As Constellation's shares fall on weak earnings, we see a buying opportunity

Published Thu, Jan 5 20233:17 PM ESTUpdated Wed, Mar 8 20232:04 PM EST

Alcoholic beverage producer Constellation Brands (STZ) reported mixed fiscal 2023 third-quarter earnings on Thursday before the opening bell. While the results came in short of our expectations, we see the subsequent drop in the Corona beermaker's share price as chance for investors to buy up the stock. Net sales climbed 5% year-over-year, to $2.44 billion, ahead of Wall Street's expectations of $2.39 billion, according to estimates compiled by Refinitiv. Adjusted earnings-per-share tumbled 9% compared with same period a year prior, to $2.83 a share, below the $2.88 a share predicted by analysts, Refinitiv data data showed. Excluding equity losses from Constellation's stake in cannabis company Canopy , adjusted earnings came in at $3.01 per share. In addition to the headline numbers, adjusted operating income of $770 million was down 7% year-over-year and below the $786 million consensus estimate, according to FactSet. Operating cash flow came in at $2.3 billion, significantly ahead of analysts' forecasts for $817 million, while free cash flow of $1.6 billion came in well ahead of the $464 million estimate. Shares of Constellation fell more than 9% Thursday afternoon and were trading around $210.30 apiece. Bottom line All in all, this was not the quarter we were looking for. While strong sales performance and an upward revision to beer-sales growth for the year speak to sustained demand for the company's leading brands, input-cost inflation plagued profit margins. That, along with recession fears, forced management to lower their full-year forward guidance, though the revised guidance is still above expectations. The other fly in the ointment was beer depletions, which decelerated quarter-over-quarter due to headwinds that developed late in the third quarter, primarily a need to raise prices more than usual as a result of inflation. That said, management expects the impact of the price hikes to settle in the coming months and anticipates depletion trends to further normalize by fiscal 2024. If depletion growth picks up in the next few months, shares should recover quickly. In addition to signs of persistent demand, we take solace in Constellation's robust cash generation and ability to raise prices while simultaneously taking market share. Cash is king and that's even more true against an uncertain economic backdrop. While today's market reaction is obviously not what we like to see, we do think it represents a buying opportunity. Moreover, the company is now more in the hands of common shareholders than ever before thanks to the recent elimination of its dual-class share structure . However, given our expectations that the Federal Reserve will continue to raise interest rates in the first half of 2023, along with management's lowered forecast, we are reducing our price target to $260 a share, down from $300. Company results Beer sales of $1.89 billion, up 8% year-over-year, were better than analysts' expectations of $1.82 billion. Operating income on beer came in at $710 million, missing the $736 million consensus estimate. The segment's operating margin took a 380-basis-point hit compared with last year, falling to 37.5%, due to an increase in the cost of raw materials, packaging and logistics. Additionally, beer shipments to distributors were up 2.7% annually, while depletions, which represent U.S. domestic distributor shipments to retail customers, were up 5.7% as a result of strength in the Modelo Especial beer brand. Constellation was the top share gainer in the U.S. beer market for the sixth quarter in a row, management said Thursday, adding that it now owns 5 of the top 15 growing high-end brands on the market. Modelo Especial remains the fastest-growing beer by sales in the U.S. Meanwhile, wine-and-spirits front sales came in at $544.6 million, a decrease of 4% year-over-year and below analysts' expectations of $565 million. Operating income of $134.8 million was also a bit short versus the $141 million expected by Wall Street. The segment's operating margin contracted 60 basis points, to 24.8%, hurt by lower shipment volumes, higher transportation costs and an increase in compensation expenses. Wine-and-spirits shipments were down 14.8% annually, while depletions declined 5.6% year-on-year year. Guidance Looking ahead, excluding Canopy, management now anticipates consolidated earnings of $11 a share to $11.20 a share for the full fiscal year. That's down from the $11.20 to $11.60 per share range provided in the prior quarter, but still ahead of analysts' forecasts of $10.98 per share. Assumed in this guidance are beer sales growth of 9% to 10% and operating income growth of 4% to 5%. Interest expense guidance was increased to a range of $390 million to $400 million, up from a prior guidance range of $360 million to $370 million. The increase in debt was a result of extra cash needed for the Class B elimination payout. Additionally, operating cash flow is still expected to come in between $2.6 billion and $2.8 billion. Taking out capital expenditures of $1.1 billion to $1.2 billion, the free cash flow forecast comes in between $1.5 billion and $1.6 billion, up from prior range of $1.3 billion to $1.4 billion. Management said it anticipated inflation to remain above historical trends, in the high-single-digit range through fiscal 2024. (Jim Cramer's Charitable Trust is long STZ. See here for a full list of the stocks.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust's portfolio. 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Corona beer, owned by Constellation Brands.

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