Constellation Brands' shares tumble on weak wine sales

Constellation Brands raised its full-year earnings guidance for the second time yesterday after seeing third quarter profits triple, so, naturally, its share price fell by 8%. Here, we examine a day of contrasts for the wine giant.

All things considered, 2010 is probably not a year for the Constellation scrapbook. Months of restructuring in order to pay down debt and cope with the vagaries of a volatile global wine sector have recently been compounded by the group's decision to sell its Australian and UK wine business at the car-boot-sale price of AUD290m (US$290m).

Against this backdrop, the Robert Mondavi producer made an upbeat start to its third quarter results day yesterday (6 January). It raised its guidance for earnings per share for the second time in the current fiscal year, which runs to the end of February, and third quarter net profits tripled to US$139m.

Constellation's optimism was soon soured by hard-nosed stock marketeers, however. The group's share price sank by 8% for the day as investors and analysts honed in on a 2% drop in third quarter net sales and worse-than-expected operating profits.

"Cashflow yes, growth no," was the rather damning title to a note by analyst group Stifel Nicolaus. It said that it saw little hope for a rise in the group's US wine sales by volume for at least the next 12 months. "Two years of case shipments exceeding case depletions imply an estimated three percentage point lag in shipment growth versus depletion growth in fiscal 2012, by our estimates," said Stifel. "As we estimate 3% depletion growth in fiscal 2012, we estimate 0% shipment growth in the period."

Constellation's CEO, Rob Sands, yesterday reiterated the group's plan to refocus on higher value wine sales in North America. Its net wine sales in the region, which contribute to around 70% of group operating profits, rose by 1% in the third quarter. 

While Constellation's stated aims look good on paper, putting them into practice is proving tricky, according to some observers. "Our thesis that stiff competition in the fragmented wine industry will restrict pricing power played out again," said Morningstar analyst Philip Gorman. He said that he does not see this situation changing "in the near-term".

Analysts have generally been kinder on the group's knock-down sale of Australian, South African and UK wine assets. Deutsche Bank analyst Marc Greenberg was quoted in the Wall Street Journal as saying that the move leaves the group with "a cleaner portfolio without any problem children".

That's certainly the image that Sands and his chief financial officer, Bob Ryder, sought to portray in yesterday's results conference call. "Although the business contributed to roughly a quarter of net sales, it contributed very little to profits," Ryder told analysts.

An 8% rise in Constellation's spirit sales in the third quarter, led by Svedka vodka in the US, was largely ignored by observers due to the division's relatively small size. There was optimism, meanwhile, for Constellation's US-based beer joint venture with Mexico's Grupo Modelo.

"The company’s imported beer joint venture (nearly 30% of EBIT) experienced accelerating depletions (up 5% in 3Q), and we expect healthy growth to continue in fiscal 2012," said Stifel Nicolaus. Constellation and Modelo settled a legal dispute in the third quarter over marketing funds for Crown, which imports Corona lager.
 
Despite the positive news in beer and spirits, however, wine dominated proceedings. It is clear from the last 24 hours that Constellation still has some way to go to demonstrate that it can do more than merely talk a good game.