Start Buying Constellation Brands Inc. Fairly Valued But Nearly Overweight

Edited by Juna Yanoyan

After divesting its Australian and U.K wine businesses in 2010, Constellation Brands sells a variety of wine and spirits in the U.S., Canada, and New Zealand. Notable premium wine brands in the firm’s portfolio include Robert Mondavi and Arbor Mist. In addition, the firm entered an agreement to purchase the remaining 50% of its Crown Imports joint venture, whereby Constellation sells the brewer’s offerings (including Corona) in the U.S.

Constellation Brands (STZ) produces and sells over 200 brands of beer, wine, and liquor, but most of the company’s revenues come from its Wine segment. The stock closed yesterday’s trading session at $36.92. In the past year, the stock has hit a 52-week low of $17.95 and 52-week high of $36.50. Technical indicators for the stock are bullish, our main concern is that the stock has entered the overbought area. All things considered, we think the company is fairly valued at current levels.

PROFITABILITY AND BALANCE SHEET

The company’s adjusted earnings of 71 cents per share in the second quarter of fiscal 2013, it was better than consensus estimate of 54 cents but below the previous year period earnings of 77 cents. During the last quarter, the company’s interest expense rose 28% to $55 million, driven by the rise of the company’s average borrowings from increasing demand as well as increased average interest rates. Constellation Brands expects fiscal year 2013 earnings to fall to $2.00-$2.10 per share, on an adjusted basis. This is primarily due to higher interest expense and a higher overall tax rate.

VALUATION AND GROWTH

STZ has a market cap of $6.74 billion, is the largest wine company worldwide, though that translates to less than 5% of the global wine business, given the industry’s fragmentation. Net sales in the quarter increased 1% to $698.5 million from the year-ago quarter. The P/E of 19.85 times is above the industry average of 17.40 times, and makes the stock attractive. The stock is currently trading at its fair value thus leaving no room of upside potential, the stock momentum though makes us optimistic. The beta of 1.13 implies higher volatility of the stock with respect to the S&P 500. The firm has a generally very high debt to equity risk.

STZ has strong global market leadership due to the increasingly growing wine market and rising demand in the developing world. On the other hand, STZ has high debt to equity to meet the increasing raw materials costs.

RECENT NEWS

October 15, 2012, 1:01 PM – 5 biggest positive earnings surprises: Constellation Brands (STZ), Surprise Amount: 31%, EPS: 71 cents vs. 54 cents (analysts). Stock Performance Year-to-Date: 70% gain.

October 14, 2012, 10:00 PM – According to a filing with the SEC, Jeremy Fowden, a Board member at Constellation Brands (STZ), purchased nearly 3,100 shares of the company’s stock on Oct. 8 at an average price of $36.22.

October 10, 2012, 12:21 PM – Form 10-Q for CONSTELLATION BRANDS, INC.

RECOMMENDATION for next 6 months: We initiate our coverage with START BUYING. The company has demonstrated a pattern of very bullish short term technical signs and positive fundamental performance. We believe that the top line will continue to grow on the back of increasing global demand for wine and spirits. Shares are 69% higher, year to date as of the close of trading yesterday.

For short term trading we suggest a long call at $38 for the December expiration.

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