A quarter ago, my Foolish colleague Ryan Fuhrmann cautioned investors against binge-buying alcoholic beverage producer Constellation Brands
Wall Street did welcome the latest results, however, pushing the company's stock higher by more than 3% in recent trading. Investors were pleased with a solid top-line increase of 9%, springing from a healthy mix of organic growth and acquisitions.
Is it time to take a closer look at Constellation as a potential investment? Let's take a closer look at its latest quarterly conference call, specifically noting the current U.K. environment.
Still a hangover in the U.K.
Early in the call, we learned that the U.K. sales environment hasn't improved much. What's the problem with the U.K., you ask? Australia, mate.
In a nutshell, too many vineyards popped up too quickly in Australia, leading to a massive overabundance of grapes in 2006. Some of the reports I read estimated the total amount of grapes dumped to rot at roughly 60,000 tons. Even with the dump, the oversupply of grapes resulted in a depression of wine prices. Lower prices might sound like good news to us wine lovers, but you can bet that wine producers around the world are none too happy.
The effects of overproduction in Australia led many grocers in the U.K. to buy up the low-cost bulk wine to create their own private-label wines, Constellation COO Rob Sands explained. These quick, upstart brands heated up the competitive environment in the U.K., making it more difficult for Constellation's brands to flourish in the region. While Constellation's overall wine sales increased by a healthy four percentage points in the latest quarter, the growth primarily came from the North American market, with the U.K. continuing to drag on results.
Based on remarks made by Sands in the call, however, it looks like the environment may soon change for the better. He noted that early estimates put 2007 Australian grape production at 25% to 30% lower than 2006 levels. Also, the country is experiencing drought conditions that may push 2008 levels even lower. Eventually, we should see wine prices increase across the board, which should lead to growing profits for Constellation Brands, as well as for competitors like Diageo
Though the situation appears to be improving, Constellation's management made it clear that the company isn't just waiting around for better days -- it's taking steps now to improve operational efficiencies in the U.K. For instance, the company is investing in a new distribution facility located close to its existing distribution center in Bristol. Positioning the two closely together will "eliminate the need for satellite warehouses" and allow the company to take advantage of "significant ocean freight savings."
Obviously, such construction has costs, draining $0.02 per share from fiscal 2008 results, and another $0.03 in fiscal 2009. However, the estimated $25 million or so to build the new facility will be significantly offset by an expected $17 million gain from the sale of its older distribution center.
In addition to improving efficiencies within its operation, Constellation also plans to place greater focus on the specialty wine segment in mainland Europe, an area of the market where margins remain healthy, in an effort to offset the current strain placed on the U.K. But when asked whether Constellation had any short-term solutions to the problem, Sands made it clear to the inquiring analyst that there is "no silver bullet" in the short term to improve the sales environment.
Stars may be aligning
While there is no silver bullet for Constellation's current woes, from my vantage point, the U.K. situation may be taking a turn for the better. Add a more efficient distribution model to the possibility of rising wine prices, and Constellation Brands is setting itself up for some serious profit gains in the near future.
Does that mean it's time to chug Constellation's stock? Not so fast. As always, invest responsibly ... and patiently. The new distribution facility will not be fully operational until sometime in fiscal 2009, so we won't see significant gains from that model until fiscal 2010.
But I do think investors will begin to see some substantial profit gains beginning in fiscal 2009, even without the added operational efficiencies from the U.K. I'm basing this on management's repeatedly expressed intent to reduce inventory levels on wines in the U.S. market this year. More specifically, I expect to see inventory reductions on wines in the value category, placing a greater emphasis on premium wines, which carry better profit margins. Reduced inventory plus an emphasis on premium wines, as well as the Australia effect (this time on the positive side), should lead to significantly improved profits in an already healthy U.S. market.
Add that to the likelihood of improved economics out of the U.K., as well as recent additions in the form of the Vincor acquisition in Canada, the new partnership to bring Grupo Modelo's portfolio of imports in the U.S. under a "single marketing platform for the first time," and -- as if that weren't enough -- the acquisition of the fastest-growing premium vodka import in SVEDKA. Taken all together, investors have good reason to be optimistic for a turnaround in Constellation's business.
- Sour Grapes at Constellation Brands
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