Constellation steadies its ship

Constellation Brands, the world’s second largest wine producer by volume, yesterday issued mixed results.

For the three months to the end of last November the company made net profits of US$104.8 million (52 cents a share) compared with US$139.3m (65 cents a share) in the same period in 2010.

Excluding one-off items, Constellation made 50 cents a share, which slightly disappointed Wall Street because the consensus of opinion was that the group would announce third quarter profits of 53 cents a share. Consequently, the stock was marked down by about 5% in early trading.

In broad terms sales fell by 27% compared with the same three months in 2010, with wine and spirits sales in the US falling by 4%. But those figures should be seen in the context of Constellation selling 80% of its troubled Australian and UK interests at this time last year. That marked a corporate U-turn.

In 21 years Constellation had made 21 acquisitions including buying the iconic Robert Mondavi, an expansion strategy that culminated in 2007 with the purchase of Fortune Brands’ wine arm.

That strategy paid off until the world financial crisis struck and Constellation’s profits nose-dived. The group took stock and decided that it had to move upmarket and cut its costs.

Since then it has sold low margin brands such as Inglenook and Almaden to pursue organic growth based on the premiumisation pattern so successfully developed by Diageo and Pernod Ricard.

Industry estimates say that Constellation is the world’s largest premium wine producer with about 17% of that category in the US market.

The global portfolio of 300 brands has been cut to about 100, debt has been almost halved from the peak US$5.3 billion and the number of employees has been slashed from 9,400 to 4,300.

So the ship has been steadied and is now back on course. On the basis of its third quarter results, Constellation has confirmed its profits forecast for the full financial year to the end of next month.

It expects to make profits of between US$1.92 and US$2.02 per share. In the context of the retrenchment, that will be very positive, but there are additional factors that underline Constellation’s successful change of strategy.

In addition to the hefty reduction of debt, Constellation has also been aggressively buying back its own shares; in the latest quarter alone it spent US$92m on repurchasing 5.2m shares. Since last February it has spent US$281m on this exercise, which adds value to the remaining shares.

Further, Bob Ryder, the chief financial officer, revealed that Constellation has increased its free cash flow target for the full year by US$100m to between US$700m and US$750m. “Our continued strong free cash flow generation enabled us to reduce our debt, fund the stock repurchases and acquire the remaining 50.1% interest in the Ruffino business,” he said.

The free cash flow target would be a record and thus prompts the question of what Constellation will do with it.

Numerous companies including Diageo, Rémy Cointreau and Davide Campari have all amassed “war chests”, so desirable niche takeover targets will be hard to acquire without a battle.

Moreover, Constellation’s shareholders will need much reassurance that any target brand or company will add value before they give it wholehearted approval – after all, it is only two years ago that the company slammed on the brakes and made a U-turn. Nevertheless, it would be surprising if Constellation were not running its eye over the market.