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Fuad Fadel Jim Fish Kevin Kaznica Matthew Krajna.

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Presentation on theme: "Fuad Fadel Jim Fish Kevin Kaznica Matthew Krajna."— Presentation transcript:

1 Fuad Fadel Jim Fish Kevin Kaznica Matthew Krajna

2 Business Segments Wine Spirits Crown Joint Venture Key Risks Health of the Consumer Joint Venture uncertainty Financial condition Corporate governance Valuation Multiple Scenario DCF Sum of Parts Market Multiples Sell Recommendation: $17 Price Target

3 Wine Spirits Business Segments

4 Constellation Lags industry CAGR of 3% Approx. 90% of sales Overall depletion trends lag industry Levered to the United States Industry Mature industry EM drive growth Value Trend Franzia Winetaps (The Wine Group) has largest market share of 7.9% Constellation lacks a Top 5 Wine Brand within the industry, by market share

5 5 Year Wine Sales CAGR Wine Sales YoY Forecast 2.25% growth -20% Actual Decreasing CAGR Lagging industry CAGR of 3%

6 Constellation Approx. 10% of sales SVEDKA double-digit growth No EM exposure, small market share Industry Global competitors EM driving growth Driven by flavored vodkas

7 Geographic Reach SVEDKA primarily U.S. based U.S. consumer remains fragile

8 Constellation Crown Imports 40% of EPS FY % of EPS FY2012 No solid commitment from Modelo beyond % growth in Net Sales Industry Craft/Imports are fastest growing category Social trend away from traditional beers

9 Joint Venture Uncertainty Financial Condition Health of the Consumer Key Risks

10 Dependence on U.S. Economy Not levered to EM or international markets U.S Economy seen as fragile Outlook for U.S. Economy PCE & Off-Premise consumption are flat Source: Bureau of Economic Analysis FY2012 Weaknesses: Weak consumer not able to trade up to premium Constellation took pricing on best wine brands No pricing power Decreasing volume trends Increased Marketing Spend Crown JV sales grew 3%, yet Equity Earnings decreased 6.3%

11 1. JV does not renew, Modelo imports own brands 2. JV does not renew, Modelo chooses new importer with more scale 3. JV renews Key Dates & Outcomes Modelo must give notice by 2013 to terminate The current JV agreement expires in 2016

12 Cash Flows $500M sustainable Balance Sheet Quality High Debt Level $2.6B on balance sheet $6B including purchase obligations and leases Low Times Interest Earned Poor quality 50% of assets Goodwill/Intangibles Income Statement Reliance on Crown JV for 40% EPS No Dividend

13 FY12 Earnings Release Target leverage ratio of x Results in debt level of $2,000M-$2,650M $2,600M / $664M = 3.92x projection New $1,000M share buyback Funded through NEW debt issuance Could increase leverage ratio Market will demand higher interest rate

14 Private Company Characteristics Dual-Class share structure Over 50% of voting rights 11.81% Equity stake Elect majority of Directors Strong resistance to changes in class structure Strong Academic Support Harvard, Wharton, Stanford Entrenchment decreases performance Value Destruction Share repurchases Source: GMI AGR: Aggressive accounting and governance behavior

15 Value destruction at all discount rates ROIC lags cost of capital

16 o $5B in acquisitions since February 2001 o $3.3B of which was Goodwill/Intangibles o $1.25B in write downs & impairments since 2001

17 Additional Risk Factors Private Company Aspect Governance Risks Company-specific risk e.g. JV termination Mid-Range WACC 10.41% Build-Up WACC 13.97%

18 Multiple Scenario DCF Market Multiples Valuation

19 11 Scenarios Base Worst Best Possible Crown JV Impacts Efficiency Gains 5 & 10 Year Valuations Sensitivity Analysis 2 Discount Rates 3 EV/EBITDA Terminal Values Price Target: $17 1.JV does not renew, Modelo imports own brands 2.JV does not renew, Modelo chooses new importer with more scale 3.JV renews

20 Constellation Brands Canisius College Base Case Net Sales$2,654M $2,661M EBIT$769M$782M EPS$2.34 (tax benefits)$1.89 Tax Rate17%35% Growth-1.0% growth2.25% growth FY 2013 EPS $ $2.09, 10% growth FCFE$ M forecast$440M estimate Tax Rate 34%35%

21 Median: 9.38 Average: Historical Avg. PE (Restated): 10.5 P/CF valuation price target of $16 P/E valuation price target of $22 P/E multiple: 10.5 Projected FY2013 EPS: $2.09 Measures Constellation value as a whole Does not discount additional risks

22 Valuation Wine SVEDKA Crown JV 3 Scenarios Sensitivity Analysis 2 Discount Rates Appropriate Scenario Conservative Simple Average Price Target: $17

23 SELL TARGET: $ % downside $17 $15.60 $17.10 Average sum of the parts valuation Average of all 11 scenarios WACC 10.49%, 13.97% Price on 4/5/2012: $21.61 $22 P/CF P/E approach

24 Key Risks Low growth/mature wine industry Weakness of U.S. consumer Corporate governance weakness Value Destruction Share buybacks Crown JV uncertainty Weak financial condition Market is inadequately pricing in risks of STZ SELL Recommendation: Price target of $17

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26 Earnings Release (25) Price Matrix (26) Crown JV graph (27) SG&A / 10yr scenarios (28) Hispanic graph (29) Modeled Growth (30) Margins (31-32) Diageo (33) WACC (34-35) Sum of Parts (36-39)

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29 EV/EBITD A of 10 Stress Tested Scenario 3, SG&A 10 w/ JV cont. Buildup$22.28 $13.90 Midrange$28.47 $21.98 WACC$33.72 $29.71 EV/EBITD A of 9 Stress Tested Scenario 3, test 1 10 w/ JV cont. Buildup$19.72 $12.76 Midrange$25.41 $20.36 WACC$30.23 $27.60 EV/EBITD A of 8 Stress Tested Scenario 3, test 1 10 w/ JV cont. Buildup$17.16 $11.62 Midrange$22.36 $18.73 WACC$26.75 $25.49 Average of Midrange $25.41$20.36 Margin Expansion Through Reduction in SG&A (Project Fusion) From 20.5% of Sales to 15% over 5 years We feel this type of efficiency is excessive Need for increased promo and ad spend Due to value proposition Crown JV Continuing for another 10 years We feel this is unlikely Modeled 8% Crown Equity Earnings growth BEST Case Scenario: 5% Wine growth 20% Svedka growth 10% Crown JV growth Price Target $21, SELL

30 Hispanic population growth is also highly focused in a few key geographic markets Strategic opportunity for Crown Imports Increase market share through increased distribution efforts Key states include California, Texas, Florida, New York, and Illinois.

31 EPS Growth modeled at 10% EBIT growth aggressively modeled at 5% Bucking 5 year negative growth trend

32 Gross Margin 40.1%, up 420bp YoY Operating Margin 20.3%, up 430bp YoY Upward biased changes due to divestiture of lower margin European and Australian wine business

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34 Diageo: U.S. Spirits business driven by flavored Vodkas [The U.S.] is showing very good signs of improvement. Its not a snapback…Now the U.S. is not going to offer us the same growth that Brazil can. Key takeaway: U.S. does not offer the growth that Emerging Markets offer Constellation Brands LACKS EM exposure Thus stuck with 90% of sales from a mature U.S. market Source: WSJ, March 26, 2012

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37 Target Price of $17 with Conservative Scenario, using build-up and mid-level discount rates

38 Wine value comes from Best Case scenario PV of wine sales only SVEDKA purchase price $384 million, adjusted for inflation, and multiplied by 4x to represent case vol growth Crown valued as the PV of forecasted equity payments

39 Crown value based on PV of future equity earnings Includes options that will be exercised Based on build-up method, discount rate of 13.97%

40 Crown value based on PV of future equity earnings Includes options that will be exercised Based on build-up method, discount rate of 13.97% Conclusion: Using both the build-up and mid-level discount rates, an average target price of $17 can be obtained, AFFIRMING SELL RECOMMENDATION

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42 Additional risk Build-up premiums (1-2% per item)

43 PVGO: The present value of growth opportunities is a tool to extract the markets expectations on future growth potential for Constellation. Using the CAPM we determined a cost of equity of 10.41% for Constellation. PVGO for Constellation under current market conditions is 16.97%. Peer median of 46.52% Market does not feel that Constellation has much growth potential. Given that Constellation has lagged the wine industry growth rate of 3%, the PVGO is justified, especially compared to its peers. Key assumptions: EPS: 1.79 TTM restated Price: on 1/12/12

44 Imported wines 1/3 U.S. wine sales USD appreciating against the Euro and Aussie Dollar Floods market with competitively-priced alternatives This is a negative for Constellation, as the U.S. consumer is still trending towards value brands

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46 STZ Vincor, Robert Mondavi, Ravenswood, Arbor Mist, and Ruffino Approximately 90% of sales Lags the industry growth rate Sold only 12.7% of the wine cases during 2010 Negative EPS between Negative organic growth in 2011 Extremely low exposure to emerging markets, leading to lack of revenue growth Industry: Smallest segment in the alcoholic beverage industry compared to beer and spirits 3% CAGR on average Mature and slow growth industry Large conglomerates, such as STZ Competitors are E & J Gallo, The Wine Group, Vina Concha y Toro, and Treasury Wine Estates 4-6% CAGR prior to the recession On-premise v. off-premise sales Larger growth in off-premise sales than on-premise (use graph showing this off Bloomberg) Value v. Premium Wine Sales Trend towards value brands continues Remains to be seen if producers can successfully persuade consumers to abandon value brands for premium Franzia Winetaps (The Wine Group), a value wine, has the largest market share of 7.9% High growth seen in developing markets, but mainly China where CAGRs are in the mid-teens

47 Californias 2011 wine grape crush, from all varieties, totaled 3,342,689 tons, down 7 percent from 2010 varieties accounted for the largest share of all grapes crushed, at 1,917,132 tons, down 7 percent from The 2011 white wine varieties crush totaled 1,425,557 tons, down 7 percent from On the price side, record highs were set for both red and white wine grapes average price for the 2011 crop of red wine grapes was $702.70, up 12 percent from 2010, while the average price for white wine grapes came in at $541.11, up 8 percent from last year. The 2011 average price of all varieties reached a record high of $588.96, up 8 percent from 2010 and 3 percent above the previous record high set in 2009.

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49 STZ SVEDKA, Black Velvet, & Paul Mason Brandy Since acquisition, Svedka is quadrupled in case sizes Approximately 10% of sales Miniscule market share with many global competitors Lacks brand recognition that competitors have Growing at double-digit rate Driven mainly by SVEDKA Industry: 2 nd largest market segment of alcoholic beverage industry Led by vodka and whiskey Smirnoff, Absolut, Grey Goose, & Skyy Diageo, Brown-Foreman, & Beam Global & Spirits Diageo controls the spirits market Shift towards spirits over wine and beer

50 STZ Crown Imports Corona, Corona Extra, Corona Light, Modelo Especial, Negra Modelo, St. Pauli Girl, Tsingtao, & Victoria JV 43.6% of EPS in 2011 Equity Earnings No solid commitment from partners beyond 2016 JV between was the only positive earnings segment for STZ Without which, it would not have been able to cover interest payments Not a beer company Industry: Largest market share compared to wine and spirits Dominated by major companies Anheuser-Busch InBev, Miller Coors, Crown Imports, Growing trend towards Imports and Craft Brews in the US Double digit growth rate compared to stagnant growth for whole industry 16.4% volume growth compared to -2%; Dollar growth, craft up 17.5% compared to.3% for the industry Attempt by companies to innovate with new products, such as Bud Light Platinum recently Strategy: Fast-growing acquisitions by major companies Ex: SAB Millers acquisition of Fosters Ex: Major companies acquiring craft breweries

51 Company had negative earnings

52 Personal Income rising, while personal savings decreasing, yet off premise spend on food/beverage flat

53 Managers protected from the market for corporate control tend to pursue inefficient investment products Journal of Finance August 2007; Masulis, Wang, Xie Democratic corporate governance strongly associated with higher relative returns Most democratic: 3.8 abnormal Most dictatorial: -5% Gompers, Ishi, Metrick Firm value increases with the cash-flow rights of the largest shareholder, but decreases when voting rights exceed cash-flow rights Claessens et al. Found a significant negative relationship between disproportional voting rights and firm value Gompers (Harvard), Ishii (Stanford), Metrick (Wharton)

54 PROPOSAL 5 STOCKHOLDER PROPOSAL Mr. Kenneth Steiner of 14 Stoner Avenue, 2M, Great Neck, New York 11021, who has indicated that he owns 1,100 shares of our stock, has given notice that he or his designee intends to make the following stockholder proposal at the Meeting. The Board recommends that you vote AGAINST the stockholder proposal. In accordance with applicable regulations, we include this stockholder proposal and supporting statement in the form proposed by Mr. Steiner: Equal Shareholder Voting RESOLVED: Shareholders request that our Board take steps to adopt a plan for all of our companys outstanding stock to have one-vote per share. This would include all practicable steps including encouragement and negotiation with family shareholders to request that they relinquish, for the common good of all shareholders, any preexisting rights, if necessary… The Board of Directors recommends that you vote AGAINST Proposal 5. Unless you properly direct otherwise, the shares represented by your proxy, if properly submitted and not revoked, will be voted AGAINST such proposal.

55 Key Assumptions: Scenario 4 – 10yr No Real Growth & JV Termination: Base Case, but with termination of JV. AB InBev would increase their stake in Grupo Modelo, triggering a cash payment of 4x EBIT to Constellation. In 2017, earnings from the Crown Imports JV will only incorporate 10 months due to the timing of the termination. Equity earnings going forward will be significantly impacted and no longer material. Constellation would receive a cash payment, estimated at $2 billion, upon notice being granted for FY2014. The scenario shows the effect of the joint-venture termination by Grupo Modelo. Scenario X – 10yr No Real Growth & JV Termination: Base Case, but with termination of JV. AB InBev would increase their stake in Grupo Modelo, triggering a cash payment of 4x EBIT to Constellation. In 2017, earnings from the Crown Imports JV will only incorporate 10 months due to the timing of the termination. Equity earnings going forward will be significantly impacted and no longer material. Constellation would receive no cash payment. The scenario shows the effect of the joint-venture termination by Grupo Modelo. Stress Tested Scenario 3 – Decreasing SG&A significantly: Same as Scenario 3, but with SG&A decreasing as a perfect of sales from 20.5% to 15%. We feel this significant of an efficiency gain would be significant, but drastic, and unlikely. 5yr Crown Cash Now, Best Case -- Modeled Scenario 3 with a $2 billion cash payment in year yr Crown Cash Later, Best Case -- Modeled Scenario 3 with cash payment of $300 million approximating estimated 50% of BV of the joint venture, upon termination this payment would be received by Constellation. 10yr Model with JV Continuing -- Base case, but assuming 10yr model 5yr Crown Cash Now, Base Case -- Modeled Scenario 1 with a $2 billion cash payment in year yr Crown Cash Later, Base Case -- Modeled Scenario 1 with cash payment of $300 million approximating estimated 50% of BV of the joint venture, upon termination this payment would be received by Constellation.

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62 Reverse Engineering: Holding all else equal for Scenario 1: At WACC of 7.18%, in order to justify price approximating current levels: A growth rate of 5% in CWNA A growth rate of 30% in Spirits A COGS of 56% in all five years SGA of 17% in all five years Equity earnings growth rate of 20% Income tax rate of 19%

63 Total estimated US Population M Boomers (2010) 79 M Millenials (2010) 77 M Generation X (2010) 51 M Source: US Census, Pew Research

64 U.S. mid-caps have historically provided only minor diversification benefits, having a correlation to large caps of more than 0.94 over the past 10 years. Mid-caps have behaved similarly to U.S. small-cap equities, exhibiting a correlation of The volatility of return on mid-cap stocks as measured by standard deviation was 18.8%, more than 3 percentage points greater than that of large caps. One way to interpret this number is to assume a normal distribution of returns. If you expect mid-caps to earn an average return of 6% in any given year, there is at least a 2% chance that the return will be less than 31.6% (two standard deviations less than the average). Viewed in this light, the 36% drop in 2008 should be viewed as unlikely but not impossible. Source: Morningstar

65 Common to use P/S valuation for: New company Company with accounting issues Value based on total net Sales Standard Deviation of 0.33 Highest target price is $16.15 = CONFIRMS SELL

66 Segment P/S Using projected sales for each segment & the average P/S and the 2011 P/S Use Crown earnings to find what investors are willing to pay for those earnings because STZ does not give Crown Revenue but Crown earnings Highest target price: Based on 2011 P/S alone, which is above average, a target price of $19.16 is obtained CONFIRMS SELL

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68 Imports grew 3.9 percent to million cases. - account for 32 percent of the volume of wine sold in the U.S. As the USD appreciates in value against the Euro and Aussie Dollar, imported value wines become cheaper to import, thus flooding the market with value brands This is a negative for Constellation, as the U.S. consumer is still trending towards value brands

69 1. Modelo gives notice by 2013 that the JV will NOT renew after 2016, and Modelo will import their brands into the U.S. 2. Modelo does NOT renew JV, chooses different party (other than STZ) as importer 3. Modelo renews the JV for another 10 years

70 Significant Governance Risk Private Company Aspect Company-specific risk e.g. JV termination WACC 10.41%WACC 13.97%

71 CAPM Book Weights WACC 7.18% Market Weights WACC 7.81% Effective debt cost Average 7.42%

72 Scenario 1 – 5yr Base Case: CWNA grown at 2.25%/year Spirits growing at 10%/year driven by SVEDKA sales Equity earnings, driven by Crown Imports, grew 8%/year

73 Scenario 2 – 5yr Worst Case: CWNA, Spirits, and Crown Imports sales grow at an inflation rate of 2%. Based on the fact our Worst Case scenario was a SELL rating, we did not do further sensitivity testing of lesser growth rates for wine, spirits, or Crown segments.

74 Scenario 3 – 5yr Best Case: CWNA sales growing at 5% YoY, which outpaces the industry average Spirit Sales driven by SVEDKA growth at 20% Equity earnings from Crown grow at 10% YoY.

75 Valuation Conservative: $17 Possible: $20 Unlikely: $24 Unlikely & Possible: $22 All: $20


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