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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
Fuad Fadel

Jim Fish

Kevin Kaznica

Matthew Krajna

Constellation Brands

table of contents

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
slide3

Business Segments

Wine

Spirits

Crown Joint Venture

wine segment

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 Growth

Wine Sales YoY

  • Forecast
    • 2.25% growth
    • -20% Actual

5 Year Wine Sales CAGR

  • Decreasing CAGR
    • Lagging industry CAGR of 3%
spirits

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
SVEDKA Growth
  • Geographic Reach
  • SVEDKA primarily U.S. based
  • U.S. consumer remains fragile
crown imports

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
slide9

Key Risks

Health of the Consumer

Joint Venture Uncertainty

Financial Condition

Corporate Governance

health of the consumer

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
possible jv outcomes

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
financial condition highlights

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
credit risk

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
corporate governance
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
  • Value destruction at all discount rates
  • ROIC lags cost of capital
acquisitions

$5B in acquisitionssince

February 2001

Acquisitions
  • $3.3B of which was Goodwill/Intangibles
  • $1.25B in write downs & impairments since 2001
build up rate justification

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
slide18

Valuation

Multiple Scenario DCF

Market Multiples

Sum of Parts

dcf scenarios

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

fy 2012 earnings release

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
market multiples

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

sum of parts

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
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

investment summary

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
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
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
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.
revenue eps growth rates

EPS Growth modeled at 10%

  • EBIT growth aggressively modeled at 5%
    • Bucking 5 year negative growth trend
REVENUE & EPS Growth Rates
fy12 margins

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
competition diage0

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 parts1
Sum of Parts
  • Target Price of $17 with Conservative Scenario, using build-up and mid-level discount rates
sum of parts2
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 parts3
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 parts4
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
pv of growth opportunities
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

wine import data

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
slide46

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
wine crush data

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
spirits1

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
slide50

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
crown jv1
Crown JV

Company had negative earnings

health of the consumer1
Health of the Consumer
  • Personal Income rising, while personal savings decreasing, yet off premise spend on food/beverage flat
academic support

Manager’s protected from the market for corporate control tend to pursue inefficient investment products

      • Journal of Finance August 2007; Masulis, Wang, Xie
  • Democratic corporate governance strongly associated with higher relative returns
    • Most democratic: 3.8 abnormal
    • Most dictatorial: -5%
      • Gompers, Ishi, Metrick
  • Firm value increases with the cash-flow rights of the largest shareholder, but decreases when voting rights exceed cash-flow rights
      • Claessens et al.
  • Found a significant negative relationship between disproportional voting rights and firm value
      • Gompers (Harvard), Ishii (Stanford), Metrick (Wharton)
Academic Support
opposition to more balanced class structure

PROPOSAL 5 — STOCKHOLDER PROPOSAL

Mr. Kenneth Steiner of 14 Stoner Avenue, 2M, Great Neck, New York 11021, who has indicated that he owns 1,100 shares of our stock, has given notice that he or his designee intends to make the following stockholder proposal at the Meeting. The Board recommends that you vote AGAINST the stockholder proposal. In accordance with applicable regulations, we include this stockholder proposal and supporting statement in the form proposed by Mr. Steiner:

Equal Shareholder Voting

RESOLVED: Shareholders request that our Board take steps to adopt a plan for all of our company’s outstanding stock to have one-vote per share. This would include all practicable steps including encouragement and negotiation with family shareholders to request that they relinquish, for the common good of all shareholders, any preexisting rights, if necessary…

The Board of Directors recommends that you vote AGAINST Proposal 5. Unless you properly direct otherwise, the shares represented by your proxy, if properly submitted and not revoked, will be voted AGAINST such proposal.

Opposition to more balanced class structure
additional scenarios

Key Assumptions:

Scenario 4 – “10yr No Real Growth & JV Termination”: Base Case, but with termination of JV. AB InBev would increase their stake in Grupo Modelo, triggering a cash payment of 4x EBIT to Constellation. In 2017, earnings from the Crown Imports JV will only incorporate 10 months due to the timing of the termination. Equity earnings going forward will be significantly impacted and no longer material. Constellation would receive a cash payment, estimated at $2 billion, upon notice being granted for FY2014. The scenario shows the effect of the joint-venture termination by Grupo Modelo.

Scenario X – “10yr No Real Growth & JV Termination”: Base Case, but with termination of JV. AB InBev would increase their stake in Grupo Modelo, triggering a cash payment of 4x EBIT to Constellation. In 2017, earnings from the Crown Imports JV will only incorporate 10 months due to the timing of the termination. Equity earnings going forward will be significantly impacted and no longer material. Constellation would receive no cash payment. The scenario shows the effect of the joint-venture termination by Grupo Modelo.

Stress Tested Scenario 3 – “Decreasing SG&A significantly”: Same as Scenario 3, but with SG&A decreasing as a perfect of sales from 20.5% to 15%. We feel this significant of an efficiency gain would be significant, but drastic, and unlikely.

5yr Crown Cash Now, Best Case -- Modeled Scenario 3 with a $2 billion cash payment in year 2014.

5yr Crown Cash Later, Best Case -- Modeled Scenario 3 with cash payment of $300 million approximating estimated 50% of BV of the joint venture, upon termination this payment would be received by Constellation.

10yr Model with JV Continuing -- Base case, but assuming 10yr model

5yr Crown Cash Now, Base Case -- Modeled Scenario 1 with a $2 billion cash payment in year 2014.

5yr Crown Cash Later, Base Case -- Modeled Scenario 1 with cash payment of $300 million approximating estimated 50% of BV of the joint venture, upon termination this payment would be received by Constellation.

Additional Scenarios
reverse engineering

Reverse Engineering:

Holding all else equal for Scenario 1:

At WACC of 7.18%, in order to justify price approximating current levels:

A growth rate of 5% in CWNA

A growth rate of 30% in Spirits

A COGS of 56% in all five years

SGA of 17% in all five years

Equity earnings growth rate of 20%

Income tax rate of 19%

Reverse Engineering
generational segments

Total estimated US Population 2011

    • 312 M
  • Boomers (2010)
    • 79 M
  • Millenials (2010)
    • 77 M
  • Generation X (2010)
    • 51 M
Generational Segments

Source: US Census, Pew Research

smid premium

U.S. mid-caps have historically provided only minor diversification benefits, having a correlation to large caps of more than 0.94 over the past 10 years. Mid-caps have behaved similarly to U.S. small-cap equities, exhibiting a correlation of 0.98. The volatility of return on mid-capstocks as measured by standard deviation was 18.8%, more than 3 percentage points greater than that of large caps. One way to interpret this number is to assume a normal distribution of returns. If you expect mid-caps to earn an average return of 6% in any given year, there is at least a 2% chance that the return will be less than 31.6% (two standard deviations less than the average). Viewed in this light, the 36% drop in 2008 should be viewed as unlikely but not impossible.

Source: Morningstar

SMID Premium
slide65

Common to use P/S valuation for:

    • New company
    • Company with accounting issues
  • Value based on total net Sales

Standard Deviation of 0.33

  • Highest target price is $16.15 = CONFIRMS SELL
P/S
segment based p s

Segment P/S

    • Using projected sales for each segment & the 2000-2011 average P/S and the 2011 P/S
    • Use Crown earnings to find what investors are willing to pay for those earnings because STZ does not give Crown Revenue but Crown earnings
  • Highest target price:
    • Based on 2011 P/S alone, which is above average, a target price of $19.16 is obtained
    • CONFIRMS SELL
Segment Based P/S
wine import data1

Imports grew 3.9 percent to 109.8 million cases. - account for 32 percent of the volume of wine sold in the U.S.

As the USD appreciates in value against the Euro and Aussie Dollar, imported value wines become cheaper to import, thus flooding the market with value brands

This is a negative for Constellation, as the U.S. consumer is still trending towards value brands

Wine Import Data
crown jv potential outcomes

Modelo gives notice by 2013 that the JV will NOT renew after 2016, and Modelo will import their brands into the U.S.

Modelo does NOT renew JV, chooses different party (other than STZ) as importer

Modelo renews the JV for another 10 years

Crown JV Potential Outcomes
build up rate justification1

Significant Governance Risk

    • Private Company Aspect
    • Company-specific risk
      • e.g. JV termination

WACC 10.41% WACC 13.97%

Build-up Rate Justification
capm understates wacc
CAPM Understates WACC
  • CAPM
    • Book Weights
      • WACC 7.18%
    • Market Weights
      • WACC 7.81%
    • Effective debt cost
      • Average 7.42%
base case scenario

Scenario 1 – “5yr Base Case”:

    • CWNA grown at 2.25%/year
    • Spirits growing at 10%/year driven by SVEDKA sales
    • Equity earnings, driven by Crown Imports, grew 8%/year
Base Case Scenario
worst case scenario
Worst Case Scenario
  • Scenario 2 – “5yr Worst Case”:
    • CWNA, Spirits, and Crown Imports sales grow at an inflation rate of 2%.
      • Based on the fact our “Worst Case” scenario was a SELL rating, we did not do further sensitivity testing of lesser growth rates for wine, spirits, or Crown segments.
best case scenario
Best Case Scenario
  • Scenario 3 – “5yr Best Case”:
    • CWNA sales growing at 5% YoY, which outpaces the industry average
    • Spirit Sales driven by SVEDKA growth at 20%
    • Equity earnings from Crown grow at 10% YoY.
sum of parts5

Valuation

    • Conservative: $17
    • Possible: $20
    • Unlikely: $24
    • Unlikely & Possible: $22
    • All: $20
Sum of Parts
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