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Meleke Capital Management
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Co-portfolio manager of value long/short fund. Background as an analyst and trader combined over 10 years of experience, actively monitoring the equity markets daily basis for over 15 years.
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  • A meaner and leaner Constellation Brands (STZ), can unlock the value in shares




    Constellation Brands Inc. (NYSE:STZ) –reported third quarter results were not enough in unlocking the value of shares. Poor top line showing indicated that the market leader in wines and spirits is lagging behind the industry growth rate in wine segment. The disappointing top-line results were attributed to an inventory overhang that resulted in extra promotional discounting along with weaker volume within their "below value" category (wines priced under $10). Despite a positive showing on the higher end wines, the street was disappointed with overall results and guidance going forward. Constellation announced they are introducing over 20 new offerings for their FY13 in attempts to offset lower volumes and hoping to gain pricing leverage on its existing premium brands. The company believes that the introduction will grow top line 2-4% for calendar 2012, slightly below the industry growth rate. While gross margins showed a solid increase of~ 400 bps in the quarter, this strength was attributed more to cost savings resulting from their divestitures in the UK and Australia. Further margin improvement for the quarter was a result of consolidating their distribution chain and increasing operational efficiencies. The street was looking to hear more positive news on margins due to sales trend; however the leverage on margins came from operating efficiencies instead. Only a small fraction of the increase in margins was attributable to price increases on their high-end wines.
    Earnings guidance for the remainder of this year is expected to be $2.00-$2.10 per share. The company’s failure to provide much color for their upcoming FY13 resulted in the market continuing to discount the stock. Overall the company hinted at a 2-4% top line growth rate for FY13 and a reduction in overall Cap Ex for FY13. Constellation disclosed lower marketing and administrative expenses will help margins this year and free up additional cash to continue improving the financial profile of the firm. For the first 9 months of this year- FY12, FCF stood at $587MM and by end of next quarter should grow to $700-750 Million. The company’s liquidity picture continues improving and next year reductions in inventory and working capital minus one-time items this year should come in around the $500 Million range for FY13. As of now, the company is focusing on using their cash position on share repurchases. Under the current authorized program, which is about 50% complete, or about ~$281M worth of shares retired, at an average price of $18.79/share, added ~ $0.06 per share on the bottom line. For FY13, it can be implied they will continue repurchasing share and retiring their debt. As of the quarter, total debt stood at $3.1 Billion and any reduction would be favorable for company liquidity profile but may not be enough of a catalyst to push the stock price higher.

    So while the company’s overall financial position continues to improve, the overall business is performing generally at mediocre levels. Constellation continues to lack the ability to drive sales in a meaningful way and set the price environment for the industry. Lack of pricing power and branding efforts will mean that earnings continue to fluctuate and remain volatile on quarterly basis. This lumpiness in sales and earnings performance is the primary reasons why shares trade at a discount to peers and the market as a whole. In the past, the street demanded Constellation to improve on their leverage profile by reducing its high debt levels. The company has been doing so over the past few years but now the marketplace is looking for another catalyst to drive shares higher. The company stock continues to sell at single digit multiples from P/E, P/S and CF/S metrics and maintains mostly a neutral rating. A more tangible catalyst for the shorter term to unlock the value in shares would require something meaningful. Besides taking out the lumpiness out of reported earnings, reducing their share count, improving their cash flow position and stronger margins, Constellation may need to take more aggressive steps.   
    By divesting more non-strategic key assets, the firm would be able to better focus on setting prices in the wine space. With a narrower brand focus, volume would play less of a role on the fluctuation of company sales while still driving margin expansion. Other suggested alternative to unlocking the value in shares would include exploring potential buyers for their Modelo-Corona joint venture. Even though the JV has been very successful for Constellation, strategically it is not where the company should be focused. By selling their stake in the joint venture to other beer producers, Constellation would be able to use the proceeds into their spirits business which is more complimentary to their leading wine position. A larger focus on Svedka Vodka and Black Velvet whiskey would help company achieve scale in similar verticals. A new stock buyback authorization program would be beneficial but it would have to be over a multi-year period on much grander scale.
    Regardless, investors are waiting for something positive out of Constellation on a grander scale. Otherwise investors will continue to be frustrated holding shares and riding the volatility associated with the stock. Value investors will find that shares may be a trap not getting caught up in.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
    Tags: STZ
    Jan 10 10:24 AM | Link | Comment!
  • 2011 : The Year to Forget
    We can easily say 2011 capital markets were less than overachieving. An encompassing fiscal and legislative environment undermined the performance of equity markets and the U.S. Economy as a whole. We entered 2011 with a bullish sentiment in the equity markets. Our optimism was being driven by the hope of an economic recovery based on massive government intervention in capital markets. We were told we escaped the “second great depression”, a sentiment echoed by financial media and economist on a daily basis to the investor class. Many professional market participants also believed the economic misinformation and went into equities full force ahead. Now as we near the end of 2011, we can confidently say that economic realities domestically are not bullish and more cautious. I continue to anticipate an underachieving economy going into 2012, unless we are able to reverse the course put forth for the economy. I am left pondering what prospects are ahead for U.S. Equities, fixed income and overall economic growth in 2012. Was 2011 just a prelude to what is in store for the markets and economy in 2012? Obviously, there are more questions going forward into 2012 than there are answers. Equity markets are searching for something that resembles stability or an indication of some return to the old norm of U.S. Economic growth.
    Let us review 2011 to try and formulate a tangible investment strategy for 2012. What was being described as an economic recovery at the start of 2011 was not a recovery at all. It was rather an accommodative Fed policy, via the extension of QE1 and continuation of QE2 that painted a picture of recovery. The Federal Reserve went and purchased massive amounts of short term debt assets, in turn, flooded the equity markets with short term liquidity. Stocks initially climbed not based on fundamental growth but rather short term capital reinvestment into equities. As QE1 & QE2 were driving equity prices higher, we were being told markets were accelerating due to an economic recovery. The truth was the U.S. economy had not exited the recession and those initial stages of recovery were just seasonal inventory adjustments from a massive destocking. U.S. corporations were not seeing great visibility of growth for the year ahead. The Federal Reserve was also proclaiming inflationary pressures had been modified, yet the opposite dynamic was occurring. In the beginning of 2011, we saw the inflation rate above 3% (excluding food and energy!), we saw gold prices past $1600oz and headed higher, and we saw the U.S. Dollar continued to be debased further. The White House was telling us that unemployment had stabilized and job creation was just around the corner, yet the opposite was really occurring. During the first months of 2011, unemployment rate remained hovering above 9%, while economic stagnation remained evident to those that were not fooled by the economic picture portrayed.
    By June, these investors started to come to grips with the economic realities. The Federal Reserve ended its $600 Billion bond buying “stabilization plan”. The smart money understanding beyond the headlines and realizing the optimism was misguided and misdirected were already on the sidelines by April 2011. The European sovereign debt crisis already had begun with numerous downgrades and countries started revealing their fears of eventual insolvency. Europe had showed us such events occurring over the prior two- three years. Meanwhile, our debt continued to rise with three massive government spending bills over past 2 years and the rating agencies warning of possible downgrade of U.S debt. On top of all of that, lower GDP revisions followed; one after another and now became even more evident that the U.S. economy was spinning its wheels. On the housing front, even a bleaker picture. Home values continued to drop by 3-4% in the first half, already from depressed levels dating back to the 2008 crash. One out of every thousand homes in the United States in foreclosure proceedings, while ~ 20% of mortgages, held by US banks, now delinquent! No wonder all these dynamics sent investors into emerging market and commodity based assets, exiting U.S. equities. Brazil, India, China, Canadian oil sands, and Gold-Metals became the investment of choice.
    All the while, Washington and its willing accomplices continue telling us that by raising the debt ceiling, it would be constrictive for equity markets. The fear of a government shutdown was more horrific than Jason versus Freddie Kruger. Yet a very viable solution to restore growth and reduce debt was presented, over a $10 Trillion reduction of debt. Of course none of the talking pundits acknowledged or spoke of such debt reduction solution that would have sent equity markets soaring and preventing a debt downgrade. They stuck to the mantra of increasing revenues to the government and attempting again to spend our way out of recession, a policy that failed three prior in the past two plus years. By late summer, flight of capital was out of equity markets, proving that the smart money was correct by not participating in the talking points. The talking points of recovery, cheap liquidity, build-up of corporate cash, upcoming mega-mergers, slew of new IPOs hitting the marketplace because it was a great environment or avoidance of a double dip recession. The fundamentals continued to dispute all those claims and the events in Japan just gave the rest of the crowd to sell out. Yet Washington D.C. continued with their wealth destroying policies by pushing through Oil Drilling Restrictions, Signing into law the Credit Card Act, imposing Frank-Dodd Bill and setting up inept super committees to stale any restoration of economic principles that have always worked in the past after a recession. Even though the corporate sector was trying to do its part by building lead inventory cycles, even without a clear confirmation that the macro picture had stabilized. Markets and corporate sector finally buckled to these realities and corrected by over 10% in just over nine days and sending indexes negative for the year for 2011.
    From July to September, the corporate sector started warning about the back half of the year. The economists and pundits finally opened their eyes to a double dip recession when not distracting us with the European crisis. We are ending the year with a slower M&A environment, lower revised GDP growth, unemployment remains high around 9%, retail and consumer confidence continues to be shaky at best, employers not forecasting growth for next year, Europe continues to have a kick the can down the road policy, domestic fiscal policy and legislative policy more reflects the Occupy Wall Street mantra than responsible adults. And we wait for a Santa Clause rally? Santa would not find any buyers with this lack of liquidity and may be looking for the MF Global scheme. The payroll tax is being held hostage because this administration refuses to make economic strides via Keystone XL pipeline coming from Canadians allies and a true job creator. Holiday spending will be seen as a positive despite a 13% vacancy rate in U.S. shopping malls. Basel III will continue to hamper lending and capital to our system and our companies. Additional implementation of new department to oversee consumer financing activities will further restrict the consumer by taking money out of their pockets by limiting lending, especially for the middle class. Imposing higher duties on cheap Chinese imports also hurts our spending on everything from spoons to toys. These initiatives lead Mr. Market to a prosperous 2012 and the finally long awaited recovery? I, for some reason am very skeptical for the prospects of 2012 unless we see change.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
    Dec 27 12:26 PM | Link | Comment!
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