Don't get starry-eyed over Constellation Brands
The Crown Imports deal is a major coup, but STZ still has issues.
By Charles Sizemore
It's not often that a stock with a $5 billion market cap soars by more than 20% in a single trading day, but such was the case Friday for Constellation Brands (STZ), the largest publicly traded wine merchant, and now the sole distributor in the United States of Corona and Grupo Modelo's (GPMCF) other Mexican beer brands.
Constellation was the unexpected winner in the Anheuser-Busch InBev (BUD) deal to buy the controlling stake in Grupo Modelo, as Constellation was able to buy out Bud's 50% share of the companies' Crown Imports joint venture for $1.8 billion. Under the new deal, Constellation will have complete control of the distribution, marketing and pricing for all of Modelo's brands in the U.S., while AB InBev will act as supplier.
The deal is a major coup for Constellation -- kudos to management for pulling it off -- but the company remains one of my least favorite stocks in the alcohol and vice sphere for a one critical reason:
Wine is much harder to brand than beer or spirits.
Think about it: When you go to a bar, you can instantly recognize your favorite beer or whiskey on tap or behind the bar. Outside of, say, Coca-Cola (KO), beer and spirits probably are the most recognizable and valuable brand names in existence. Not surprisingly, premium beer and spirits businesses tend to enjoy high margins and high returns on equity relative to their peers:
- AB InBev (BUD): 30.19% operating margin, 7.02% return on assets, 16.12% return on equity.
- Diageo (DEO): 26.12% operating margin, 10.28% return on assets, 41.07% return on equity.
- Constellation (STZ): 18.33% operating margin, 6.23% return on assets, 17.02% return on equity.
Wine is a different story. The attractiveness of a given vineyard varies from year to year, and few have national or international brand awareness. Wine connoisseurs know their favorite vintages, but there is little brand loyalty at the mass-market level. For a company of Constellation's size, wine is a much harder business to operate.
This is not to say that I dislike Constellation or never would consider owning it. "Sin Stocks" are some of my favorite long-term holdings thanks to their defensive nature and due to their tendency to pay high dividends (Constellation currently pays no dividend), and an argument can be made for making room for Constellation in a diversified vice portfolio. But I definitely would give a higher weighting to premium spirits groups such as Diageo, Jim Beam (BEAM) and Brown-Forman (BF.B).
One last thing to note: The Crown Imports deal allows Constellation to get a significant chunk of its revenues and profits from the premium beer segment rather than wine. This is good news. But it's also a source of concern because of a certain provision in the deal. AB InBev has a "call option" of sorts to buy the Modelo brands back in 10 years at 13 times earnings before interest and taxes. This price does not at all appear unreasonable, but if exercised, Constellation will find itself as purely a wine merchant again.
Charles Lewis Sizemore, CFA, is an editor and the chief investment officer of Sizemore Capital Management. DEO and BEAM are held in Sizemore Capital accounts. His new special report: "Top 3 ETFs for Dividend-Hungry Investors."
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