Constellation Brands (STZ) is a company trying very hard to buck industry trends and find new avenues for expansion. The beer industry had a tough 2018, but for the most part Constellation's lineup remains strong. It's an interesting dynamic. I for one don't buy into the notion that legalized marijuana will mark an end of demand for beer. That's simply too radical a thought. Not everyone wants marijuana. Beer is a time-tested industry, and I don't see it taking a backseat to anything. Do I think the market is becoming a bit oversaturated? Yes I do. Do I think some current consumer preferences are limiting the growth potential of beer sales right now? It certainly seems that way. So I do see some risk here. It doesn't help that Constellation also created billions of debt with its investment in Canopy Growth (CGC) , an investment that could pay off big over the long-term. Key words here are "long-term".
Beer sales increased 16% in the fiscal third quarter to nearly $1.21 billion. Gross profits for the segment increased 14% to $651 million, while operating income grew a comparable 14% to $450.9 million. The quarter represents a continuation of the year as a whole. For the first nine months of fiscal 2019, Constellation's beer segment has grown a solid 12% to $2.24 billion in sales. Subsequent operating income increased 10% to $1.6 billion. At the same point in fiscal 2018, the company had only produced 10% sales growth in beer through the first nine months, meaning things are continuing to trend higher.
Even more encouraging is how growth in the third quarter outpaced last year's fiscal third quarter. Fiscal third-quarter 2018 beer sales grew 8% vs. this year's 16%. It's definitely a good thing. It's just hard to know whether it can keep going. Some have asserted that today's pullback is an overreaction. That very well may be. But if you're risk averse, you must consider the dynamics of the situation. We have weaker full-year guidance, slowing wine/spirits sales, the impact of an expensive investment in a marijuana company that is not yet producing earnings; all while the company relies on their beers to buck the trend of the beer industry at large.
One of the redeeming virtues I saw in Constellation Brands' portfolio was their growing Wine and Spirits business. As it grew, it provided a hedge against the possibility of weaker beer results. Wine and Spirits stagnated in the third quarter; hitting $762.8 million vs. $759.4 million a year ago. For the year, the segment is up 2% to a little over $2.2 billion; with a 2% decline in operating income. I don't think that will cut it.
Of course, what am I worrying about? Their beer sales are strong! That's true. But guidance suggests profits from those sales might not be as exciting was once thought. The company revised full-year guidance in their third-quarter results to earnings of $9.20-$9.30 compared to the comp sales guidance of $9.40-$9.70 that was put forth back in fiscal Q1. I have to suspect the revision comes as a result of the higher costs being incurred to drive their growth story. It's similar to what has been happening to smaller players like Boston Beer Co. (SAM) In order to drive sales growth, brewers are getting pressed to market hard. The company noted in the third quarter results that marketing expenses increased 11% as a percentage of net sales.
Bottom Line
This is still a strong business. There are just many factors at play that need to be considered. The beer market as a whole might steady out over the long term. In the mean time, I'm inclined to think Constellation can't avoid the market trends indefinitely. They'll have to keep spending on marketin if they hope to do so. Outside of beer, we're seeing some weakness in what was a strong wine and spirits segment. So if beer were to take a hit, where does the growth come from? I think the payout from the very expensive investment in Canopy Growth is a ways off. Right now, the investment is actually weighing on the stock. Canopy's potential for profits is not yet known. Over the long run suppliers should obviously perform well, but in the next year things could be underwhelming.
Overall, Constellation still has a lot to prove. On the plus side, the stock is cheap relative to guidance. I'm just a little nervous that this might be the start of more low earnings guidance. We need to see what happens with Canopy Growth's earnings before a real judgment can be made.
