The Long and Short

Constellation Brands simpler capital should not affect ratings

Meredith Contente | July 29, 2022

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.

Constellation Brands’ board has urged shareholders to eliminate its Class B common stock to simplify the company’s capital structure. Each share of class B carries 10 votes and is considered a super-voting class. Eliminating Class B would also reduce the voting control of the Sands family. The proposal calls for a share swap to Class A shares and a cash payment for each Class B share. Management has noted the company will likely raise debt to fund the $1.5 billion payment. The added debt looks unlikely to hurt ratings now that the company has delevered from its equity stake in Canopy Growth, which was acquired in 2019. Ratings should remain intact once the company eliminates Class B shares and leverage should remain close to the company’s 3.5x net leverage target range.

Exhibit 1. STZ Leverage (Pro Forma – FYE 2019)

* Pro Forma LTM EBITDA assumes Bloomberg estimate for FY23
Source: Company Reports; Bloomberg; APS

Terms of the Share Swap

Under the terms of the proposal recommended by STZ’s Board of Directors, each outstanding share of the company’s Class B common stock will be converted into the right to receive one share of Class A common stock plus a cash consideration of $64.64 per share of Class B common stock. Given the amount of Class B shares outstanding, the total cash payment to be made by STZ to execute the swap is $1.5 billion. STZ expects to achieve a few corporate governance and other benefits with the share swap. First, the swap will reduce the concentration of voting power by the Sands family from 59.5% to 19.7%. The simplification of the equity capital structure will help to align the voting rights and interests of all shareholders. Additionally, there will be operating cost and administrative savings from the share swap. Upon reclassification of the shares, Robert and Richard Sands, Executive Chairman of the Board and Executive Vice Chairman of the Board, respectively, will retire from their executive capacities with STZ. The reclassification is not expected to go to vote until management calls a Special Meeting of Shareholders post filing a registration statement with the SEC sometime in the second half of calendar 2022.

Management noted on the last earnings call that while they have not fully figured out how they are going to fund the cash payment, given that they only have just over $100 million of cash on hand, they do expect it will include some new debt. The company will likely assess the interest rate market before deciding to issue new public debt. STZ maintains an untapped $2.25 billion revolver, maturing 4/14/27, that they could use should the primary debt market be unfavorable or “closed” as we have witnessed in prior weeks.

Strong Start to Fiscal 2023

STZ posted strong fiscal first quarter results with comparable sales up 17% year-over-year and operating income growth of 10%. The company also witnessed a 6% increase in operating cash flow, to $758 million. Results were largely fueled by the beer business which posted depletion growth of roughly 9.0% on a combined basis. The beer business represents roughly 75% of the company’s sales and EBITDA; performance at Modelo Especial remains robust with more than 15% depletion growth in the quarter given its ranking as the number one beer in the high-end category. The brand was also the leading share gainer in the U.S. beer category in terms of dollar sales. Pacifico likewise witnessed double-digit depletion growth, up 21%, as the brand regained distribution as brown glass availability increased.

The wine and spirits business also posted positive depletion growth and gained share in the quarter. STZ’s fine wine and craft spirits portfolio witnessed 16% depletion growth with brands such as The Prisoner Wine Company, Casa Noble Tequila and High West Whiskey posting significant growth well ahead of their respective categories. Management continues to use innovation to spur growth in the wine business and noted that Meiomi Red Blend became the second largest new product contributor in the wine category. In fact, Meiomi’s Cabernet Sauvignon, Red Blend and Pinot Noir hold the top three share gains in the ultra-premium wine segment.

Full Year Guidance Reaffirmed

Given the strong fiscal first quarter results, management affirmed full year guidance. Comparable EPS is expected to be in the $11.20-$11.50 range, which includes $1.3 billion in share repurchases through June 2022 as well as increased investments in the company’s digital business. Operating cash flow is still expected to be in the $2.6 billion-$2.8 billion range, with capital expenditures in the $1.3 billion-$1.4 billion range. Capex is increasing this year relative to 2021, with the lion’s share delineated to the expansion of the company’s Mexican beer operations. Through fiscal 2026, management expects to spend between $5.0 billion-$5.5 billion to support the addition of up to 30 million hectoliters of modular capacity, which includes the construction of a new brewery in Southeast Mexico. Given the increase in capital spending, free cash flow is being guided in the $1.3 billion-$1.4 billion range.

Meredith Contente
meredith.contente@santander.us
1 (646) 776-7753

This material is intended only for institutional investors and does not carry all of the independence and disclosure standards of retail debt research reports. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.

This message, including any attachments or links contained herein, is subject to important disclaimers, conditions, and disclosures regarding Electronic Communications, which you can find at https://portfolio-strategy.apsec.com/sancap-disclaimers-and-disclosures.

Important Disclaimers

Copyright © 2023 Santander US Capital Markets LLC and its affiliates (“SCM”). All rights reserved. SCM is a member of FINRA and SIPC. This material is intended for limited distribution to institutions only and is not publicly available. Any unauthorized use or disclosure is prohibited.

In making this material available, SCM (i) is not providing any advice to the recipient, including, without limitation, any advice as to investment, legal, accounting, tax and financial matters, (ii) is not acting as an advisor or fiduciary in respect of the recipient, (iii) is not making any predictions or projections and (iv) intends that any recipient to which SCM has provided this material is an “institutional investor” (as defined under applicable law and regulation, including FINRA Rule 4512 and that this material will not be disseminated, in whole or part, to any third party by the recipient.

The author of this material is an economist, desk strategist or trader. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM or any of its affiliates may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.

This material (i) has been prepared for information purposes only and does not constitute a solicitation or an offer to buy or sell any securities, related investments or other financial instruments, (ii) is neither research, a “research report” as commonly understood under the securities laws and regulations promulgated thereunder nor the product of a research department, (iii) or parts thereof may have been obtained from various sources, the reliability of which has not been verified and cannot be guaranteed by SCM, (iv) should not be reproduced or disclosed to any other person, without SCM’s prior consent and (v) is not intended for distribution in any jurisdiction in which its distribution would be prohibited.

In connection with this material, SCM (i) makes no representation or warranties as to the appropriateness or reliance for use in any transaction or as to the permissibility or legality of any financial instrument in any jurisdiction, (ii) believes the information in this material to be reliable, has not independently verified such information and makes no representation, express or implied, with regard to the accuracy or completeness of such information, (iii) accepts no responsibility or liability as to any reliance placed, or investment decision made, on the basis of such information by the recipient and (iv) does not undertake, and disclaims any duty to undertake, to update or to revise the information contained in this material.

Unless otherwise stated, the views, opinions, forecasts, valuations, or estimates contained in this material are those solely of the author, as of the date of publication of this material, and are subject to change without notice. The recipient of this material should make an independent evaluation of this information and make such other investigations as the recipient considers necessary (including obtaining independent financial advice), before transacting in any financial market or instrument discussed in or related to this material.