USA: Constellation Brands can get beer margins back to 40% without raising prices, analyst says

Constellation Brands Inc. is poised to get beer margins back to 40% without input cost declines or price hikes, according to Roth MKM analyst Bill Kirk.

Kirk reiterated his buy rating on Constellation’s stock and raised his price target to $284 from $270 in a note published on July 3, as he weighed in on the company’s better-than-expected fiscal first-quarter earnings posted on June 30.

The note highlighted the company’s beer segment results, where its Modelo Especial recently replaced Anheuser-Busch’s Bud Light as the bestselling beer in the U.S. That’s partly due to the backlash against Bud Light that began in April in response to its partnership with trans influencer Dylan Mulvaney.

Constellation’s beer sales rose 11%, driven by a 7.5% increase in shipments. Beer depletions, a metric that measures the number of cases sold by distributors to retailers, rose 5.5%, although that was down from 6.3% in the fourth quarter.

Kirk said depletions likely accelerated through the quarter and entered the second quarter at about 10%.

“The cadence tracks our recent upgrade thesis, but incremental upside was offered in the form of increased brewing efficiencies,” Kirk wrote in the note.

The analyst upgraded Constellation Brands to buy in late May, after being at neutral since January 2021, while boosting his stock price target to $270 from $216.

“We believe 3mn hectolitres in more efficient use of existing assets can bring beer EBIT (earnings before interest and taxes) margins back to 40% (without any change in inflation or sequential pricing),” Kirk wrote.

Constellation executives told analysts on the earnings call that it had become 3 million hectolitres more efficient with existing capacity.

“This would represent an ~8% throughput improvement that would carry strong incremental margin,” said the note.

Another positive is that Constellation left its guidance unchanged, despite the earnings beat. Kirk said he does not think the current guidance includes benefits from the Bud Light share losses.

One risk to his thesis is further weakness at Constellation’s Canadian cannabis asset, Canopy Growth Corp., he added. Constellation invested $4 billion into Canopy in 2018 as Canada was gearing up to become the first G-7 country to fully legalize cannabis for adult use.

Despite that substantial sum, Canopy has struggled to make money ever since for a variety of reasons, including a massive oversupply of product and a shortage of retail outlets early on.

Last week, Canopy added “going-concern” language to its latest quarterly update, in which it said it has cut 1,200 jobs in the last year.

Constellation said it does not plan to provide any more capital to Canopy Growth but it will retain its ownership stake in the company.

Constellation’s stock has gained 7% in the year to date, while the S&P 500 has gained 16%.

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