How The Canopy Growth Acquisition Is Weighing on Constellation Brands

Constellation Brands (STZ 0.07%) has a long history of successful M&A, notably gaining U.S. distribution rights to Modelo brand beers, which include Corona, in the U.S. However, the alcohol distributor seems to have stumbled when it spent $4 billion on cannabis grower Canopy Growth (CGC 9.68%) in 2017 as that company has struggled and continues to put up sizable losses.

In this episode of "Beat and Raise," recorded on Jan. 20, Fool contributors Toby Bordelon and Brian Withers discuss Constellation's performance with and without the impact of Canopy and why the cannabis grower has been such a drag on its results.

Toby Bordelon: We've talked about this company before. I think this is our second quarter looking at Constellation Brands on "Beat and Raise." It announced earnings about two weeks ago now, for their second-quarter 2022 fiscal year. Their fiscal year runs from July 1 to June 30. This is the second quarter which ended Dec. 31. Think of it as the fourth quarter of the year, but their second fiscal quarter, and it was pretty good, Brian. It was pretty good.

We can see here revenues $3.32 billion, that was down 5%, but that was a marginal beat, but a little bit of a beat from where people were looking at. Earnings, again, it looks way low, 62% drop on that. But that was a beat from what people were expecting. On their outlook, is it a raise? Is it a lower? It depends on your perspective.

Let's take a step back here. What is Constellation Brands do now, I think a lot of people know them from the alcohol business? They have a beer business, they have a wine and spirits business. Those are the two alcohol components. They also have a significant investment in Canopy Growth, a cannabis company . We can get to that in the second and that has not been doing too well.

But in terms of their outlook, what they're saying is that they are looking at earnings per share of a loss from $0.10 to $0.25. If you exclude the Canopy, expectations, this is for their full fiscal quarter, through June of this year, if you exclude the Canopy segment out of that, they're saying they might earn between $10.50 and $10.65 a share.

Brian Withers: Holy cow.

Bordelon: Yeah, that's a big swing. If you exclude Canopy, it's better than what the market was expecting the alcohol business to do. If you include Canopy in it's worse than what the market was expecting that to be for the fiscal year.

Withers: This was a recent acquisition for them.

Bordelon: Fairly, so 2017 they made this big investment. They're a minority. Let's talk about that. Canopy, they have a minority interest, but it is consolidated in the balance sheet. It's enough of it for that. They invested $4 billion in 2017. They've gotten some more shares. Some of that was warrants licenses exercised turned into shares. They have through this quarter a $424 million unrealized net loss and investment. They wrote down an additional $200 million in market value this quarter, made another adjustment, and sales were up for the quarter, just Canopy were up 3% to $104 million with a net loss of $56 million.

Again, minority investment, they don't have control of this business. But that loss is driven from major inventory write-downs due to excess product, price compression, shipping, and storage costs, a bunch of things that aren't really going well. That's dragging on this business. We look at the highlights, the beer business, Brian, is doing quite well. I know you may be familiar with Boston Beer (SAM -0.47%) and their struggles with the seltzer market, their depletion. Beer, generally, for the last several years, has not been doing great. Anheuser-Busch (BUD 0.56%) has been struggling, Molson Coors (TAP -1.13%) as well. But Constellation, with beer is their two biggest brands are Modelo and Corona Extra, Mexican beers. Depletion is up 8% for the quarter, so that's really good news. We're seeing some solid growth there. Modelo Especial, specifically depletion is up 13% -- depletion being what their distributor is selling. Because there's this pretty complex...

Withers: Selling into retail.

Bordelon: Exactly. But up 13%, Corona Extra depletion up 11%. The operating margin down a little bit due to costs increases, but the beer is looking pretty good. Wine and spirits also looking pretty good. Now, on the surface, it's down a lot. But they sold big brands to E. & J. Gallo, on the wine side, sold a brandy brand to Sazerac. Organically, you look at the organic growth. Organic sales were up about 3% in the wine and spirits business for the quarter. That's really good. The alcohol business is doing pretty well. The cannabis dragging on them in a big, big way.

Other thing to note here, they did announce a deal with Coca-Cola (KO -0.53%). What they're doing, they're doing a ready-to-make cocktail line. Fresca-branded cocktail line, they are going to be producing in partnership with Coca-Cola. That's pretty good news. We'll see if that segment starts to tick up. Others are doing that too, the ready-to-drink cocktails.

Sam Adams remember Boston Beer has a partnership with Pepsi (PEP -2.97%) to do a Mountain Dew alcoholic version. You're starting to see this right, but they've got to deal with Coke. We'll see how that, how that works out. The other thing I just want to mention quickly here is in terms of that deal. There were rumors earlier in the last year that they might be looking to merge with Monster Beverage (MNST -0.61%), and that has not materialized.

Excuse me. Monster has a big distribution with Coke, who owns significant chunk of Monster. There was some thought that this might be a precursor to that. We're going to do this Fresca deal and explore how we work together because there's really no way Constellation can do a deal with Monster if Coke wasn't onboard. It would be very, very difficult, so they try to test the waters there.

But a week after that, we learned that Monster was buying CANarchy Craft Brewery. I'm not sure those rumors are going to pan out. I would be shocked to see a Constellation-Monster merger coming on the heels of the Monster acquisition of CANarchy, especially when you're looking now Constellation maybe moving in a different direction with a Coca-Cola partnership, maybe there will be more of that. I don't know. That's just my long way of saying, watch this company for deals throughout this year because there has been some rumors, there has been some movement. We don't know what's going on.

But I think overall, their core business, the alcohol business seems to be doing fairly well from what we saw this quarter. If I were a capital allocator and I was looking at what that Canopy business has been doing for the last since 2017. I don't like it. It's a drag and I would almost say that's something that should look at getting rid of.

Withers: Yeah, if they were hoping for it to add to the top line at this point. I don't know that the breakup of the different brands, they've only gained about 18% revenue on the top line over the past five years. The bottom line has gone from nicely positive to somewhat negative.

Bordelon: As cannabis, as marijuana, it's more and more legal in the United States, do we think the competitive landscape is going to get easier? I don't think so.

Withers: No.

Bordelon: I don't know. We'll keep an eye close on it now because that is my biggest concern with this business. I would not want to see them continue to throw more good money after that unless we see some serious recovery from Canopy, it's not great.

Withers: If you were to grade the quarter for Constellation Brands, A to F, where would you grade them?

Bordelon: I would almost say let's give them a B+. Because most of what's going bad they don't control.

Withers: Yeah.

Bordelon: Right. A B+ because I'm knocking you for not being more proactive in trying to fix what's going on.