Under the Spotlight Wall St: Constellation Brands (STZ)

When Berkshire Hathaway’s ($BRK.B) releases its eagerly awaited annual letter this weekend, investors will scour it for details about Warren Buffett’s newly acquired taste for Mexican beer. 

Constellation Brands ($STZ), which owns the rights to sell Corona and Modelo beers in the U.S., is the newest addition to Berkshire Hathaway’s portfolio. The US$1.2b investment ranks as Berkshire’s 19th largest position and adds to a portfolio that reflects Buffett’s disregard for the food pyramid: Coca-Cola Company ($KO) and Kraft Heinz ($KHC) are in the top ten holdings.

Started as a bulk wine seller in 1945, Constellation has a beer portfolio that includes Modelo Especial, the top selling beer in the U.S. after it snatched the crown from Bud Light in 2023. Its Corona and Pacifico beer brands are also performing strongly, helping offset an underperforming wine and spirits business.   

However, Constellation shares have tumbled 29% over the past year. After its FY25 net sales growth target was cut from 4%-6% to 2%-5% in January, $STZ was trading near a five-year low. The stock is doing worse than alcohol beverage rivals like Anheuser-Bush Inbev ($BUD), down 15% over the past year, and Molson Coors ($TAP), which has shed 4%. For the Oracle of Omaha – whose US$150b net worth was built on buying stocks on beaten-down valuations and holding them for the long term – this presented an opportunity.

Top brew

Buffett believes ‘a powerful world-wide brand is essential for sustained success.’ The newly acquired stake in Constellation Brands comes with some of the most popular beer brands in the U.S. 

According to the company’s Q3 earnings, Modelo Especial was the #1 beer brand not just in dollar sales, but also in dollar share gain. Corona Extra is a top five brand in dollar sales and continues to gain share, while Pacifico was the #4 dollar share gainer among U.S. beers.

The problem for Constellation – and its investors – is the U.S. beer market faces headwinds from tight consumer budgets. And beer accounted for 82% of all Q3 net sales of US$2.46b. The US$30b company cited value-seeking behaviour, like smaller pack sizes and cheaper alternatives, as it lowered its FY25 beer net sales growth target to 4%-7%, down from 6%-8% laid out in October. Operating income growth expectations for beer have been reduced to 9%-12% from 11%-12%. An operating margin of 39% is expected. The Q3 results highlighted the tough environment: shipments rose by only 1.6% year-on-year and net sales increased just 3% to $US2.03b. 

Constellation is investing heavily to maintain its market leadership regardless of penny-pinching consumers. Additional distribution is driving increased awareness and consumption: the company has acquired more than half of the incremental 500,000 points of distribution that it has targeted in its FY24-FY29 strategy. It’s also spending more on marketing. That investment may position it well as the U.S. emerges from winter, with some analysts citing summer as the next big catalyst for the stock. 

Bad spirits

In Q2, the company decided to take a US$2.25b writedown on its wine and spirits business. Non-core assets have been dumped: it recently sold the SVEDKA vodka business as it seeks to focus its portfolio on premium products. It sold wine assets to EJ Gallo in 2021 and The Wine Group in 2022. 

There is more work needed to put the wine and spirits business on a stronger footing. Sales have been hurt by cautious consumers, particularly in lower-priced segments, and retailer inventory destocking. Wine and spirits shipments fell 16% YoY in Q3, which was the primary driver of the 14% and 25% declines in net sales and operating income. Constellation did itself no favours with investors by adjusting its forecast FY25 net sales declines from 4-6% to 5-8%. Operating income is expected to fall 17%-19%. 

But there are some positive signs: its largest premium wine brands, Meiomi and Kim Crawford, saw depletion increases of over 7%. Depletions are the rate at which products leave a distributor's inventory and reach consumers at the retail level. This aligns with the company’s focus on improving margins by driving higher end brands and operating efficiencies. Constellation is using tactical pricing and marketing support in selected markets to boost its top ten largest brands. 

Cash slab

Constellation Brands continues to generate healthy cash flows despite consumer restraint. And that’s likely a reason for Berkshire Hathaway’s interest.

While the Q3 results were peppered with downgrades for sales growth, the company actually upgraded its cash flow forecasts. Operating cash flow guidance was lifted to US$2.9b-US$3.1b, up from a prior range of US$2.8b-US$3b. More importantly, free cash flow is expected to be US$1.6b-US$1.8b, up from US$1.4b-US$1.5b. This comes as the company continues to invest in new brewery capacity in Mexico. Assuming a normalisation of consumer spending, this capacity could drive additional sales and increased cash flows over coming years.

So far, the cash has flowed to shareholders: nearly US$220m was spent on share buybacks and over US$180m in dividends in Q3. This brings total year-to-date cash returns through share repurchases to approximately US$670m, or to more than US$1.2b including both repurchases and dividends. 

Liquid courage 

Warren Buffett has built his reputation on backing companies with big brands and undervalued shares. Berkshire Hathaway’s new stake in Constellation Brands provides exposure to some of the most popular U.S. beers, with cash flows for dividends, buybacks and capex.

A beaten-down stock price offers some margin of safety as Constellation awaits a rebound in consumer confidence, better performance from its (increasingly premium) wine and spirits business and, soon enough, some fine drinking weather in America.  

This is not financial advice nor a recommendation to invest in the securities listed. The information presented is intended to be of a factual nature only. Past performance is not a reliable indicator of future performance. As always, do your own research and consider seeking financial, legal and taxation advice before investing.