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Delevering accelerates for Constellation Brands

| April 5, 2019

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.

Constellation Brands announced it will sell approximately 30 lower-end wine brands and apply the proceeds to debt reduction. The accelerated delevering should be a catalyst for STZ debt to outperform debt of peers General Mills and Anheuser-Busch InBev in the 10-year to 30-year parts of the curve.

Constellation Brands announces asset sale

It was a busy week for STZ as the company announced that it would be selling approximately 30 lower-end wine brands to E. & J. Gallo for roughly $1.7 billion, ahead of its fiscal 4Q19 earnings announcement. The deal includes related facilities located in California, New York and Washington. The asset sale was expected as the company has been looking to shed some labels from its wine portfolio in an effort to focus on more premium brands. The wine labels being sold all retail for $11 or below. Management believes the sale will help position the portfolio for growth while delivering higher margins, after the company just delivered its second consecutive quarter of sales and operating income declines in the division. Despite the weaker results in the wine and spirits unit, STZ’s beer portfolio continues to drive growth on record volume levels and effective price increases. The deal is expected to close by the end of STZ’s fiscal first quarter (5/31/19).

While the $1.7 billion of proceeds came in a little light of expectations of $2.0 billion, the sale and continued commitment to debt reduction is a positive for STZ credit spreads. Management reiterated that proceeds from the sale will be used to for debt reduction, and that they will not return cash to shareholders via buybacks until reaching their leverage target. The company has $1 billion of debt maturing in 2019 which will likely be repaid, and $2 billion of term loans outstanding which can be prepaid in order to hit their leverage target.

Leverage to decline relative to peers

Constellation Brands ended the fiscal year with leverage of 4.4x.  Applying the wine proceeds and free cash flow (after dividends) to debt reduction could decrease leverage to 3.6x over the next 12 months, bringing them roughly in line with their 3.5x target. The ability to not only bring leverage below the 4.0x threshold but close to their target should push spreads tighter relative to similarly rated food and beverage peers.

General Mills (GIS – Baa2/BBB/BBB(n)) ended its most recent quarter with leverage of 4.3x.  While the company is in the process of delevering from its Blue Buffalo acquisition, free cash flow (after dividends) will only reduce leverage by roughly 3 ticks annually, bringing it down to the 3.6x to 3.7x by the end of fiscal 2021. Furthermore, Anheuser-Busch Inbev (ABIBB – Baa1/A-(*-)/BBB) has been slow to reduce debt and ended the most recent year with leverage of 5.0x.  Even after cutting the dividend by 50% to free up cash for debt reduction, ABIBB will be hard pressed to bring leverage below the 4.0x threshold over the next 2 years.

Exhibit 1: Current and estimated leverage metrics

Source: Company reports, Bloomberg consensus estimates

Relative value

While STZ currently trades on top of ABIBB, the wine sale is likely a catalyst for STZ to trade through ABIBB and closer to GIS. In the 30-year part of the curve, STZ’s mean spread trading differential has been roughly 13 bp through ABIBB year to date. That said, given the expectation for STZ to bring leverage to the mid 3.0x area approximately one year ahead of GIS, we think STZ spreads could collapse closer to, if not on top of, GIS.  Currently, STZ trades roughly 14 bp behind GIS in both the 10-year and 30-year parts of the curve.

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