Constellation Brands wine business a work-in-progress

Just how well is Constellation Brands doing in its first year without those troublesome Australian wine assets? The group has raised profits guidance after a strong first-half at the bottom line, but some analysts remain concerned about wine sales.

Constellation Brands was labelled a "US hot stock" by the Wall Street Journal following its half-year results statement this week. The Robert Mondavi winemaker's share price shot up by 9% yesterday (6 October), after it reported a 69% leap in profits for the six months to the end of August, to US$237.2m.

Management, naturally, was in chirpy mood on the group's conference call. After lowering full-year guidance following the first quarter, full-year earnings per share are expected to come in slightly ahead of what the group predicted at the beginning of the 12-month period.

For all the stock market cheer, though, question marks continue to hover over Constellation's mainstay US wine business. Group net profits largely spiked thanks to tax gains and, while overall group operating profits did rise by 7.5% for the half-year, operating profits in the North American wine business slipped back by 3% on the same period of last year, to $303.9m. Volume sales also dipped, although net sales from ongoing business crept up in low single digits thanks to pricing.

"Overall," analysts at Morningstar said, "we have not wavered from our take that, despite its scale and positioning at the premium end of its core markets, Constellation lacks a sustainable competitive advantage."

They said that Constellation's margins are under pressure from a highly consolidated retail market. "Consumers maintain a significant number of choices when it comes to wine brands and have demonstrated little brand loyalty, which doesn't bode well for Constellation over the longer term," they warned.

Some of this standpoint was reflected in Constellation's own confence call. Constellation's CEO, Rob Sands, talked about US consumers' growing thirst for deals. "If we look at pre-recession versus post-recession, I'd say the biggest change is that the consumer is looking for more bargains," he told analysts. There'll be no let-up in the consumer's hunt as long as the US economy remains in trouble, he said.

This assessment may well set a few nerves jangling. Afterall, the US, is one of the great hopes for wine, and talk of more promotions and bargains raises uncomfortable comparisons with the UK; a market that was once also considered the future but is now guaranteed to crease brows at any winemakers' dinner.

Such concerns are not justified, according to Constellation. Despite promotional activity, group CFO Bob Ryder said: "Generally, the more expensive wines are growing much faster than the less expensive wines." Wines above $5 per bottle have outpaced sub-$5 wines, he said. 

Constellation was also keen to stress that orders for its wine are on the rise, particularly for its 19 higher-margin focus brands. Ryder said: "We do expect to experience better depletion growth in the back half of the year than we did in the front half because of the incremental promotion spend and the kick in of additional new products."

On the supply side, there is tighter supply and demand in the US wine market, partly due to smaller grape harvests in California, according to analyst group Rabobank. In its quarterly report on the global wine sector, published this week, Rabobank said that US wine grape prices "are likely to remain elevated".

Sands appears to be calm on the consequences of this for Constellation. "Since supply and demand pretty much remains balanced, we don't expect higher grape prices per ton to really affect us beyond what we've already built into our guidance and expectations in general," he told analysts yesterday.

So, how best to sum up the mixed messages surrounding Constellation at present? There are some green shoots, for sure, but the newly-streamlined winemaker remains a work-in-progress.