Constellation Brands (STZ +0.66%) launched into the wine industry more than 70 years ago and jumped into the spirits arena 25 years ago. The company has steadily built a world-leading presence in the premium market, a space where authenticity and regionality carry significant weight. In the most recently reported quarter, the company's wine and spirits segment contributed roughly a third of sales.
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But fiscal-year 2018 and first-quarter 2019 performance of the wine and spirits segment was weaker than in prior years. The first quarter notched a year-over-year decline of roughly 3% in net sales of wine and spirits.
The quarterly sales shortfall, as explained during the Q1 earnings call, was from a shortage of Meiomi wine. Demand was higher than expected and it took the company time to produce more. There was also speculation that retailers ordered more products than they needed in Q4 2018, creating slower sales in Q1 2019. Operating declines were due to higher cost of ingredients and transportation and more marketing expense.
| Period | Net Sales, YOY Change | Operating Income, YOY Change |
|---|---|---|
| FY 2016 | 3% | 8% |
| FY 2017 | 6% | 10% |
| FY 2018 | (6%) | -- |
| Q1 2019 | (3%) | (8%) |
Data source: Constellation Brands. Data for company's wine and spirits segment. FY = fiscal year. YOY = year-over-year.
The stars are aligned for wine and spirits to grow
Wines sales notched a compound average growth rate of 5% over the past three- and five-year periods. Premium wines, where Constellation plays, grew 13% over the same time periods. Total U.S. spending on alcohol topped $70 billion in 2017,driven by premium options in vodka, whiskey, and tequila. Constellation Brands' strategy for wine and spirits puts the company in a good position to address consumer-driven market dynamics.
The importance of the story
Telling the story behind brands has been shown to boost sales, and Constellation Brands has stepped up to engage consumers. For instance, High West Whiskey educates buyers about the story (and science) of blending and the CEO of Casa Noble tequila, Jose "Pepe" Hermosillo, traces his family tree back to the first known producer of tequila.
A story may get people to try a brand, but getting them to buy again is based on taste. The brands in Constellation's wine and spirits line-up are consistent (and award-winning) performers. The company won Beverage Dynamics' Wine Supplier of the Year Award in 2018, while its Svedka Vodka ranked in the Top 5 list of Established Growth Brands, and High West Whiskey ranked third among Spirits Rising Stars.
What is it about the taste of the wines and spirits Constellation Brands offers that propels its products to the top of the charts? "Focus" brands -- Black Box, Kim Crawford, Meiomi, and The Prisoner -- deliver reliable (and adventurous) blends, craveable pinot noir, and exciting tastes from New Zealand. Blended whiskeys meet consumers' desire for flavor varieties. High-end tequilas like Casa Noble provide a super-premium, smooth finish that's worth the price.
Building momentum
Led by CEO Robert S. Sands, the company is taking its wine and spirits experience into new products for incremental growth. Svedka's test of spiked premium seltzer is under way. Small-batch whiskey techniques are fueling Western Standard, "a high-end, barrel-finished, easy-drinking lager," according to Sands. Rum barrels are storing Mondavi merlot, Casa Noble barrels are aging sauvignon blanc and Svedka's blue raspberry flavor helped the brand grow last year.
Constellation Ventures, created in 2015, keeps the company connected with the innovation emerging from craft distilleries and small wineries. Partnerships with companies like The Real McCoy expand the portfolio to include other spirits like rum and gin. Marketing dollars and general support help fuel interest in the categories overall.
With all that's right, what could go wrong?
Grape harvests have been affected globally by unexpected temperature shifts and domestically in California by wild fires.Wineries are trying to adapt by planting in new areas and planting vines better able to thrive with variable temperatures and smoke. But grapes in the variety and quality Constellation Brands is known for may cost more in 2019.
The shipping costs that dogged Constellation in Q1 aren't expected to improve. Trucking costs increased significantly in 2017 with no slowdown in sight. In the past decade, shipping costs increased more than seven times the rate of product pricing, according to a look at the overall picture reported by Forbes. Keeping up with growing demand for its premium wines and spirits could be a challenge with higher fuel prices and fewer trucks available.
The Constellation Brands leadership team remains confident wines and spirits will deliver net sales and operating income gains between 2% and 4%. The opportunity is solid. Preparations have been made. Although the challenges can be anticipated, they can't be fully controlled.
