Constellation Brands, Inc. (NYSE:STZ) Barclays 2022 Consumer Staples Conference September 7, 2022 11:15 AM ET
Company Participants
Garth Hankinson – Chief Financial Officer
Conference Call Participants
Lauren Lieberman – Barclays
Lauren Lieberman
So we’re going to get started. We’ve now got Constellation Brands. And I’m very happy to have Garth Hankinson, the company’s CFO with us today. Garth, thanks for being here, so good to be back in-person. So looking forward to exploring a lot of different areas of Constellation’s business during this fireside, but I wanted to first – kind of before we dig into the individual segments, maybe talk a little bit about the bigger picture investment philosophy for the company because I think that’s often a big topic of discussion. So first off, Constellation stood out to us recently by the fact you actually raised reinvestment plans for fiscal 2023, accelerated $35 million to $40 million of digital investments, not a lot of companies are spending more in this environment and sort of proactive longer term projects. So I was curious to first hear a little bit about what this incremental spending means, what kind of things it can enable the company to do that haven’t been the case historically.
Garth Hankinson
Sure. Well, Lauren, thanks for hosting us and thanks for everybody to joining. It’s great to be able to do this in-person for the first time in quite a long time. Before I get to that question, if you let – indulge me on a couple of housekeeping matters. First is that I’m sure that there’s continues to be a lot of interest in the B share reclassification that is something that we filed in the preliminary S-4 with the SEC that’s up for – that’s up on our website for people to review it. So to the extent anybody has any questions, I would just refer you to the website for both the S-four and anything else that we’ve filed with the SEC. And then just finally as you know we just closed out our fiscal second quarter a few days ago, so I can’t speak about Q2 results. So we’ll just talk really about performance at the beginning of the year.
With that housekeeping behind us, digital business acceleration. So, first of all, let me say, as you noted that not a lot of companies are doing this, but we think that this is what best-in-class companies do. And that’s to continue to reinvest in yourself so that you can maintain the momentum that you have and continue to drive the growth and the margin profile that we have. The digital – the DBA initiative that we announced earlier this year really is kind of a continuation of some of the investments we made most notably last year with the implementation of a new ERP system that went across our – the entirety of our business. It used to be that we were wine and spirits divisions, we’re on separate ERP systems and even within our beer division, they operated both in a JDE platform and as well as in SAP.
So for the first time we have a common ERP platform across the entire enterprise. And as a result of that, we have much more insight and availability of data that we can then use to measure the performance of our business and to deliver insights on how we can continue to drive the business forward. And so, the entire DBA program really is geared towards that, really improving and creating ourselves as a leader in the digital space and maintaining the momentum of the business. And this will be a multi-year project. Obviously, we announced the initiative earlier this year around three specific initiatives, which we’ll get to in a minute. As we move closer to FY 2024, we’ll have more details around what is next for this program, if you will.
The things that we announced this year again given that we do have greater availability and insight into our business is to be able to take those insights and to be able to drive real sustainable improvements either from a cost basis or from a performance basis. The three that we announced, we’ll start with end-to-end supply chain. So with the availability of more data around where inventory is in our system both on our – in our own shop as well as with our distributors, and then look at purchasing behaviors, we’ll be able to optimize where inventory is that should increase our on-time and in full order rate or fulfillment rate and should also take costs out of the business as we won’t have to move product unnecessarily around the country to ensure that we’ve got plenty availability of supply.
The second thing that we’re working on is procurement. If you look at the totality of the procurements that we spend on an annual basis and you look at the number of suppliers that we deal with, we now, again, have a greater insight to those various suppliers, the various rates that we’re paying, and then we have better benchmark data available for us to be able to look and see where is there opportunity for us to take cost out. So we’re excited about that as well. And then finally, this year’s – the other initiative we have this year is really around optimizing our performance efforts and efficiencies, particularly around attracting new consumers through digital initiatives, more social media marketing, making sure that we’re attracting the right consumers for the right brands and doing it in an efficient way that sort of we’re not necessarily advertising in markets that don’t support the efforts.
So we’re very excited about how that can augment our existing marketing efforts and how that can bring new consumers to our franchises. I think it goes without saying, but I’ll say it anyways is that certainly you invest ahead of getting the benefits, but each one of these initiatives has a high return associated with it. So certainly something that we think is going to be key to us continuing to perform in the way we have performed.
Lauren Lieberman
Okay, fantastic. I’m going to shift to investments in beer production capacity. You’ve committed $5 billion to $5.5 billion over the next three years, adding 25 million to 30 million of hectoliters in capacity. How much of these construction costs are kind of locked in versus at risk of experiencing their own inflationary pressures, material, labor, freight, et cetera?
Garth Hankinson
Yes. So let me start by saying we already had additional capacity come online last year at Obregon. We continue to have some further capacity coming online in Obregon throughout the remainder of this fiscal year. The good news from a cost perspective is, as those costs are sort of already locked in, we’re kind of in the final phases of much of that. Then if you look at the expansion at Nava, most notably the expansion of – in the creation of a – and a facility specific to AABs that – that facility was largely finished last year, but then we’ve added flexibility and added capabilities to that facility. And so that will come online early next fiscal year. So again, the cost associated that is largely, already out the door so to speak.
But if you look at what we have coming sort of in front of us, specifically Veracruz, where we announced earlier this year, we’ve identified a site for our third brewery in the Southeast of Mexico. When we announced the $5 billion to $5.5 billion, as we historically have said, those Greenfield sites take about three to four years for them to sort of come online and be finalized. And we also announced that we would be at the higher end and maybe already above where we historically had been on a Greenfield. So the historical range has kind of been at that $150 to $200 per hectoliter. Again, we said, we’d be at the high end of that range if not slightly over. So that already took into account the inflationary environment that we’re currently operating in.
Clearly, our plans are still evolving as it relates to Veracruz on exactly what that brewery will look like and in terms of what the output is as well as the type of output, so those plans are still a bit fluid. But we feel we’re in a pretty good position, particularly given where we got it on the $5 billion to $5.5 billion that it reflects the current pricing environment or the current cost environment.
Lauren Lieberman
Okay, great. And then I guess, how are you thinking about the current production footprint just in the context of the drought in Northern Mexico over the summer? How does that tie back to your water stewardship efforts and the new goals that you’ve set?
Garth Hankinson
Yes, so we feel good about overall our production footprint. As you know, we’ve had a couple of years in a row where we’ve had some interruptions in production and that’s resulted in some out of stocks. We’re now in a position with a new capacity that has come online that we’re finally ahead of demand. And so again, we feel really, really good. We’re in a good inventory position across our own warehouses and those of our distributors. And we have ample capacity to fuel future growth both where we are now, plus with the expansions that we’re doing. Specific to water in the north we have the water that we need for our current footprint as well as for the planned expansions that we have in the north and in Veracruz working with President López Obrador’s administration. We’ve identified the appropriate titles that we need and we’re under contract for many, if not all of that.
So we’re making good progress there. I will say from a water stewardship perspective we’ve been very mindful of improving our efficiency if you will. And if you look at the period between our fiscal FY 2020 – our fiscal 2017 and fiscal 2022 on a per hectoliter basis, we’ve reduced our consumption at Obregon by about 18% and we’ve reduced our consumption at Nava by 13%. And we’re continuing to looking at ways for us to be able to be more efficient with our water usage. Beyond that, we want to be good citizens of the communities in which we operate. And then as such, we’ve been working again with federal and local governments and non-government agencies to do our best to make sure that there is ample availability of water for those communities.
I’ll give you a couple of examples of things that we’re doing there. So in the State of Coahuila and in the City of Zaragoza, we’re working with the local water authority there to drill additional wealth as well as replace some aging infrastructure. So that that makes for a much more – it increases availability and increases efficiency, and some of the age infrastructure we’re seeing that we’re replacing that can be up to sort of 60% wastage. And so again, we’re looking to be good corporate citizens. In the state of Sonora where Obregon Brewery is located, we’re working with the Yaqui water authority, and we’re helping rebuild three dams around the Yaqui canal. And as a result of those efforts that will be reclaiming 15 billion cubic meters of water over a three year period of time. So again, I mean, we’re doing our level best to be more efficient at our breweries and to be good stewards in the community to ensure that the communities or the citizens in the communities, in which we – that we operate are happy to have us as for their neighbors and creating good sustainable relationships with our governmental partners.
Lauren Lieberman
Okay, great. Just one more question as we look sort of more broadly at capital allocation. We’re approaching the end of the full year $5 billion cash return target. I guess, how should we maybe think about incremental cash returns to shareholders in 2024 and and beyond versus kind of pursuing other growth opportunities? I will leave out the segment of my question about the Class B.
Garth Hankinson
Well, by the way, I could probably answer that question if I will.
Lauren Lieberman
Okay. Okay.
Garth Hankinson
So, first of all, I would say that, we’re – obviously we’re committed to the $5 billion commitment of returning capital to shareholders. In fact we’ve already met and exceeded our commitment on share repurchases. So again, we finished that early and we over delivered. So that really just leaves continuing to payout the dividend in the normal course. So clearly, I’m highly confident that we’ll meet our $5 billion commitment. I would say that what’s beyond that. We’ll have more to say about that as we get closer to our fiscal 2024. And as the results of the reclassification coming to more sharper focus, if you will. So clearly, we’ll have more to say about that.
That being said, our capital allocation priorities remain unchanged. We’re committed to being investment grade. And as we’ve said, we have a target of 3.5x and quite candidly we’ve operated comfortably below that really for more than a year now. Now, as that relates to the reclassification, should that get approved? That would pulse us above the 3.5x for a period of time. Fortunately, we’ve got a nicely growing business, but with best-in-class operating margins that generates a lot of cash. So we’ll be able to delever relatively quickly. So we feel quite positive about that. As it relates to that – to the potential reclassification, we’ve already secured about $1 billion of that with committed financing on a delayed draw feature.
It’s three years in duration, which we think is – it’s – and it’s prepayable at par. So it’s a very effective way for us to be able to delever post-transaction. Beyond our leverage targets, clearly, the second priority is continuing to return capital to shareholders through dividends and share repurchases. And again, we just – we need to get the reclassification flow behind us before we can talk much more about what comes next. The third priority then is continue to reinvest in the in the organic growth of our business in both beer and in wine and spirits. Most notably in beer right now is the $5 billion, $5.5 million that you’ve already referenced.
And then finally, the last priority is to round – rounding out our portfolio – filling portfolio gaps through a smaller scale bolt-on, tuck-in type of acquisitions. Historically, we’ve done transactions like the Naomi’s of the prisoners of the world. But most recently we’ve really leveraged our venture portfolio. This past year, not even a year, we acquired the Booker wine Booker wine’s Booker wine space out of our venture portfolio. And we acquired Austin Cocktails as well which is a neat spirit based RTD that’s completely on trend. Both of those brands are actually growing quite nicely. We also acquired a small Oregon winery Lingua Franca. And the neat thing about that is if you look across those three acquisitions tool, which came from our venture portfolio, if you look at the total dollar outlay and then you net that against a venture investment that we decided to divest, which was a very nice asset, but non-strategic asset, we almost completely offset the cash outlay through the divestiture. So we’ll continue to take that approach to M&A and to capital allocation more broadly.
Lauren Lieberman
Okay, that’s great. So you mentioned you’re a nicely growing business. So, in late June right things had still been very strong in terms of underlying demand across the portfolio despite the sort of macro backdrop. So just curious what you’ve been seeing in terms of consumer behavior any changes in terms of pretty much changes in the market, on-premise behavior, convenience in gas, but anything you could point to in terms of changes in consumer behavior in recent weeks.
Garth Hankinson
Look, I mean, the consumer takeaway trends continue to be quite robust in the latest 12 week period for our beer business, Modelo Especial almost up 17%, Corona Extra up almost 10%, Pacifico goes up over 40%. We’ve got four of the top 15 share gainers in the beer category. In the 12 week period, we’ve taken about 1.8 percent share points of total beer and about 2.5 of the high end in at least four weeks, we’ve actually taken two – we’ve gained 2% share in total beer and 2.7% in the high end. So things continue to fire on all cylinders for beer. And in wine, we’re seeing continued outperformance versus the competitive set, which has really been consistent for the last six months, which gets still one of the reasons why we continue to be very positive or have a very positive outlook for wine. So again, syndicated data is really strong.
As you look at the metrics that we’re monitoring, one of the ones that we monitor most closely is buy rate, which is the number of trips that consumer makes to a retail outlet times, the dollar spend per trip. And the good news is that the consumer continues to be very resilient. If you look at high-end beer, and you look at the Hispanic consumer in beer, you’re seeing an increase in both the number of trips and in the dollar spend. So again, it’s pretty resilient.
And then you’re seeing similar things in high-end wine where buy rate continues to be strong, sort of in line with more recent historical norms. Trips seem to be somewhat I would say consistent, but you’re seeing a little bit increase in the amount of purchase per trip. So again, you were seeing some real resiliency with the consumer.
Lauren Lieberman
Okay, great. And Corona Extra in particular, right, has been very strong, right, coming off a strong fiscal 2022, without asking for guidance beyond this year. Just how sustainable do you think that refresh momentum is for the brand? I mean, what continues to drive this resurgence in Corona Extra?
Garth Hankinson
Yes. Look, it’s been a fantastic brand, specifically recently, it’s – as I noted, the latest 12 weeks and the syndicated data it’s up 9.7% in our first quarter, our first fiscal quarter. Depletions grew about 4%. We think for the balance of the year, it’s going to continue to grow. It’s sort of in that rate, which is in line with our medium-term algorithm. And we think that there continues to be opportunity for Corona Extra. If you look at the brand, it’s – it continues to have some distribution opportunities. I mean, it’s pretty widely distributed across the coasts. But there’s still opportunity for that sort of in the center of America. Even along the coasts while it’s widely distributed, it still doesn’t have the same distribution as some of its competitive set.
So there’s clearly opportunities for increased points of display. Given, the strength of the brand equity, we think that there continues to be opportunity for us to leverage that brand equity and to appeal to younger consumers. And we’re going about that through various marketing efforts as well as sponsorship efforts. And so we think that that continues to be a real opportunity. And then and that would be remiss if I didn’t mention that, we have favorable demographic trends. The Hispanic consumer is – Hispanic demographic is expected to continue to kind of grow to 3% to 3.5% compound annual growth rate for the foreseeable long future. And that brand is one that SKUs 35% or 35% of the brand performance is with the Hispanic consumer.
So, very good demographic transfer for us there. And then we still have opportunities to leverage some of the recent line extensions that we’ve that launched. Corona Premier which is on trend. And certainly something that last year as we had some of the production issues. And as we had some tightness on glass, we experienced more out of stocks on that brand than maybe the broader portfolio. And so that’s now back in full distribution and just given the dynamics within the market. We think that there’s continued room for strong growth with that brand within the brand, within the Corona brand family. So, again, I mean, I think that all indications are that Corona continues to be really healthy and still has opportunity for good growth.
Lauren Lieberman
Okay, great. Have to ask that Modelo of course, right. So growth has been so strong there in double digits. I don’t even know how long at this point. But while Chelada has been in the market for quite a while, or is I think a different push in terms of innovation. So how important is innovation to continue to drive the growth of Modelo kind of what are you seeing on the initial reach in from that brand? How’s the track, I guess, relative to Premier, when Premier was at, as the Corona family?
Garth Hankinson
Yes. So, I mean, just in general around Modelo, I mean, Modelo continues to be a super healthy brand, right. I mean, as we just mentioned 70%, the latest 12 weeks. So – and there’s still a lot of opportunity for Modelo Especial again with distribution, same kind of story as I just outlined for Corona Extra, although there’s more opportunity – certainly more opportunity in the middle part of America and even further opportunity along some of the less traditional coastal cities. We’re seeing good growth for that brand and in markets like New Orleans for instance, and in North and South Dakota. So that brand continues to have great distribution tailwinds. Obviously, there’s also the Hispanic consumer demographic that we already talked about growing.
And for that brand, that’s a brand that right now is about 55% – 55% of that is with the Hispanic consumer, 45% general market. There is the general market opportunity for Modelo Especial. I mean, that’s a brand that about five years ago or so before we started actively marketing to the general consumer. The profile of that brand was about 80% Hispanic, 20% non-Hispanic. So that’s now 55%, 45%. And as I previously mentioned, Corona as a comparison is at 35%, 65%. So there’s opportunity there. And then, there is innovation, right? The Modelo has been a – it’s been a – it’s turned into a sneaky big brand with tremendous growth. And it’s one that we think is going to continue to experience this dynamic growth. So we’re very bullish around Chelada and we come out with new flavors. We come out with new packaging formats which we think makes the brand even more dynamic and more approachable, so to speak.
So again, I mean, it’s a very, very healthy brand. I would say that innovation is not the key to that brand going forward. Much like innovation is not the key to our entire beer portfolio going forward. Our long-term growth algorithm is 7% to 9% and we know that we can get into that range, albeit at the long end without innovation. And so, it’s – the brand is very, very healthy.
Lauren Lieberman
Okay. And initial reach on Oro.
Garth Hankinson
Initial reach on Oro, I’m sorry. Started in four test markets performed really well. And then if we looked at it against the metrics of both of our internal and external benchmarks, it performed in line or better than as expected. And as a result, I think was announced earlier this year that we’re going to go on – we’re going to launch that brand nationally next spring. It really is a unique offering. I think we’ve really kind of nailed it with the pace profile and with the brand proposition. So we’re excited about what that brand can be.
Lauren Lieberman
Great. And Pacifico, so I’ve been sort of intrigued by Pacifico is a third, like for a long time. And I – the, I know that there’s been supply chain challenges and so on. We past that now, so you mentioned you cited the really strong growth that you’ve seen in the scanner data. I guess, where do you stand, do you think on Pacifico kind of getting the marketing right. Getting that brand to be something that can be that sort of leg in a viable way?
Garth Hankinson
Yes. This is a question we ask ourselves internally all the times, like what’s the best way to sort of manage the growth of Pacifico going forward. I’ll restate that, again, in the latest four weeks, it’s – our latest 12 weeks it’s up over 40% in track channels. In our Q1 depletions, we’re – our depletion growth was over 15%. We’re expecting depletion growth for the full year to be in that 10% to 15% range, which is kind of consistent with our mid-term algorithm for the brand. That’s a brand whose growth, at least the near-term growth will be almost entirely distribution driven. As you know, it’s a brand that started out very strong in the West, and it’s just now starting to migrate across the rest of the country.
We’re going to prioritize key DMAs here for the next little bit specifically in the West and Midwest as we roll out. But we think that that brand has got – that’s got a lot of runway in front of it. It’s a bit of a different consumer. So it’s quite additive to the portfolio, which skews younger to the – more Gen Z active lifestyle. And that’s reflective of the marketing in which we do. And again, it’s a different consumer, so highly accretive to portfolio.
Lauren Lieberman
Okay, great. I appreciate you maybe very tired of getting asked this question, but I would be remiss if I didn’t. So just latest sentiment on pricing, particular that your competitors taking pricing up kind of high single digits, and you reiterate this 1% to 2%, so latest stance, and maybe why?
Garth Hankinson
Sure. And Lauren, I don’t get tired of you asking if you don’t get tired of me answering. And that’s going to be that the 1% to 2% is a very, very disciplined approach, right? I mean, and we take this 1% to 2% pricing every year. And some of our competitors are more or less disciplined in terms of the timing and the cadence in which they take pricing. But we get this 1% to 2% every year. And we do it in a way that, again you’ll hear me say this word a lot. It’s very disciplined. We – well, it’s stated is 1% to 2%, it’s not 1% to 2% sort of across the board. We look at this on a market-by-market, brand-by-brand, SKU-by-SKU basis.
And we don’t from year-to-year, necessarily take pricing on the same – in the same markets on the same brands on the same SKUs. So in any given year, when we do take pricing on what we’re taking pricing on, it’s actually well above the 2%, right. It just so happens that it averages to 1% to 2% over the entirety of the portfolio. So – and that has served us well, right? As we’ve been able to get this compounding effect of pricing, and we’ve been able to do it in a way that has not impaired the performance, the momentum that we have behind the brands. And we certainly don’t want to lose that momentum. I will also note that the 1% to 2% is not a floor or a ceiling. I mean, this disciplined approach gives us a lot of optionality to look at what the various market conditions are and how the consumer is reacting. And I think last year is a good example of that, where we achieved pricing in excess of the 2%.
So – and you heard us, reference that I think in our Q1 earnings call where we said that, we have the optionality based on again, market conditions. A couple things that I just want to sort of point out relative to our pricing particularly relative to the competitive set is one, I would just continue to encourage people to look at gross versus net pricing, sort of what’s the stated increase versus what are people actually realizing after they promo or price discount back.
When we say we’re getting 1% to 2% pricing, we’re really getting 1% to 2% pricing. And so that’s the net effect. I would also remind everybody that our portfolio resides entirely at the high end. And many of our competitors span multiple price tiers, if you will. And so when we say we’re taking our price up sort of 2%, that in some instances is analogous to others who are saying, they’re taking theirs up, whatever it is, 3%, 4%, 5%. If you look at it on an absolute dollar basis, just given the price gaps between us and our competitors. So the percent increase might be different. But the dollar impact, again, in many instances is quite similar.
And again, as we’ve said before, I mean, we’re always trying to do what’s in the best instance of the brands and not do something where pricing consumers out of the portfolio.
Lauren Lieberman
Okay. And so it sounds like, what you’re telling me that the gap in effective pricing is much smaller than perceived, because I think the question I get is what’s the risk of Constellation’s portfolio no longer being the high end, if you’re right, if you’re pricing less and your competitors, the gaps narrow, are you still the high end?
Garth Hankinson
Yes. Look, I would just encourage you to look at the data and see, like, what are you seeing in the data. And I think that, even without 1% to 2% pricing, if you look at the most recent IRI data and you look at price increases for the high end versus our portfolio. I think you’re seeing that we’re pricing above the high end. And those gaps by the way, those price gaps between us and our competitors have expanded over time. And so I don’t think that there’s any risk that our portfolio will not be positioned very strongly within the high end.
Lauren Lieberman
Okay, great. Okay. I’m going to make sure to touch on wine and spirits in last few minutes. Actually, I’m going to jump, so on wine and spirits, you’ve talked about the goal to migrate towards kind of low single to high-single digit revenue growth from the 28% [ph] to 29% margins after the portfolio rationalization. But it seems like that timeline has been pushed out of it. So could you just walk through whether that filter, like the appropriate long-term set of targets and the main building blocks to get there?
Garth Hankinson
Yes. And I’m sorry that we’re running out of time because I’d like to talk more about wine and spirits, our strategy and how we’re migrating from a company that’s been mostly focused on wholesale, mainstream, high volume focus to one that’s more of a higher-end omnichannel, global beer or wine company. So we’ll cover that another time. But specific to the margins, look, we still think that those are the right margin targets. I mean, obviously, when we went through the portfolio reshaping size, it started about three years ago or so. We had a target of about 30%. We lowered that this year to 28% to 29% to really reflective of two things.
One is the inflationary environment that we were currently in and the impacts that has had. And then the second is just the investment that we’re making to fully leverage the opportunities that are in front of us around 3-tier e-commerce and DTC, and building out the capabilities we need to effectively participate in those segments. And we’re being quite successful. We’re outperforming by 3.5 percentage points, the competitive set in DTC and 3-tier e-commerce. And so we think that the 28% to 29% is the right target. We’re going to end this year. The target at the end of this year is to be right around 24.5% operating margins. And that’s about 130 basis point improvement on a year-over-year basis.
And as we’ve said before, I mean that improvement is going to be – it’s going to come from a variety of different factors. We’re going to continue to take pricing. We’re going to build out that pricing discipline in wine and spirits similar to what we have in beer. And we announced pricing in the spring that we announced our intention for pricing this year in the spring that went into effect in Q2. So through the second half of this year, we’ll start to see the benefits of that. Mix is going to continue to be a positive provider with incremental margin for us. And then, we always said we had to what we’ll call kind of design the value opportunities to make sure that we’ve got the right sort of consumer proposition at the right price points doing in a way that does not detract from the consumer experience.
In fact, continuing to overdeliver on the consumer experience. So, it obviously took us a little bit longer to get to our – it’s taking us a little bit longer to get the margin profile that we wanted to. Those were really driven by two things. One was the time it took to actually close the transaction to divest our lower end wine business. And then the second was it was the inflationary environment, but we still feel like those are the best or those are the right targets. And we think when we achieve those and we’ll have best-in-class wine margins, like we have best-in-class beer margins.
Lauren Lieberman
Okay, great. I’m sorry, we didn’t get to talk more about it strategically.
Garth Hankinson
That’s okay. Next time.
Lauren Lieberman
Next time. All right. Thank you so much for being here, Garth. It was really great. Please join me in thanking Garth for joining us.
Garth Hankinson
Thanks.
Question-and-Answer Session
Operator
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