Constellation Brands Inc (STZ) Presents at Barclays 2019 Global Consumer Staples Conference (Transcript)

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About: Constellation Brands, Inc. (STZ)
by: SA Transcripts
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Earning Call Audio

Constellation Brands Inc (NYSE:STZ) Barclays 2019 Global Consumer Staples Conference September 4, 2019 3:00 PM ET

Company Participants

David Klein - EVP and CFO

Conference Call Participants

Lauren Lieberman - Barclays

Lauren Lieberman

We're going to get started. And next up, we have Constellation Brands. Beer has been a tough place to be for several years now but Constellation’s high end import-focused portfolio has been a sustained share winner. Depletion growth continues to pace in the high-single-digits with the continued remarkable performance of both Modelo and Corona. The landscape keep getting tougher, but Constellation is proactively looking to extend its competitive advantages through innovation and targeted marketing, and of course, investment in cannabis and portfolio optimization for wine and spirits. So we have CFO, David Klein with us today for a fireside chat. I doubt I will run out of questions, so we will probably save audience questions for the breakout if even -- I don't think we'll have time anyway.

Question-And-Answer Session

Q - Lauren Lieberman

So, it's hardly new that there has been debate and discussion around secular headwinds facing beer. And know your growth has continued to well outpace the category, trends have decelerated a bit. So I thought we'd kind of start with bringing the categories outlook a little bit vis-à-vis your own business projections.

So the medium-term outlook assumes beer grows in the high-single-digits and revenue with 1 to 2 points of pricing. We've had questionable weather in 2019, what we will call it but trends have seemed to be very much on track. But we've got now the silver September is a new thing, because dry January wasn't enough apparently. There's sober curious people, I'm not one of them, and health and wellness implications of kind of growth that’s out there.

So as you're thinking about beer industry growth, how do you frame this with all these headwinds that turn out?

David Klein

So look, we've seen a lot of the media discussion around sober curious people. And so we had our insights, people spend some time on it. And it turns out people don't always do what they say they do on a survey. So the research that we have suggests that millennials in 2013 consumed about 24 alcohol drinks per month. In 2019, millennials consumed about 29 alcohol drinks a month, right? So the -- and by the way, that particular demographic has an alcohol penetration, so about 77% are alcohol users. The demographics across age groups in the U.S. or the 20 plus age group in the U.S. range from about 71% to about 77% penetration.

Now, I will say that the Gen Z, so people 21 to 24 are entering the category slightly more slowly in terms of the amount of consumption than the millennials did. However, a lot of what they're drinking they view is being higher quality. So I think what we have is people saying that they're drinking less or drinking better, but that's really driving people into trends like Corona Premier and seltzer and the culture and brands like that.

Lauren Lieberman

Okay, that's great. And you said the millennials were drinking more, because they had kids.

David Klein

Well, I think that's exactly the answer, right. So, what we don't know though is, will we see that same thing with Gen Z as they age, will they -- well life gets more stressful for them and they drink a little more but it's too early to tell, but we definitely have seen that with millennials.

Lauren Lieberman

Okay, great. Distribution and package mix has been a big piece of the growth story, availability has driven some of the market share gains that you've seen for Corona and Modelo. How much runway there's still on the trend? And just maybe some examples of opportunities you're actively pursuing?

David Klein

So, I think the thing that’s maybe most missed about our portfolio is the growth engine of the portfolio for the past few years and we believe for the next several years is Modelo Especial. It's the entire Modelo family, but in particular, Modelo Especial. Modelo Especial had slowed a little bit last year, we think because of the introduction of Corona Familiar which may be cannibalized a little bit of the consumption in Hispanic households but you can see in the recent IRI data that Modelo Especial has accelerated. And that's a big brand. That brand is actually bigger than Corona and it's the number one beer brand in California. I learned this morning that it's the number one beer brand in Chicago DMA, right.

So, it's a brand that is large and is growing quickly, right. So I want to put that out there because when you think about our ability to grab space and continue to get household penetration in the U.S., you almost have to center on Modelo Especial before you go into innovation. And from a distribution standpoint, the ACV for Modelo Especial is just a little bit less than Corona. So not a lot of room there. But we mostly focus on effective distribution, which is having the right packages in the right account and having enough holding power so that you don't stock out. And we think that that’s the story behind Modelo, getting the brand appropriately distributed, not just one package in a location but the right packages in all the locations it that should be in and having enough shelf capacity. We will continue to drive half of our total projected growth for the next several years. We have a lot of confidence in the number but it rides on the back of Modelo.

Lauren Lieberman

Okay. And I think a good follow on from, let’s talk a little bit about shopper first shelf, because I think it’s a really interesting concept and in particular the shelf that suggest kind of being data based, right. And I think implementation maybe has been a little bit slower than you might have hoped 18 months ago call it. So can you talk to outcomes that you’ve had, where it’s been implemented, kind of what impediments have been to broader adoption? And is there still like an agenda to actively keep growing out that through additional outlets?

David Klein

Yes. We’re pushing that pretty hard, what we see, we’re in about -- we started out in about 5,000 independent locations. And when we go into a retailer we take out about 20% of the SKUs at retail in that particular retail but it actually drives the category to like a 5% to 10% growth rate, right. And so it's very effective for the retailers. We’ve started -- we've been in the process of doing test stores with some of the very large retailers and that's giving similar results. So we just think it needs to take time for people to decide they are going to trust in the data that they are seeing because we don’t walk in as the category leader, we're not taking over category captaincy at the retailers. We’re simply walking in with what we think is superior data and we’re letting that speak for themselves or speak for itself. So yes, we’d like it to go a lot faster but it continues to perform as we expect and we just think we’re going to see more and more retailer uptake.

Lauren Lieberman

Okay. Is that an iterative model that is data driven or is it sort of like here is the white paper that we put out 18 months ago, and this is ways it goes or is it, has been ….?

David Klein

No because things that we wouldn’t have even spent a lot of time on 18 months ago like seltzers, not that they weren’t around 18 months ago but they simply exploded in the last nine months to 12 months. That has to be set into the dataset. It’s going to say the same thing now which is, you need to have enough of an assortment to drive foot traffic into your store, but then you need to actually fill yourself up with the stuff that the consumer is going to take away.

Lauren Lieberman

Yes, okay, and we’re testing it sty some large retailers now?

David Klein

Yes.

Lauren Lieberman

And so, shifting a bit to innovation more specifically, you’ve been busy. And I think, some of the things that, particularly it’s a beer data you talked about kind of managing and looking at what the opportunities are a little bit further out was very interesting. So first, let’s talk fiscal ‘19, arguably the first real test of your innovation capabilities as a company at least there? So let’s talk about Premier. So year two we can see in the track channel data, we are Nielsen not IRI but we see kind of mid-teens type growth. I think objective for this should to be more like 30% to 40%, I know there’s on premise draft that’s also missing from what I can see. But can you just kind of help with these two and with the performance you’ve been seeing?

David Klein

Yes, so we have been seeing kind of 20-ish percent consumer takeaway on Premier. But you have to keep in mind that Premier is overlapping a very aggressive launch last year. We literally had no product in the market at the beginning of FY19. We loaded out some markets. We threw a lot of very effective advertising at it early on last fiscal year and now we’re overlapping that.

When we get into the second half of the year, we think that from a brand, from an advertising weight perspective, we’ll be heavier this year than we were last year. Our ACV continues to grow on the brand. And I think we’re only -- from an on premise standpoint, we’re in like 20% or 30% of the places where Corona Extra is and we think we should be in all of them right.

So, I know we threw out the 30% to 40% number at the beginning of the year, I don’t know if we’ll get there, but I think we’ll get pretty close.

Lauren Lieberman

Okay, let’s move to Refresca. So on the call, Bill was very enthusiastic about it. Just went national in May. How’s it been doing since launch and is it fair to maybe use the Chelada, the Modelo Chelada is like a benchmark for how big this could be in the first year?

David Klein

Well, I don’t know. The thing with Refresca is that, we’ve said that we launched it at the beginning of May but we really didn’t have product throughout the market until maybe the middle of May. We didn’t turn on any advertising until middle and late May. And then, we saw really good reaction in June and July and then further into August. And in fact, we’re -- as at the end of July, we were well over half a million cases into the -- depleted into the market place which is a little ahead of our expectation.

So, we would have said a success in Refresca was a few million case brand, it could be a little bit bigger than that, given the growth in FMBs in the U.S. and the quick uptake that we’ve seen from the consumers on it. So, we’re really excited about it. And it’s the kind of brand that people have to try. And so we have to convince them to try through our branding and through its relationship with Corono. But once they try it, it’s pretty unique and we get pretty good repurchase rate.

Lauren Lieberman

Okay, so then you’ve been seeing pretty good repeat, it’s ….?

David Klein

Yes.

Lauren Lieberman

Okay. These are stores I’ve been to, my limited samples, that though is like I find it but there’s like one little teeny facing in maybe [three] little cases or cartons that would be.

David Klein

Yes. We’ll get the sales guys on that, wherever you shop, right?

Lauren Lieberman

I've very small hands but. Okay. We can't really talk about beer without talking about hard seltzers. So category has really taken off obviously as you mentioned last year taking shelf at the high-end. Do you plan to participate in this space and if so when?

David Klein

So we had seltzer in this space and we thought we had the taste proposition set, the SVEDKA brand didn’t resonate with consumers. And I'm not sure if it wasn't people not understanding kind of SVEDKA as a seltzer, maybe they felt like it was more like a Smirnoff Ice or something like that, right? So we think we had the brand proposition wrong. So we inadvertently at an investor event a couple of weeks ago announced that we actually are coming to market with a seltzer next year. We're not providing any more data at this -- or any more information about that at this point in time because we're going to have a kind of a typical splashy launch announcement coming up over the next 60 to 90 days, but we will be in the market next year with a seltzer.

We had said we didn't want to be in the seltzer space until we knew we could have that brand proposition that resonated with the consumer. And we could be profitable producing it. So we think we've cracked the code on bringing a profitable seltzer to the market that will resonate with the consumers and fit with our portfolio. And I guess we'll hear more about it over the next couple of months.

Lauren Lieberman

Okay. Can I ask …?

David Klein

The brand guys don't want the finance people at an investor conference stealing their thunder. So I can't say anymore, I won't be able to go back to the office.

Lauren Lieberman

I guess broadly though also, what other new trends are you kind of doing your homework on these days?

David Klein

I think for us, we looked at white spaces within our portfolio, and when you think about our SKU count within beer versus SKU count against our competitors, we're like tiny. And so we do have other places we can go. But I think we want to make sure that we're supporting the things we get into the market. We don't want to kind of run to the new item that's out there. So we think we have to provide adequate support to Premier for several more years. We have to provide adequate support in year two for Refresca, and then we'll come out with a seltzer next year.

Beyond that, we have a couple of things that we're working in test markets like fashionable beers in the domestic super premium space. But we want to make sure that each launch we get has an appropriate mindshare within our company and with our distributors to be successful.

Lauren Lieberman

How much of it is a matter of capacity of distribution partners to really support and get behind something versus financial constraints on the Constellation …?

David Klein

Yes, it’s first financial constraints than it's more -- it is more the mindshare and like our distributors are outstanding. We could put a lot of things on their plate and they would get it in the market. But we want to have that really focused drive behind making Premier, I don't know 100 million case brand, making Refresca a lot larger than we expect, really being having a very competitive seltzer launch, right. So we want to make sure that we don't inadvertently focus our partners by throwing a whole bunch of stuff at them if we don't have like the consumer proposition and the support appropriately lined up behind it.

Lauren Lieberman

Just to round out the beer conversation, let's talk little bit about profitability. So just to refresh everyone, medium term guidance there, goal is for high single-digit EBIT growth. Now you’ve all of your production in-house, how should we think about the drives of operating profit growth going forward and kind of what are the key puts and takes in the margin branch in the next couple of years?

David Klein

Yes. So I’d like to start this answer because it’s asked all the time as you know, I’d like to start the answer really with we have best-in-class beer operating margins and we're pretty proud of that and we're going to make sure we stay there. When you look at our portfolio, we have some drags on profitability like we’re subject to inflation rates in Mexico versus in the U.S. and inflation in Mexico is higher in the 4% to 6% range, and I’m taking wage rate inflation. We also know that we have some headwinds from glass costs, and our brands are more heavily weighted to glass and the competitive set right. So we get a different set of inputs. And then this year, we have some freight headwinds carrying over from last year as a result of entering into long-term agreements with some of our partners.

We think entering into those agreements by the way allow us to get savings over time because we can do some value engineering among the backend of the supply chain. So we have some cost headwinds offset by some cost things that we manage like design to value, optimizing our production footprint. We also have some headwinds caused by our domestic operations and in particular Ballast Point as well as launching or working on some of the domestic super premiums, right. So we have several puts and takes, which gets us to the place where we're really confident that we can sustain the margins that we have kind of in that 39% range, which is why we think grow top-line high single-digits, through the bottom-line high single-digits and there is just a lot of moving parts in there.

Lauren Lieberman

So it sounds like because we didn’t talk about any of the -- you’ve had puts and takes, opposite. You like to talk about negative, right? What about the positives, right. I mean there how should be -- one would think if you are going to absorb all these negatives, and maintain the margins, what are the positives?

David Klein

Yes. So there are a couple of things that offset the negative. So it's pricing and we consistently take about 1% to 2% pricing across the portfolio annually and it's important to note that we don't take a 1% price increase anywhere because that sound de minimis. We move price points in a market such that it averages out across our portfolio to be that 1% to 2%. And when we take pricing, we get a significant drag on the business. So, we have pricing as a positive lever. We have the value engineering and design to value initiatives that can give us a lot of savings over time in our portfolio, and that's really the hard work of running a business, right. And so to me I think we view it as a victory to be able to hold our margins kind of in that 39% range.

That said, I always feel like I'm sitting here talking down our margins. We will deliver the highest possible margins we can, it's just you know it's easier said than done.

Lauren Lieberman

Do breweries get more efficient the longer they run the way that a EPG manufacturing plant kind of -- do you optimize as it runs, because your facilities are new?

David Klein

Yes, I think that’s true. I think the other -- since I did talk, I did add up a lot of the drivers, I missed one which is really bringing the facilities -- the new facilities in Obregon and Mexicali online. And so that will happen over the next couple of years. When those facilities come online, we’ll add a big chunk of depreciation. Now, we’ve already spent that cash because that’s the capital going into the facilities today but that will put pressure on operating margins, because we tend to focus on operating margins. Our competitive set focuses on EBITDA margins right. So we’re going to be in a situation over the next couple of years where we could decide to accelerate the commissioning of our Mexicali plant and it would make good sense from an economic standpoint, because they sell about 25% of my beer into California, if I can produce it just out of the border in Mexicali, which will give me a better cash transfer to my business, it will actually put downward pressure on my operating margins, right.

So, back to optimizing individual plans yes, that’s exactly what I'm talking about when I'm saying that the operations teams are sitting in Nava today. Now that Nava is complete, really working on ways to optimize line efficiency and how we’re moving the goods through the plant, both on the input side and the output side and then clearly optimizing how we’re moving glass around in all the facilities. So, again it’s just we have opportunities on margins and so I don’t want to discount that. I just think that there is just -- there’s a lot of work to get there.

Lauren Lieberman

Okay. I think the cash ends up in places that shareholders like, they’d be happy with the cash emphasis. Okay, let’s switch to wine and spirits. So it’s smaller piece of pie, but hopefully one that’s coming with better growth and profitability. So first just, less strategic question. Is there any updates on timing for when you expect to complete the planned transaction with Gallo and anything relative to fiscal ‘20 guidance that would have implications?

David Klein

No, because I think like the vacation period has just ended right, so now we get all of the right people working on the request that’s in front of the FTC at the moment. So, no new news there, other than we’re still confident that it’s going to close in the second half of the year, our fiscal year. And last quarter, we provided guidance, a guidance update that took us through the end of Q2 as if we kind of closed at the last day of Q2, clearly we didn’t.

So, the first week of October when we have our next earnings release, we’ll give guidance that takes us through either the end of Q3 or even better if we know a close date, takes us through the close date.

Lauren Lieberman

Okay, okay, great. And then also you recently announced the divestiture of Canadian whiskey brand Black Velvet, so just talk a little bit, the financial profile of the brand, what drove the decision to divest it?

David Klein

Yes, so it was a brand that didn’t fit in our go-forward portfolio, which for us the hurdle rates are, it needs to be a good -- have good -- strong growth prospects and needed to be able to deliver that 30% sort of operating margin. There was not real synergy benefits from having a production facility in Canada. So, the brand contributed $65 million to $70 million of revenue and it was about -- when we sold the brand it was like 8 to 9 times on a CAM basis.

Lauren Lieberman

Okay.

David Klein

So, we think we got fair value for our brand that’s declining. And we think it’s a streamline to the rest of our portfolio.

Lauren Lieberman

Okay, great. So now go-forward portfolio presumably is set. So how do you think about the business? And here you have the management for the division, how would you or how are they articulating kind of the growth prospects and profitability aspirations and so on?

David Klein

Yes. So we're really excited about the portfolio, because the remaining portfolio gets us to the place where we can get to mid-single-digit growth on that portfolio. And that includes some really big growers that are kind of intertwined with a brand like Woodbridge, which we retained, both to keep the Mondavi wine family together, as well as to give us a brand with real value and to put through our facilities. So we think the whole portfolio gets to the mid-single-digit growth, we think the operating margin for that portfolio gets to 30% over time.

Now, this year, because we haven't closed yet on the Gallo transaction, there's going to be a lot of volatility both in the performance of the brands that are in the sold portfolio as well as the brands that are in the retain portfolio. We are delayed in getting out our stranded costs, because I guess they're not stranded yet, we haven't closed. But -- so it's going to take a little bit to get to that mid-single-digit rate and to get to those 30% margins. But we think we have the right portfolio to do that.

And when you think about that portfolio, it also has a pretty good looking sort of ROIC behind it as well, because you take a brand like Kim Crawford, it doesn't have a long aging profile. It has exceptional margins. In fact, it may be the highest margin product in Constellation’s portfolio, including our beer business, right. So, there are some real good consumer led brands in that portfolio that have really good financial characteristics.

Lauren Lieberman

Okay. Alright. Great. The last up on our tour needs to be Canopy. So one week after the Canopy acreage deal was approved by shareholders, right, major change in leadership with Bruce Linton leaving. So can you just help us understand a little bit what prompted this, maybe how the strategy has changed since Bruce left and when we might start to see the benefits of this kind of materialize in Canopy's results?

David Klein

Yes, so I think that Bruce did an outstanding job of creating Canopy from nothing and putting the company on the map. We felt, we the Board and this isn't just Constellation, there's seven members on the Board we have for the seats, but we, the Board, felt that it was time to make a change from that startup culture to a culture that was going to be more focused. I think the biggest mistake that can be made in the cannabis space today is spreading yourself too thin. There are so many opportunities, even the small opportunities feel like large opportunities when you look at recreational cannabis, medical cannabis, animal health, TBD, CBD in a form to -- that would be may be medically applied versus CBD that people are putting in skin cream, right? There are so many places you can go in cannabis. And we believe that we're going to have to focus in order to win. And so that won't entail major changes in terms of the strategy at Canopy but just some tweaks to kind of what we're doing today and more focused application of capital and resources in the areas that we think will be the real homerun, right. So I would say it's more of an adjustment to the strategy than it is a change in strategy.

Lauren Lieberman

Okay. I would also like to hear a little bit more about the acreage relationship. Kind of what Constellation’s best guess is to when we might see that triggering event? And why you are so excited about this deal, kind of both today and it’s like status quo regulatory environment and also looking ahead to maybe one day the promised land of a free United States?

David Klein

So I’d like to think about it more like from a perspective of almost cannabis ecosystem that we're creating between our three companies. And so you have Canopy which has global scale. They have production, meaning grow and extraction know how. They have intellectual property behind brands like Tweed and Tokyo Smoke. They have intellectual property around formulation of products. We're going to bring beverages to the market here over the next several months. So Canopy has all of this intellectual property capability that they can bring into the marketplace. They have a global footprint. They are also entering the U.S. in CBD because they can do so in the U.S. and they can build out a CBD footprint that then can connect with the acreage THC cannabis led footprint in the U.S. once we have a triggering event.

Meanwhile acreage is positioning itself to be one of the biggest multi-state operators in the U.S. And so to me when we hit a triggering event, we have an outstanding footprint. We want to have recognized brands. We want to have outstanding production capabilities and we will have a very sizable balance sheet to bring to bear as the U.S. market opens. And so we think you put all of those together and we had a triggering event and we’re going to be really well positioned. Now I don’t know when the triggering event happens. But every day that goes by you hear new news about things just loosening up a little bit in the U.S., last week or the week before was published in the Federal Register that the DEA is going to allow the experiment -- the growth of cannabis in the U.S. for research purposes. That's new, right. It's just little things like that, that just loosening up regulations we think are just pointing us toward that inevitable de-scheduling of cannabis.

Lauren Lieberman

So I want to wrap up with a question or two about capital allocation. So you laid out the plans to return $4.5 billion to shareholders over the next three years. I guess first, is it fair to describe that $4.5 billion is a commitment? And within that we assume the split of like $2.5 billion to repurchase and $2 billion in dividend, is that kind sound like the right way to purchase?

David Klein

So first of all yes it’s a commitment. And secondly, we think about it more from the perspective of we target about 30% payout ratio from a dividend standpoint. We see no reason to really deviate from that in the near term. And then we want to remain investment grade and we put our target around that investment grade algorithm at about 3.5 times leverage ratio. And so, keeping those -- keeping the 30% payout ratio and the 3.5 times leverage, we're going to return $4.5 billion to our shareholders over the next few years.

Lauren Lieberman

And then you sort of re-answered this. But with the restructuring of the Canopy warrants, like our math had to able to deliver on your commitment to return cash to shareholders with leverage closer to 3.5 times and the 4 times, you sort of previously would have been targeting towards. So I guess, once you achieve that commitment, that $4.5 billion, do you plan to stay in that 3.5 range or you’re comfortable operating at 4 times?

David Klein

So, first thing we want to do is return the $4.5 billion. And then once we get beyond that, yes we would target to 3.5 times, and we’ve said in the past that our range is more like 3 to 4 times and we’d be opportunistic within that range. But with the amount of cash that our business throws off, once we’re in that 3.5 range, we can still do sizable repurchases, continue to invest in particular behind the brands that we have, invest behind our ventures portfolio. We have a lot of options. And so I want to get that $4.5 billion commitment behind us before we go further.

Lauren Lieberman

Okay. And when do you think you can get to the 3.5 times?

David Klein

We said that we would be below 4 times within 12 months of closing on the transaction last year. We’ll be close to that, and we’ll delever as quickly as we can on that.

Lauren Lieberman

Okay, I think we can stop there. I think we have some commercials to roll while we’re all kind of exiting the room. So thank you so much for this. We’ll go to breakout here, okay. Thank you.