Cheap Wine Stock Should Age Well

03/17/2011 1:25 pm EST


Gavin Graham

Chief Strategy Officer, INTEGRIS Pension Management Ltd

After reversing an ill-fated acquisition spree, Constellation Brands is getting back to basics, writes Gavin Graham in the Internet Wealth Builder.

Constellation Brands (NYSE: STZ), the largest wine company in the world by revenue and the largest premium wine company, offers a value-priced play on the potential growth of the US wine market.

Constellation also owns 50% of Crown Imports, the joint venture that distributes Corona Extra and Corona Light, the best selling imported beer in the US. As well, Constellation owns Svedka Vodka, one of the fastest growing premium vodkas.

The company's well-known wine labels include Woodbridge and Robert Mondavi (acquired in 2004), Vendange (2001), Franciscan Oakville Estate, Estancia, Ravenswood, Arbor Mist (1998), and Clos du Bois (2007).

If you notice a number of acquisitions on this list, that is because Constellation spent the decade between 1998 and 2007 building up its position as the largest premium wine maker in the US, with sizeable positions in the UK, Canada, Australia and New Zealand as well.

Acres of Room to Grow
The two Sands brothers, Rob (CEO) and Richard (chairman), whose father founded the company and took it public in 1973, wanted to create economies of scale and establish a strong position with US distributors.

Growth in wine consumption in the US averaged 4%-5% per year between 1991 and 2007, as the baby boomers aged and became more discriminating in their tastes.

But the average annual US consumption of wine is still only 10 liters (2.6 gallons) per capita. This compares with France at 53 liters per capita, Italy at 50 liters and Spain at 33.

Other Anglo-Saxon countries such as the UK and Australia have higher average per-capita consumption, at 19 and 23 liters respectively, so there is room for the US—which is already the second-largest market in the world—to grow further.

A Move Upscale
Constellation's acquisition drive came to a sharp stop in 2008, as several negative factors converged. First, the company’s purchases had been financed mostly with debt, so Constellation's net debt to earnings before interest, taxation, depreciation & amortization (EBITDA) rose to 4.7.

Meanwhile, the challenges of integrating the various acquisitions had seen its return on invested capital fall to only 6.9%.

Constellation concluded that growing through acquisitions had left the company with too many low-priced offerings, and that distributors were not focused enough on selling its products instead of the hundreds of other wines they had available.

In the last three years, Constellation sold its Almaden and Inglenook lower-priced wines and its US value spirits business for a total of $550 million. In 2010, it disposed of its UK-based Gaymer's cider business for £45 million. Just recently, it divested an 80% stake in its UK and Australian wine business for $230 million.

As a result, net debt to EBITDA fell from 4.7 times to 3.4 times between February 2008 and February 2010, while return on invested capital rose from 6.9% to 8.8%.

Constellation’s valuation is less than eight times projected 2012 EBITDA. It’s valued well below spirits makers Brown Forman (BF-A) and Fortune Brands (FO), which are selling at 9 and 9.7 times 2011 EBITDA. However, the stock has tasted sour so far this year, fizzling 17%.

Constellation does not pay a dividend, so investors need to be comfortable that there will be renewed growth in its US wine business and that Crown Imports will be able to halt the decline in the sales of Corona Extra.

For those who believe that the long-term growth trend in wine consumption in the US, Canada, and other non-traditional markets will continue, Constellation represents an attractive play on rising living standards and the change in consumer drinking tastes as people age.

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