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Better Buy: Costco vs. Constellation Brands

By Rhian Hunt - Jan 22, 2021 at 7:07AM

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An e-commerce success story pitted against a high-end beer seller for your investment dollar.

2021 arrived with with the availability of COVID-19 vaccinations, but doubts remain about the pace and success of business reopening while the virus is still active. In such uncertain times, Fools interested in consumer discretionary stocks have some attractive choices in companies that have so far weathered the pandemic.

Among these, Costco Wholesale (COST 0.55%) used its warehouse club e-commerce savvy to move profitably through the worst of COVID-19, while Constellation Brands (STZ -0.40%) is a beer company with a brand portfolio that's been punching above its weight even as bars and restaurants undergo closures or capacity limitations for health and safety reasons.

Two people in suits armwrestling

Image source: Getty Images.

Warehouse sales on the rise

According to McKinsey & Co. research from December 2020, COVID-19 boosted the "digital transformation" of the American economy ahead by as much as seven years, creating a switchover from brick-and-mortar to digital sales in a few months which otherwise wouldn't have been seen until 2027. Costco, while it continues to make solid in-store sales, has also managed to position itself successfully in the digital realm, with its adjusted fourth quarter (Q4) 2020 e-commerce sales skyrocketing 91.3% year over year and its full-year e-commerce sales rising 50.1%.

Even after incremental expenses from COVID-19, Costco's overall adjusted comparable sales, or comps, rose 13.6% in Q4 and 9.2% for the year. Its fiscal year net income rose from $3.7 billion in 2019 to $4 billion in 2020, a 9.3% increase. On top of this, the company's free cash flow has grown even faster than revenue. This appears to show its efficiency is increasing rapidly as it scales up its operations, indicating both good management and the cash necessary for flexible responses to future challenges or opportunities (such as acquisitions):

COST Free Cash Flow Chart
Data source: YCharts.

As a warehouse store, Costco has certainly profited from consumer stockpiling during the pandemic. Its brick-and-mortar sales per square foot climbed above $1,400 during 2020, according to reporting by The Robin Report, far outpacing Sam's Club's (NYSE:WMT) sales of $733 per square foot during the same period. The question, then, is whether it can maintain its growth into the future once the pandemic ebbs, or whether 2020's gains were a unique "blip" in its history.

In this regard, however, it appears Costco also has plenty of room, and plans, for continued growth. In just one sector, its international business, Costco has ample space to flourish. Its first warehouse club in China generated 139,000 new memberships in its first day open in August 2019, well before COVID-19 had any influence over sales, and reached 240,000 memberships by year's end -- and Costco has more stores in development in this vast market. Its expansion may slow after COVID-19 panic buying dies away, but the company appears to offer a future of steady ongoing profits, though probably not explosive gains.

One more factor weighing in Costco's favor is its dividend, which has risen 13% over the past half-decade. While Constellation Brands also has a dividend, Costco can at least approximately match its rival in this regard, while its 28% payout ratio means it has 72% of its cash available for other purposes, such as investing in growth initiatives.

Selling Corona amid the coronavirus pandemic

Despite restaurant and bar shutdowns and limitations, Constellation's shift to premium alcohol brands and divestiture of lower-priced beer and wine brands appears to have paid off in rising cash flow and growing sales. Net sales rose 3% overall for the first nine months of 2021, with beer sales up 6%, wine and spirits down 2%, and Canadian marijuana company Canopy Growth Corporation net sales rising 33%.

The primary driver of Constellation's success is its beer. According to its "Q3 FY2021 Investor Overview," high-end beer and spirits are booming, while lower-end beer and spirits are losing popularity. The presentation shows case volume of craft beers rising 11% and high-end beers jumping 6% over the past decade, while "all other beer" has seen volumes decline 4% over the same period.

Beer volume over time as presented by Constellation Brands

Image source: Constellation Brands.

Constellation matched its strategy to the trend, with its most recent divestiture, selling off its lower-end Paul Masson Grande brandy brand for $265 million. The company says it is now ready to look for more acquisitions in the premium beer sector. Case volume has risen for three of its major beverage families -- 1% for Corona, 16% for Casa Modelo, and 13% for Pacifico. Corona Hard Seltzer has been particularly popular, with case volume expected to grow 150% between 2020 and 2025.

Constellation also notes that 50% of its customers are Hispanic, and with the Hispanic population growing at a 3% cumulative annual growth rate (CAGR), the ongoing demographic transformation of the U.S. will likely continue driving sales and volume increases:

Demographic changes improving Constellation's sales.

Image source: Constellation Brands.

Its better beer margins have led to earnings growth and boosted cash flow. Its Q3 fiscal 2021 results, reported on Jan. 7, 2021, show earnings per share (EPS) skyrocketing 44% year over year to $3.09. In annual terms, analysts now expect EPS to climb 8% to $10.22 in fiscal year 2022. Net cash flow from operating activities rose $287.3 million year over year for the first nine months of fiscal 2021.

Looking toward the future, Constellation still has $11 billion in debt, but is using its healthy cash flow to reduce its debt, paying down long-term obligations by $1.2 billion between Feb. 29, 2020, and Nov. 30, 2020.   The company has improved its debt-to-equity ratio over the past decade, bringing it down from a high of 1.61 in 2013 to 0.76 on Nov. 30, 2020, according to MacroTrends data.

Constellation is also putting its cash flow to work in other ways beneficial to its shareholders. Quarterly dividends of $0.75 for Class A shares and $0.65 for Class B shares will be paid Feb. 23, 2021, while a $2 billion share buyback has been authorized by the Board of Directors, increasing the value of existing shares held by investors.

Which stock is a better bet?

Both stocks are a solid choice for a Foolish portfolio, but Constellation Brands appears to be the better buy over Costco. While Costco will likely continue to grow (possibly at a slower pace) even after COVID-19 recedes, Constellation's strategies of focusing on premium beers, aggressively entering the popular hard seltzer market, and appealing to the tastes of the changing U.S. population all mark it as the winner in this comparison.

The return of warmer weather, and the likely relaxation of lockdowns and limits, will release the brake on sales moving into summer 2021. Thereafter, with herd immunity possibly achieved through vaccination by autumn 2021, Constellation will be able to continue building on its gains, pursuing its acquisition strategy to strengthen its market share in the profitable high-end beer and spirits sector, and continue delivering growth, value, and dividends to its shareholders.

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Stocks Mentioned

Costco Wholesale Corporation Stock Quote
Costco Wholesale Corporation
$440.11 (0.55%) $2.40
Constellation Brands, Inc. Stock Quote
Constellation Brands, Inc.
$243.03 (-0.40%) $0.97

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