Stock of the Week - Constellation Brands (20.02.2025)

Constellation Brands (STZ.US) stock gained 6.5% following Warren Buffett's Berkshire Hathaway's disclosure of a $1.24 billion stake, despite ongoing concerns about potential Mexican import tariffs and weakening consumer spending. The investment highlights potential value in the company's premium beer portfolio and strong market position, even as near-term headwinds persist.

Q3 FY2025 Earnings Highlights

• Revenue & Profitability:
  • Total Revenue: $2.46 billion (-0.3% year-over-year)
  • Adjusted EPS: $3.25 (+1.9% year-over-year)
  • Operating Income: $802 million (-2.0% year-over-year)
  • Operating Margin: 32.5% (down from 33.1% in Q2)
• Segment Performance:
  • Beer Revenue: $2.03 billion (+3% year-over-year)
  • Beer Operating Margin: 37.9% (-0.6 percentage points)
  • Wine & Spirits Revenue: $431.4 million (-14% year-over-year)
  • Wine & Spirits Operating Margin: 22.1% (-3.3 percentage points)
• Key Financial Metrics:
  • Free Cash Flow: $1.6-1.8 billion (FY2025 forecast)
  • Cash Position: Substantial with strong balance sheet
  • Capital Structure: $10.88 billion in total debt
• FY2025 Guidance (Revised):
  • Enterprise Net Sales Growth: 2-5% (down from 4-6%)
  • Beer Net Sales Growth: 4-7% (down from 6-8%)
  • Wine & Spirits Net Sales: -5% to -8% (down from -4% to -6%)
  • Comparable EPS: $13.40-13.80 (down from $13.60-13.80)

Earnings vs Estimates. Source: Bloomberg L.P.

Strategic Position: Premium Portfolio Leadership

Constellation Brands maintains strong market leadership in the premium Mexican beer segment, with Modelo becoming the #1 beer brand in the U.S. in 2023. The company's beer portfolio, representing over 80% of revenue, continues to show resilience despite broader industry challenges. Strategic focus remains on expanding distribution networks and capitalizing on favorable demographic trends in the Hispanic market.

Beer Business Development

The beer segment continues to demonstrate steady growth despite macroeconomic headwinds, with depletions growing 3.2% year-over-year. Premium innovations like Modelo Oro have shown strong performance, addressing consumer demand for low-calorie options. Distribution expansion remains a key growth driver, with plans to add 500,000 new points of distribution by 2028.

Strategic Challenges and Opportunities

The company faces several significant challenges, including potential 25% tariffs on Mexican imports, which could materially impact margins given that 85% of revenue comes from Mexican imports. Management has outlined mitigation strategies including cost savings initiatives, inventory management, and strategic pricing adjustments. Additionally, changing consumer preferences and health consciousness present both challenges and opportunities for product innovation.

Market Outlook

While near-term headwinds persist, including macroeconomic uncertainty and potential tariffs, the company's strong market position and premium portfolio provide resilience. The beer segment's continued growth and potential for distribution expansion offer meaningful upside, while the wine and spirits segment undergoes strategic repositioning to address performance challenges.

Regulatory and Competitive Environment

The primary regulatory concern centers on potential Mexican import tariffs, currently paused for 30 days. The company maintains strong relationships with both U.S. and Mexican governments, highlighting its economic impact in both countries. Approximately 75% of total inputs are USD-denominated, potentially mitigating some tariff impact.

Investment Considerations

Despite near-term challenges, several factors support a positive long-term outlook:

• Strong market position in premium beer segment with consistent growth
• Significant distribution expansion opportunities
• Berkshire Hathaway's investment providing validation of value proposition
• Attractive valuation with forward P/E of 12.2x
• Strong free cash flow generation and balance sheet stability

Investors should monitor developments regarding Mexican tariffs, consumer spending patterns, and progress in the wine and spirits segment turnaround as key indicators for future performance.

Valuation

Based on our analysis of Constellation Brands using historical data and company financials, we've developed projections incorporating various growth scenarios. Our base case DCF model uses the following key assumptions:

Core Operating Assumptions:

• Revenue growth rate: 3.0-3.2% for the initial period
• Operating margin: 33-34%
• Terminal WACC: 7.0-7.2%
• Current price: $172.42

DCF Sensitivity Analysis 

Our sensitivity analysis reveals interesting dynamics at different operating scenarios. With a 3.0% revenue growth rate and 34% operating margin, the model suggests a fair value of $246.49. Increasing the revenue growth to 3.2% with the same operating margin would push the implied value to $260.71, suggesting significant upside potential from current levels.

The terminal value sensitivity analysis, using various WACC and growth scenarios, shows that with a terminal revenue growth rate of 3.0% and terminal WACC of 7.2%, the model suggests a fair value around $234.11. However, if terminal growth improves to 3.2% with a lower WACC of 7.0%, the implied value increases to $260.71.

Source: Bloomberg Finance LP, XTB Research

Source: Bloomberg Finance LP, XTB Research

Peer Comparison Analysis 

Looking at peer comparison analysis with major beverage companies including Coca-Cola, PepsiCo, Monster Beverage, and Keurig Dr Pepper, Constellation Brands currently trades at significantly lower multiples. The multiple-based valuations suggest substantial potential upside across different metrics:

Implied Valuations Based on Different Approaches:

• Mean-based valuation range: $213.56 to $383.30
• Median-based valuation range: $232.17 to $428.01
• Cap-weighted valuation range: $211.74 to $463.74

Source: Bloomberg Finance LP, XTB Research

Required Return Analysis 

The required return sensitivity analysis suggests that with a dividend growth rate of 6.5% and required return of 8.9%, the fair value is approximately $177.50, close to the current market price. However, with slightly more optimistic assumptions (6.7% dividend growth and 8.7% required return), the fair value increases to $213.40.

Source: Bloomberg Finance LP, XTB Research

Comprehensive Valuation Assessment 

Based on our comprehensive valuation analysis:

1. DCF Analysis indicates a fair value range of $234-261, suggesting 35-51% upside from current levels
2. Peer Multiple Analysis shows significant discount to peers across most metrics, with implied values suggesting 23-169% upside potential
3. Required Return Analysis suggests fair value range of $177-213, indicating 3-24% upside

The wide range in valuation metrics reflects current market uncertainty regarding:

• Potential impact of Mexican import tariffs
• Consumer spending patterns in premium beverages
• Wine & Spirits segment turnaround potential
• Competitive dynamics in the beer market

Recommendations: 

Constellation Brands has 28 recommendations, with 18 "buy" and highest price of $300, 10 “hold” with lowest price of $190 and 0 “sell”. The 12-month average stock price forecast is $241.48, implying a 40% upside potential from the current price.

Technical analysis (Daily interval): 

The stock is trading near its September 2020 lows. Bulls will aim to retest the 23.6% Fibonacci retracement level, while bears will attempt to push the price below its yearly lows. The RSI has formed a bullish divergence with higher lows, and a similar divergence is occurring on the MACD.