Foundation capital

Constellation Brands: capital restructuring, a basis for growth

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Investment thesis

Constellation Brands, Inc. (NYSE: STZ) is a manufacturer and distributor of beer, wine and spirits. STZ decided to eliminate Class B shares to improve its capital structure and corporate governance profile. I believe this event can provide a solid foundation for future business growth and align decision-making with the economic interest of all shareholders, which can yield attractive returns.

About Constellation Brands

STZ is a manufacturer and distributor of beer, wine and spirits operating in the United States, New Zealand, Mexico and Italy. The company holds the third-largest market share among all major beer suppliers and is the largest beer import company in the United States. The Company’s product portfolio includes famous brands such as Corona Extra, Modelo Especial, Robert Mondavi family of brands, Kim Crawford, Meiomi, The Prisoner Wine Company and High West. The Company reports revenue through four segments: Beer, Wine & Spirits, Corporate & Other Operations and Canopy. The company generates 76.6% of its consolidated net sales from beer, while wine accounts for 20.6% of total sales. Spirits is the smallest segment and contributes only 2.8% of consolidated turnover. The canopy segment is eliminated during consolidation.

Constellation Brands Revenue Segmentation

Revenue Segmentation (FY2021 Annual Report)

The company has increased its production capacity four times over the past nine years to maintain its leadership in the US premium beer market. It continues to grow and expand as it invested $800 million in beer projects in Mexico in fiscal 2022. It also completed a significant portion of the Obregon Brewery expansion, which will increase the company’s production capacity of 39 million hectoliters. The expansion should be completed by the end of the current year. From fiscal year 2023 to fiscal year 2026, the company has planned to spend between $5.0 billion and $5.5 billion on capital expenditures.

STZ’s 20% growth is driven by customer demand, while innovation influences 30% of growth and 50% comes from space and distribution. For any beer and wine business, space and distribution strategy plays a critical role, and a 50% growth in this component is a sign that the business has an efficient method that has significantly reduced costs. and has the highest margins in the beer industry. To improve the capital structure and corporate governance of the company decided to eliminate Class B common stock, which can increase the efficiency of capital expenditure.

Elimination of Class B common shares

The company has decided to eliminate Class B common stock (STZ.B), including one held by the Sands family. Pursuant to the terms of the agreement, each outstanding share of the Company’s Class B common stock will be converted into the option to receive one Class A (STZ) common stock of the Company together with a cash consideration of an amount of $64.64 per unit of Class B shares outstanding, for a total of $1.5 billion. This is a 26.3% premium to the closing price of Constellation’s Class A common stock on August 3, 2022.

The elimination of Class B shares reduced the concentration of voting power, which improved decision-making. A single-voting-class share structure can speed up expansion plans, reducing decision-making time. The simplified capital structure can strengthen its corporate governance profile because it has reduced the concentration of voting rights, synergizing decision-making with the economic interest of the company. It will also provide a solid foundation for the organic and inorganic growth of the company as the allocation of capital will be efficient and in the interests of the shareholders. This event will also save approximately $15-20 million in fiscal 2022 operating costs related to executive compensation and benefits. I believe this capital restructuring is a solid foundation for future growth as it can improve the company’s decision-making and capital allocation. I believe this event could accelerate strategic development and generate attractive returns for shareholders in the years to come.

What is the main risk facing STZ?

Huge long-term debt

As of May 31, 2022, STZ had long-term debt of $10.3 billion. On the other hand, he had cash and cash equivalents of barely $100 million. This is a big concern for the company and a major factor in the company’s tight profit margins. The Fed’s hike in interest rates further compounded the problems. High interest payments affect business cash flow and ultimately lead to tight margins for any business. The management must solve this problem to improve the efficiency of the company in the coming years.

Technical analysis and fundamental valuation

STZ Stock Technical Analysis Chart

Technical Analysis Chart (Investing.com)

STZ has positive technical indicators reflecting a buy rating from current price levels. The stock is enjoying strong support at the $240 level, which is its 100-day weighted moving average (WMA) zone. The stock is currently trading above its 100-day and 50-day WMA levels, indicating strong momentum in the stock price. Also, the 50-day WMA may soon cross the 100-day WMA, which could give the stock further momentum. The WMA parameter indicates a buy from the current price level. The RSI indicator does not reflect any divergence, but the stock is consolidating in the 50-60 RSI range. This range is generally considered a good buy zone for the stock. I think the stock may soon test the 70 band levels, reflecting a buying opportunity.

STZ has seen a 10% increase in share price over the past year. The stock is currently trading at a price of $245. STZ is trading at a P/E multiple of 22x with FY22 EPS estimates of $11.02. I think it is undervalued at current P/E levels compared to competitors like Brown-Forman Corporation with a P/E of 37x and The Duckhorn Portfolio, Inc. with a P/E of 30x. Going forward, the company may trade at a higher P/E multiple given its high growth and cost optimization aspects. I think STZ will trade at a P/E multiple of 27x with FY22 EPS estimates of $11.02, giving us a target price of $298.

Conclusion

The elimination of Class B shares, which should improve capital governance, will benefit long-term company performance. Another positive factor for the company is the expected operating cost savings due to proactive management actions. It is currently trading at a cheaper valuation than its peers, and I believe the company will trade at a higher valuation going forward. I assign a buy recommendation for STZ after analyzing all these factors.