wine business (roughly one third of sales), which posted a 3% decline in depletions. Management now expects full-year sales in this business to decline by a low-single-digit rate, versus a 2%-4% increase prior. Accordingly, it estimates comparable earnings per share will fall between $9.20 and $9.30, versus its prior outlook of $9.60 to $9.75 and our $9.63 estimate. We plan to trim our fiscal 2019 earnings per share estimate and near-term outlook for the firm’s wine business, which should reduce our $204 fair value estimate by a low-single-digit percentage. However, our longer-term outlook, which calls for around 6% sales growth and mid-30s operating margin on average, remains intact. Even with these revisions, we think shares offer a compelling entry point for investors.

Constellation’s wine performance was hampered by the sub-$11 price point, which approximates a third of volume in its wine portfolio. While our longer-term outlook for the wine segment has already been quite muted, at just low-single-digit growth, we remain constructive on opportunities within the high-end. Over the last several years, the firm has made several efforts to refocus its wine portfolio on more profitable fare, divesting its lower-margin Canadian wine business in late 2016 and rationalizing lower-margin, value-priced SKUs. Premiumization trends within the wine market should support momentum for Constellation’s higher-end wine brands; according to management, retail sales in the above $11 price point grew at a 13% compound rate between 2012 and 2017, versus 5% for the overall category. As evidence, higher-end brands like Kim Crawford and Meiomi have posted double-digit retail sales growth over the trailing 12 months.

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