Drink Your Way To Profits With This Stock!
Shmulik is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
There aren't many consumer products that sell well in good and bad times alike. Coca-Cola, for instance, is a good example of such a consumer product. People will consume the sugary carbonated water whether the economy prospers or not. Wine and spirits are another good example for an "all- weather" beverage. When times are good, people might spend more on fancy wines. But when recession looms, people simply won't give up on their beer and spirits. In fact, in the midst of the financial crisis in 2008, demand for beer increased, not diminished. That's why it's a good idea to look for the company that dominates the wine and beer segment.
The "Coca-Cola" of wines
Constellation Brands (NYSE: STZ) is the largest premium wine producer in the world. Premium wine is wine that retails for more than $5 a bottle. Constellation is also the second-largest wine producing company of any kind, after E&J Gallo, a privately held company.
The U.S. is Constellation's largest market and the largest wine market in the world today. The U.S. has overtaken France as the No. 1 wine-consuming nation in the world. Since 1990, the wine-drinking population has risen 29.5%, from 173 million to 224 million. But the amount of wine each person drinks has risen even more, 55%, from 1.96 gallons per person per year to 3.04 gallons per person per year. More than ever before, the U.S. is a wine-drinking country. That makes Constellation the leading premium wine producer in the biggest wine-drinking nation. Lucky for Diageo, it has only 21% of its sales volume dependent on currently recessionary Europe. Brown-Foreman, on the other hand, depends on Europe for hefty 27% of its sales.
Another operating segment for Constellation is beer. The company has a 50% stake in Crown Imports, the No. 1 beer importer in the U.S., through a joint venture with Mexico's Grupo Modelo. It has 43% of the U.S. imported beer market. That's why I liken Constellation to Coke which controls 42% of the market for carbonated drinks. Dominating a market is a typical characteristic of a market leader. Once a company is able to dominate a market, it's hard to take it away from it.
The company's rivals
The company's competitors include Diageo (NYSE: DEO) and Brown-Forman (NYSE: BF-B). Diageo owns a selection of the most recognizable brands in the world, such as Johnny Walker which is the best-selling Scotch whiskey worldwide. Over a million cases a year are sold in the US alone. Total yearly sales are more than 130 million bottles. And it also sells spirits. Smirnoff is the number one premium spirit by volume and is sold in over 130 countries around the globe. Brown-Forman is yet another distinguished name with a stable of distilled brands that includes Jack Daniels, Southern Comfort, Canadian Mist, Finlandia, and several other brands such as Gentleman Jack and Tennessee Honey,
A successful turnaround
Constellation wasn't always as focused on organic growth and new brand extensions as it is today. From 1999 through 2007, Constellation bought several premium wine brands around the world. To do this, the company borrowed billions of dollars. It increased its debt load from $333 million in 1998 to more than $5.2 billion by 2007. Interest payments soared more than tenfold during the period, from $32.2 million in 1998 to $348.3 million in 2008. The strategy imploded when the financial crisis and ensuing recession hit. Sales fell, and Constellation booked two consecutive years of net losses. But then management decided to sell its less profitable assets, pay down debt, and turn the focus from growth by acquisition to growing through its most profitable premium wine brands.
A cash generating machine
Over the last 10 years, returns on capital have been in the single digits, typically between 7% and 9%. Diageo earned a 35% return on capital last year, and competitor Brown-Forman earned 38%. Constellation should be able to achieve that within two to three years. There's definitely potential for better returns. With more profits and more cash, also come more share buybacks. Share buyback programs are a great indication of a shareholder-friendly company. Coke, for example, authorized a new buyback program six months ago. The company intends to buy back 500 million shares, valued at about $20 billion, as it returns cash to investors. In 2010, Constellation bought back $300 million of stock. In 2011, the board authorized an additional $500 million in share repurchases. Constellation expects to spend the $500 million over a multi-year period.
While Brown- Forman trades at a hefty price-to-earnings of 22x and a price-to-sales of 5x, Diageo is much cheaper. The giant brand owner trades at a price-to-earnings of 17x and a price-to-sales of 4x. Constellation is cheaper than both, trading at a price-to-earnings of 14x and a price-to-sales of only 3x.
Looking forward, the current P/E valuation of Brown- Forman is almost 20% greater than the company's highest valuation mark in the past sixteen years. Since Brown- Forman is priced to perfection, it will be somewhat difficult for the company to maintain such a high multiple for years to come. As for Diageo, the company has reached a $2 billion deal for a 53.4% controlling stake in Indian-based United Spirits group, a decade after exiting the country’s market. This move is likely to give Diageo the grip that it needs so badly in Asia.
My Foolish conclusion
I believe that the market for branded wine and spirits is a great sector to be in. It's relatively stable and recession proof. Constellation, with its cash generation, share buybacks, and market dominance, could very well become the leader of this sector over the next few years.
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Shmulik Karpf has no position in any stocks mentioned. The Motley Fool recommends Coca-Cola and Diageo plc (ADR). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!