Constellation Brands Turns the Corner

FILED DECEMBER 1, 2009

Dear Client:

Constellation Brands is at “the beginning of a multi-year turnaround,” says UBS senior analyst Kaumil Gajrawala in a note to clients, with cfo Bob Ryder as a “key driver behind the focus on improving returns.” The positives include: “(1) exclusive distributor relationships, (2) streamlined portfolios, (3) new compensation structure based on improving margins and FCF, (4) improved balance sheet. Importantly, UBS does not “believe any large-scale acquisitions are imminent” as Constellation execs are more focused on rationalizing their assets and paying down debt.

But that doesn’t mean an acquisition is entirely implausible. UBS lists the following as risks: “(1) exposure to the UK wine market, (2) weakness at Crown, (3) the potential acquisition of wine assets from MO/Fosters and (4) soft on-premise trends.” Although the firm doesn’t believe Constellation will make any major acquisitions in the next year, they admit there’s a chance it could acquire Foster’s Wine Estates (or some of its brands), and/or Ste. Michelle Estates from Altria Group (which recently acquired the winery with the rest of UST).

Beginning in the summer, Constellation moved to a single distributor system in 19 states and “is finally starting to leverage its scale as the largest wine company globally and the second largest gross profit provider to distributors in the US behind only Diageo.” Kaumil notes that Constellation now has more “bargaining power with large retailers like Walmart,” which should improve productivity and drive organic topline growth once transitional issues have passed.

“Diageo has commented often about the success they’ve had with a similar exclusive distributor program and we believe this should fuel stronger topline numbers for STZ going forward. However, the next quarter or two could be bumpy as the transition to new distributors takes place and the new dedicated sales force is fully trained,” says the note.

It’s also important to note that distributor consolidation “increases support from the distributors due to the scale STZ can now provide them with...we are also hearing from our industry contacts that the distributors have agreed to increase global marketing funds for STZ under the new arrangement.”

While Constellation is first and foremost a wine company, it also owns one of the fastest growing spirits brands: Svedka Vodka. Kaumil says that Svedka is now the third largest vodka in the US and has grown double digits in the first two quarters of 2010. “While much of this growth is being driven by increasing distribution, we believe STZ can continue to deliver solid growth given its attractive price point and opportunity to expand on-premise.”

A negative for Constellation is its presence in Australia, where the industry faces major oversupply, and the UK, where Constellation faces extreme price competition from cheap private label brands (stemming from the glut in Australia). The company is taking steps to sell underperforming businesses in Australian and rationalize SKUs in the UK. UBS believes “STZ may be considering exiting the [UK] market, but is struggling to find a buyer given current conditions.”

UBS rates Constellation shares a “buy” with a $21 price target.

SOUTHERN GRANTED PERMIT TO OPERATE IN INDIANA

Southern has confirmed that its subsidiary, Southern Wine & Spirits of Indiana, has obtained a wholesaler’s permit to operate in Indiana. You’ll recall that WSD reported on the news in November, but the decision was not yet final as there were some loose ends to tie up.

"We are extremely pleased about the prospect of establishing operations in Indiana, where we see many opportunities to extend our industry-leading sales and market capabilities and operational efficiencies," said Harvey R. Chaplin, chairman and chief of Southern. "We look forward to serving Indiana's licensees -- as well as all of the future supplier partners who will join us there."

About a month ago, Ed Dunsmore, the executive secretary at the Indiana Alcohol and Tobacco Commission, confirmed to WSD that the state has approved Southern's request for a wine and spirits license at a rehearing, although a final inspection was in order before officially issuing the license. You’ll recall that Indiana used 2 main arguments to initially block Southern from entering the state. The last and final hindrance was that Southern’s supposed joint-venture with Glazer’s would create a monopoly in the state, but as you know that j-v was called off in September.

Referring to the licensing process, Harvey Chaplin said, "We are grateful that the IATC officials recognized Southern's qualifications, and we look forward to working closely with them as we establish operations in Indiana."

For more background, click here.

FRANCIS FORD COPPOLA FILES SUIT OVER “DEFECTIVE” BOTTLES AND CAPS

Francis Ford Coppola’s food and wine company (Francis Ford Coppola Presents) is suing cork and bottle manufacturer Vinocor USA, claiming that it ruined 55,000 cases of its wines. Coppola reportedly paid Vinocor $685,000 for special bottles and screw caps for its "Encyclopedia" series, but claims it instead received chipped and deformed bottles and defective caps from Vinocor that "materially degraded or destroyed" virtually all the wine due to oxidation.

According to the lawsuit, the first shipment had bottles with chipped glass, bent necks and deformed seals, while the screw caps had uneven threading and were bent from “careless shipping.” Coppola alleges that Vinocor promised it would fix the situation after he complained about the first shipment. He then ordered another 100,000 screw caps and another round of bottles, but they were also defective. The winery is hoping to get its money back and unspecified damages for breach of contract, fraud and negligence. The suit was filed in Napa County Court and Coppola is being represented by Barry Lee with Manatt Phelps & Phillips.

Sources: Courthouse News Service and Am Law Litigation

LARGE COMPANIES LOSING STEAM IN AUSTRALIA?

The last point in our lead story today leads us to this: a new report from Australia is claiming small wineries in the area have taken significant market share from companies like Foster’s and Constellation Australia. This could be partly because these large companies are selling underperforming brands and businesses in Australia for the simple fact that there’s too much wine to go around. The article says Foster’s market share has dropped from 28.5 per cent in 2005 to 21.2 per cent, while Constellation Wines Australia has fallen from 22 per cent to 13.5 per cent. Meanwhile, family wine companies such as Casella, d'Arenberg, Peter Lehmann, McWilliam's, Brown Brothers and De Bortoli, and private label wines are growing.

Winemaker Grant Burge told the paper, “You have to have a long-term view, the wine industry is no place for public companies with fast-buck approaches, because you need to constantly reinvest.” He also said the large companies are at fault for the glut by inviting “growers to grow grapes and now they're walking away from them.” Meanwhile, the longterm growers must work together in solving the oversupply problem.

WSD BRIEFS:

NEW APPOINTMENTS FROM PERNOD USA. Jonas Renner Tahlin has been named vp of marketing, vodkas, and Tim Murphy is appointed to the newly created role of vp, marketing innovation. Jonas most recently worked as regional vp/commercial director - Americas at The Absolut Company. Tim, meanwhile, is currently vp of marketing vodkas and gins for Pernod Ricard USA. Both will assume their new position on Jan. 1 and will report to Matt Aeppli, senior vp, spirits marketing, Pernod Ricard USA.

SCOTCH OUTSELLS CHAMPAGNE. While champagne is lagging, Scotch is growing worldwide mainly due to demand in India and China. This helped offset negative effects from the economy and trade destocking, says the Scotch Whisky Association. The Scotch industry said export volumes grew by 1.5% in the nine months to September, while value declined -3.5%. By comparison, champagne lagged -40% in the same period and cognac was down -20%. All three segments are hoping to drive major growth in the current holiday period.

SUNTORY HOLDINGS has agreed to buy an 80% stake in Hong Kong-based wine importer ASC Fine Wines Holding from its current shareholders, Austria Wine Holding GmbH, and ASC Fine Wines' founding family members. Suntory did not disclose financial details, but industry sources estimate the cost at about $56.8 million.

CALLING ALL HANDS. WSD is looking for testimonials to display on our new website. If you have something you’d like to share, please send them to megan@beernet.com. Thanks for your help – it’s greatly appreciated.


Until tomorrow, Megan

“The world is a tragedy to those who feel, but a comedy to those who think.”
Horace Walpole

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