Constellation presents a mixed bag

In the next couple of weeks both Diageo and Pernod Ricard will comment on the latest state of trade, so it is inevitable that their progress will be benchmarked against Constellation Brands’ latest performance in the key US market.

On Wednesday, the world’s largest wine producer presented a mixed picture.

Profits in the second quarter of the year fell by 8.4% in absolute terms to US$93.1 million, but if one-off items such as the costs associated with the sale of the UK cider business are stripped out, Constellation actually beat the market’s forecasts despite sales falling by 2% to US$863m.

Beer sales in North America were problematic but wines were more buoyant. The company said that consumers were gradually trading up to higher priced wines, which was encouraging.

Wine sales in North America are Constellation’s biggest earner and rose by 4% on a constant currency basis compared with the second quarter of 2009. Wholesale volumes to retailers rose by about 7%, partly reflecting Constellation’s move to focusing more on exclusive distributors, a pattern pioneered by Diageo a few years ago.

But much of the consumer’s move up the quality ladder was due to discounting and promotions, a pattern that the company expects to continue over the Thanksgiving and Christmas holiday periods.  

Chief executive Robert Sands said that wine volumes were growing by about 2% to 3% a year, but the key question is what happens when the company seeks to impose higher margins and cease promotions.

In Europe and Australia wine sales dropped by 12% and spirits revenues fell by 15%. Constellation has acted to cut costs on both continents but, like Fosters, remains beset by low-margin Australian wines and while spirits have been a source of growth, analysts are cautious about that trend continuing in the US.

Despite a reported 15% decline in spirits earnings, the Svenska vodka brand performed strongly with double-digit sales growth to distributors. Can that trend continue, however? The absorbtion of Svenska into Constellation’s portfolio is almost complete, so maintaining such a buoyant growth rate could prove tricky.

Nevertheless, Constellation is maintaining its full year-profits forecast despite expecting sales growth to moderate early in 2011 as discounting eases.

Cost savings have increased the operating margin by about 70 basis points to about 17%. That compares unfavourably with both Diageo and Pernod Ricard, whose business focuses more on higher margin spirits than Constellation’s wine-based business model, but at least it is moving in the right direction.

The margin improvement and the confirmation of this year’s expected profits pushed the shares up by 4% on the day of the results announcement.

Finance on Friday, 08.10.2010