What the future holds for Constellation Brands

Constellation Brands, the largest multi-category alcohol supplier in the US, is on the verge of completing a deal it believes will transform its growth and profitability.

It is almost two years since the first reports appeared that Constellation wanted to offload up to 30 wine brands at the lower end of its price and profitability spectrum and 18 months since an initial US$1.7 billion deal with Gallo was announced.

Now, after much negotiating with US competition authorities, the deal will be completed in a few days time, watered down to $1.03 billion in value.

Significant brands moving to Gallo include Clos du Bois, Franciscan and Ravenswood, while (pro tem at least) Constellation will retain both J Roget’s and Cook’s California “Champagnes” and a number of other minor lines, plus the Mission Bell winery.

Separately, Gallo will buy Constellation’s Nobilo New Zealand brand and facilities for $130 million.

Since 2013, Constellation has focused relentlessly on its premium beers, notably Corona and Modelo, which bought when AB InBev was forced to relinquish the US rights to the brands. In short order, Constellation has made them the leading premium offerings in the US.

The strategy now is to focus on wines with retail price points starting at $11 and spirits above $14, concentrating on margins rather than volumes.

In the same way that it has driven rapid growth in beer, Constellation reckons that by concentrating on only premium-end wines and spirits (Mondavi, Kim Crawford and Svedka vodka, for example) it will be able to increase its overall operating margin to 30% and within a comparatively short time frame begin returning a further $5 billion to investors via share buybacks and dividends.

In 2019 alone the company reduced its outstanding debt by $1.4 billion and returned more than $600 million to shareholders and on Friday it announced the early redemption of $650 million debt.

While coronavirus has affected sales and costs (it is more expensive to produce cans and bottles for the take-home market), the company has fared reasonably well during the pandemic and has a €1.7 billion cash stash and an extra $1 billion-plus coming in from the Gallo deal.

Wall Street analysts are confident that the company will continue to grow organically with its present portfolio, despite a dispute with the Mexican government of the location of a giant new brewing facility.

But they are more excited by the long-term prospects of new ventures, not least seltzers and cannabis-infused beverages, two sectors where Constellation has been blazing the trail.

The Corona hard seltzer brand was launched in the US only in March, just as the pandemic hit North America, but analysts reckon it has already grabbed market share of about 6% and growing.

Undoubtedly it is helped by the popularity of the Corona brand name and the switch to home consumption, but they have little doubt that Constellation’s seltzers will remain leading contenders in the fast-burgeoning, but so far comparatively small, category, backed by its marketing power and distribution network.

Constellation signalled its intentions in the market for cannabis infused beverages more than three years ago when it bought 10% of Canopy Growth, Canada’s leading marijuana business. It has since increased that holding 38.6% and has the right to take it up to a controlling 55% via various financial instruments it holds.

Canada was the first significant country to relax its cannabis laws, giving Canopy a head start on competitors based elsewhere.  Estimates suggest that earlier this year legal sales of cannabis products in Canada overtook the illicit market.

To date Constellation has spent some $4 billion in buying its stake in Canopy and funding brand development. That level of outlay, and the initial poor return has raise eyebrows, but the US group has changed Canopy’s top management and put in more stringent controls.

Although it has yet to make a profit, Canopy is the biggest player in the North American market for legal cannabis products and launched a range of cannabis-infused drinks in Canada in March under names including Deep Space and Tweed. By July it needed to double production to beat stock shortages, sales no doubt boosted by lockdown.

Canopy claims to hold 70% of the Canadian market, having sold two million cans since March. On the back of that, it plans to enter the US market next year via California and Illinois.

Not all is plain sailing. Retailers report problems including shelf life of only a few days and inconsistent taste, which can deter potential repeat consumers.

While Canopy and Constellation hope the sector can overcome these technical obstacles, the stark fact is that Constellation is showing a large loss so far on its investment in the cannabis company.  In the three months to the end of June it recorded a loss of $31 million in Canopy.

According to Reuters, the latest research predicts that the global legal market (medicinal and recreational including drinks) will enjoy an 18% compound annual growth rate to make it worth €73.6 billion by 2027.

And Constellation will benefit from Canopy’s product spectrum, including medicinal cannabis not just beverages – it already holds 22% of Germany’s bulk cannabis flower market.

As it stands, Constellation has stolen a march through Canopy, with other drinks groups taking a much more cautious approach, recognising that the high hopes for cannabis-infused drinks becoming a global market will depend on how far and how fast national governments ease their laws.

In the United States, much could hinge on the outcome of tomorrow’s elections.

Shareholders will be hoping that Constellation’s heavy investment in Canopy is relying on more than pot luck.