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Fuad Fadel Jim Fish Kevin Kaznica Matthew Krajna. Constellation Brands. Business Segments Wine Spirits Crown Joint Venture Key Risks Health of the Consumer Joint Venture uncertainty Financial condition Corporate governance Valuation Multiple Scenario DCF Sum of Parts
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Fuad Fadel Jim Fish Kevin Kaznica Matthew Krajna Constellation Brands
Business Segments • Wine • Spirits • Crown Joint Venture • Key Risks • Health of the Consumer • Joint Venture uncertainty • Financial condition • Corporate governance • Valuation • Multiple Scenario DCF • Sum of Parts • Market Multiples • Sell Recommendation: $17 Price Target Table of Contents
Business Segments Wine Spirits Crown Joint Venture
Constellation • Lags industry CAGR of 3% • Approx. 90% of sales • Overall depletion trends lag industry • Levered to the United States Wine Segment • Industry • Mature industry • EM drive growth • Value Trend • Franzia Winetaps (The Wine Group) has largest market share of 7.9% • Constellation lacks a Top 5 Wine Brand within the industry, by market share
Wine Growth Wine Sales YoY • Forecast • 2.25% growth • -20% Actual 5 Year Wine Sales CAGR • Decreasing CAGR • Lagging industry CAGR of 3%
Constellation • Approx. 10% of sales • SVEDKA double-digit growth • No EM exposure, small market share • Industry • Global competitors • EM driving growth • Driven by flavored vodkas Spirits
SVEDKA Growth • Geographic Reach • SVEDKA primarily U.S. based • U.S. consumer remains fragile
Constellation • Crown Imports ≈ 40% of EPS FY2011 • 43% of EPS FY2012 • No solid commitment from Modelo beyond 2016 • 3% growth in Net Sales Crown Imports • Industry • Craft/Imports are fastest growing category • Social trend away from “traditional” beers
Key Risks Health of the Consumer Joint Venture Uncertainty Financial Condition Corporate Governance
Dependence on U.S. Economy • Not levered to EM or international markets • U.S Economy seen as “fragile” • Outlook for U.S. Economy • PCE & Off-Premise consumption are flat • Source: Bureau of Economic Analysis • FY2012Weaknesses: • Weak consumer not able to trade up to premium • Constellation took pricing on best wine brands • No pricing power • Decreasing volume trends • Increased Marketing Spend • Crown JV sales grew 3%, yet Equity Earnings decreased 6.3% Health of the Consumer
JV does not renew, Modelo imports own brands JV does not renew, Modelo chooses new importer with more scale JV renews Possible JV Outcomes • Key Dates & Outcomes • Modelo must give notice by 2013 to terminate • The current JV agreement expires in 2016
Cash Flows • $500M sustainable • Balance Sheet Quality • High Debt Level • $2.6B on balance sheet • $6B including purchase obligations and leases • Low Times Interest Earned • Poor quality • 50% of assets • Goodwill/Intangibles • Income Statement • Reliance on Crown JV for 40% EPS • No Dividend Financial Condition Highlights
FY12 Earnings Release • Target leverage ratio of 3.0-4.0x • Results in debt level of $2,000M-$2,650M • $2,600M / $664M = 3.92x projection • New $1,000M share buyback • Funded through NEW debt issuance • Could increase leverage ratio • Market will demand higher interest rate Credit RISK
PrivateCompany Characteristics Dual-Class share structure Over 50% of voting rights 11.81% Equity stake Elect majority of Directors Strong resistance to changes in class structure Strong Academic Support Harvard, Wharton, Stanford Entrenchment decreases performance Value Destruction Share repurchases Corporate Governance Source: GMI • AGR: • Aggressive accounting and governance behavior
Value Destruction • Value destruction at all discount rates • ROIC lags cost of capital
$5B in acquisitionssince February 2001 Acquisitions • $3.3B of which was Goodwill/Intangibles • $1.25B in write downs & impairments since 2001
Additional Risk Factors • Private Company Aspect • Governance Risks • Company-specific risk • e.g. JV termination • Mid-Range WACC • 10.41% • Build-Up WACC • 13.97% Build-up Rate Justification
Valuation Multiple Scenario DCF Market Multiples Sum of Parts
11 Scenarios • Base • Worst • Best • Possible Crown JV Impacts • Efficiency Gains • 5 & 10 Year Valuations • Sensitivity Analysis • 2 Discount Rates • 3 EV/EBITDA Terminal Values DCF Scenarios JV does not renew, Modelo imports own brands JV does not renew, Modelo chooses new importer with more scale JV renews Price Target: $17
Constellation BrandsCanisius College “Base Case” • Net Sales $2,654M $2,661M • EBIT $769M $782M • EPS $2.34 (tax benefits) $1.89 • Tax Rate 17% 35% • Growth -1.0% growth 2.25% growth FY 2013 • EPS $1.89-2.03 $2.09, 10% growth • FCFE $425-475M forecast $440M estimate • Tax Rate 34% 35% FY 2012 Earnings Release
P/CF valuation price target of $16 • P/E valuation price target of $22 • P/E multiple: 10.5 • Projected FY2013 EPS: $2.09 • Measures Constellation value as a whole • Does not discount additional risks Market Multiples Median: 9.38 Average: 11.13 Historical Avg. PE (Restated): 10.5
Valuation • Wine • SVEDKA • Crown JV • 3 Scenarios • Sensitivity Analysis • 2 Discount Rates • Appropriate Scenario • Conservative • Simple Average Sum of Parts Price Target: $17
Price Target Average of all 11 scenarios WACC 10.49%, 13.97% Average sum of the parts valuation $17 $17.10 P/CF $15.60 Price on 4/5/2012: $21.61 SELL TARGET: $17 21.3% downside P/E approach $22
Key Risks • Low growth/mature wine industry • Weakness of U.S. consumer • Corporate governance weakness • Value Destruction • Share buybacks • Crown JV uncertainty • Weak financial condition • Market is inadequately pricing in risks of STZ • SELL Recommendation: Price target of $17 Investment Summary
Appendix • Earnings Release (25) • Price Matrix (26) • Crown JV graph (27) • SG&A / 10yr scenarios (28) • Hispanic graph (29) • Modeled Growth (30) • Margins (31-32) • Diageo (33) • WACC (34-35) • Sum of Parts (36-39)
potential catalysts • Margin Expansion • Through Reduction in SG&A (Project Fusion) • From 20.5% of Sales to 15% over 5 years • We feel this type of efficiency is excessive • Need for increased promo and ad spend • Due to value proposition • Crown JV Continuing for another 10 years • We feel this is unlikely • Modeled 8% Crown Equity Earnings growth • BEST Case Scenario: • 5% Wine growth • 20% Svedka growth • 10% Crown JV growth • Price Target $21, SELL
Opportunity to Grow Crown Earnings • Hispanic population growth is also highly focused in a few key geographic markets • Strategic opportunity for Crown Imports • Increase market share through increased distribution efforts • Key states include California, Texas, Florida, New York, and Illinois.
EPS Growth modeled at 10% • EBIT growth aggressively modeled at 5% • Bucking 5 year negative growth trend REVENUE & EPS Growth Rates
Gross Margin 40.1%, up 420bp YoY Operating Margin 20.3%, up 430bp YoY Upward biased changes due to divestiture of lower margin European and Australian wine business Fy12 Margins
Diageo: • U.S. Spirits business driven by flavored Vodkas • “[The U.S.] is showing very good signs of improvement. It’s not a snapback…Now the U.S. is not going to offer us the same growth that Brazil can.” • Key takeaway: U.S. does not offer the growth that Emerging Markets offer • Constellation Brands LACKS EM exposure • Thus stuck with 90% of sales from a mature U.S. market • Source: WSJ, March 26, 2012 Competition: Diage0
Sum of Parts • Target Price of $17 with Conservative Scenario, using build-up and mid-level discount rates
Sum of Parts • Wine value comes from “Best Case” scenario • PV of wine sales only • SVEDKA purchase price $384 million, adjusted for inflation, and multiplied by 4x to represent case vol growth • Crown valued as the PV of forecasted equity payments
Sum of Parts • Crown value based on PV of future equity earnings • Includes options that will be exercised • Based on build-up method, discount rate of 13.97%
Sum of Parts • Crown value based on PV of future equity earnings • Includes options that will be exercised • Based on build-up method, discount rate of 13.97% • Conclusion: Using both the build-up and mid-level discount rates, an average target price of $17 can be obtained, AFFIRMING SELL RECOMMENDATION
Additional risk Build-up premiums (1-2% per item)
PV of Growth Opportunities • PVGO: The present value of growth opportunities is a tool to extract the market’s expectations on future growth potential for Constellation. • Using the CAPM we determined a cost of equity of 10.41% for Constellation. • PVGO for Constellation under current market conditions is 16.97%. • Peer median of 46.52% • Market does not feel that Constellation has much growth potential. • Given that Constellation has lagged the wine industry growth rate of 3%, the PVGO is justified, especially compared to its peers. Key assumptions: EPS: 1.79 TTM restated Price: 423.62 on 1/12/12
Imported wines ≈ 1/3 U.S. wine sales • USD appreciating against the Euro and Aussie Dollar • Floods market with competitively-priced alternatives • This is a negative for Constellation, as the U.S. consumer is still trending towards value brands Wine Import Data
STZ • Vincor, Robert Mondavi, Ravenswood, Arbor Mist, and Ruffino • Approximately 90% of sales • Lags the industry growth rate • Sold only 12.7% of the wine cases during 2010 • Negative EPS between 2008-2010 • Negative organic growth in 2011 • Extremely low exposure to emerging markets, leading to lack of revenue growth • Industry: • Smallest segment in the alcoholic beverage industry compared to beer and spirits • 3% CAGR on average • Mature and slow growth industry • Large conglomerates, such as STZ • Competitors are E & J Gallo, The Wine Group, Vina Concha y Toro, and Treasury Wine Estates • 4-6% CAGR prior to the recession • On-premise v. off-premise sales • Larger growth in off-premise sales than on-premise (use graph showing this off Bloomberg) • Value v. Premium Wine Sales • Trend towards value brands continues • Remains to be seen if producers can successfully persuade consumers to abandon value brands for premium • Franzia Winetaps (The Wine Group), a value wine, has the largest market share of 7.9% • High growth seen in developing markets, but mainly China where CAGRs are in the mid-teens Wine
California’s 2011 wine grape crush, from all varieties, totaled 3,342,689 tons, down 7 percent from 2010 varieties accounted for the largest share of all grapes crushed, at 1,917,132 tons, down 7 percent from 2010. The 2011 white wine varieties crush totaled 1,425,557 tons, down 7 percent from 2010. On the price side, record highs were set for both red and white wine grapes average price for the 2011 crop of red wine grapes was $702.70, up 12 percent from 2010, while the average price for white wine grapes came in at $541.11, up 8 percent from last year. The 2011 average price of all varieties reached a record high of $588.96, up 8 percent from 2010 and 3 percent above the previous record high set in 2009. Wine Crush Data
STZ • SVEDKA, Black Velvet, & Paul Mason Brandy • Since acquisition, Svedka is quadrupled in case sizes • Approximately 10% of sales • Miniscule market share with many global competitors • Lacks brand recognition that competitors have • Growing at double-digit rate • Driven mainly by SVEDKA • Industry: • 2nd largest market segment of alcoholic beverage industry • Led by vodka and whiskey • Smirnoff, Absolut, Grey Goose, & Skyy • Diageo, Brown-Foreman, & Beam Global & Spirits • Diageo controls the spirits market • Shift towards spirits over wine and beer Spirits
STZ • Crown Imports • Corona, Corona Extra, Corona Light, Modelo Especial, Negra Modelo, St. Pauli Girl, Tsingtao, & Victoria • JV 43.6% of EPS in 2011 • Equity Earnings • No solid commitment from partners beyond 2016 • JV between 2008-2010 was the only positive earnings segment for STZ • Without which, it would not have been able to cover interest payments • Not a beer company • Industry: • Largest market share compared to wine and spirits • Dominated by major companies • Anheuser-Busch InBev, Miller Coors, Crown Imports, • Growing trend towards Imports and Craft Brews in the US • Double digit growth rate compared to stagnant growth for whole industry • 16.4% volume growth compared to -2%; Dollar growth, craft up 17.5% compared to .3% for the industry • Attempt by companies to innovate with new products, such as Bud Light Platinum recently • Strategy: Fast-growing acquisitions by major companies • Ex: SAB Miller’s acquisition of Foster’s • Ex: Major companies acquiring craft breweries Beer