Constellation Brands: Are Consumers Trading Down for Rail Drinks?

Key Points

• Consumers may be trading down from Constellation Brands premium beverages to cheaper alternatives in a slowing economy.
• Economic downturns result in less disposable income for consumers to spend on booze, but rising stress levels may lead others to drink more. This leads to the apex point where consumers spend less by downsizing to cheaper brands. In a nutshell, they can drink more and spend less by downsizing to cheaper brands.
• Weakening on-premise restaurant dining and traffic are a drag on the top and bottom lines for Constellation Brands.
• Investors are conditioned to expect big EPS beats, so the small miss and flat guidance on its fiscal Q3 2023 sent shares lower.

High-end spirits and beverages producer Constellation Brands Inc. (NYSE: STZ) stock has been bouncing around 50-point trading for over a year. Alcohol falls under the category of an elastic commodity which is virtually recession-proof in theory. However, there is an apex where consumers opt not to drink less but rather spend less on their booze. This can result in them trading down premium brands for cheaper brands.

So while alcohol may be elastic in principle, the reality is that cheaper alcohol tends to weather economic downturns better than premium booze. The trading down action is illustrated by shoppers choosing cheaper private label brands over national brands at grocery stores operated by The Kroger Co. (NYSE: KR).

The “Trading Down” Dilemma

This is the dilemma with Constellation Brands in a nutshell. The maker of premium alcohol brands like Corona, Modelo beers, Kim Crawford, Ruffino wines, Casa Noble tequila, and Svedka vodka faces more fierce competition with cheaper brands like Anheuser-Busch InBev SA/NV (NYSE: BUD) and Molson Coors Beverage (NYSE: TAP). In addition, input costs remain high due to inflationary pressures, which it expects to remain in the high single-digit range for fiscal 2024. As a result, you won't find any of Constellation Brands' stock on the rail bar.

Slowing Down

On Jan. 2023, Constellation Brands released its fiscal third-quarter 2023 results for November 2022. The Company reported earnings-per-share (EPS) of $2.83 versus consensus analyst estimates for $2.87, a (-$0.04) per share miss. Revenues rose 9.2% year-over-year (YoY) to $2.44 billion, beating analyst estimates for $2.38 billion.

Flat Guidance

The Company issued fiscal full-year 2023 EPS guidance of $11.00 to $11.20 versus $11.05 consensus analyst estimates. It expects Beer net sales to grow 9% to 10% with 4% to 5% operating income growth. Wind and Spirits are expected to decline up to (-2%), with operating income growing from 3% to 5%.

This excludes the $44 million of net sales and $26 million of gross profit less marketing which is no longer a part of its Wind and Spirits business results. The Company affirmed its fiscal 2023 operating cash flow target of $2.6 billion to $2.8 billion and raised the free cash flow generation projection to $1.5 billion to $1.6 billion. 

Conference Call Takeaways

Constellation Brands CEO Bill Newlands stated that its premium beer business continues to lead share gains in the U.S. beer category for the sixth consecutive quarter with its Corona Extra and Modelo Especial labels. Modelo Especial was the top share gainer and the number one premium beer brand, followed by Corona Extra, the third largest share gainer and number three high-end brand.

The beer business has 54% sales growth compared to the third quarter of 2019 at pre-pandemic levels.

In its Wine & Spirits business, its largest higher-end brands, Kim Crawford, Meiomi, High West, and The Prisoner, delivered 72% dollar sales growth compared to pre-pandemic levels. In addition, while the Company acquired five brands since fiscal 2020, including My Favorite Neighbor, Empathy, Halpern & Kings, Bronco Wines, and Austin Cocktails, it divested 36 brands in its mainstream segment.

This reshaped its portfolio to higher-end brands of 62% versus 34% pre-pandemic.

Concerning Depletion Growth

He noted that depletion growth is normalizing as it decelerated to 5.7% for its beer business in the quarter. This indicates that beer sales may be leveling off, especially after favorable outlier conditions, which is a cause of concern. Several headwinds were causing this, like increment weather in California which lapped double-digit depletion growth due to better weather in November of 2021 and a better economic climate.

This makes for tough comps. Its top Modelo Especial brand delivered 4.4% depletion growth, but that was after lapping 13.2% depletion growth in the year-ago period. However, the brand has achieved depletion growth of 9.9% throughout fiscal 2023 year-to-date. Its latest premium beer brand Pacifico still has a long runway as its achieved 26% depletion growth, and Modelo Chelada hit 44% depletion growth in the quarter.

Eroding Pricing Power

CEO concluded with comments about bracing for near-term headwinds, “To that end, based on our current expectations of the pressures that the consumer will continue to face in the near term, we are giving even more careful consideration to our pricing actions for fiscal '24.

In addition, while some input costs are below the peaks from earlier this fiscal year, we anticipate inflation to remain above historical trends in the high-end single-digit range for fiscal '24. As always, we will continue our disciplined approach to managing these evolving conditions through cost-saving initiatives.

But these persistent inflationary headwinds will be compounding on the double-digit cost uplift we have faced in fiscal '23.” This indicates a weakening of its pricing power as the consumer faces economic challenges, which could lead them to trade down for cheaper alternatives.

Year-Long Weekly Rectangle Trading Range

STZ stock has been in a 50-point range, as illustrated by the weekly rectangle on its candlestick chart. From a low of $207.35 to a high range of $258. There were two instances where the top range initially looked to break out as shares approached $261.52, but they barely lasted a week before falling right back into the rectangle range.

The most recent breakout attempt, in November 2022, ended up crashing back toward the lower range at $208.12 and shaking out anyone who attempted to enter the breakout.

The weekly market structure low (MSL) buy triggered again on the $226.84 breakout as the weekly stochastic contemplates crossing back up to support the bounce. The weekly 20-period exponential moving average (EMA) resistance is $234.43 as it crossed over the weekly 50-period MA at $237.48.

The weekly market structure high (MSH) sell trigger at $241.89 is the next significant resistance test before another potential run to the upper rectangle range resistance at $258. Pullback supports are at $222.39, $218.10, $214.48, $210.75, $207.35 weekly swing low, and $202.70.