Constellation Brands Q2 2022 Earnings Call Transcript

Quartr
Provided by Quartr
October 5, 2021

Key Takeaways

  • Constellation raised its full‐year beer guidance, now targeting 9%–11% net sales growth and 4%–6% operating income growth, driven by strong consumer demand for imported core beer brands despite supply constraints set to normalize by end Q4.
  • The company took an $80 million obsolescence charge on Corona Hard Seltzer inventory and lowered its growth expectations, planning to focus on differentiated ABAs and new seltzer innovations like Refresca and Limonata.
  • Premiumization in wine and spirits showed healthy performance in the high‐end segment, with strong growth from brands like The Prisoner and Naomi Cabernet, while e-commerce and direct-to-consumer channels grew 3–4× versus 2019.
  • Constellation’s disciplined innovation strategy will emphasize consumer-led, margin-accretive products across beer, wine and spirits, including ready-to-drink expansions such as Stedka, Woodbridge Wine Seltzers and boxed wine.
  • Capital allocation remains focused on debt reduction and shareholder returns, with $1.4 billion of share repurchases in Q2 toward a $5 billion target by fiscal 2023, while reinvesting in Mexican beer capacity expansions.
AI Generated. May Contain Errors.
Earnings Conference Call
Constellation Brands Q2 2022
00:00 / 00:00

There are 14 speakers on the call.

Operator

Welcome to the Constellation Brands Q2 Full Year 2022 Earnings Conference Call. At this time, all participants have been placed in a listen only mode. Following the prepared remarks, the call will be opened for your questions. Instructions will be given at that time. I will now turn the call over to Patty Jan Urloff, Senior Vice President of Investor Relations, please go ahead.

Speaker 1

Thanks, Josh. Good morning, and welcome to Constellation's Q2 fiscal 'twenty two conference call. I'm here this morning with Bill Newlands, our CEO and Garth Hankinson, our CFO. As a reminder, reconciliations between the most directly Comparable GAAP measure and any non GAAP financial measures discussed on this call are included in our news release or otherwise available on the company's website atcbrands.com. Please refer to the news release and Constellation's SEC filings for risk factors, which may impact forward looking statements we make on this call.

Speaker 1

Before turning the call over to Bill, similar to prior quarters, I'd like to ask that we limit everyone to one question per person, which will help us to end our call on time.

Speaker 2

Thank you, Patty. Good morning and welcome to our Q2 call. Let's dive right into a discussion about the quarter. There were a number of puts and takes impacting our results in Q2, and Garth and I will spend time walking through them. However, The fundamentals of our business remain solid and consumer demand for our brands, particularly our core beer portfolio remains strong.

Speaker 2

This gives us confidence to increase our EPS guidance for the year, which we outlined in our press release earlier today and Gaurav will review in more detail shortly. In addition, we repurchased a significant number of shares in Q2 at prices that are favorable, As we believe Constellation stock is undervalued at current levels. We've received some feedback from investors on this topic in recent weeks and will address key themes that emerged from these discussions in our remarks. As we walk through our Q2 performance and outlook for the remainder of the year, there are several key takeaways we'd ask you to keep in mind. Number 1, The momentum of our core imported beer brands provides a point of competitive strength versus industry peers, as we're the leading share gainer in the high end of the U.

Speaker 2

S. Beer market. The majority of our growth continues to be driven by Modelo Especial, supported by strong consumer demand for Corona Extra and Pacifico, and we expect this to continue for the foreseeable future. We continue to believe that Modelo Especial, in particular, has a long runway for growth, given the steadily increasing household penetration for this brand among non Hispanic consumers and continued strong velocity. Now, we've admittedly had some supply challenges this fiscal year, driven by several external factors, the most relevant being the ongoing robust demand for our beer brands.

Speaker 2

We expect to return to more normal inventory levels by the end of Q4. Despite these challenges, we continue to be on track to deliver a better than expected year for our beer business. In fact, Our strong performance to date gives us the confidence to increase guidance for our beer business, as we now expect to achieve 9% to 11% net sales Growth and 4% to 6% operating income growth for fiscal 2022. Our view is reinforced by recent 12 week IRI trends, showing the Constellation's beer business is significantly outpacing the high end and total U. S.

Speaker 2

Beer industry. Point 2. As it relates to our Hard Seltzer business and building off our last point, we are unique Our position versus our competitors in this space as our primary growth is coming from our core beer portfolio and we're not reliant on the growth of Hard Seltzers and ABAs to achieve the medium term growth goals for our beer business. The Heart Seltzer landscape has shifted considerably in recent months. Therefore, we've lowered our growth expectations for Corona Hard Seltzer, resulting in a sizable obsolescence charge taken for Q2, which includes our view of the total impact for the fiscal year.

Speaker 2

But let's be clear, we continue to see the Hard Seltzer and broader ABA space as a meaningful sector in the beer market. And we continue to believe it's important to participate in and gain our fair share in this segment to complement the growth of our core imported beer portfolio and to maintain our position as a leader in the high end of the U. S. Beer market. Going forward, we plan to focus on competing in this space in where we offer meaningful points of differentiation and unique value to consumers.

Speaker 2

I'll have more to say on this topic in a moment. Number 3, while our wine and spirits business was challenged in the Quarter by underperformance of several mainstream brands due to tough COVID comparisons, our recent route to market transition And supply chain challenges for our imported wine brands, we continue to see the benefits of our premiumization strategy take hold. We're performing well in the high end of the wine segment, which represents the vast majority of expected industry growth over the next several years. And we continue to strengthen our capabilities in emerging growth channels, key to long term success such as e commerce and DTC. Number 4, we continue to enhance our approach to innovation with a more consistent, strategic, disciplined and consumer led approach with a focus on high growth segments aligned with consumer trends.

Speaker 2

Our innovation agenda is designed to complement our organic growth and we're developing sustainable products that are incremental to our business, while further premiumizing our portfolio into margin accretive price points. Over the years, we've been able to extend some of our brands into new spaces, recruiting new drinkers and expanding occasions, and we've achieved a healthy balance between both from the core and from innovation. Number 5, Our capital allocation strategy remains unchanged since I assumed the role of CEO almost 3 years ago. Since then, we've made significant progress in reducing debt and achieving our goal of returning $5,000,000,000 in value to shareholders by the end of fiscal year 'twenty three through a combination of dividends and share repurchases. In fact, to date this fiscal year, we have repurchased $1,400,000,000 of our shares.

Speaker 2

And when combined with our dividend, we have achieved nearly 60% of our $5,000,000,000 goal. To be clear, Our shareholder value equation is based on outsized growth combined with return of dollars to shareholders. One of the most important capital allocation priorities is to continue reinvesting in our beer business to keep up with robust demand for our products. Despite initial challenges associated with the build out of a third In Mexico, we have moved on to other capacity alternatives in the country. Our expansions in Nava and Overgang It better enables us to manage through unexpected events like we've experienced these past 2 years.

Speaker 2

We continue to work with Mexican government to solidify plans for a new brewery in Southeastern Mexico with adequate water supply and an available talented workforce. Now let's move on to a more fulsome discussion about our performance within the quarter. During the quarter, the Modelo brand family posted depletion growth of 17% the quarter and single handedly drove total import share gains in IRI channels on a dollar basis. As the number 2 beer brand in dollar sales in the entire U. S.

Speaker 2

Beer category, Modelo Especial It's the only major beer brand growing household penetration and is leading the way as the number one shared gainer among high end brands. Modelo Chillada has become the number 2 brand family in the chillada space, posting depletion growth of more than 50% for the Q2. Corona Extra continues its growth trajectory as the 2nd fastest share gainer and the number one loved brand in the import category, driven by a return to growth in the on premise, which currently represents approximately 11% of our beer business volume. In addition to the comments I made earlier about our Hard Seltzers, I'd like to discuss industry trends and our refreshed approach to this sector of the beer market going forward. In the short to medium term, we believe that there will be consolidation within the Hard SeltzerABA space, primarily due to the chaos of SKU and brand proliferation with too many new entrants that don't have the velocity or consumer demand to warrant shelf space.

Speaker 2

We also believe this subcategory will evolve Beyond low calorie, low carb offerings and open up to more distinctive consumer value propositions that include things like more flavor, different alcohol bases and functional benefits. We've already started to innovate in this way with distinct products like Refresca and Limonata. We've also discovered that consumers are looking for more robust taste and flavor in their seltzers. As a result, We will be altering the flavor and taste profile of our seltzer portfolio to better align with the changing consumer preferences, while also introducing single serve packages to better serve the growing convenience channel, our largest trade channel. And we have a solid lineup of innovation that we have yet to introduce.

Speaker 2

We have several great examples of our innovation strategy at within our wine and spirits portfolio. This business continues to drive growth from recently launched innovations, including Naomi Cabernet Sauvignon, Kim Crawford Illuminate, The Prisoner Cabernet and Chardonnay, all of which are amongst the top 10 innovations across high end wine in IRI channels during the quarter. And our wine and spirits innovation pipeline is ready to go with further Consumer led new products as we head into our peak selling period, including the expansion of our Stedka ready to drink platform and the introduction of Woodridge Wine Seltzers and Boxed Wines. In addition to driving growth through innovation, We're making progress with our core wine and spirits portfolio despite the previously mentioned challenges. We continue to take price to further premiumize our mainstream portfolio as these steps are critical to maintain brand equity and to improve profitability, which will serve our brands well over the long term.

Speaker 2

We're putting points on the Board in a number of areas where we're outperforming the U. S. Wine market. Our high end Super Premium Plus portfolio grew net sales double digits during the quarter. In on premise channels, our investments are paying off with enhanced wine offerings at major restaurant chains.

Speaker 2

We're thriving in critical emerging channels like feature e commerce and direct to consumer, which continue to drive high end growth, where we're outpacing For example, Constellation's fine wine share has expanded significantly in the latest 12 weeks due to the robust growth of the Prisoner on Instacart and Robert Mondavi Winery on wine.com. In fact, e commerce and DTC sales are up nearly 3 to 4 times versus 2019, and they comprise roughly 3% to 5% of our business versus 1% pre pandemic. Going forward, we will continue to focus on becoming a category leader in e commerce and DTC, as we believe these channels will make up a significant portion of our mix over time and will continue to be an opportunity for high end growth. I'd also like to provide you an update on our U. S.

Speaker 2

Harvest, which is about 70% complete at this point, while our production facilities, wineries and tasting rooms remain untouched by recent wildfire activity. This quarter, our ventures activities included investments in Adaptogen Infused HOT WATER and Aaron Paul and Bryan Cranston's Artisanal Dos Ambres Mezcal. Hot water is a non alcoholic calorie free sparkling water infused with adaptogens and nootropics to provide the perfect balance of function and flavor for health conscious consumers. The non alcoholic segment Total beverage alcohol grew almost 40% in 2020 in dollar sales through IRI channels. And according to IWSR Research, 60% of consumers are switching between non alcoholic or low alcoholic and full strength drinks within the same occasion.

Speaker 2

Dos Ambras is an award winning handcrafted mezcal brand created by Breaking Bad costars who have developed an exceptional liquid that receives frequent praise from both the industry and consumers. The overall U. S. Mezcal category grew 14% in 2020 according to IWSR, Super premium Mezcal placed above $30 per bottle is projected to be the largest and fastest growing segment within the category. Moving on to Canopy Growth.

Speaker 2

We're encouraged by the recent introduction of the Cannabis Opportunity and Administration Act draft bill, And 2 thirds of those are in favor of legalizing for recreational use as well. In fact, nearly 2 out of 3 Americans already have legal cannabis access as 37 states have legalized for medical use and 18 states for adult use. While we're optimistic about federal legislation within this Congress, Canopy is not waiting for this reality to materialize. Canopy's U. S.

Speaker 2

Business grew 91% year over year in their most recent quarter, driven by robust consumer demand for their CBD CPG products, including Martha Stewart branded products, Quattro Beverages, Storz and Bickel vape products and BioSteel's new RTDs. Over the coming years, revenue from Canopy's U. S. Business is expected to grow significantly as it benefits from increasing distribution and new product introductions. Once THC permissibility becomes a reality in the U.

Speaker 2

S, Canopy expects their U. S. Business to make a substantially greater contribution to their results. Canopy has scaled a multi state route to market plan ready for legalization and has leveraged Constellation's distributor relationships to fuel their U. S.

Speaker 2

Non THC business with more opportunities in a world post federal permissibility. Overall, we're comfortable with Canopy's progress and we're looking forward to the growth and legalization prospects for the business. In closing, I'd like to reiterate our main takeaways for this quarter. First, continued strong demand for our core imported beer brands provides a point of competitive strength versus industry peers, led by the number one share gainer in the beer category, Modelo Especial, which we feel has ample runway for growth well into the future, given the steadily increasing household penetration rates among non Hispanic consumers and continued strong velocity. The short term supply disruption to our imported beer business does nothing to dampen our long term prospects as we expect to return to more normal inventory levels by the end of Q4 and we're on track to deliver a better than expected year for our beer business.

Speaker 2

2nd, we continue to see the hard seltzer and broader ABA space as a meaningful sector within the beer market. Going forward, we plan to focus on competing in this space in ways where we can offer meaningful points of differentiation and unique value to consumers, and we have some upcoming innovation in this space that we're optimistic about. Number 3, We continue to see benefits of our wine and spirits premiumization strategy take hold. We're performing well in the higher end of the wine segment, and we continue to strengthen our capabilities in emerging growth channels key to long term success such as e commerce and DTC. 4th, we continue to enhance our approach to innovation with a more consistent, disciplined and consumer led approach focused on high growth segments aligned with consumer trends to complement our organic growth, while developing sustainable products that are incremental to our business at margin accretive price points.

Speaker 2

And 5th and certainly not least, Our shareholder value equation continues to be based on outsized growth combined with the return of dollars to shareholders. And let me reiterate, Our capital allocation strategy remains unchanged. We remain committed to our goal of returning $5,000,000,000 in value to shareholders by the end of fiscal year 'twenty three through a combination of dividends and share repurchases. Our strong operational performance And cash flow generation allowed us to make significant share repurchases in Q2, aligned with our commitment, which contributed to the increase in our EPS guidance for the year. At the same time, we remain committed to continuing to reinvest in our business with an emphasis on our beer business to keep up with the robust demand for our products.

Speaker 2

And with that, I'd like to turn the call over to Garth, who will review our financial results in the quarter. Garth? Thank you, Bill,

Speaker 3

and hello, everyone. Q2 certainly reflected yet another strong quarter of marketplace performance for our beer business. Due to continued robust consumer demand for our core beer portfolio, we now expect to see our initial top And operating income targets for our beer business. Additionally, our strong cash flow generation enabled us to continue to repurchase shares during the quarter. And through September, we've repurchased 6,200,000 shares of common stock for $1,400,000,000 As a result, we've increased our full year fiscal 2022 comparable basis diluted EPS target, and we now expect to be in the range of $10.15 to $10.45 This range excludes Canopy equity and earnings impact and reflects Increase in beer operating income guidance and decrease in the weighted average diluted shares outstanding based on shares repurchased through September, partially offset by an increase in the tax rate for fiscal year 2022.

Speaker 3

Now, let's review Q2 performance And our full year outlook in more detail, we're all generally focused on comparable basis financial results. Starting with beer. Net sales increased 14%, driven by shipment volume growth of nearly 12% and favorable price, partially offset by unfavorable mix. Depletion volume growth for the quarter came in above 7%, driven by the continued strength of Modelo Especial and Corona Extra, as well as the continued return to growth in the on premise channel. Depletion trends tempered in Q2 versus Q1, driven by out of stocks due to ongoing robust consumer demand as well as lost shipping days for some of our distributors due to severe weather events, including hurricanes and wildfires.

Speaker 3

We estimate that these factors hampered Q2 growth by approximately 2 to 3 points. As Bill mentioned, on premise volume accounted for approximately 11% of the total beer depletions during the quarter and grew strong double digits versus last year. As a reminder, the on premise accounted for approximately 15% of our beer depletion volume pre COVID accounted for only 6% of our depletion volume in Q2 fiscal 2021 as a result of the on premise shutdowns and restrictions due to COVID-nineteen. Selling days in the quarter were flat year over year and will also be flat in Q3. Wholesaler depletions continue to outpace cases shipped during Q2, resulting in lower than normal distributor inventory on hand at the end of the quarter.

Speaker 3

To rectify this gap, shipment case volume is expected to exceed depletion case volume throughout the second half of the fiscal year, resulting in a gradual improvement of distributor inventories during Q3 and Q4 as inventories are expected to return to normal levels by the end of the fiscal Moving on to beer margins. Beer operating margin decreased 5 30 basis points versus prior year to 37.2%. Benefits from favorable pricing, mix and foreign currency were more than offset by unfavorable COGS, Increased marketing investments and higher SG and A. The increase in COGS was driven by several headwinds that include the following. First, a Q2 obsolescence charge of $66,000,000 As a result of our production constraints earlier in the year, We prebuilt hard seltzer inventory in advance of the key summer selling season based on our best estimates for fiscal year 2022.

Speaker 3

Due to the overall slowdown in the hard seltzer category in the U. S, some of that growth is not going to materialize in the fiscal year, resulting in excess inventory.

Speaker 2

2nd,

Speaker 3

increased brewery costs driven by labor inflation in Mexico, increased headcount and incremental spend related to capacity expansion. 3rd, a step up in depreciation expense largely due to the incremental 5,000,000 hectoliters at OpRegon. And finally, as expected, increased material costs predominantly driven by increased commodity prices inflationary headwinds on pallets, cartons and aluminum. These COGS headwinds were partially offset by favorable fixed cost absorption. Marketing as a percent of net sales increased 150 basis points to 9.9 versus prior year as we return to our typical spending cadence, which is weighted more heavily towards the first half of the fiscal year.

Speaker 3

As a reminder, marketing spend in the first half of the prior year was significantly muted, resulting from COVID-nineteen related sporting and sponsorship event cancellations and or postponements. Lastly, The increase in SG and A was primarily driven by an increase of approximately $12,000,000 in legal expenses as well as higher compensation and benefits. As mentioned earlier, we are increasing full year fiscal 2022 net sales and operating income guidance for our beer business. We are now targeting net sales growth of 9% to 11%, reflecting the strength of our core beer portfolio and Pricing actions that are higher than initially planned. Furthermore, we are now targeting operating income growth of 4% to 6%, which implies operating margin in the low to midpoint of our stated 39% to 40% range.

Speaker 3

Please note The updated guidance includes all obsolescence charges and legal expenses incurred in the first half of the fiscal year. We continue to expect our gross margin to be negatively impacted for the fiscal year as benefits from price and our cost savings agenda are expected to be more than offset by several cost headwinds. However, the mix and magnitude of these headwinds have changed from our original assumptions presented the beginning of our fiscal year. First, we're still estimating a significant step up in depreciation expense, which began to accelerate in Q2. However, some of this depreciation started later in the year versus planned.

Speaker 3

As such, we are now estimating total beer depreciation expense to approximately $250,000,000 an increase of approximately $55,000,000 versus last year or a $10,000,000 decrease versus our original planned estimate. 2nd, we still expect substantial inflationary headwinds across numerous cost components to continue during the second half of our fiscal year as commodity prices continue to rise, specifically across aluminum, diesel and pallets, resulting from a rather volatile inflationary market. And third, due to the growth moderation within the hard seltzer market, As well as lower ACV levels across the category on new items, we do not expect our hard seltzer SKUs to meet originally planned volume expectations, which results in a positive mix benefit versus our original estimate. Conversely, due to the slowdown in the hard seltzer sector, Excess inventory resulted in a fiscal year to date obsolescence charge of approximately $80,000,000 Please note These losses cover our Hard Seltzer obsolescence exposure and as such, we do not expect to take any additional obsolete charges in the back half of the fiscal year for Hard Seltzers. From a marketing perspective, we continue to expect full year spend as a percentage of net sales to land in the 9% to 10 Which is in line with fiscal 2021 spend of 9.7 percent of net sales.

Speaker 3

Looking ahead to Q3, I'd like to remind everyone of the difficult volume overlaps we will encounter as we're facing a 28% and 12% growth comparison for shipment volume depletion volume respectively. Additionally, we expect to perform our normal annual brewery maintenance during Q3, which will result in less throughput versus Q2 as we have to shut down production for Q days. As such, we are estimating low single digit shipment volume growth for Q3. Moving to wine and spirits. Q2 fiscal 2022 net sales declined 15% on shipment volume down 36%.

Speaker 3

Excluding the impact of the wine and spirits divestitures, organic net sales increased 15%, driven by organic shipment volume growth of nearly 6%, favorable mix and price and smoked tainted bulk wine sales. Robust mix driven by the Prisoner Brand family, Naomi and Kim Crawford accounted for approximately 9 points of the year over year organic net sales growth. Shipments were negatively impacted by port delays for our international brands and route to market changes, which also impacted Depletion volume declined 2% during the quarter and was additionally impacted by the challenging overlap to consumer pantry loading behavior, especially for our mainstream brands that experienced robust growth during the beginning of the COVID-nineteen pandemic. However, As we head into the second half of the fiscal year, we feel as though most of these challenges are behind us and expect shipment volume and depletion volume to generally align in the second half of fiscal twenty twenty two. Moving on to wine and spirits margins.

Speaker 3

Operating margin decreased 620 basis points to 19.7% as mix benefits from the existing portfolio and divestitures combined with favorable price were more than offset by increased marketing and SG and A spend, higher COGS and margin dilutive smoked tinted bulk wine sales. Higher COGS were driven by unfavorable fixed cost absorption and increased transportation costs. The unfavorable fixed cost absorption resulted from Decreased production levels in New Zealand due to a frost during their harvest season earlier this year, as well as decreased production levels at our wineries in California due to the 2020 U. S. Wildfires.

Speaker 3

These headwinds were partially offset by lower grade raw materials and other cost savings initiatives. Keep in mind that we're lapping lower SG and A spend in Q2 fiscal 2021 due to COVID and have a smaller business post the divestitures resulting in significant marketing and SG and A deleveraging impacting operating margins. For full year fiscal 2022, the wine and spirits business continues to expect net sales and operating income to decline 22% to 24% and 23% to 25%, respectively. This implies operating margin to approximate 24%, which is flattish to prior year on a reported basis, which shows significant margin expansion on an organic basis. Excluding the impact of the wine and spirits divestitures, Organic net sales is expected to grow in the 2% to 4% range.

Speaker 3

From a Q3 perspective, Keep in mind that we are lapping unfavorable fixed cost absorption of $20,000,000 in the prior year, resulting from decreased production levels as a result of the We expect this favorable overlap to be partially offset by continued increase in transportation costs and incremental unfavorable fixed cost absorption due to the New Zealand frost. Also, We continue to expect marketing and SG and A deleveraging as a result of the Wine and Spirits divestitures. As such, We expect marketing and SG and A to continue to be a significant drag to operating margins in Q3 fiscal 2022. Now, let's proceed with the rest of the P and L. Fiscal year to date corporate expenses came in at approximately $117,000,000 up 7% versus last fiscal year.

Speaker 3

The increase was primarily driven by higher consulting services and compensation and benefits, partially offset by favorable foreign currency impact. We now expect full year corporate expenses to approximate $245,000,000 driven by increase in compensation and benefits. Comparable basis interest expense for the quarter decreased 4% to approximately $96,000,000 versus prior year, primarily due to lower average borrowings. We now expect fiscal 2022 interest expense to be in the range of $355,000,000 to 365,000,000 The slight decrease versus our previous guidance reflects early redemption of higher interest rate debt, as well as $1,000,000,000 of senior notes issued in July at attractive rates. Our Q2 comparable basis effective tax rate excluding Canopy Equity earnings came in at 21.8% versus 16.9% in Q2 of last year, primarily driven by the timing of stock based compensation benefits and a higher effective tax rate on our foreign businesses.

Speaker 3

We now expect our full year fiscal 20 22 comparable tax rate excluding Canopy equity earnings to approximate 20% versus our previous guidance of 19%. This increase is primarily due to a higher effective tax rate on our foreign earnings than originally estimated. I would also note that we expect stock based Compensation tax benefits to be weighted towards Q4. As a result, we expect our Q3 tax rate to be higher than our full year estimate and approximate 21%. We also now expect our 2022 weighted average diluted shares outstanding to approximate $192,000,000 reflecting the impact of our September year to date share repurchases previously discussed.

Speaker 3

Moving to free cash flow, which we define as net cash provided by operating activities less CapEx. We generated free cash flow of $1,200,000,000 for the first half of Fiscal 2022, which is flat to prior year, reflecting strong operating cash flows, offset by an increase in CapEx. CapEx Totaled $353,000,000 which included approximately $295,000,000 of beer CapEx, primarily driven by expansion initiatives at our Mexico facilities. Our full year CapEx guidance of $1,000,000,000 to $1,100,000,000 which includes approximately 900,000,000 targeted for Mexican beer operation expansions remains unchanged. Furthermore, we continue to expect fiscal 2022 free cash flow to be in the range of $1,400,000,000 to $1,500,000,000 This reflects operating cash flow in the range of $2,400,000,000 to $2,600,000,000 and the CapEx spend previous outlined.

Speaker 3

In closing, I want to iterate that while we had our fair share of challenges during the first half of our fiscal year, resulting in several puts and takes impacting our results. The fundamentals of our business remain strong and consumer demand for our products, Particularly, our imported beer portfolio remains robust, providing us with strong momentum as we head into the second half of our fiscal year. With that, Bill and I are happy to take your questions.

Operator

Thank you. Our first question comes from Kara Mohsenian with Morgan Stanley.

Speaker 4

Hey, guys. So on the beer top line front, first, just a detailed question. Given the volatility here and the tough comp in Q3, can you give us an update on how September depletions are trending so far? And also for the quarter, are you expecting depletions to still be above that low single digit shipment rate that you mentioned? Or is that tough With the difficult 12% depletion comp.

Speaker 4

And then second, the longer term question is, You raised your revenue guidance for this year. How much of that is underlying demand strength and depletions Maybe versus shipments and perhaps getting more supply into the balance of the year versus pricing. And on the pricing front, you've sounded more aggressive in terms of pricing expectations going forward publicly. A, I guess, is that correct? And B, Is that more just to combat higher commodity costs or is it more confidence in market share gains or

Speaker 3

that the

Speaker 4

consumer environment is conducive to taking pricing care? Thanks.

Speaker 2

Sure, Dara. Let me take a swing at that and if I miss anything, Garth can Phil in behind. So relative to depletes in September, we expect those to be fairly consistent with year to date trends. We're just about all wrapped up for September. Keeping in mind, that's going against the 20% increase that we had during September of last year.

Speaker 2

So that's A pretty powerful start to the quarter. We do expect that depletions are going to continue to be above shipments for the reasons that Gaurav noted in his remarks. So we would expect the depletions would be above it for that window of time. The pricing environment remains relatively strong. As we've said, we expect to be slightly ahead of our usual algorithm, driven more by taking it to pricing on some SKUs that we had not anticipated earlier in the year, more than we're doing anything unique to take additional pricing where we overall what we had already planned.

Speaker 2

Garth, anything you want to add to that?

Speaker 3

No. I would just say on the depletions The quarter depletion growth will absolutely outpace shipment growth in the quarter, but on an absolute basis, shipments will outpace Depletions, which helps us get into a better position from an inventory perspective.

Speaker 2

Yes, keep in mind, as we've said, We have our inventory levels at our distributors below what we would like to see and what they would like to see on an ongoing basis. So we would be expecting to fill some of that in as we get our inventory levels back to normal position by the end of the fiscal year.

Operator

Thank you. Our next question comes from Bonnie Herzog with Goldman Sachs. You may proceed with your question.

Speaker 1

All right. Thank you. I actually had a question on your guidance as well. I just in thinking through it and thinking about the mid Points of your new beer guidance for the full year, this does imply a pretty big step down in the second half. For instance, your new guidance implies around 4%, 4.5% beer shipment volume growth, 3% op income growth and then beer margins of 39 percent for the second half.

Speaker 1

And that compares to your beer margins of 40% in the first half, which did include the $80,000,000 Obsolete's charge that you pulled out. So I guess I'm trying to understand your level of conservatism with your new FY Guidance, especially with margins, given you mentioned there's going to be no more charges in the second half. You highlighted you plan Take incremental pricing and then there are a few other net positives, Garth, that you called out. So, just want to make sure I'm not missing anything or maybe what's changed here. Thanks.

Speaker 3

Thanks, Bonnie. I mean, look, let me try to give you the walk on margins, right? And you noticed as you noted, we've got some headwinds and we've got And so just on the tailwinds. Obviously, we said in my opening remarks, we've got a bit of a benefit on depreciation Just starting later than expected in the year. And so that's a net positive.

Speaker 3

As Bill just articulated, we're taking more we're taking Increased pricing across more SKUs than we originally planned. So we'll be above our range there. So that's a net positive. We also have the mix benefit of seltzers, and again, a net positive there. And then, the increase In core beer outlook is a net positive.

Speaker 3

So those are all the headwinds. But we still have or those are all the tailwinds. But we still have the headwinds that we've been talking about all year long, right? So even though depreciation is coming in less than expected, we still have an uptick in depreciation in the second We still are facing increase in commodity prices, including aluminum, diesel, natural gas, Would. Those will continue in the second half of the year.

Speaker 3

Now, we think that the guidance we provided takes into account all of those cost increases. So, we feel we have those covered. But again, I mean, we just continue to have these puts and takes and we feel confident that in the margin outlook that we provided. Keep in mind too that even though we're going to have a mix benefit from From seltzers, we still are going to sell seltzers and those are margin dilutive as we've noted previously.

Operator

Thank you. Our next question comes from Nik Modi with RBC Capital Markets. You may proceed with your question.

Speaker 5

Yes. Thanks. Good morning, everyone. So, I have two questions. One is a real quick one.

Speaker 5

Just on the seltzer reformulation, Bill, I know you probably don't want to provide too many details until it's in the market, but will this change the calorie or the sugar levels? So just curious on that. And then my broader question is, Modelo is clearly doing very well. We see that in the data with non Hispanic consumers. But as we look at some of the numerator data and we look at different cohorts, what we notice is that Corona's kind of leverage to some of these demographics that Modelo is doing much better with, you're seeing some of those numbers deteriorate.

Speaker 5

So just wanted to get a sense on Incrementality of Medela, when you think about Medela and Corona together. And do you ever think that maybe there's a different merchandising scheme you can use Instead of putting both brands right next to one another to kind of reduce some of that cannibalization?

Speaker 2

Sure. So relative to your First quick point, there won't be a radical change in the caloric formulation of our seltzer layout. Relative to Modelo and Corona. Obviously, there's interaction between those two brands as you would expect. However, as we've said before Nick and I'm sure you're quite Our household penetration on Modelo is still significantly below where Corona is To say nothing of it's below other brands that are that it competes against.

Speaker 2

So while it is a true statement that As Modelo grows or as Corona grows, it does into some of our brands. We still see it as largely positive as we see that growth profile. And as we've talked before, Modelo, It's continuous to grow velocity. There's a lot still a lot of runway to expand distribution. The household penetration, which I touched on just a second ago, remains a massive Tracing, which I touched on just a second ago, remains a massive opportunity for that.

Speaker 2

And we've Only started advertising to the non Hispanic community about 3.5 years ago. So we're really just getting started on Modelo and the opportunity that presents itself there. So while you continue to see some interaction and clearly I think The idea of separating those at retail to some degree has some opportunity. I think overall, we're still focused on expanding our presence of both of those brands. As you probably saw, Corona Extra had a very good quarter.

Speaker 2

And it just shows the ongoing strength of the core Corona franchise in addition to exceptional performance by Medill.

Operator

Thank you. Our next question comes from Lauren Lieberman with Barclays. You may proceed with your question.

Speaker 2

Great.

Speaker 6

Thanks. I want to see a little bit about Corona Extra since you called out the 5% depletion growth for that brand and how That kind of shakes out between on premise recovery versus Track channels or sorry, I should say off premise. And then I was hoping you could also talk a little bit about Nielsen IRI versus what you guys saw in terms of off premise trends in total, including untracked outlets? And then finally, just any kind of update on Pacifico? Just continually intrigued to hear about progress you are or aren't making with that brand.

Speaker 6

Thanks.

Speaker 2

Sure. So probably 50%, give or take of the growth profile that we saw in Corona Extra is The reopening of the on premise. As we've said in prior calls, we were down as low as 3% of our business A few quarters ago during the sort of the peak of the initial COVID pandemic issue, that's now up to 11%. And Clearly, with the Corona being one of the most loved brands that exist in the category, the increase that you would expect to see as on premise opens Has been important. But don't underestimate Corona actually has done very well at retail as well.

Speaker 2

Relative to Pacifico, We continue to feel like Pacifico is another great opportunity. It's like a baby Modelo. It's developing in a very similar way to what Modelo did Say 20 years ago with extensive growth profile on the West Coast and as it's starting to filter East. As you know, we're investing more against Pacifico than we have historically. We had a little bit of challenge in this quarter With brown glass, which had some impact on Pacifico during the quarter as it did with Modelo Negra as well.

Speaker 2

But those are ongoing supply chain challenges that we're working our way through. It does nothing, nothing to slow down what we expect

Operator

Thank you. Our next question comes from Chris Carey with Wells Fargo Securities. You may proceed with your question.

Speaker 7

Hi. Thank you very much. Just on Hard Seltzer, you had originally planned On investing pretty significantly behind the launch this year, are you getting any savings from those investment plans now that the category has slowed or Are those locked? And presumably that can be a good story going into fiscal 'twenty three. In addition, you had mentioned that you had planned to double capacity for your ABAs.

Speaker 7

And so, how are you thinking about flexing that capacity toward beer? Obviously, you're looking at Building a new brewery in Southeast Mexico, does this get to delay that new build out over time because

Speaker 3

Yes. Thanks for the question. So, on the capacity piece first, right. As we announced last spring, We are investing in 5,000,000 hectoliters worth of AVA capacity. That is moving forward as planned and should come online earlier in our Fiscal year 2023, that's still an important initiative for us because as Bill outlined in his prepared remarks, while the seltzer category has slowed, The AAV segment within beer continues to be a dynamic and meaningful part of the high end and it's one that we need to compete in.

Speaker 3

And by having dedicated AVA capacity, that frees up capacity for our core Mexican beer portfolio. So that goes on as planned. And then furthermore on the investment that you referenced in the first part of your question, we did indicate that we were going to spend $60,000,000 this fiscal year behind Corona Heart Seltzer, most of that spend was slated to be spent in the first half of the year. So That has been spent and that which wasn't spent is being redirected to invest behind our core Mexican beer portfolio.

Speaker 2

The only other thing I'd add to that on the last part of your question was about whether or not it causes any Delay in what we would do to invest in the Southeast. As I said, we're continuing to work with the Mexican government. We feel the Southeast It's highly likely to be where we put our next brewery position. And as we've said, because of robust demand, we're going to continue to invest to support our business. So we would not expect to see any radical change of what our time frame is all about.

Speaker 2

Demand has been higher than expected. We need to create some redundancy in our system as we've noted on prior calls and A brewery in the Southeast will be an integral part of that strategy.

Operator

Our next question comes from Vivien Azer with Cowen. You may proceed with your question.

Speaker 6

I was hoping you could comment please on intra quarter trends in on premise, whether you saw an evolution or a softening there around The variant. And as well, perhaps from an industry perspective, are you observing any changes in consumer alcohol preference Across kind of TBA, any cross category switching as consumers venture back out into bars and restaurants? Thanks.

Speaker 2

Sure. We saw a lot of variation in on premise. And At the risk of saying yes, no, yes, no and yes, no, it largely depended on where you were geographically And what was going on in particular markets. So while we would sit here and say State X is coming up and we're seeing more on premise, If you saw a wave of COVID challenges in another market you saw stuff go the other way. So what that basically I think There wasn't an overarching answer to that question.

Speaker 2

It was really on a localized basis that you Many of the movements within the quarter. Again, in the aggregate, on premise was better than it was in the prior year. And it continues to be increasing as a percentage of our business, but it's still not quite where it was before the pandemic. So hopefully that helps. It's very hard to give a real aggregate of the thing because it's really made up of a lot of individual answers Rather than something being an overarching trend across the marketplace.

Speaker 2

I think relative to your question about cross category, I think the overarching thing that you see there is the premiumization trends continue. Whether you think about it in ready to drinks, in our AVAs, you continue to see People premiumizing, you see it in the wine business where the higher end of the wine business continues to outperform the mainstream sector of the business, and you continue to see that in Spirit. So I think that is an overarching trend that you see. You also see what we found for many years now, which is consumers are more interested in having an array of beverages Depending on the exact occasion in which they are consuming product and are less likely than they used to be to consume only one type of product at any one occasion than what was perhaps the case historically. So hope that helps.

Operator

Thank you. Our next question comes from Kevin Grundy with Jefferies. You may proceed with your question.

Speaker 8

Great. Thanks. Good morning, everyone. Bill, just picking up on the last question, but really kind of lasering in, I guess, a little bit on wine and broadly for the industry, because there's been some discussion in the marketplace about The recent slowdown, and it's not limited to the on premise and we've seen the Nielsen data. So, your point is extremely well taken.

Speaker 8

The premiumization trends are still in place, Obviously, broad based across total beverage alcohol. But even on a 2 year average basis, this is we're seeing the trend slowdown here. So, I'm not sure how much more you can add to your comment previously. Do you view this as transient at this point, some of this deceleration we're seeing in the category? Is there a bigger, Maybe a bit more difficult to quantify dynamic going on around ready to drink beverages in a way there hasn't been with wine before, if you could comment on that.

Speaker 8

And Garth, just sort of a cleanup, but I think Important. The 30% operating margin target in the wine segment, is that still the target? And then is fiscal 'twenty four, so over the next couple of years, is that sort of enough Tom, a timeline to take out the stranded overhead. So your comments there would be helpful. Thank you both.

Speaker 2

I think you got to keep in mind relative to the Higher end of the wine business. You're also seeing some, what I'll call, channel evolution, and things like 3 tier e commerce and direct Consumer, those are up for us 3 to 4 times what it was in 2019. And you're seeing that as sort of 3% to 5% of our business today where it was 1% before. So some of what you're seeing in that is a difference in the way the consumer actually acquires, and it may or may not be reflective Of some of the IRINielsen data, because it's not picked up in those channels. Some of it is with 3 tier e commerce, but Certainly, the direct to consumer channel is not.

Speaker 2

So you've got some of that dynamic in play. And of course, almost all of that Tends to the higher end. That's where that consumer purchasing behavior occurs. So I do think there's Ebbs and flows on all of those things. I think you saw probably more consumption behavior at home during COVID.

Speaker 2

So you're probably seeing A little bit of more challenging comparable versus prior year. So I think as we get hopefully back to a bit more normalcy, I think you'll continue to see what the long term trend is, which is that the higher end of the business continues to outperform And then, it's a strong growth play for that sector. Garn?

Speaker 3

Yes. On the wine margins, certainly, the target margin for wine is still 30%. As we've said all along, it was going to take us about 2 years post divestiture of the low end for us to be able to achieve that 30% operating margin. So, by the time we get to the end of our fiscal 2023, wine should be in that zip code. Obviously, the progress on that is underway.

Speaker 3

We're making good progress. As we've said before, in order to get there, there's a number of initiatives that have to that we have to make progress on that's pricing mix, footprint optimization, making smart design to value choices. And like I said, we're making good progress and we're confident that we can get to 30% by the end of 2023.

Operator

Thank you. Our next question comes from Robert Ottenstein with Evercore, you may proceed with your question.

Speaker 9

Great. A couple of questions. First, Obviously, the low inventories hurt depletions. Can you give us a sense of where you think depletions would have been If you had full inventory levels, and I'm hearing it hurt corona most, can you verify that?

Speaker 2

Obviously, that's a little bit of a tough question to answer because unlike a year ago where we were very selective of what we produced, This year, we've been producing all SKUs. We've just had trouble keeping up with the demand. Our best estimate would Maybe in the 2 to 3 percentage points that we lost in this process. But again, in most instances, if the consumer is looking for our brand, they may have an issue at a particular point in time finding a SKU, but they don't have trouble finding our brand. So I think that's probably the way to think about it.

Speaker 9

Great. And then second question, as you kind of do a diagnostic On what happened with Corona Seltzer, I think I heard you say that flavor was an issue, that the consumer wants More flavor. So as you think about it, was it a question of the taste not being differentiated Or is there an issue with having a brand that's associated with a beer? Or are there other factors In addition to obviously the sector slowing a little bit, just like to hear a little bit more of your diagnostic on the situation.

Speaker 2

Well, I would put more emphasis on your very last point, which is the sector changed a lot versus what everybody anticipated. I think we were probably a bit on the conservative end compared to some of the competition as to what they expected going into this year, where some of them were predicting in excess of 50% growth. We projected less. But even as it was, we were wrong. So that is the fundamental issue.

Speaker 2

When you combine that with the fact that we pre produced, which again at the time was about production Scheduling and in our judgment was the right thing to do at the time. That in hindsight did not work out for us as well either. But you got to keep in mind, Despite all that, it's a relatively small percentage of our overall growth profile. It is additive to our growth. It is not the majority of our growth.

Speaker 2

The majority of our growth continues to be the robust demand against our core beer portfolio and that's where we expect It continues to be. So now relative to the formulation, we've just we obviously do a lot of consumer research and we track consumer perspectives. And we have found that consumers are desiring a bit more flavor and a bit more differentiation within their seltzer preferences, Great. Thanks for the question. Thinking longer term on the margin front and some of the long term exposures you have and hedges you have in place, Is the second half of fiscal 'twenty two the right way to be thinking about margins in 'twenty three?

Speaker 3

Look, I think the right way to think about margins over the near and medium term is consistent with our long term growth algorithm, which is that we're going to Margins in the range of 39% to 40%. And as we say in every call, those are best in class margins and we're unapologetic about And in any given fiscal year, margins might be slightly higher than that Due to tailwinds and in some years they might be slightly lower than that, too many headwinds. But the right way over the medium term is to think about those in the range of 39% to 40%.

Operator

Thank you. Our next question comes from Nadine Sarwat with Bernstein. You may proceed with your question.

Speaker 10

Hi. Thank you for taking my question. I want to circle back to Pacifico, and you had called out the brown glass challenges that you faced. So obviously that brand saw weaker Nielsen off trade trends this quarter. And I noticed that you didn't call out its depletion figures in the release.

Speaker 10

So, could you provide this and maybe give us some color as to if there were other issues outside of the glass issue you already called out? Thanks.

Speaker 2

Sure. We had mid single digit depletion growth in that brand during the quarter. And obviously, it was constrained. We would have expected it to be higher without any supply chain issues that revolved around Brown West.

Operator

Thank you. Our next question comes from Andrea

Speaker 11

You said depletion should outpace the low single digit shipments you guided in the 3Q, which would imply a sequential acceleration in 3Q from the 12% on a 2 year stack that you achieved in the 2nd quarter. So Given that you're facing a tougher comparisons as you grew depletion the same amount about 12% in the Q3 of last year, Is that acceleration on the 2 year coming mostly from on premise and at home decelerating but still growing? Is that the way we should be thinking? In other words, should we think about beer depletion growing around mid single digit when you said I think you said it effectively that the 3rd Water depletions would outpace shipments as well. And then related to and just a clarification on the pricing front, should we think that you We'll have about 2% price mix realization already in the 3Q.

Speaker 11

And what are you seeing elasticity playing out so far? Thank you so much.

Speaker 3

Sure. So, just on Q3 shipments and depletions. What we said in terms of from a growth perspective, shipments will grow in the low single digits and depletions will grow higher than that. We furthermore said that on a volume basis, depletion shipments would outpace Depletions and therefore we've made progress in returning inventory to more normal levels by the end of our fiscal year. On the pricing question, what we said on that was is that our typical pricing algorithm has us Gaining 1 to 2 percentage points per year.

Speaker 3

Given the pricing environment that we're in this year, we're able to be a little bit more aggressive on products that we wouldn't otherwise take pricing on. And So, we're going to take pricing on those SKUs. And as a result, we'll be slightly above our 2% this year.

Operator

Thank you. Our next question comes from Laurent Grandet with Guggenheim. You may proceed with your question.

Speaker 12

Yes. Good morning, everyone, and thanks for the question. So I'd like to come back on the sales category. So first, what is The gross your organization for the category and really I'm interested in the rationale behind it and thinking about the next, let's say, year or so. And then as you mentioned, there will be a consolidation with elimination of lower velocity SKU.

Speaker 3

Do you see

Speaker 12

a risk potentially for The Corona sales are the white can, as your as that SKU has been severely underperforming the category. So do you see a risk here That you could lose ACV? And finally, how you planning to gain the fair share of the subject category, especially as Mexican brand, I mean, Topo Chico is really becoming more national in the beginning of next year and also launching a margarita More flavor than SKU. So, I'd like to understand how you play that.

Speaker 2

Sure. If I understood the first part of your question correctly, Keep in mind that the beer category has been roughly flat at a time when we are up roughly 8%. So there is a significant delta between what the overall category is performing and what we are performing. We're radically outperforming of the category. Relative to our desire in the seltzerABA space, there's a number of things.

Speaker 2

First of all, We're going to focus our attention on where we think we bring differentiated products that are distinct. Given what we have today, I would use Refresca and Limonata as two examples of that that meet specific needs and are not what I would describe as need to products. We also have, as we noted in our scripts, Some innovation agenda items that we think are going to be distinctive and will bring unique value to the table as well. So we continue to believe this is going to be Thank you.

Operator

Our next question comes from Bill Chappell with Churys. You may proceed with your question.

Speaker 13

Thank you. Sorry to belabor the seltzer questions. But I mean, I guess Two things, one simple, one bigger picture. I mean, 2 quarters ago, like you said, you have a lot of market research. You and everybody else was very bold up about the market and it seems like it was a soft summer, but it didn't seem like The category was a fad or it's over.

Speaker 13

But in kind of redirecting marketing and advertising and moving to kind of Focus SKUs, it seems that is what you're kind of saying. So, I guess, is that what you're saying? Do you see this as kind of a small niche Permanently or do you and everybody was kind of wrong, it was going to be a bigger place or is this just a pause for the category? And then the second question is, With you redirecting kind of advertising marketing towards your core beer portfolio, does that result in the I know it's Small but seltzer falling off a cliff over the next two quarters and creating kind of headwinds for your growth on beer. Thanks.

Speaker 2

Sure. Relative to the category, our view of it is this. We still think that the overall ABA space is going to be a growth category, Whether or not the seltzer sub segment of the beer category is going how much of that is going to be driven by the seltzer sub segment remains to be seen. Quite frankly, clearly, it's going to be a lot less than what everyone anticipated coming into this year. But again, for us, it's a relatively small percentage of our overall play.

Speaker 2

So, we are not entirely reliant on In the seltzer category, in fact, we expect to achieve our algorithm through our core beer business. Relative to the question of will this put a damper on our growth in the beer business if Seltzer is challenging? Not really. I mean, the fact that we were able to raise our guidance is largely driven by the fact that we're able to make more beer. And we're able to make more beer because we're making a little less seltzer and that is margin accretive and it's a very high growth category.

Speaker 2

So I realize There's a bad side and a good side to that answer. But the reality is, it's not inconsistent with what we've always seen, which is our core business portfolio A beer from Mexico continues to radically outperform the industry and we continue to be the leader in the high end and the high end growth. So,

Speaker 5

is it going to

Speaker 2

be any different going forward? I think it's a little bit remains to be seen. We're going to have a little bit more of a watch and see efforts than we had before. I think everyone got a little bit excited about seltzer. And frankly, the category has slowed significantly.

Speaker 2

So I think we will probably do a much better job of being guarded in terms of our expectation around that, while continuing to leverage

Operator

Thank you. I would now like to turn the call back Over to Bill Newlands for any closing remarks.

Speaker 2

All right. Thanks very much. And thank you all for joining our call today. Despite some challenges impacting our results this As you can see, we remain very confident in the strength and underlying fundamentals of our business. Our beer business in particular Continues to be a path growth driver within the industry, while we continue to see the benefits of our wine and spirits premiumization take hold.

Speaker 2

We remain bullish on the future performance of our powerful collection of consumer connected brands, which provides us with strong momentum as we head into the second half of our fiscal year. Our next quarterly call is scheduled for early January. So we hopefully wish everyone a safe, happy and holiday season. Please remember to enjoy some of our great products during your celebrations, and please remain safe.

Speaker 3

Thanks for joining the call.

Powered by Quartr