Positioning

Constellation Brands, Inc. (STZ) Management Presents at RBC Capital Markets Global Consumer & Retail Conference (Transcript) – Seeking Alpha

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Constellation Brands, Inc. (NYSE:STZ) RBC Capital Markets Global Consumer & Retail Conference Call June 2, 2022 12:00 PM ET
Company Participants
Garth Hankinson – Executive Vice President and Chief Financial Officer
Conference Call Participants
Nik Modi – RBC Capital Markets
Nik Modi
Good afternoon, everyone. I’m Nik Modi, RBC’s senior HPC, beverage, packaged food and tobacco analyst. I am pleased to introduce Garth Hankinson, Constellation Brands’ Executive VP and Chief Financial Officer. Garth has been with STZ since 2001 has held a variety of roles across corporate development, business development and financial planning and analysis.
Constellation Brands has been one of the most attractive top and bottom line growth profiles across our coverage with strong trends continuing for its beer business and the wine and spirits business at stabilizing after the divestiture of the low end business. A lot of the investor debate on Constellation over the last year has been on capital allocation. So we are very excited to have Garth to talk about all of these topics.
So I guess, Garth and by the way, thank you for being here. The question really is I want to open with this beer top line guidance, right? So you are sitting in that kind of 79% range, which is in line with your medium-term algorithm. Can you just talk about kind of how you think about that in terms of how conservative that number is given the operating environment that we find ourselves in?
Question-and-Answer Session
A – Garth Hankison
Yes. Well, first of all, thank you, Nik, for hosting us and thank all of you for being here. It’s nice to see people exist in 3D and not just on video screen.
Nik Modi
Actually these are just robots.
Garth Hankison
So look, Nik, I mean I think that we continue to be in a very enviable position as it relates to the portfolio of brands that we have in our performance as we look at our first quarter and I’ll start with depletions. Our depletions are running in line with our expectations for the full year and in line with our expectations for the quarter. And that’s – and that’s taking into account some really difficult overlaps particularly earlier in the quarter for the months of March and April. So we are on good track there.
Moving on to consumer takeaway, if you look at the IRI and you look at the most recent trends, we continue to outperform the competitive set in the broader category. In a latest 4-week period, we are outperforming total beer by about 11 percentage points. We are outperforming in the high-end by about 9.5 percentage points. We have increased our share taking additional share of about 1.7% in the total category and about 2.4% in the high end. Those share gains are an acceleration over recent trends. So we are performing quite well. And I think that, that momentum is going to continue. We are very comfortable with our mid-term growth algorithm and we define our midterm period as kind of that 3 to 5-year period. We feel really good about being able to deliver that high single-digit growth at the net revenue line with 1% to 2% of that coming from pricing. So we are in really good shape as we head throughout the year.
Nik Modi
And of course, being a premium-oriented portfolio and a leader in the high-end, investors will always worry about consumer trade-down in an environment of inflation. So can you just address that dynamic and kind of how you feel about the portfolio and the positioning within this kind of consumer landscape?
Garth Hankison
Sure. And this is obviously something that we pay particularly close attention to and something that we are monitoring as we go through the fiscal year. Fortunately, for us, we participate in a category. And if we look back on historical sort of economic slowdowns or recessionary appearance, that total beverage alcohol has been somewhat insulated meaning that the rate of growth might slow, but it doesn’t stop and it certainly doesn’t start declining. That’s true across all beverage alcohol it’s also true of the premiumization trends. That premiumization continues maybe at a bit of a slower rate, but continues to grow and that, that migration continues to occur. And then when the recessionary period or the weakness of subsides, you get right back on kind of where you were that growth trajectory that you were historically at. So, we feel pretty good about that. We also feel good as our research would indicate that if you look across all of the categories inside of grocery, the consumers have the least amount of concern around pricing as it relates to beverage alcohol products. So we feel like we are somewhat insulated in that front.
And if you think about this in the context of the broader grocery basket and beverage alcohol only being about 2% of consumer spend, it doesn’t represent a big part of a consumer’s wallet. So we – again, we think that that’s a net positive for us. Obviously, as I said, this is something we are going to continue to monitor as we move throughout the year. Things like the continuing inflationary environment, the impact that higher interest rates could have as government programs that were in response to COVID sort of fall away, we will see – we will monitor their impact. But so far, we have seen no indication that consumers are trading down or trading out.
Nik Modi
Excellent. So, Modelo Especial has obviously been the key growth engine of the portfolio. So one thing we have noticed as we have looked through the data, some numerator data is how the brand really recruited a much broader consumer demographic during the pandemic and they tend to be actually higher income, quite frankly. So I am just curious, when you think about the opportunity for Modelo going forward. Can you just talk about it within the lens of broadening the profile going from kind of a more core Hispanic consumer group to kind of broadening the rings around different demographics?
Garth Hankison
Over the medium term, Modelo, Modelo Especial is going to continue to be our number one driver of growth. It’s now the number two brand in the U.S. It’s been on a 30 plus year really unbelievable tear. There is still a lot of upside for that brand if we look at it in the context of space and distribution. And again, to your point on the consumer makeup, on that point specifically, about 4, 5 years ago, we made the decision to start expanding or extending our marketing and advertising beyond the base Hispanic consumer to the broader market to the more general consumer. Before we do that, the consumer makeup was about 80%, Hispanic consumer, about 20% general market. Fast forward to where we are today and that’s 55%, 45%. So I think that, that kind of gets to the point you were making about who the consumer is now and what their profile looks like. There is still room to be able to attract new and different consumers to that brand and that franchise. If you look at that in context to Corona, Corona right now is about 35% Hispanic and 65% general market. So again, I think that, that’s an indication of where the brand can go.
Beyond that, there is still an opportunity to increase household penetration. While Modelo is now bigger than Corona, it still only has about 80% of the household penetration if we can close that gap. That represents another 2 million consumers that we can bring to the franchise. And then beyond that, we have, as I say, space and distributions continue to be a big driver of growth for us. It – Modelo continues to have fewer points of distribution compared to its biggest competitor and also has fewer points of distribution compared to Corona. It’s the number one brand in a number of key markets and number two brand in some other key markets, but we are seeing some really interesting growth for that brand in some of the middle tier markets and in some of the interior of the U.S. We have seen very strong growth in markets and historically haven’t been strong with us all markets like Birmingham, Alabama, New Orleans. And so we think that there continues to be a lot of runway for both effective – basic and effective distribution. And as you know, basic distribution has been to get on the shelf and an effective distribution meeting, getting the amount of shelf space allocated that our brands deserve based on the turn to profitability and its rate of growth. So, that’s a lot of runway left for there. And I haven’t even touched on the ability to extend that brand. We have been pretty successful in extending the Corona brand to new variants that are consistent with the brand equity and consistent with the brand essence. We really haven’t done much of that with Modelo outside the Modelo Chelada, which has kind of been a sneaky big brand for us. There is a lot of runway for sure with Modelo Especial. If you think about awareness and extending that, that’s a brand that this year we are adding pack sizes, we are adding formats, we are adding flavors. So we think we will continue to grow that brand family through Chelada. We have got some interesting things in test market, most notably in Modelo Oro, which is a light variant. That’s in a few markets right now. Early – it’s too early to get a firm read on that, but the early indications are that, that’s quite successful in additive. We are probably still a couple of months away before we make a decision is just how incremental that could be and where do we want to take the brand, but we are excited about that. So, again, a long runway for us, lot of growth opportunities still for the Modelo Especial and the Modelo family.
Nik Modi
And just going back to the whole distribution, I know it’s been a long battle and struggle in terms of shelf space and really getting your fair share based on the velocity that your portfolio brings to the table. Are you finally seeing retailers start to open up in terms of rethinking how much spacing they allocate different suppliers?
Garth Hankison
Yes, we have had an initiative underway for the last several years that we call Shopper-First Shelf and that’s ourselves working with our retail partners using real data to try to influence how they think about shelf sets. And it’s not just the shelf, it’s the shelf. It’s what’s on the floor and it’s what’s in the coal box. And having retailers think about their shelf space is the most precious asset that they have and then allocating that asset to those brands that turn the fastest, grow the fastest, have the most profit associated with them. We’ve been very successful. Over the course of the last 2 years, we’ve been able to gain about 15% shelf space in each one of those years. And then we’re expecting to gain another 15% this year. So it’s an initiative that we’ve focused on the last few years. We’ve got a lot of success when we’re expecting that continued success.
Nik Modi
Excellent. Now Modelo obviously has been a great growth driver, but Corona has really accelerated. Can you just talk about why that happened? Like what is really driving the acceleration of that brand as large as it is?
Garth Hankinson
Yes. As you know, on the Corona Extra in particular – in the recent past, it’s kind of been in the low single-digit growth rate. Last year, it was about 9%. Last year, it benefited from the reopening of the on-premise that, that drove a lot of its outsized growth. That being said, we know that that brand equity is sort of over indexes versus other brands. in terms of the equity in it. So we think that there continues to be velocity gains there. That’s a little bit of what I would say is the wildcard for us going forward is whether or not that 9% that we experienced last year is really just reflective of the reopening or whether or not there’s some continued momentum over and above the recent past, as Corona Extra.
For the Corona Franchise, we continue to think that there’s a lot of belief that there’s a lot of room to grow Corona Premier. That’s a segment within the high end that has been very attractive since its inception a few years ago, it’s had double-digit growth. And again, we continue to expect to enjoy strong growth going forward. Its growth last year was moderated a little bit due to some shortages of raw materials. And as a result, we had a few stocks there. We’re now fully in stock with Corona Premier. So that will be a big focus for us going forward. Interestingly enough, Corona Premier is an opportunity first in on-premise that’s starting to get real traction there. So we’re going to invest in both draft beer and cans, light beer, premium light beer, high-end light beer, that can format is the dominant format there. So there’s room for us to invest there and make good headway as it relates to cans. So that will be a key driver for the Corona brand family, a brand like Refresca, which is a smaller RTD or FMB, if you will, I should say is a brand that pre pandemic had started to grow quite nicely and exceeded our expectations. Unfortunately, as we went through the pentane had our we had a production slowdown out of Mexico, and we have prioritized our top SKUs. That was one that we had to deprioritize, so we took it out of market. We reintroduced it last year. That’s rebounding nicely. It’s a very nice alternative drink, certainly an alternative to things like Seltzer, which are lower flavor – lower carbs more of a full flavor of higher calorie but certainly has consumer positioning that resonates with folks.
So we think that that’s a real opportunity. And we continue to believe that we’re going to play in the broader, what we call AAV space with the Corona franchise, whether that’s with Corona Hard Seltzer or Lemonada Seltzerita. We think that AAVs and Gerald had a long runway of growth or long history of growth, I should say. It’s a dynamic category. Things kind of come in and come out of it, but it’s important to the high end is a leader in the high end. We’ve got to compete there. We’ve got to be successful, and we think the Corona brand is the right brand to play in that space. We just have to do it in a very differentiated way. We probably didn’t do that with our first offering of Corona Hard Seltzer, but certainly we feel Lemonada Seltzerita and the reformulated, repackaged Corona Hard Seltzers, is more consistent with the brand and is differentiated versus our competitive set. So again, it’s another strong brand franchise for us.
Nik Modi
Yes. And then kind of rounding out the top three brand franchises, Pacifico, which you’ve been kind of on and off, it was doing really well and it kind of had a moment of time where it was a bit soft and now it’s really recovering nicely. And I know you have some glass supply issues that you are dealing with, but just talk about that brand and the geographic opportunity that you have with that brand?
Garth Hankinson
Yes. So that brand I mean historically has been very strong in Southern California. And it’s really just been in the last couple of years where we start to expand that more broadly, more nationally as I spend behind it. That’s a brand that our Head of Beer Jim Sabia you know him well and prior to him taking over the role for running Oliver. He was our Chief Marketing Officer. He is a big advocate proponent for building brands the right way and building brands over time so that you’re generating real equity and you’re building a sustainable brand. So we’ll migrate that in a very thoughtful manner across the country, folks in kind of on the west, not to say that you can’t find it out east, but you focused on the west. It’s a brand that’s differentiated from the rest of the portfolio in terms of its consumer. It tends to be a bit younger and more active lifestyle, and you see that in the way we position it and we market behind it when we promote it. It’s a brand that given its growth potential. We’re increasing our investment behind that brand by about 62% this year. So we’re spending behind it strongly. And interestingly enough, was the one direct grower last year in the on-premise. So we think that there’s some real tailwinds for us in the on-premise with Pacifico. So it’s a brand. We have a lot of interest in seeing how that develops in – and you’re right, last year, growth has moderated a little bit, mostly due to brown glass shortages that seems to be behind us at this point. And so it’s full speed ahead.
Nik Modi
Excellent. So obviously, with going from a pandemic to endemic I think, at least for now, the on-premise has been recovering. Can you just talk about that because that took a real big hit obviously like it did for the rest of the beverage industry – beverage alcohol industry. So where are we? What’s the state of the union on on-premise?
Garth Hankinson
Yes. So on-premise, just in general, we think, is about 90% recovered from the pandemic for us and as a channel, you’re seeing rates of growth there in recent periods of really high double digits and in some instances, triple digits. So again, the channel is strong. As you know, pre pandemic then made up about 15% of our sales portfolio-wide. And its low point during the pending got down to 3%. We finished last year for the full year at about 11%. But in Q4 of last year, we ended at about 12%, and we think we’ll get back to that mid-teens in relatively short order.
We think that this is a big opportunity for us. If you look at a brand like Modelo, which is the number two brand overall. It’s only the number five draft brand on-premise. It only has about 11% distribution. So it was the number two growing draft brand behind Pacifica last year. So again, we think that there’s an opportunity there. Corona continues to be a strong brand on-premise. That has about high teens percentage of its sales come on-premise. So if you juxtapose that Modelo get up to where Corona is a big opportunity for Corona. Corona Premier is really taking off in the on-premise. So it will be a focus there. And as I mentioned earlier, Pacifico, given its growth rate on-premise, we think that, that’s another opportunity for us. So the on-premise is, in short, the on-premise is coming back and coming back strong. We think it will be – for us, we think it will be – it will make up a similar percentage as it did pre-pandemic over the course of the next few several months, and we think it’s an opportunity for us going forward.
Nik Modi
Now there’s been a lot of debate controversy, if you will, around Constellation’s pricing strategy. And I think it’s because maybe people don’t have the right context of what the company has done over time, right? So you have several of your peers or competitors taking up pricing at a rate that is much more dramatic than what Constellation has indicated in his public commentary. So can you just talk about that? So it’s just kind of clear like what is actually driving some of your strategy?
Garth Hankinson
Sure. And I think you’re right, there’s a lot of questions on this. And the question is really, why aren’t we taking more pricing given the inflationary environment that we are in, particularly what you are hearing from not only our competitive sets, but what you are hearing from other companies in consumer packaged goods. And so our response to that has been and continues to be that look, we have a very disciplined approach to pricing. And we use the same disciplined approach year after year. And as we said in our growth algorithm, we’re going to get high single-digit in net sales growth and 1 to 2 points of that is going to come from pricing. And historically, we’ve got to the usually at the higher end of that range. When we’re looking at taking price, we do it on a brand-by-brand market-by-market SKU by SKU basis. And we don’t often take pricing on the same SKU in the same market in two consecutive years. So, when we are taking price on a particular SKU, in a particular market, it’s more than that 1% to 2%, so happens and that’s what it averages out over the entirety of the portfolio. Again, we do that every year. And so some of our competitors within the beer space don’t necessarily do it every year, some do, some don’t. Some do it every year. We do, right. And so those that are taking more are perhaps playing a little bit of catch up as a result of the inflationary environment. We also tend to think that when you look at the headline price increases from some of our competitors versus what they will actually achieve, those might end up being different in terms of where you price up and then how you promote back. We tell you what our pricing algorithm is, that’s the net effect. And so we think that, that’s – and that’s clearly a difference between us and other consumer packaging categories. We know that other things, particularly in the food space, haven’t been able to take price now because of the rising input costs, they have played catch up for the last couple of years. So, it’s a little bit different. I think I just want to round out this response too, again, we take this disciplined approach because we want to – we have the consumer in mind when we are thinking about price. What we don’t want to do is we don’t want to price our consumers out of the franchises that we have. We don’t want to lose the momentum that we have on the top line. And if you look at from the consumer lens, sure real wages are growing, but they are not growing as fast as inflation and the gap between those two things has actually widened over recent periods. And when you also consider that our consumer still tends or over-indexes to span consumers and if they span a consumer tends to get harder in periods of economic uncertainty and slowdown and recover more slowly, we have to be very mindful of that. And that’s why we are going to continue on a very disciplined approach, Nik.
Nik Modi
Excellent. And just kind of dovetailing into the cost side, right? So, obviously, you are still feeling inflation. Several companies that have been at this conference have indicated that they are expecting it to remain inflationary over the next 12 months, right? So, not betting on deflation. What’s your philosophy in terms of the overall inflation environment? Where should we be thinking about potential movers in terms of things that could get worse or could get meaningfully better. So, any perspective on that would be helpful.
Garth Hankinson
Yes. So, I mean first, as a general comment about the inflationary environment and like, look, I would like to be able to tell everyone what the outlook for that really is, but we have been wrong, not just Constellation, but all of us have been wrong for the last year. I mean when we were together a year ago, we were talking about inflation where we said, okay, inflation is going to spike in the summer and then we are going to start reverting towards mean at the end of the summer. As we move to the summer, we pushed that out three months and we got another three months. And so I still think that there is an expectation that the inflationary environment gets better in the second half of the year. But again, I think we have been wrong for last year. We think that we are managing rising input costs in a pretty responsible way. As we announced in our last earnings call, we entered the year more hedged, more highly hedged than we typically do. Taking a step back, we typically plan on inflation in any year – in any given year, it’s being right around 3%, plus or minus a little bit. This year, we are expecting to be in that high-single digit to low-double digit range. On that last call, I went through a whole range of input costs. And on the low end, they are going up 5% and the high net go 36%, averages out to that high-single digit, low-double digit. That’s why we entered the year more highly hedged. We typically enter the year at about 50% to 60% hedged. We entered this year around 60% to 70% hedge and then we continue to layer in some hedges when we have seen some softness in the commodity markets. Right now, we are about 90% hedged on DSO, about 75% on aluminum, about 70% on natural gas. So, again, higher than we would typically be. So, that’s one of the keys for us to be able to manage for the inflationary environment where we have some exposure and where we might continue to see some pressures is even though we are highly hedged in diesel, things like trucking, domestic trucking continues to be an area that there is tightness. There is certainly a shortage of drivers, particularly over shorter hauls. That’s certainly where there is greater exposure there on our Wine & Spirits business, and there is on our beer business. Our beer business, about 70% of our freight is done via rail. Those contracts are largely fixed, but we do have some exposure to diesel surcharges. Again, we think based on the contracts and relationships we have plus the hedging, we think we are well over there. But it’s a pretty volatile commodity market. I think move pretty wildly at times. And in experience, we will continue to have some headwinds as it relates to international shipping, obviously, Kim Crawford and Ruffino are big brands for us. And just given the congestion at ports and the costs associated with that, those costs continue to be a headwind. So, that’s another area. Those are some of the biggest areas. But we will likely have more to say on that here in a couple of weeks when we get to our Q1 earnings. We are just – we are kind of in day two of closing out our first quarter of the fiscal year as well as doing our first sort of latest estimate for the balance of the year now that we are a quarter in. So, it could be more to come on that here in a few weeks.
Nik Modi
Excellent. We look forward for that, Wine & Spirits, a lot of stuff going on, a lot of activity, right? You have the low-end divestiture. You have done a couple of bolt-on deals. You have this transition to Southern Glazer’s, but the business has been under pressure because there are some onetime issues. So, just kind of talk about what the prospects are? When do you think you will get back to your kind of normal algo and when we can expect some of those margins that you guys were anticipating a couple of years ago?
Garth Hankinson
Yes. I got the answer. I am more bullish on the wine business than maybe folks who are just looking at it from the outside. Number one, I think that there is real momentum building it in Wine & Spirits and let me just remind you that the reason that we are falling short of our top line growth algorithm this year is because of those one-time impacts from last year being smoke here at bulk wine and some of the route-to-market changes that occurred. But if you look at recent IRI data, right, for the last several periods, you will see that there is some real momentum building in our portfolio. We are now outperforming the broader category. We are outperforming at mainstream wine. We are outperforming in the high-end wine brands like Meiomi can profit. The Prisoner is showing really good signs of growth. Woodbridge, which has had – which is falling under pressure in the last couple of years, and we have been doing some repositioning of that brand. We are starting to see the fruits of that. And that’s in a price category that’s been under pressure. That now an IRI data, if you look at us back to growing. So, I think that there is momentum building for our Wine & Spirits division. And we fully expect to be back in our top line range next year. And to get into the range that we have stated for margins, we tend to be there on a run rate basis by the end of next fiscal year.
Nik Modi
Got it. Okay. And then just to round out the question set here, a final question on capital allocation, which is, of course, a topic that investors love to talk to Constellation about. So, a lot of stuff has been in the marketplace. You guys have been very clear. Can you just talk about capital allocation priorities, just remind us this whole notion of bolt-on versus large scale? And then any perspective around share repurchases and the A to B conversion that was recently announced?
Garth Hankinson
Sure. And like, look, I hope when we talk about capital allocation, I am going to give you a boring answer because you have heard me say it before. But we have sort of four priorities within our capital allocation considerations, if you will. First is we remain committed to being investment grade. This is something that we think provides us a lot of flexibility. It’s important to us. We have said that over the sort of mid-term, our target leverage ratio is right around 3.5x. It might be times we are a little bit below that might be times we are a little bit above that. We ended last year at 3.1x. So, we are in a very good position there. Priority number two is to continue to return capital to shareholders through the combination of dividends and share repurchases. Last year, we made fantastic progress on our share repurchase program. We bought back almost $1.4 billion worth of shares. We entered the year, I think we are going to buyback $1 billion. And in Q2 of last year, when we saw some weakness in our share price, we got a little bit more aggressive, and we upped our spend for the full year by the tune of almost 40%. Obviously, we announced earlier this year, the ASR for $500 million, and we will have more to talk about our share repurchase activity when the quarter close this year or when we announce our earnings in a few weeks. We also, for that matter, on a rate per share basis, increased our dividend. So, again, I think that, that just goes to show the commitment we have in terms of both share repurchases and dividends. Then we are going to continue to invest in the growth of the business. Again, we are in a very enviable position that we have a growing portfolio. And we are in the enviable position that it’s highly profitable and generates a lot of cash, so we can act on all of our priorities. And again, the third one of those is investing in the business. The most notable piece of that is the $5.5 billion that we announced earlier this year in January this year. The expansion is going to take place over 5 years in Mexico to build out capacity so that we can continue to supply the robust demand we have for the brands. And then on one experience, we have invested in front of things like DTC and three-tier e-commerce. Again, which we think is going to be a big growth driver for us moving forward. And then the final piece of our capital allocation strategy is rounding out the portfolio, doing some gap portfolio, gap fillers, bolt-on acquisitions. We are going to utilize our venture arm to the best extent that we can. We did that last year. Last year, we had three M&A transactions, Booker Wine Company, awesome cocktails and Lingual Franca, all of those were relatively small dollar amount, but they represent big opportunities for us from – if you look at that from a consumer positioning perspective. And we were able to fund those almost entirely through the divestiture of one non-core venture investment. So, net-net, those three M&A transactions only resulted in a net $20 million outlay when you take into account the inflows we have from the divestiture. So, that’s how we are – that’s how we have been prioritizing our capital, how we are going to tie to prioritize our capital allocation.
Nik Modi
And any update on the A to B conversion, or are we still waiting to get…
Garth Hankinson
Nik, that’s just something that there is not an update really something as we said on the last call, management is not involved and that’s a discussion that takes place between the family and the special committee. And I just – I don’t have anything to share.
Nik Modi
Well, thank you for that anyway.
Garth Hankinson
For sure, Nik.
Nik Modi
And thanks for being at the RBC Consumer Conference. We are out of time. Thanks everyone for coming. And thanks again.
Garth Hankinson
Thank you.

source

future-dyanmics

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