In today's Oxen Group recap, we will be looking at Constellation Brands (STZ) after the company's latest earnings report. We want to update our STZ 12-month price target as 2014 is starting to take shape. The Oxen Group covers Constellation Brands year round, and we want to update our current pricing to reflect recent occurrences. In our Company News section, we will take a look at Plug Power (PLUG) after the company has had a couple of high volume days with some key speculation and news. Additionally, as always, we will do our typical market overview and examine what's coming next for the market.
The market was weaker on Thursday, despite that it had every reason to rise. The market got some good news from employment data, positive numbers from Europe, and interesting data from China. On the employment front, jobless claims and continuing claims both came in under expectations. Jobless claims came in at 330K versus expectations of 338K. Europe economic confidence reports broke 100, beating expectations as well. And, China saw inflation numbers come in under expectations. All that was not enough as the Dow Jones (DIA) and Nasdaq (QQQ) fell on the day, weighed by Verizon (VZ) and AT&T (T). Further, the market was not moving much prior to the all-important Nonfarm Payrolls report on Friday. If that report comes in solid, it should set up for big gains with a lot of very solid economic data overall.
On the company news side, we will be focusing on Plug Power today. The company has risen over 40% in the past week and almost 100% in the past month. The stock has risen over 500% in the past three weeks. There has been a lot of buzz around the stock over the past month, and we want to give our view on what is going on with the company. Let's take a look at what has happened in the past month or so:
December 4 - The company announced that it has seen an additional $17.8M in bookings since its October earnings call as well as expectations that they will see $30M - $40M in orders during Q4.
December 20 - The company regains compliance with the NADSAQ listing price requirements.
January 2 - The company announced that it met its Q4 order targets with orders totaling $32M with contacts including repeat business with Walmart (WMT), Kroger (KR), Mercedes, BMW, as well as a major contract with a food distribution customer.
January 7 - PLUG announces that it will develop hydrogen fuel cell extenders for FedEx (FDX). Under the deal, the company will help extend the range of twenty trucks by up to almost 2x current range. The US Dept. of Energy as well as FDX Express funded the fuel cell solution for $3M.
The company has come a long way in the past twelve months from bankruptcy and a potential NASDAQ delisting to now seeing business growth, meeting NASDAQ standards, and what could be potentially a large turnaround. The story has seen two excellent Seeking Alpha writers split and created quite a bit of buzz.
One interesting claim from the bear (Dr. Akston) is that PLUG is going to have to have an equity infusion in Q1 2014. What's interesting is that the company has seen cash expanding in 2013 without being profitable, but it is due to selling stock. The logic is that the company burns about $7M of cash each quarter. They aren't rising cash in any other way, and the company's last equity raise was in September of 2013, bringing the company's total cash to $11M. They will see around $4M in cash at the end of the year, and that will mean they will need more funding in Q1. Yet, the company is also nearing profitability, and trading for much higher valuations, attracting more market interest. The company it is true diluted shares over the last twelve months, and they did have trouble securing funding in Q1 2013. Yet, the company is now nearing profitability, giving them a much better reputation with creditors. Further, if the company can move to close to profitability and show that they can be profitable, they will have a much easier time getting funding from third parties as well as potentially selling more equity if they need to do that as well without taking big cuts to value.
Further, one of the big concerns that has been noted is that KPMG issued a "going concern" for PLUG in the company's most recent 10-K. That 10-K was released at the end of FY2012, again a time when the company needed more funding and had a business that was nowhere near the potential profitability that it was today. While the article written by Dr. Akston does bring about interesting points, it uses information that is not recent. The KMPG issue and creditor issue happened at the end of 2012. He calls the business plan flawed since it has not worked for 16 years. Yet, there has been little demand for fuel cells for 16 years. No fuel cell company has been profitable during this time either. Ballard Power (BLDP) is not, Fuelcell Energy (FCEL) is not, and no fuel cell company we can find is. The demand by the market has never been there before, and so it's almost pointless to note the company has never had strength as an argument against it. That is basically the equivalent of saying that Tesla (TSLA) is worthless up until 2012 because it wasn't profitable since it started.
Investors in PLUG must understand it's a speculative stock. Even the general counsel for the company notes that:
Gerard Conway, general counsel for Plug, said the "going concern" letter did not come as a surprise, and that people reading the annual report should have a full understanding of the company. "It is what it is," he said. "Whether or not [KPMG's statement] was there, people who are going to invest need to understand that while there is great potential here, there is also significant risk. This is not a stock for the faint of heart."
At the same time, we believe that its important to realize that this stock has made an unbelievable move in the past several months, and that it is time to start to see some actual profits in this stock before we start to give it more credit. Yet, let's not criticize a company that is in a much different position than it was twelve months ago for the position it was in 12 months ago. At the same time, we need to understand this is a speculative company only. Those that believe in fuel cell business and take the time to understand the nature of that demand and PLUG's business should be the only ones taking these shares on. And with price/book at 33x and price/sales nearing at 10x, shares are expensive at this time. The best thing is to wait and see if the company can get to profitability in Q2 of 2014. If it can, there will still be a lot more to gain. If not, Dr. Akston will have one heck of "I told you so" to write.
We continue to like Constellation Brands. The company is very enticing right now, and we believe that they have more upside in the coming year. Our 2014 price target is now $110, which shows 40% potential upside in the coming year. We believe that the company's new Crown Imports acquisition combined with their continued strong wine/spirits business has made this a company with a lot of potential.
In this section, we will cover the current catalysts for the company as well as issues we foresee. We will conclude by breaking down how we got to our price target of $110.
The obvious main catalyst moving forward for Constellation is their acquisition of Crown beer, which includes Modelo, Pacifico, Victoria, and Corona in its portfolio. The company bought the final 50% of Crown Imports in 2012 but it took some time to gain approval. The latest quarter saw the company start to see the fruits of their acquisition, and the results were very exciting.
Here were some of the highlights from the latest quarter:
- Crown Imports saw 21% gain in sales
- Depletions rose 18%, 6%, and 20% at Modelo, Corona, and Victoria, respectively
- The company was able to see a lot of success due to successful marketing and advertising
- The beer business led to 350 basis point growth in operating margins and had operating margins at 30%
- Gross margin rose 140 basis point
Constellation has big plans for their beer business, and they have the ability to see solid multi-year growth from this acquisition. The company is expected to see 50%+ growth in beer in FY2014 with 15-16% growth in FY2015. The FY for Constellation is slightly different with its Q3 ending in November. The benefit that we see with STZ is that the company is focused on expanding inside of the USA. The company expects to double the output of Grupo Modelo over the next two years with expansion in Mexico.
The US market is definitely saturated with beer and growing craft beer does have some negative impact on the company, but the company is doubling expansion because they believe that they can still see a lot more growth in the USA. Corona and Corona Light are the top two imported beers in the beer and light beer markets while Modelo is the third-largest brand.
That can lead to 4-5% growth in revenue at least in FY16-FY18. The company has done well with marketing their brands and has been able to do well with the growing Latin community in the USA as well. Comments from the company seem to suggest that the transition is going smoothly:
We believe that the realization of significant benefits from the beer business acquisition, along with excellent execution within Crown's U.S. commercial business, are the key driver of this stock price appreciation. In addition, we have successfully completed the transition of our new brewery in Nava, Mexico. Beer operations are running smoothly, the supply chain is operating efficiently, and all key performance metrics are being achieved at the brewery. As you know, we are in the initial phase of the brewery expansion project which will include the buildout of the brewhouse, packaging, warehousing and site infrastructure.
An additional benefit of the business is growth of margins. The beer margins were 30% on the operating side and added 350 basis points in the first quarter of inclusion. The company believes that they can see these move to the low-to-mid-30s by FY 2017, which is another lift to earnings overall. The company did give some caution, however, about looking too far into the margins because for the first time they will be producing, expanding production, and are cautious in this outlook.
Another benefit will be the growth of draft of Corona, Corona Light, and the rest of the divisions. Draft was not there prior for most of these brands as we can tell from Victoria being the largest draft part of the market. The expansion of draft is going to help a lot with getting into more taps and on the lips of more drinkers:
And in addition, as we get into new accounts with draft, we do see some evidence that helps our case sales as well. It's a very good marketing point to have those tap handles in front of the consumers as they are enjoying our products on-premise. But this year, total draft is growing about 30%, and actually, our largest draft product is Pacifico, but I think we're expecting great things from Corona Light draft, which we were in test market last year and we're rolling that out nationally as we go forward. So we probably expect Corona Light to be our biggest draft brand, followed by Pacifico, and then I think Modelo Especial is closely behind that. But we see great things for our draft business.
There is a lot of solid moving parts here right now for the beer business, and we believe that it will definitely continue to be a benefit for the company moving forward. The company is going to see solid margin and sales expansion from this deal, and we believe that the market is still not completely pricing in this deal's potential, as we will show in the next section.
Revenue - We expect revenue to be able to increase over 50% in FY14 and 15-16% in FY15 as the company will get the full accounting effects of adding in the beer business. From there, we expect 4-6% growth per year with catalysts from lots of volume increases; draft builds, and expanded control. The wine and spirit business is a little bit less enticing, but it has been able to still grow at a solid rate of 3-5% per year that should continue.
Operating margin - Here is where increases will happen. The company already is moving to 22% in the 2014 FY and should move to 26% in 2015. From there, we expect things to stagnate around 27%. The growth of beer margins helps, but wine and spirits are less profitable given more expensive inputs. The company does expect wine margins to increase with grape costs coming down and a better mix, but it will be marginal improvements.
Taxes - The company expects taxes to stay at 32%.
Capital Expenditures - These should continue to rise with the build out of expansion, brewery, and increased marketing spend. Additionally, we would not be shocked to see the company add more parts to the mix with beer.
In our model, we used a cap rate of 3.4%, which is consistent with growth names. The company is in a strong growth phase, and they should be priced appropriately. When we reduce that cap rate to fit with more natural alcohol trends and sort of remove the temporary two-year upside, we see shares are worth about $81. What that means to us is that the market does not view STZ as a growth stock right now, but we believe as that growth starts to unfold throughout this year it will start to take on a more premium-pricing model.
Things look quite solid for the market if NFP delivers tomorrow. With all other employment figures doing well, NFP could deliver quite an explosive move for the market. We believe that it should, based on the success of all other indicators. If it misses, downside risk seems more limited to us. There has already been such strong weakness given how strong the data was that it seems a bit of weakness is pricing in right now. We see a more neutral to slightly down environment on a miss. Watch the unemployment rate as well as it could lead to some downside if it drops too strongly as it will push a quicker taper.