canisius college student research - cfa institute...january 2012: constellation brands reported q3...

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students competing in the CFA Institute Research

Challenge.

Ticker: ● STZ (NYSE) Recommendation: ● Sell

Price: ● $21.02 Price Target: ●$17

Earnings/Share

May. Aug. Nov. Feb. Year P/E

Ratio 2009R $0.29 $0.39 $0.66 ($0.07) $1.27 10.3x

2010R 0.36 0.53 0.49 0.20 1.58 9.5x

2011R 0.34 0.53 0.64 0.34 1.85 11.0x

2012E 0.42R 0.54R 0.57R 0.30E 1.83E 11.5x

R: Restated EPS

Highlights

January 2012: Constellation Brands Reported Q3 Earnings: Constellation Brands reports Q3

earnings of $0.50 versus $0.66 last year. EPS decrease was driven by a 17% decline in comparable

basis EBIT, as a result of overlap of the Q3 fiscal 2011 distributor inventory build, incremental

marketing funding at Crown, and the divestiture of the Australia and U.K. Wine business.

January 2012: Constellation Brands Product Innovation and Growth: Constellation continues

innovation, with over 20 new product launches underway for fiscal 2012, with strong momentum in

labels such as Primal Roots Sweet Red Blend, Rex Goliath Moscato, Ruffino Prosecco,

Woodbridge Malbec, The Dreaming Tree brand, new varieties of Arbor Mist and the Simply Naked

unoaked line of varietals. However, Constellation‘s growth lagged the overall U.S. wine category

growth for the year due to the decision to take pricing in the value segment. Q3 2012 depletions for

focus brands grew 6%, including SVEDKA which grew at a double digit rate and gained market

share in the IRI channels.

January 2012: Crown Imports Strong Growth and Gaining Market Share: According to

SymphonyIRI retail data, Crown Imports continues to outperform the total U.S. beer industry, the

import category and the other 3 major beer suppliers in both case and dollar sales. Crown was the

only major supplier to gain industry dollar share and case share in the quarter.

January 2012: Constellation Brands Improving Free Cash Flow: Free cash flow for the first

nine months of the year amounted to $587 million, or $287 million more than the same period last

year. As a result, the company increased its FCF target by $100 million to a range of $700 million

to $750 million. The cash flow generation has allowed for a reduction of debt, repurchase of stock,

and the acquisition of the remaining 50% interest in Ruffino.

January 2011: CWAE Divestiture: STZ divested 80.1% of its Australian and U.K. business

(CWAE) in an effort to eliminate lower margin products from their portfolio. This transaction is in

alignment with Constellation‘s transition to higher margin products, and previous divestitures of

other low margin brands.

We recommend a SELL on shares of Constellation Brands

Constellation Brands, Inc.

Date 01.20.2012

Beverages – Distillers

& Vintners

52 Week Price Range $16.42-$23.19

Average Daily Volume 1,745,800

Beta 0.967

Dividend Yield (Estimated) n/a

Shares Outstanding 199,680,000

Market Capitalization $4.2B

Institutional Holdings 93.82%

Insider Holdings 0.56%

Book Value per Share $13.20

Debt to Total Capital 45.10%

Return on Equity (Restated, ttm) 12.65%

Market Profile

Key Points to SELL Thesis:

Low growth environment for

mature wine industry

Weakness of U.S. consumer

Corporate Governance

weaknesses

Risk of Crown Imports JV

termination

Poor Balance Sheet quality

High level of debt

Management historically has

destroyed value

Market is inadequately

pricing in the significant

risks associated with STZ

S&P 500 v Constellation

Source: Capital IQ

$0

$5

$10

$15

$20

$25

STZ Daily Stock Price

CFA Institute Research Challenge 1.20.2012

2

Business Description Constellation Brands (NYSE: STZ) was founded in 1945, and is an alcoholic beverage producer, marketer

and distributor headquartered in Victor, New York. The company focuses primarily on wine sales,

particularly premium wines. As of 2010, Constellation was the third largest wine producer/distributor by

volume, surpassed only by The Wine Group and E & J Gallo, two private wine labels. In addition to wines,

the company is also involved in the production, marketing and distribution of spirits and beers. The beer

category is centered around the Crown Imports joint venture (JV) with Grupo Modelo, where Constellation

Brands is the exclusive importer of the Modelo Brands, including Corona. The spirits business consists of

SVEKDA, Black Velvet, and Paul Masson Amber Brandy. The company‟s market capitalization as of

January 19, 2012 was $4.2 billion, with a workforce of over 4,300 employees.

Business: In 1945 Constellation Brands began as a small family-operated concern, focused solely on wines.

The company has grown through acquisition, with over twenty acquisitions in the past twenty years.

Examples of successful acquisitions are Robert Mondavi Corporation in 2004, SVEDKA vodka in 2007, the

formation of the Crown Imports joint venture with Modelo in 2007, and Ruffino, which was finalized in

2011. Due to the growth by acquisition strategy, divestitures have been plentiful as Constellation sheds low

margin businesses. The 2008 divestitures were focused on low price point California, Idaho and Washington

State wine brands acquired earlier from Beam Wine Estates. In 2009, The Company sold Barton Brands, a

low price point spirits business. Finally, in 2011 The Company sold 80.1% of its interest in its Australian and

UK business (CWAE), and retains a 19.1% interest known as Accolade Wines. The 2011 divestiture marks

Constellation‟s move away from low margin wines and into the premium segment. Constellation now

consolidates its sales into Constellation Wines North America (CWNA), which include all wine and spirits

sales in the United States, Canada, and New Zealand. Joint Venture revenues are not consolidated, but rather

the company accounts for their portion of earnings under the equity method.

Wines: Wine sales make up approximately 90% of total revenues. With the divestiture of its CWAE business

segment, The Company aims to shift its wine portfolio to a more premium offering. The wine portfolio

includes over 100 labels, with a focus group of approximately 17 labels, including Mondavi, Kim Crawford,

& Clos du Bois. Constellation wine sales currently lag those of the industry, which has grown at a compound

annual growth rate (CAGR) of 3% over the past 10 years.

SVEDKA & Spirits: Constellation‟s spirit sales are driven by sales of SVEDKA vodka and Black Velvet

whisky both of which are considered premium priced spirits, despite selling at or below price points of

comparable premium or super premium spirits such as Absolut, Grey Goose, & Smirnoff vodkas. SVEDKA

and Black Velvet are strong brands, and have won accolades such as inclusion in the 2010 and 2011 Power

100 list, which is derived from a panel of judges who rate spirits brands based on a multitude of factors,

including market share, price positioning, brand awareness, growth, as well as others. SVEDKA has been a

strong driver of growth, increasing from a 1 million case brand in 2007 to a nearly 4 million case brand in

2011. SVEDKA has been growing at a double digit rate in terms of depletions and sales growth.

Crown Imports: Constellation entered into a 50-50 joint venture with Diblo, S.A. de C.V. (76.75% owned

by Grupo Modelo and 23.25% owned by Anheuser-Busch) in January of 2007. In the joint venture, dubbed

Crown Imports, Constellation has the exclusive right to import the Modelo Brands, including Corona, Corona

Extra, Corona Light, Modelo Especial, Negra Modelo, St. Pauli Girl and Tsingtao. The Modelo Brands have

been a significant source of growth for Crown Imports, with a strong connection to the Hispanic and Latino

populations, the fastest growing demographic in the United States (see page 25 of appendix). Crown is

focusing on increasing distribution in these established markets, with a goal of increasing market penetration

and market coverage in those areas. The significance of Crown Imports should not be underestimated, as the

joint venture accounts for approximately 40% of Constellation‟s net income.

Industry Overview and Competitive Positioning The alcoholic beverage industry is influenced by the global economy, with an emphasis on the overall health

of the consumer. The health of the consumer is critical as Constellation continues to move from a value-

oriented product to a more premium product. Furthermore, the industry has been consolidating, with a focus

on maximizing synergies and economies of scope and scale, as large multinational beverage companies

strategically acquire others that fit their business model. The industry competes for on-premise and off-

premise sales. On-premise sales include bars & restaurants, while off-premise include retailers.

Global Economy: The strength of the overall global economy has a direct impact on the health of the

alcoholic beverage industry, and especially Constellation, as the company shifts to a premium priced product

Source: Capital IQ

Source: Canisius College



3

portfolio. Factors such as disposable income, unemployment, and consumer confidence are directly tied to the

overall health of the consumer, as was evidenced during the most recent recession when consumers traded

down to value priced brands. U.S. Disposable Income growth has decelerated since 1990, falling below 2%

YoY for the first time since 2010 Q2. The graph to the left shows 10yr U.S. disposable income growth, and

YoY growth of a meager +0.1%. Companies will need to focus on product innovation and new packaging to

increase and protect market share. Credit ratings across the industry are high, with most of the large

producers holding investment-grade credit ratings, while Constellation is junk rated. Unemployment

expectations of 8-9% in the foreseeable future for developed nations, with a 8.5% level expected in the U.S.

in 2013. Currently, the U.S unemployment rate is hovering near 8.5%.

Wine: Wine is the smallest segment in the alcoholic beverage industry. Large companies such as

Constellation are divesting their value brands in favor of premium brands in order to boost margins. Even

during the recession in the United States, wine volume sales continued to grow. Wine sales prices at or

above $25 were especially hit hard in the Americas in terms of volume. On-premise wine sales were

negatively affected, despite a 4-6% CAGR prior to the recession. With the economy struggling and industry

shift towards premium brands in developed nations, it remains to be seen whether producers can successfully

persuade consumers to abandon value brands for premium. The trend with younger consumers continues to

be a shift in consumption of wine to beer and spirits.

Spirits: The spirits segment is comprised of many small companies, but it is controlled by five main

companies: Diageo, Beam Global Spirits & Wine, Bacardi USA, Sazerac, and Pernod Ricard USA. Diageo is

by far the largest company in the spirits industry, producing spirits such as Smirnoff, Baileys, and Jose

Cuervo. These five companies dominate the spirits industry due to their brand recognition, customer loyalty,

and pricing power over smaller producers. Vodka has the largest market share within the spirits segment,

comprising 26% of the market. As of May 2011, the six most powerful vodka brands in terms of sales and

recognition were Smirnoff, Absolut, Grey Goose, SVEDKA, Stouchnaya, and Skyy. Whiskey comprises the

second largest spirits part in terms of market share, which consists of straight blended, and Canadian

whiskey. Brandy and Cognac comprise another spirits segment, dominated by E & J Gallo. Spirit sales are

growing as younger generations prefer spirits to wine.

Beer: Beer is the largest alcoholic beverage segment and is dominated by large companies such as Anheuser-

Busch InBev (AB InBev, 47.9% market share in 2010), Miller Coors (28.9%), Crown Imports (5.3%),

Heineken USA, and Pabst. Small craft beer companies such as Sierra Nevada and The Boston Beer Company

comprise 9.1% of the market. Increased marketing and overall consumer preference towards craft beers and

imports drive the craft and import segment over traditional beers. Younger generations such as the

Millennials favor beer over spirits and wine, which should lead to stronger growth in this segment. Craft and

import beer demand is growing at a double-digit growth rate, driven by rising demand for more flavorful

varieties of beer. This shift is causing larger companies that do not have local brands, craft offerings, or

imports to acquire these types of brands and tap into the growing revenue stream. It is expected that craft beer

volume will increase significantly as more convenience stores stock craft beer products.

Competitive Positioning

Wine: Wine is Constellation‘s main revenue source, and is especially critical as The Company shifts towards

premium brand wines over value branded wines. Constellation fully acquired the remainder of its interest in

Ruffino, the third largest premium wine brand. It has also launched new wine products such as Collaboration

and Rioja Vega as premium wines. In May 2011, The Power 100 rankings rated Robert Mondavi the third

most powerful wine brand during 2011, behind Gallo and Concha y Toro. While its wine power is growing, it

is still not the most dominant company in the segment, as E & J Gallo and The Wine Group in 2010 sold

22.5% and 15.4% of the cases in the market, respectively. Constellation sold only 12.7% of the wine cases

during 2010. Constellation is a large player within the wine segment, which is comprised of a few major

players, and an abundance of small competitors. The trend towards value brands over premium is shown via

the top five brands. For the most part, the top five wine brands in terms of market share are value brands,

including Franzia Winetaps (The Wine Group), which has a 7.9% market share. Competition should increase

in the coming years as wholesale chains such as Costco are taking steps to develop their own brands. With

value brands at off-premise locations being the company‘s main wine sales growth, this could significantly

lower Constellation‘s market share with its new premium wine brands positioning. Constellation wines‘

brand recognition is strong and consumers may trend towards its wines due to brand loyalty and product

innovation. With off-premise sales growing quicker than on-premise sales and value brands dominating the

industry, Constellation is not positioned well in its main market. Looking forward we see low single-digit

growth in its wine segment, despite strong brand recognition and consumer loyalty. Constellation loses

pricing power to value brands due to its shift towards premium wines.

SVEDKA is ranked #4 most

powerful vodka brand

Source: The Power 100

U.S Disposable Income

growth YoY was +0.1%

Source: Bloomberg



4

Spirits: In 2007, Constellation expanded its beverage portfolio by acquiring the SVEDKA brand.

Management is pushing the SVEDKA brand and promoting it through new flavors. It now has six flavor

offerings, including the newly launched grape flavor. Management strongly promotes SVEDKA, however, it

does not have the brand recognition or revenue stream that the other brands have in order to allocate more

promotional and advertising spend. SVEDKA 1.75L imports are sold at approximately $22.99, giving the

brands pricing power over Absolut ($32.99) and Grey Goose ($58.99). Overtaking the top three vodka brands

seems unlikely with their brand recognition and popularity despite SVEDKA selling at a lower price point.

Smirnoff currently controls the largest market share for spirits with approximately 5%.. Constellation offers

Black Velvet as a whiskey product. Whiskey is the second largest spirit in terms of market share and has

three main types: straight, blended, and Canadian. The whiskey market is dominated by brands such as

Crown Royal, Jack Daniels, and Jim Beam. Black Velvet does not have the brand recognition, large

marketing allocation or consumer preference that these other brands have. Jack Daniel‘s whiskey is the

whiskey market leader with 2.4% spirits market share. Brandy is the other spirit sub-segment that

Constellation is active in, with their only product offering being Paul Masson Brandy. The brandy sub-sector

has been dominated by E & J Gallo since 2004 when it had a 24.4% market share. Constellation diversified

its product line by offering these three spirit types, but its spirits portfolio does not control a large market

share like Diageo (23.5%) or Beam Global Spirits & Wine (9.4%), nor is it a significant source of revenue for

Constellation, accounting for approximately 10% of sales. It should be noted that while spirits do not

comprise a large portion of revenues for Constellation, they are growing at a double digit rate, compared to

wine sales lagging the industry growth rate of 3%.

Beer: In 2007, Constellation Brands entered into its Crown Imports JV with Grupo Modelo. Crown Imports

is the largest imported beer company in the U.S., with a 42% dollar share of the imported beer market. Grupo

Modelo is 50% owned by various shareholders and 50% by AB InBev. It is the third largest U.S. beer

company overall and has recently launched and acquired new products. Victoria is Mexico‘s oldest beer and

was imported to the U.S starting in 2010. Tsingtao brand is Crown Import‘s foothold into the Asian beer

market. Since 2005, Tsingtao has grown revenue and the trend is expected to continue. Crown Imports

accounts for 40% of Constellation‘s net income. In 2010, Crown Imports had a 5.5% market share (orange,

left graph). In the United States, the market is dominated by companies such as AB InBev (red) and

MillerCoors (green). In fact, the top five brands by market share are: Bud Light (AB InBev – 19.26%),

Budweiser (AB InBev – 8.96%), Coors Light (MillerCoors – 8.9%), Miller Lite (MillerCoors – 7.68%), and

Natural Light (AB InBev – 4.5%). On a volume basis, Craft beers were up 16.4% compared to the industry,

which grew -2%. From a dollar change standpoint craft beers were up 17.5% compared to the industry‘s .3%.

As the social trend continues to shift towards craft and import beers, Crown Imports stands to continue to

gain market share.

Competitive Summary: Constellation has a diverse beverage portfolio but is not the dominant company in

any of the segments. Moreover, Constellation is not seeing significant growth in its premium wines which is

its main business segment and core business strategy going forward. This can also be seen through negative

organic growth in the most recent quarter. Management is attempting to re-position the image of the company

to a premium wine company, despite current industry trends towards value products. Off-premise value brand

sales continue to remain popular with consumers due to the slow economic recovery coming out of the most

recent recessionary period. Constellation‘s wine brands face stiff competition in the wine market, and we do

not foresee growth outpacing the industry average of 3%. Its spirits business and Crown Imports JV will

continue to be the only significant areas of growth moving forward. SVEDKA is the main driver of growth in

the spirits line, but is not the dominant product that other vodkas are, even though it continues to gain

traction. However, SVEDKA has quadrupled in cases size since being acquired in 2007.




5

Investment Summary Figure 1: STZ Timeline: Significant Events

Valuation

Weighted Average Cost of Capital (WACC): In determining an appropriate discount rate to use for our

discounted cash flow (DCF) model, we calculated a weighted average cost of capital (WACC) using both

book and market value weights. The key inputs to our WACC were a cost of equity computed using the

CAPM to be 10.41% and a cost of debt of 7% based both on historical effective interest expense as well as

historical debt issuance from 2008 when the company issued debt at a coupon of 7.25%. Based on the current

interest rate environment, and the financial market‟s search for yield, we feel that a cost of debt of 7% is

downward biased. Having a junk rating on its debt, Constellation would most likely have to issue debt at a

higher cost if it were to issue a 10 year or 20 year bond. We estimate that this rate would be in the 8-10%

range based on historical norms for junk rated debt. For our risk free rate used in the CAPM, a 10-year

Treasury yield of 2% was used. Historically, the yield is depressed from a normal level closer to 3%.

Therefore, based on current book values from FY2011, we have computed a WACC of 7.18%. Furthermore,

using book values from FY2012 Q3, the WACC can be computed as 7.51%, which is an increase from 7.18%

due to the fact that the company is reducing its debt, therefore lowering the weight of debt. Moreover,

inputting a cost of equity into that calculation of 13.97% based on a build-up method, the WACC can be

computed as 10.53%. We believe that a WACC of 7.18% is not indicative of a historical measure for this

company. Furthermore, we believe that a discount rate of 7.18% does not adequately reflect the risks that are

associated with this company. Please see pages 38-39 in the appendix for detailed WACC calculations.

In our valuation, we have incorporated stress tests and valuation scenarios utilizing two additional discount

rates. The first alternative is simply our cost of equity, which is approximately 10%. The second discount rate

used is a buildup method to formulate a cost of equity given the fact that Constellation has characteristics that

resemble a private company. This is discussed thoughout the Corporate Governance section located on pages

9-10 , and well as pages 21-23 in the appendix. Therefore, a buildup method of 13.97% was computed as a

cost of equity to incorporate these risks. As such, this discount rate borrows from techniques used to value

private companies. We feel this approach is justified because the current share class structure and voting right

inequities make Constellation appear to be more of a private entity than a truly public one. As a very

conservative figure, we built up a discount rate of 13.97%, which takes into account an extra risk premium

for small to midcap companies provided by Morningstar financial services. Even so, a 13.97% discount rate

could be considered too low if we are not building in enough risk to the company. The scenario analysis takes

into account all three discount rates in order to put into context the different levels of risk that must be

discounted in determining our intrinsic value. Risks that would need to be taken into account include

qualitative issues such as corporate governance that are extremely difficult to quantify.

Scenario Analysis Valuation – Free Cash Flow to the Firm (FCFF): The alcoholic beverage industry is a

mature industry, especially the wine segment. Cost of goods sold, excise taxes, SG&A expenses, are

historically predictable on a common size analysis. Continuing grape harvest shortages and lack of efficiency

C

A

B

E

D

F

G

H

I

J

A- STZ acquires 40%

interest in Ruffino –

December 2004; STZ

acquires Robert Mondavi

Corporation – December

2004

B- Formation of Crown

Imports – January 2007

C- STZ acquires Spirits

Marque One, owner of

SVEDKA – March 2007

D- STZ divests large portion

of value wine business –

June 2008

E- STZ divests Barton

Brands (value spirits) -

2009

F- $300M stock repurchase

plan approved – April

2010

G- STZ sells 80.1% of stake

in CWAE – January,

2011

H- Additional $200M stock

repurchase plan

approved – April 2011

I- Grupo Modelo has

option to announce

termination of Crown

Imports – January 2013

J- Earliest date that Crown

Imports can be dissolved

– end of 2016

Source: Bloomberg



6

gains by STZ lead to minimal margin increases. Main adjustments in each scenario presented are growth rates

for CWNA, spirits, and equity earnings (Crown Imports). Growth rates are nominal.

Key Assumptions (see detail schedules on pages 26-36 in appendix):

Scenario 1 – ―5yr Base Case‖: Because STZ‘s wine segment lags the industry, CWNA was grown at

2.25%/year. SVEDKA is the fastest growing vodka and spirits was projected at 10% growth per year. Equity

earnings, driven by Crown Imports, grew 8% YoY. Valuation is driven by strong equity earnings growth.

Scenario 2 – ―5yr Worst Case‖: CWNA, spirits, and Crown Imports sales only grow at an inflation rate of

2%. This could be caused by continued economic hardships or loss of brand image or recognition. Based on

the fact our ―Worst Case‖ scenario was a SELL rating, we did not do further sensitivity testing of lesser

growth rates for wine, spirits, or Crown segments.

Scenario 3 – ―5yr Best Case‖: CWNA sales grow at 5% YoY, which outpaces the industry average.

SVEDKA drives spirits growth at 20%, and earnings from Crown grow at 10% YoY.

Scenario 4 – ―10yr No Real Growth & JV Termination‖: Base Case, but with termination of JV. AB

InBev would increase its stake in Grupo Modelo, triggering a cash payment of 4x EBIT to Constellation. In

2017, earnings from the Crown Imports JV will only incorporate 10 months due to the timing of the

termination. Equity earnings going forward will be significantly impacted and no longer material.

Constellation would receive a cash payment, estimated at $2 billion, upon notice being granted for

FY2014. The scenario shows the effect of the joint-venture termination by Grupo Modelo.

Scenario X – ―10yr No Real Growth & JV Termination‖: Base Case, but with termination of JV. In 2017,

earnings from the Crown Imports JV will only incorporate 10 months due to the timing of the termination.

Equity earnings going forward will be significantly impacted and no longer material. Constellation would

receive no cash payment. The scenario shows the effect of the JV termination by Modelo.

Stress Tested Scenario 3 – ―Decreasing SG&A significantly‖: Same as Scenario 3, but with SG&A

decreasing as a percent of sales from 20.5% to 15%. We feel this efficiency gain would be unlikely.

5yr Crown Cash Now, Best Case – Modeled Scenario 3 with a $2 billion cash payment in year 2014.

5yr Crown Cash Later, Best Case – Modeled Scenario 3 with cash payment of $300 million approximating

estimated 50% of BV of the JV, upon termination this payment would be received by Constellation.

10yr Model with JV Continuing – Base case, but assuming 10yr model

5yr Crown Cash Now, Base Case – Modeled Scenario 1 with a $2 billion cash payment in year 2014.

5yr Crown Cash Later, Base Case – Modeled Scenario 1 with cash payment of $300 million approximating

estimated 50% of BV of the JV, upon termination this payment would be received by Constellation.

Price Target: Taking an average of all 11 scenarios using the midrange discount rate and the buildup

discount rate, we get an average price of $17.10. Therefore, we recommend a SELL on shares of

Constellation Brands with a $17 price target. This represents a 19% decrease from today’s closing

price of $21.02. Please turn to page 17 in the appendix for the intrinsic value matrix.

Valuation Summary for Scenario Analysis

Sum of Parts Valuation: In calculating a sum of the parts valuation, we took into consideration

Constellation‘s three most valuable segments, which are the wine business, the SVEDKA brand, and the

Crown JV. In trying to ascertain a market value for each part, we took a different approach for each part. For

SVEDKA, when Constellation purchased the brand in 2007 it was a 1 million case brand, with $55.1 million

in sales. In FY2011, SVEDKA was approaching a 4 million case brand. Therefore, we took the market value

of the transaction when completed in 2007, which was $384 million, and adjusted that figure for inflation of

2% per year, and multiplied it by a factor of 4 to adjust for the increase in cases. This gave us a theoretical

market value of $1.696 billion for the SVEDKA brand. It is currently the fastest growing vodka brand.

Constellation does not report case data or specific sales data for SVEDKA.

In FY2011, the Crown JV had sales of $2.393 billion. Based on an average revenue multiple of 2.47, taking

into account the median of industry M&A takeovers, Constellation‘s acquisitions, and the recent SAB Miller

acquisition of Foster‘s, we calculated a theoretical market value of the JV of $5.902 billion, of which

Constellation‘s 50% ownership would be worth $2.951 billion. This is the value of the unlikely scenario

because it is unlikely that any company except AB InBev would acquire the JV, and if AB InBev were to

acquire the JV, they would do it sooner in time rather than later, triggering a potential $2 billion payment to

Constellation by taking over Grupo Modelo. Otherwise, AB InBev might as well let the JV run its remaining

life, meaning that the realizable value is more of a book value payment, which would be approximately $300

million. However, if AB InBev was to increase their stake in Grupo Modelo, we estimate that the payment of

4x EBIT to Constellation would be approximately $2 billion. This is a possible scenario, yet we believe it is

still unlikely. Lastly, in a more conservative scenario, we valued the equity payments that the Crown JV

brings to Constellation, in which a value of $1.046 billion was calculated.



7

Based on our 5-year DCF model, we calculated the PV of the CWNA reporting segment using three different

discount rates. This is assuming that the wine business is to grow at 2% in perpetuity. Using a discount rate of

13.97% (build up cost of equity), 10% (midrange), and 7.18% (WACC), we generated terminal values based

on the terminal year cash flow of $3.191 billion, $4.488 billion, and $6.286 billion respectively. Taking these

terminal values into account, we generated an average price of the 9 scenarios run to be $23 on a sum of

the parts basis. This would represent a $6 premium to our target price of $17, resulting in a 35%

premium. The $23 price target represents a $2 premium to the closing price of $21.02 on January 19,

or a 9.5% premium. We feel this aggressive approach will never be realized. Please refer to pages 29-32

for detailed schedules.

The debt load for Constellation stands at $3.137 billion for this calculation. This is a book value measure

from FY2011. Backing out the debt of the company, and using a denominator of 221 million shares, we

calculate three intrinsic values of Constellation based on a sum of the parts analysis and scenario analysis.

P/E Valuation: Historically, Constellation Brands has traded at an average P/E, on a basic EPS basis,

multiple of 13 from FY2000-2011, with the outliers occurring during the bull market leading into 2007-2008.

Excluding the years 2005-2008, the average P/E over the same time span was approximately 10. In the years

since, Constellation has undergone a series of divestitures and restructurings of its business reporting

segments. Therefore, focusing on years 2009-2011 gives us a more realistic picture of what the CWNA

business segment looks like. The forthcoming restated EPS also take into consideration a restated tax rate as

if the company were to have paid income tax in the years it had losses. Based on a three year average P/E

multiple of 10.5, and a projected FY2012 EPS of $1.83, a price of $19 can be obtained, which still affirms

our SELL rating. The most recent three year average affirms the long term trend of a P/E of 10-10.5.

P/S Valuation: Price to Sales is driven by net profit margin (NPM), and on an analysis of Constellation‟s

peer group, it can be seen that Constellation has a lower NPM than its peers. The industry P/S multiple is

2.37. Due to the changes in corporate structure over the past five years, P/S takes out management‟s

manipulation and significant changes as sales values cannot be altered. P/S is an appropriate valuation

method for companies or with a changing corporate structure. Constellation has changed its corporate

structure multiple times and can be treated like a new company as it helps to avoid accounting manipulation.

Since 2000, Constellation has traded at a average P/S multiple of .99 and at 1.02 since 2009. On February 28,

2011, STZ traded at a P/S of 1.30, which is abnormally high for the company. Projected net sales for FY2013

of $2.73789 billion and 221 million shares outstanding were used for this valuation. Altering the number of

shares by 10 million (to come to the number of shares used by the company for reporting purposes) does not

significantly impact the results. Using these figures and P/S multiples of .99, 1.02, and 1.30, price targets

obtained were $12.21, $12.68, and $16.15, respectively. Running our “best case scenario” results in net sales

of $3.193 billion, and a price target of $18.78, again affirming a SELL rating. Please see page 15-16 in the

appendix for detailed schedules.

PVGO: The present value of growth opportunities (PVGO) is a tool we use in our analysis to extract the

market‟s expectations on future growth potential for Constellation. The portion of current price that can be

attributed to the company as it stands now, with no future growth is essentially a perpetuity based on our cost

of equity assumptions. Using the capital asset pricing model (CAPM) we determined a cost of equity of

10.41% for Constellation. The PVGO for Constellation under current market conditions is 16.97% of share

price. When compared to the peer median of 46.52% under current conditions it can be seen that the market

does not feel that Constellation has much growth potential. Given that Constellation has lagged the wine

industry growth rate of 3%, the PVGO is justified, especially compared to its peers which are growing at a

faster pace. Please see page 36 in the appendix for an analysis of PVGO.

EVA: Economic valued added (EVA©), a financial analysis approach that was trademarked by Stewart and

Stern Company, is based largely on the concept of economic profit and residual income formulized by

neoclassical economist Alfred Marshall. The theory essentially states that net income is a deficient measure

of a company‟s performance because it only deducts the expense related to interest-bearing debt. Residual

income, and EVA, considers not only the cost of debt, but also the less obvious opportunity cost of capital

when determining the bottom-line performance of a company. This can also be conceptualized as the value

that was created for all financial stakeholders in the firm. We compiled historical data for Constellation on

the book value of debt and equity, and used our restated net income to estimate EVA for the firm. We do

recognize that it is equally acceptable to use market values of debt and equity, but given the volatile nature of

these items, we feel justified in using a book-value approach. The estimated EVA presented in this report

paints an accurate picture of the dynamics of value creation and value destruction for Constellation. In the

calculation of EVA, the WACC serves as the driver of the opportunity cost that is subtracted from NOPAT.

Therefore, given that we have stated that our WACC of 7.18% is downward biased, we can still feel

confident that Constellation has been destroying value because as the WACC increases, so does opportunity

Avg. P/S ratio of 1.0 since 2000

Source: Factset

Additional P/S discussion

can be found in the

appendix




8

cost, and therefore more value is destroyed. The company has been destroying value to stakeholders in three

of the past five years. In periods of value destruction, the company‟s ROIC was below its cost of capital

(WACC), therefore destroying value. It should be noted that in years 2007 and 2009, based on a downward

biased WACC, value is shown to be created. However, if the WACC was raised, value would be destroyed.

Please see page 35 in the appendix for a detailed schedule of EVA.

Risks to Our Price Target

Our model does not attempt to project, forecast, or estimate non-recurring items (positive tax outcomes,

restructuring charges, or gains on hedging or derivative instruments). We used 221 million shares to increases

dilution of EPS, to take into account more options being exercised. Additionally, our assumptions related to

our discount rate directly affect our intrinsic values. Lastly, it is possible that we have underestimated sales

growth rates moving forward and have understated the overall health and purchasing power of the consumer.

A significant uptick in consumer spending and a drop in the unemployment rate in the United States could

benefit Constellation Brands and undermine key assumptions in our model.

Financial Analysis

Earnings: Presented EPS was calculated using restatements (please see page 40 in the appendix) that

removed unusual items such as restructuring charges, merger and related restructuring charges, impairment of

goodwill, gains on sales of assets, and asset write-downs. An effective tax rate of 35% was applied to

previous years due to unusual tax items and deductions. The reason EPS increased 24.4% 2009-2010 and

17.1% 2010-2011 is due to higher gross profit margin as a result of lowered cost of goods sold YoY. In 2012,

STZ will experience a slight decline in EPS due to the loss of income from Europe and Australia, coupled

with a slow growth environment.

In an analysis of the growth of the different segments, the growth clearly comes from SVEDKA and Crown

Imports. These segments of the business are what drives its overall growth and the majority of its earnings.

With Constellation lagging the overall wine industry in terms of growth, which is a mature rate of 3%,

Constellation relies on its SVEDKA brand and Crown JV to generate earnings. We do not feel that the

growth rate for the wine segment will significantly outperform the industry over time. We feel that as a best

case scenario, the wine segment will grow at 5%, slightly outpacing the industry 10 year CAGR of 3%. With

a projected ―double digit‖ growth rate in SVEDKA, being conservative at 10%, even if that is raised to 20%,

there is a minimal change in earnings. This further supports the notion that the Crown JV is the main driver of

earnings generation for Constellation. Crown has grown at double digit depletions, which falls in line with

industry trends, which show that craft and import beers are the growth driver of the overall beer industry.

This bodes well for Crown. Therefore, we are able to project a growth rate of 8-10% for Crown, used in our

base and best case scenarios. Based on our analysis, we feel that the loss of the JV would be a significant

blow to Constellation, as Crown accounts for 40% of net income. Without Crown, the company would lose

its most significant driver of growth.

Cash Flow: For FY2012 the company projects cash flows of $700-750 million, an increase from previous

guidance and previous free cash flow generation in part due to anticipated favorable settlements from the sale

and divestiture of their CWAE business segment. Currently, management believes that a sustainable level of

free cash flow is approximately $500 million. Based on these projections, we have modeled our free cash

flow model accordingly. Given that the company is able to generate significant free cash flow, and has a

targeted debt/TTM EBITDA ratio of 3-4, with a current debt/TTM EBITDA ratio of 3.4, the company will be

able to use their cash flow generation for both debt repayments and share repurchases. Currently, there is

approximately $200 million remaining on the current board authorized share repurchase plan. Additionally,

based on current debt covenants, the company does not issue a dividend, making it one of the only companies

in the industry not to have a dividend. In the long term, Constellation may be able to issue a dividend

approaching the industry norm of 2.4% once it has a more stable balance sheet and less leverage.

Balance Sheet & Financing

Balance Sheet Quality: We believe that the overall health of Constellation‟s Balance Sheet is quite poor.

This is due to the fact that goodwill and intangible assets comprise approximately 50% of total assets.

Debt: Constellation‘s long term debt consists of three bonds with maturities of 12/15/14, 09/01/16, and

05/15/17. At a BB rating, Constellation‘s cost of debt is approximately 7% due to its junk bond status. The

2014 bonds have a coupon rate of 8.375%, and for the longer maturity bonds the coupon is 7.25%. Each bond

is callable. The Company recently paid off $250 million bond that came due on January 15, 2012. These three



9

bonds comprise $2.1 billion of Constellation‘s debt, with the other amounts coming from notes payable and

its revolving credit facility with JP Morgan Chase Bank.

Contractual Obligations & Commitments: When taking into consideration long-term contractual

obligations outstanding as of February 28, 2011, there are approximately $6.1 billion worth of total

obligations and commitments. This is compared to the long-term debt level on Constellation‘s balance Sheet

of approximately $3.1 billion. The contractual obligations and commitments are comprised of $340 million of

operating leases and $1.4 billion of unconditional purchase obligations to purchase grapes and raw materials

over the next 14 years. The remainder of the $6.1 billion is made of interest payments and other liabilities.

Pension Status: Currently, Constellation has a pension which is underfunded by approximately $10 million.

We do not consider this to be a material amount.

Investment Risks

The Crown Imports JV continues to be the main driver of earnings, and poses a significant risk to

Constellation should its contract not be renewed in 2016. We feel that the termination of the 50-50 JV is a

strong possibility. In year seven of the contract Modelo can give notice to Constellation that the contract will

not be renewed. Constellation is not a beer company, and most likely has no intentions of acquiring a beer

company, as it most likely does not have a supply chain in place that is beer specific where synergies such as

economies of scope or scale could be maximized. Grupo Modelo should be considered a takeover target due

to its brand portfolio and geographic reach. With AB InBev already holding a 50.2% stake in the company,

there is a strong argument to be made for Modelo being acquired by AB InBev. Such an acquisition would

make sense due to the industry trend of consolidation. Furthermore, large breweries have seen sales of their

flagship beers stagnate, and have watched the consumer gravitate towards craft and import beers, making an

acquisition of Modelo attractive. In the case of AB InBev, an acquisition of Modelo would have many cost

synergies, as well as open up the Modelo brands to AB InBev‘s distribution network, further allowing the

Modelo brands to gain market share and market coverage in the United States. The Corona offerings would

also complement Bud Light Lime, and offer AB InBev a premium price point to position Corona in the

market. Constellation Brands is going against the current industry trends in its wine segment, and is not a

dominant company in the saturated spirits segment. This will lead to slow growth over time, and increase the

overall risk to the company, as a termination of the JV would significantly decrease earnings power. Besides

a relationship dating back to its Barton Beers brand, we do not see anything unique about Constellation that

would make it more compelling for Modelo to use Constellation as its importer rather than a different

company such as AB InBev. The termination of this JV would not only have a material adverse impact on the

earnings and profitability of Constellation, but would leave the company with only one significant area of

growth, that being SVEDKA, as the wine business is a mature industry in which Constellation already lags

the overall industry from a growth standpoint. This is a significant risk to the business as Constellation

accounts for earnings of this JV under the equity method, meaning that profits from Crown Imports directly

account for 40% of net income. Lastly, moving along with the social movement of craft and import beers

overtaking traditional beers on a volume basis, it would make sense that a large multinational brewing

company with a larger distribution market and market penetration would be more attractive for Grupo

Modelo.

Health of the consumer: The overall health of the consumer is very fragile at the moment. Consumers still

look to be seeking out value propositions in an economy which boasts a historically high unemployment rate.

This idea is contrary to the shift that Constellation is positioning itself for, mainly the trade up to more

premium brands. The duration of a weak consumer could have a negative impact on sales and new product

initiatives. It can be seen in the graphs to the left that the average household spent less money on alcoholic

beverages in 2010 than it did in 2000 as a percent of total beverage spend.

Quality of Balance Sheet: Constellation has a balance sheet that is definitely lacking in terms of quality.

With Goodwill and intangible assets comprising about half of total assets, and long term debt being in the

range of $3 billion, the quality of the balance sheet for Constellation is a weakness for the company, and

poses a significant risk moving forward in terms of potential write downs or impairments of goodwill and/or

intangible assets, and also in terms of the amount of debt coming due in the next 5 years.

Corporate Governance: Robert S. Sands and Richard E. Sands serve as the Chairman of the Board,

President, and CEO of Constellation and control a majority of voting rights. With their shell investment

companies, they own 5 million Class A shares or 2.83% of Class A shares and votes. However, they also

control 87.12% of Class B shares and thus the voting rights attributable to them. Overall, Robert and Richard

Sands control 51.08% of the voting rights of the company, and therefore the entire company due to their stake

in Class B shares. In other words, they hold the most power within the company. It could be said that interest




10

in the company is aligned with shareholders, but the overwhelming control of Constellation will not lead to

the higher potential return for other shareholders. For example, with their voting rights, they may block a

takeover that could create wealth for shareholders. Also, they control the board of directors as Class A shares

vote on two directors and Class B shares vote on six directors. With controlling close to 90% of the Class

B vote, they control the directors. This analysis does not take into account other known family relations to the

Sands, such as Abigail Bennett, Zachary Stern, and the Trust for the benefit of Andrew Stern in the Will of

Laurie Sands. Constellation appears to be a private company trying to act like a public company. Private

companies‘ required rates of return are much higher than public companies. Based on this analysis, it can be

concluded that a higher discount rate should be used when valuing shares of Constellation Brands.

This would support the use of a discount rate even higher than what we were able to quantify, because

corporate governance risk per se cannot be quantified.

STZ is not creating value for shareholders as measured by Economic Value Added. Management has not

made value added decisions in mergers, acquisitions, and divestitures. They acquired certain companies in

previous years and then divested those same companies within a year, leading to higher costs for the

company. Management believes Constellation to be a premium company and has centered Constellation‘s

portfolio on premium wine brands, despite the current value trend with the consumer. Due to the

overwhelming control by Robert and Richards Sands and STZ thus being more like a private company than a

public, valuation of STZ should be discounted at a higher rate. Governance issues cannot be quantified but

WE believe that it should be taken into consideration.

Conclusion: After thoroughly analyzing the wine industry, we feel that Constellation is levered towards a

mature industry that will not experience a sharp increase in growth in the near future. The Company

generates approximately 90% of its sales from wine, making it more susceptible to trends within the overall

U.S. economy and specific to the industry. Constellation is heavily reliant on the overall health of the U.S.

economy, the consumer, and the consumer‘s ability to spend. We have seen that the consumer is still hesitant

to trade up to more premium price points, and has gravitated to the value propositions that Constellation has

shed from its business. Furthermore, consumer spending as a whole in the U.S. is still weak due to a lack of

an increase in disposable income. Looking specifically to the industry, we do not feel that Constellation will

be able to outpace the industry in terms of growth. As for spirits, the segment only comprises approximately

10% of sales, and therefore will not significantly impact total sales at this time. In terms of the Crown JV, we

feel that the market is not adequately pricing in the risk of Constellation losing the exclusive right to import

the Modelo brands in the long term. This is significant because 40% of earnings come from equity earnings

from the Crown JV.

As for risks, we feel that there are many risks that are extremely significant to Constellation moving forward.

First and foremost, we feel that the Corporate Governance risks associated with the Sands family having

control of the company are not adequately being priced into the share price. We believe that the best interests

of shareholders of this company may not be aligned with top level management, as seen by the fact

management consistently destroys value for shareholders. This company is a prime example of a privately

controlled company masquerading as a publicly traded company. Additional risks to this company include

significant levels of debt and an overall weak balance sheet, as over half of total assets are comprised of

goodwill and intangibles. These risks are further exemplified by a ―very aggressive‖ AGR score. Due to these

risks, we feel that the market is not adequately pricing these factors in to the current stock price.

Finally, having modeled out eleven different scenarios using three different discount rates, we feel extremely

confident averaging together the intrinsic values derived from each scenario using the midrange and buildup

discount rates. We have tossed out the WACC as a discount rate because we believe it to be downward

biased. Given that we have a $17 price target on the stock, we feel shares of Constellation Brands are

significantly overvalued at the present closing price of $21.02. Even when considering an analysis of

potential value that could be unlocked for shareholders (using a sum of the parts approach); we do not feel

that there is much upside potential in the stock. There is a distinct possibility that a discount rate of 14%

(build up method) is itself downward biased, meaning a higher discount rate could be justifiable based on

the qualitative risks associated with Constellation Brands. Such a discount rate would further support our

SELL rating on shares of Constellation Brands.

Additional Corporate

Governance discussion can

be located in the appendix on

pages 19-22.


11

Appendix: Constellation Brands

Other Headings Relevant to Company

Additional Company & Industry Analysis

The Alcoholic Beverage sector is a subset of the Beverage Industry, with sub-segments including wine,

spirits, and beer. The industry competes in ‗on-premise‘ sales (e.g. restaurants, bars, and hotels) and ‗off-

premise‘ sales (e.g. retailers and grocery stores). Constellation‘s main focus in the industry is its premium

domestic wine sales with emphasis towards on-premise sales.

Excise Taxes: Taxes impact the industry as a major expense. However, in the U.S., total excise taxes

decreased from 2010-2011 with federal taxes increasing but state and local taxes decreasing at a greater rate.

Moving forward, excise taxes for Constellation will significantly decrease as a percent of sales due to the

divestiture of CWAE. Consumer confidence impacts the global alcoholic beverage industry and is

correlated to sales. US consumers have the potential to spend more on alcoholic beverages, especially in the

off-premise market. Consumers responded positively to the product innovations by the industry, such as ‗at

home-kegs‘. In November to December in 2011, consumer confidence increased 30% showing increasing

sales growth potential.

Inventory: Monitoring inventory is important as many global wine markets experience inventory supply

issues. By decreasing inventory, it decreases total assets and holding costs, which allows companies to

increase total asset turnover and margins. Increasing asset turnover and margins will drive a higher ROE. It is

important to lower the inventory amount in the supply chain by increasing visibility in the supply chain and

integrating all business partners and facets. Figure 1 to the left depicts how production and consumption in

the wine industry are converging, trying to reach an equilibrium standpoint.

Distribution: In September of 2009, Constellation initiated a new distributor relationship program in order to

improve the effectiveness of its sales efforts in the U.S. Under this program, long-term contracts were

negotiated with its five largest U.S. distributors of wines and spirits. These contracts give the distributor the

sole right to market Constellation‟s brands in their respective territories, along with obligations to maintain

contractual levels of inventory and to commit a portion of sales staff to the marketing of Constellation brands.

These contracts have benefited Constellation and initially run through the end of 2015. The nature of these

contracts reduces the volatility of sales, since these distributors have historically accounted for around 60% of

Constellation‟s net sales in the U.S. These distributors include RNDC, Young‟s, Johnson, Southern, &

traditional franchise/control states.

Wine: Currently, there is an oversupply of wine in the world due to the lack of consumption against the

increasing production during 2007 to 2009. The U.S. recession led to a decrease in consumption. With

oversupply of wines and grapes, countries offered producers and suppliers to cut and burn vines. Since 2010,

the trend is towards equilibrium between production and consumption.

On-premise vs. Off-premise sales: On-premise (red, bottom) sales are sales to restaurants, bars, and hotels.

Off-premise (yellow, top) sales occur at retailers such as grocery stores and wholesalers. The industry is

dominated by off-premise sales, especially during a struggling economy. Off-premise sales increased 23.2%

during the last 10 years, which outpaced on-premise sales growth of 11.6%. Since the 2008 recession, off-

premise sales increased 12.9%, which strongly outpaced on-premise sales growth of 3.3%. In the United

States, annual alcoholic beverage spending declined in terms of macro-beverage market share, as it decreased

each year from 57.1% in 2000, to a market share of 53.3% in 2010. With the questionable economy in the

United States, decreasing disposable income, and the continued trend of entertaining at home, consumer

spending is expected to continue towards off-premise sales. Spending at restaurants declined during 2008-

2009 but strengthened since early 2010 due to U.S. unemployment maintaining a 9% level. The expected

unemployment rate decline should aid in higher on-premise sales, leading to higher margins for the industry.

The lack of significant growth in on-premise sales in recent years, as shown by the graph to the left, coupled

with the questionable economy, leaves in doubt if on-premise sales will rebound and outpace off-premise

sales in the near future. According to Bloomberg, the growth rate for off-premise sales over the past three

years has been 12.9%, or an annual rate of 4.1%. As for on-premise sales, the growth rate over the past three

years has been 3.3% or an annual rate of 1.1%. This does not bode well for Constellation, as it further depicts

a slow growth environment.

Source: M&A International

Source: Bloomberg


12

Porter's Five Forces

Summary

Factor: Score: Reasoning:

Buyer's

Power Neutral

STZ controls a large market share of the wine sector, but lags in spirits and beer. Within the wine industry

there are other firms with larger market shares. Buyers are currently influenced by price due to the

economy.

Supplier's

Power Neutral

Constellation has many suppliers of raw materials globally. However, suppliers are influenced by harvests

and the environment which is used as leverage for pricing.

Industry

Competition Intense

The Alcohol Beverage Industry has many firms within it that compete in wine, spirits, and beer segments.

Marketing, product innovation, and price are key determinants for competition.

Threat of

Substitutes High

There are many emerging nations with increasing exports of wine, as well as the growing trend towards

international wine. There are domestic and international substitutes for Constellation

Barriers for

New

Entrants Low

Many wine companies are private and exist across the globe. The industry is moving toward consolidation

but there are many wineries that can compete even though they may be small or new.

Source: Bloomberg Industries



13

Consolidation, Supply Chain, and Industry Margins: In 2010, the top five companies in the industry

accounted for 45% of global sales, up from 41% in 2006. The trend in the industry has continuously been to

acquire smaller companies that will diversify the company‘s portfolio, expand geographic reach, and improve

margins through cost synergies and economies of scope and scale. The most recent example was in 2011 with

SAB Miller‘s acquisition of Foster‘s. Companies compete within the supply chain, by maximizing

efficiencies, making the vertical integration of distribution systems by large wineries another key trend in the

to improving profitability. By controlling and globally diversifying the supply chain, companies are able to

improve their margins. The large companies that dominate this industry are trending to improve margins,

especially by divesting lower margin brands and acquiring companies that better fit their core-assets and

diversify their portfolio. Constellation has implemented Project Fusion, an integrated technology platform to

strengthen and enhance the company‟s global business capabilities and processes.

Input and Packaging Costs: Input and packaging costs have been on the rise heading into the second half of

2011, but are beginning to fall (as seen in chart below). Wheat, rice, aluminum, hops, grain alcohol, barely,

glass, oil, and grapes are all important costs to monitor within the alcoholic beverage industry. These input

costs have been declining, such as wheat dropping 33.99%. The drop in input costs allows companies to

allocate towards innovating products (e.g. flavored whiskeys and vodkas), improving margins, and increasing

market share. Grapes supply is expected to decrease on a volume basis, but is expected to be offset with

increases in demand in 2012. Close to 99% of the wine market supports glass bottles, but there are secondary

possibilities such as plastic bottles with screw caps to decrease costs. Currently, there is a product to package

weight ratio of 60:40, when it could improve to 93:7. Eliminating glass bottles would lead to lower freight

costs and increase convenience. Decreasing packaging and input costs will lead to decreasing prices and

higher volume. With a combined high unemployment rate and increasing prices to offset the costs, it could

result in consumers‘ continued preference for value brands.




14

Alcoholic Beverage Segments: Wines, spirits, and beer comprise the three alcoholic beverage segments. In

recent years, there is a growing trend towards beer and spirits over wine. The market share breakdown in

2010 for these segments was 51% beer, 34.8% spirits, and 14.2% wine. Millennial and Generation X

individuals consume more beer and spirits than wine, leading to market share favoring beer and spirits over

wine. Baby Boomers are expected to trade up to premium brand wines over the value wines they consumed in

their early years. Off-premise sales support this trend, as beer sales comprised 47.2%, spirits 28.5%, and wine

24.3% market share. Alcoholic beverage retail sales in the U.S. rose 3% YoY ending October 30, 2011,

driven by volume growth in wines (5%) and spirits (4%) via product innovation and the continued home

entertaining trend. Consumer spending on alcoholic beverages for at-home consumption has risen sharply

across all three segments since 2008.

Competitors: Since Constellation is such a unique company, it is difficult to find peers with similar business

models, market capitalizations, and product offerings. It was especially difficult to find comparable public

companies in the wine industry. We chose an Australian company, Treasury Wine Estates, as a wine

company peer. The leading U.S. wine companies are all private. To address the spirits segment, we chose

Brown Forman (US). As a third competitor we chose Diageo, a U.K. business that sells spirits, wine, and

beer, which makes it the most comparable company to Constellation.



Note: Constellation

is part of ―other‖


15

Additional Valuation Techniques & Analysis

Market WACC: In determining a market value based WACC, we analyzed market values rather than book

values, since market values reflect what the company‟s actual capital is worth today. In our analysis, we

decided to use book values for weights which offers the advantage of eliminating biases that would be

introduced by the volatility of market prices, especially in the equity markets. Ultimately the choice was

somewhat immaterial for Constellation because using market prices in lieu of book prices when determining

WACC did not significantly change the resulting WACC. As we expected, WACC increased (from 7.18% to

7.82%). Had we used the latter in our DCF, it further supported our sell recommendation. When using a

build-up approach to determine cost of equity, the resulting market value build-up WACC is 9.81%,

compared to a book value build-up WACC of 9.60%.

Price/Sales: Another way to value Constellation using P/S multiples is as a summation of the parts based on

net sales, namely, CWNA, Crown Imports, and SVEDKA/Spirits. In this approach, each part‟s revenue is

segmented out, leading to its own P/S ratio. CWNA has been a segment of the company since 2009 and has

traded at an average P/S of 1.37. In 2011, CWNA traded at its highest P/S of 1.70. Crown Imports average

P/S (using its equity earnings as its „sales‟) trades at 16.38. In 2011, Crown Import‟s P/S equity earnings was

17.82. SVEDKA revenues extrapolated out trade at P/S of 1.10. This analysis used projected sales on a „base

case‟ scenario for each segment and applied it to the average P/S for each segment as well as its 2011 P/S

multiple. These values for each segment were then multiplied by the percent of earnings that it contributed to

total earnings. The results for a target price on an average and 2011 P/S multiple basis was $15.72 and

$19.16, respectively. A price target averaging these two methods is $17.44, affirming our sell decision

and previously mentioned scenario valuation analysis.

Rather than using equity earnings for Crown Imports, its revenue generated can be used to see what investors

are willing to pay for sales of Crown Imports. This analysis used the same assumptions above and same

aspects for CWNA and SVEDKA/Spirits. The only difference is using revenue for Crown Imports to

calculate a P/S multiple rather than equity earnings. The average P/S for Crown Imports‟ based on revenue

was 1.58 and was 1.82 in 2011. Applying these multiples to projected revenue for Crown, results in a

segment target price of $19.89 and $22.93. These values must once again be multiplied by its percentage of

earnings. Combining the three segments together and using an average P/S and 2011 P/S multiples, results in

target prices of $17.49 and $20.81.

The average price target using all of the P/S approaches is $16.32, supporting a SELL Recommendation for

Constellation Brands. Using analysts‟ projected sales for competitors and respective historical P/S,

Constellation Brands target price is significantly lower than competitors. This shows that within its industry,



16

Constellation Brands is not the ideal choice for money managers. Because the JV does not add revenue to

Constellation in the form of sales, using Crown Import‟s P/S based on equity earnings is a better fit. The

average target price using this approach is then $17.44. Altering the assumptions, such as the number of

diluted shares outstanding or using the best case scenario projected sales for next year, does not alter the sell

support.

As Equity Earnings for Crow n

Summation P/S Projected Valuation Average 2011 P/S

CWNA P/S 1.37 1.70

CWNA Projected Net Revenue 2,673.67 2,673.67

CWNA Price Target 16.60 20.55

*Used Projected Shares Above = 221

Crow n Imports P/S 16.38 17.82

Crow n Imports Projected Equity Earnings 284.37 284.37

Crow n Imports Price Target 21.08 22.93


Svedka P/S 1.10 1.10

Svedka Projected Revenue 268.18 268.18

Svedka Price Target 1.34 1.34


CWNA Target as % of Earnings (82.87%) 13.76 17.03

Crow n Imports as % of Earnings (8.81%) 1.86 2.02

Svedka Target as % of Earnings (8.3%) 0.11 0.11

Total Target Price 15.72 19.16

As Revenue for Crow n

Summation P/S Projected Valuation Average 2011 P/S

CWNA P/S 1.37 1.70

CWNA Projected Net Revenue 2,673.67 2,673.67

CWNA Price Target 16.60 20.55


Crow n Imports P/S 1.58 1.82

Crow n Imports Projected Revenue 2,791.08 2,791.08

Crow n Imports Price Target 19.89 22.93


Svedka P/S 1.10 1.10

Svedka Projected Revenue 268.18 268.18

Svedka Price Target 1.34 1.34


CWNA Target as % of Revenue (46.64%) 7.74 9.59

Crow n Imports as % of Revenue (48.69%) 9.69 11.16

Svedka Target as % of Revenue (4.67%) 0.06 0.06

Total Target Price 17.49 20.81

P/S Projected Valuation Average 2011 P/S 2009-2011 Average

P/S Multiple 0.99 1.30 1.02

Projected 2013 Net Sales 2,737.89 2,737.89 2,737.89

Projected 2013 Shares (Diluted) 221 221 221

Target Price 12.21 16.15 12.68

Business Segments

For the Fiscal Period Ending

Projected 2012

12 months

Feb-28-2011

12 months

Feb-28-2010

12 months

Feb-28-2009

12 months

Feb-29-2008

Revenues

Constellation Wines North America (CWNA)2,614.84 2,557.3 2,434.7 2,703.4 -

Constellation Wines Australia and Europe (CWAE) 774.7 930.1 951.2 -

Crow n Imports 2,584.33 2,392.9 2,256.2 2,395.4 2,391.0

Corporate and Other (2,392.9) (2,256.2) (2,395.4) (2,391.0)

Constellation Wines - - - 3,773.0

Constellation Spirits - - - -

Constellation Beers - - - -

Constellation Beers and Spirits - - - -

Popular and Premium Wine - - - -

U.K. Brands and Wholesale - - - -

Fine Wine - - - -

Total Revenues 3,332.0 3,364.8 3,654.6 3,773.0

Crown Imports Equity 284.4 243.8 213.6 186.6 257.9

Diluted Shares Outstanding 213.8 221.2 217.7 218.9

Total Revenue/Share 15.585 15.212 16.787 17.236

Price at Year End 20.32 15.04 13.05 19.93

Average P/S

P/S 0.99 1.30 0.99 0.78 1.16

Avg P/S 2009-2011 1.02

CWNA Revenue/Share 11.96 11.01 12.42

CWNA P/S 1.37 1.70 1.37 1.05

Crow n Imports Equity Earnings/Share 1.14 0.97 0.86 1.18

Crow n Imports P/S 16.38 17.82 15.58 15.23 16.92

*Crow n Imports Revenue/Share 11.19 10.20 11.00 10.92

Crow n Imports P/S 1.58 1.82 1.47 1.19 1.82

CWAE Revenue/Share 3.62 4.20 4.37

CWAE P/S 4.06 5.61 3.58 2.99


17

Intrinsic Value Matrix: The average intrinsic values for the Midrange and Buildup discount weights across

EV/EBITDA multiples of 8, 9, and 10 create a price target of $17 and a SELL recommendation.

Alternative theoretical “sum of the parts” targets:

Sum of Parts Buildup Sum of Parts

Midrange

Sum of Parts

WACC

Conservative $16.22 $18.76 $20.86

Possible $19.86 $22.38 $24.49

Unlikely $24.16 $26.68 $28.80

5yr- Crown

CASH

NOW

5yr- Crown

CASH

LATER

10 w/

5yr- Crown

CASH

NOW

5yr- Crown

CASH

LATER

Average

(BEST) (BEST) JV con’t. (BASE) (BASE)(see excel

tab)

Buildup $14.54 $13.06 $19.08 $18.33 $11.37 $22.28 $19.20 $12.94 $13.90 $17.59 $11.33 $15.78

Midrange $19.26 $17.52 $24.69 $26.11 $18.63 $28.47 $24.01 $17.37 $21.98 $22.07 $15.43 $21.41

WACC $23.24 $21.29 $29.44 $33.46 $25.58 $33.72 $28.03 $33.63 $29.71 $25.81 $30.45 $28.58

10 w/

5yr- Crown

CASH

NOW

5yr- Crown

CASH

LATER

Average

JV con’t. (BASE) (BASE)(see excel

tab)

Buildup $12.67 $11.28 $16.78 $17.19 $10.23 $19.72 $18.46 $12.20 $12.76 $16.97 $10.71 $14.45

Midrange $17.03 $15.40 $21.94 $24.49 $17.01 $25.41 $23.12 $16.49 $20.36 $21.32 $14.69 $19.75

WACC $20.70 $18.87 $26.31 $31.35 $23.47 $30.23 $27.02 $32.21 $27.60 $24.96 $29.26 $26.54

5yr- Crown

CASH

NOW

5yr- Crown

CASH

LATER

10 w/

5yr- Crown

CASH

NOW

5yr- Crown

CASH

LATER

Average

(BEST) (BEST) JV con’t. (BASE) (BASE)(see excel

tab)

Buildup $10.81 $9.50 $14.47 $16.05 $9.09 $17.16 $17.72 $11.47 $11.62 $16.35 $10.09 $13.12

Midrange $14.80 $13.27 $19.19 $22.86 $15.38 $22.36 $22.24 $15.61 $18.73 $20.58 $13.94 $18.09

WACC $18.17 $16.45 $23.18 $29.25 $21.37 $26.75 $26.02 $30.79 $25.49 $24.11 $28.06 $24.51

Average of all Buildup and Midrange scenarios is $17.10

5yr- Crown

CASH

NOW

5yr- Crown

CASH

LATER

EV/EBITDA

of 8

Scenario 1

(BASE)

Scenario 2

(WORST)

Scenario 3

(BEST)

Scenario 4:

10yr ($2B

CASH)

Scenario

X: 10yr

(NO $2B

CASH)

Stress

Tested

Scenario 3,

test 1

Stress

Tested

Scenario 3,

SG&A

EV/EBITDA

of 9

Scenario 1

(BASE)

Scenario 2

(WORST)

Scenario 3

(BEST)

Scenario 4:

10yr ($2B

CASH)

Scenario

X: 10yr

(NO $2B

CASH)

Stress

Tested

Scenario 3,

test 1

EV/EBITDA

of 10

Scenario 1

(BASE)

Scenario 2

(WORST)

Scenario 3

(BEST)

Scenario 4:

10yr ($2B

CASH)

Scenario

X: 10yr

(NO $2B

CASH)

Additional Support for EV/EBITDA multiple

analysis can be found on page 22 of the appendix


18

Looking at shares of Constellation from a Price/Cash Flow basis, we have analyzed P/CF multiples for Constellation since

2000. This resulted in an average and median P/CF multiple of 11.13 and 9.38 respectively. In testing our terminal values

using these multiples, as well as both our FY2017 FCFF figure, and estimated FY2017 sustainable FCFF based on

management guidance, we obtained the intrinsic values above using both our buildup and midrange discount rates. Taking

the average of all eight intrinsic values, we calculated an average intrinsic value of $15.60, which supports our SELL

rating on shares of Constellation.


19

Ratio & Peer Group Analysis

Financial Condition Comparison

Constellation Brands financial condition lags when compared to its peers, and the distillers and vintners

industry as a whole. For our peer comparison we decided to use Beam (BEAM: NYSE), Brown-Forman (BF:

NYSE), Diageo (DEO: LSE), and Treasury Wine Estates (TWE: ASX).

Short Term Liquidity: Compared to its peers, Constellation‘s current ratio is only larger than Diageo‘s.

When inventory is taken out, Constellation‘s quick ratio is the poorest of its peers. From a cash conversion

perspective, Constellation Brands is 85 days behind its nearest peer TWE, and more than 100 days behind the

industry average of 265 days. Constellation‘s cash conversion cycle is impaired by a longer than average

inventory holding period and accounts receivable turnover.

Asset Turnover: Constellation Brands is also a poor performer when it comes to asset turnover. The

company‘s total asset turnover ratio of .35 lags the industry average of .50, and is only superior to TWE‘s

ratio of .20. Constellation‘s weak inventory turnover also affects them negatively, as the industry average is

1.3, while Constellation‘s inventory ratio is 1.

Solvency: From a solvency standpoint, Constellation Brands earns nearly 3 times its interest, well below the

industry average of 6.8 times. While the company is less levered than the industry average, a loss of the

Crown JV coupled with slow sales growth could negatively affect the company‘s ability to cover its debt

obligation.

ROE Decomposition: Note that STZ return on equity of 12.65% is based on restated EPS figures as seen in

our restatements.

All ratios below based on TTM figures

Short term Liquidity Industry STZ TWE DEO Brown Beam

Current Ratio 1.9 1.85 3 1.5 2.6 2.2

Quick Ratio 0.53 1.2 0.7 1.4 0.7

ACP(ar/sales/365) 50.2 95.7 74.2 55 79.1 44.4

days inv. Held 276.4 364.5 246.7 307.4 273.9 190.4

avg days payable out 116.7 87.4 34.8 79.4 168.6 43.6

cash conversion 265.6 372.8 286.1 283 184.4 191.2

Asset Turnover

Inventory turn 1.3 1 1.5 1.2 1.3 1.9

Accts. Rec turn 7.4 3.81 4.9 6.6 4.6 8.2

Fixed Asset Turn 3.5 1.95 1.3 4 6.6 5.2

Total asset turn 0.5 0.35 0.2 0.5 0.8 0.6

Long Term Debt

Debt ratio Liab/Assets 0.424 0.635 0.223 0.697 0.454 0.454

LTD to Capital 0.215 0.451 0.045 0.478 0.256 0.256

Debt to equity 0.327 0.989 0.047 1.14 0.251 0.367

Leverage 3.95 2.74 NM 3.3 1.831 2.237

TIE 6.8 2.9 NM 4.1 26.2 4.2

ROE decomp

Total asset turn 0.5 0.35 0.2 0.5 0.8 0.6

Leverage 3.95 2.74 1.289 3.3 1.831 2.237

NPM 8.9 13.2 4.39 19.12 21.3 7.4

Return on equity 17.60% 12.65% 1.13% 31.55% 31.20% 9.93%



20

Additional Investment Risks

Constellation’s growth by acquisition strategy over the past two decades may prove to be unsuccessful

and dilutive to shareholders: As part of the alcoholic beverages industry trend of consolidation within the

industry, Constellation has made over twenty acquisitions over the past two decades, many of which have had

a significant portion of goodwill as a percentage of assets acquired. With this strategy of growth by

acquisition, significant restructuring, unusual, or non-recurring charges may overstate earnings power of the

company, or decrease its profitability, as the fair value of acquired business may not remain constant. This is

in line with the recent trends over the past five years of significant goodwill impairments and restructuring

charges as mentioned above. The synergies from these acquisitions may never be realized as the preferences

of the consumer change amidst a tumultuous economic environment.

Excise tax situation: In the current distributor model in the United States, some states regulate the

distribution of alcoholic beverages. With the possibility of more states deregulating this aspect of the

industry, this could benefit STZ. In terms of excise taxes, each state has different taxes that are levied,

making this aspect of the business hard to predict change in.

Additional Corporate Governance Discussion

Corporate Governance: Corporate Governance is important for any investor and can influence the amount

of risk within a company, as shown by the poor governance examples within companies such as Enron,

Adelphia, and WorldCom. The important areas to look at for analysis of Constellation‘s corporate

governance are the differences between the multiple classes of shares, voting rights, insider shares held,

exercisable options by executives and directors, and overall value creation or destruction by the company.

Constellation has three classes of shares: Class A, Class B, and Class 1. Class A shares are the main form

traded in the market with 176 million shares outstanding as of the most recent quarter. Class A shareholders

receive one vote per share. Class B shares (STZ/B) are also traded, but are typically shares for management.

This class has a total of 23.5 million shares outstanding. Class B shares have super voting rights and receive

10 votes per share. One share of Class B may be converted to one share of Class A at any time at the option

of the holder. The third type of shares is Class 1 option shares, which shares outstanding are approximately

11,500. These options may be exercised for Class A shares at any time but must be sold immediately upon

being exercised, so as not to be dilutive to current Class A shares.

The on-going stock repurchase plan and the exercisable options play a role as well. If the shares being

repurchased are not the shares of Robert or Richard Sands, then they are gaining more control of the

company. Each year they are also awarded stock options for compensation. Last year combined, they were

awarded $5.6 million worth of options alone and total compensation was $16.2 million or a 17% increase.

Combined, Directors saw a 14% decline in compensation.

Furthermore, the company repurchased $281.3 million worth of stock in the 12 months ended November 30,

2011. Subsequent to the most recent quarter ended November 30, 2011, and prior to January 9, 2012, the

company re-purchased 242,700 shares of Class A stock at an average price of $18.46, for a total of $4.5

million. Throughout the entire repurchase program, shares may be re-purchased using either cash or revolver

borrowings. The company used BOTH cash from the balance sheet and revolver borrowings to re-purchase

stock. This is worth noting because Constellation had $55.8 million of cash and cash investments on the

balance sheet as of November 30, 2011, and brings to light a potential corporate governance weakness when

it comes to earnings management. This is due to the fact that Constellation has the ability to use debt to

reduce the number of shares outstanding at the end of a given period, and still maintain adequate cash levels.

With executive compensation linked to EPS targets, each officer will receive a 50% payout of their

performance-unit-share (PSU) upon Constellation reaching its target EPS level.

It should also be noted that the Board of Directors recommended that shareholders vote AGAINST Proposal

5 at the last shareholder meeting. This proposal, as outlined below, is in regards to the super voting rights

held by the Sands in the form of Class B shares.



21

PROPOSAL 5 — STOCKHOLDER PROPOSAL by Mr. Kenneth Steiner

Source: SEC Form DEF 14A

―Equal Shareholder Voting

RESOLVED: Shareholders request that our Board take steps to adopt a plan for all of our

company‘s outstanding stock to have one-vote per share. This would include all

practicable steps including encouragement and negotiation with family shareholders to

request that they relinquish, for the common good of all shareholders, any preexisting

rights, if necessary.

This proposal is not intended to unnecessarily limit our Board‘s judgment in crafting the

requested change in accordance with applicable laws and existing contracts. This

proposal is important because certain shares not owned by the general public have super-

sized voting power with 10-votes per share compared to one-vote per share for stock

publicly-owned.

The danger of giving disproportionate power to insiders is illustrated by Adelphia

Communications. Adelphia‘s dual-class voting stock gave the Rigas family control and

contributed to Adelphia‘s participation in ―one of the most extensive financial frauds ever

to take place at a public company.‖ See Securities and Exchange Commission Litigation

Release No. 17627 (July 24, 2002).

The SEC alleged that Adelphia fraudulently excluded more than $2 billion in bank debt

from its financial statements and concealed ―rampant self-dealing by the Rigas Family.‖

Meanwhile, the price of Adelphia stock collapsed from $20 to 79¢ in two-years.

With stock having 10-times more voting power our company takes our public shareholder

money but does not let us have an equal voice in our company‘s management. This

includes the shareholder money of more than 300 institutional investors. Without a voice

shareholders with large investments, such as institutional investors, cannot hold

management accountable.

The merit of this Equal Shareholder Voting proposal should also be considered in the

context of the need for additional improvement in our company‘s 2010 reported corporate

governance status.

Please encourage our board to respond positively to this proposal for Equal Shareholder

Voting — Yes on 5.‖

Conclusion on Proposal 5:

We believe that Mr. Steiner‘s shareholder proposal (―Equal Shareholder Voting‖) brings to the public light

the inherent corporate governance risks that exist for Constellation Brands. Class B stock and super voting

rights allow the Sands and related family to maintain control of this company. This supports our notion that

a higher discount rate (greater than the market is inferring) must be used to value this company in order to

properly take into account the associated risks that exist with a company that is majority controlled by a

single family.

Three Classes of Shares:

Class A (NYSE: STZ)

Class B (NYSE: STZ/B)

Class 1

Source: GMI


22

The graph above shows that the GMI Accounting and Governance Risk ratings for Constellation dating back

until December 2008. The ratings are based on metrics derived from a statistical analysis of accounting data,

in an attempt to identify accounting items that are correlated to historically fraudulent financial practices. Additional metrics are derived from governance issues that arise during SEC prosecution of companies

related to accounting fraud. The ratings are on a scale from 1 to 100, with 100 being the most favorable.

The AGR graph clearly depicts the Accounting Governance Risk that is associated with Constellation Brands

and supports our overall opinion on weak corporate governance. We feel corporate governance is a

significant risk to shareholders, but one that we is difficult to quantify. At the same time, failing to address

the extreme disparity between the voting power of upper management and owners compared to their relative

equity stake in the company would be ignoring a major risk.

Academic research has provided strong evidence that a share-class structure that puts a disproportionate

number of votes in the hands of upper management and owners tends to decrease organizational performance.

One specific study from Harvard Business School (Extreme Governance: An Analysis of Dual-Class Firms in

the United States) shows that a dual-class structure identical to that of Constellation is a more effective

defense against outsider intervention than traditional entrenchment tactics such as golden parachutes and

poison pills. Ultimately, the large body of research on this topic has shown that companies tend to

underperform the market and destroy value when management has voting rights that are disproportionate to

its equity stake (as is the case in the typical 10:1 vote-to-share relationship in a dual-class share structure).

This is not inconsistent with similar research which shows that performance tends to increase when

management has a large equity stake, without different classes of voting shares.

Shares Outstanding:

Our model takes into account a diluted share base of 221 million, based on the notion that at a price of

$20.31, the options would be exercised because the current market value of STZ shares is above that price.

Shares Outstanding: Dec. 31, 2011 Number of Shares Outstanding

Class A Common Stock, $.01 par value per share 176,087,973

Class B Common Stock, $.01 par value per share 23,578,116

Class 1 Common Stock, $.01 par value per share 11,500

Total A & B 199,666,089

Exercise Price

Options Exerciseable 18,148,632 $20.31

Total Calss A&B Shares, including Options 217,814,721

Sensitivity of 221m shares compared to 218m shares is immaterial to our recommendation

Shares Outstanding, Most Recent Form 10-K Number of Shares Outstanding

Diluted Shares (Class A & B) 202,933,000 Exercise Price

Options Exerciseable 18,148,632 $20.31

Total 221,081,632

Total

Holder Class A Shares Held % of Class A "A" Votes Voting % Class B Shares % of Class B Total Votes Voting % Total Voting %

Robert S. Sands 332,217 0.19% 332,217 0.19% 1,350,000 5.73% 13,500,000 5.73% 3.36%

Richard E. Sands 166,425 0.09% 166,425 0.09% 1,355,640 5.75% 13,556,400 5.75% 3.33%

RSS Holdings 0 0.00% 0 0.00% 5,300,000 22.48% 53,000,000 22.48% 12.87%

RES Holdings 0 0.00% 0 0.00% 5,300,000 22.48% 53,000,000 22.48% 12.87%

SSR Holdings 233,902 0.13% 233,902 0.13% 619,892 2.63% 6,198,920 2.63% 1.56%

SER Holdings 2,333,902 1.33% 2,333,902 1.33% 619,892 2.63% 6,198,920 2.63% 2.07%

CWC Partnership I 1,919,420 1.09% 1,919,420 1.09% 5,995,344 25.43% 59,953,440 25.43% 15.02%

Shares Controlled 4,985,866 2.83% 4,985,866 2.83% 20,540,768 87.12% 205,407,680 87.12% 51.08%

Total Shares Outstanding 176,088,000 176,088,000 23,578,000 235,780,000

Class A Receives 1 vote:1share

Class B Receives 10 votes:1 share

Class B Stock is convertible into one share of Class A stock at any time at the option of the holder

Class A Shares Class B Shares

Class 1 shares can be converted to Class A shares at any time but must be sold immediately upon completion - not dilutive (approximately 11,000 shares

outstanding as of last proxy)

This analysis does not include relationships to Abigail Bennet (known relative), Zachary Stern (known relative), and the Trust Fund for the benefit of Andrew

Stern under the will of Laurie Sands

Sources: Canisius College,

Bloomberg


23

Executive Compensation:

The above table illustrates executive compensation levels for the past three years. The current trend indicates

that executive compensation has increased each year.

Additional Market Multiples:

We compiled data on price-to-earnings (P/E), price-to-book (P/B) and enterprise value multiples for the

companies analyzed for fiscal year end 2011. Note that we restated Constellation‟s earnings for the period to

remain consistent with the rest of our analysis. Since this is not a crucial portion of our valuation, we

refrained from similar treatment for the competitors.

From a P/E analysis, it is justifiable that Constellation has a lower P/E than the peer median of 19.1x. This

lower P/E multiple is consistent with the fact that expected growth for Constellation at 3.4% is half the 9.30%

median expected annual growth for the peers that we chose. Constellation‟s adjusted beta is higher than that

of the peer median (0.976 for STZ vs. 0.81 for peers). However, when viewing leverage as the risk factor we

find that another peer with similar leverage, Diageo, is trading at a P/E of 18.37, while Constellation is

trading at a P/E of 11.81. Diageo is a faster growing company, with a more diversified premium international

brand portfolio, and does not have the additional qualitative risks that Constellation does.

P/B is a distorted metric to use because of the frequent impairments that Constellation has had in past years

and may have in the near future. Additionally, many peers use different accounting standards than

Constellation.

We also performed a relative enterprise value multiple analysis. Specifically, we chose to analyze enterprise

value-to-EBITDA (EV/EBITDA). On a relative basis, it does appear that Constellation‟s lower EV/EBITDA

compared to peers (7.84 and 10.18, respectively) is justified. This is because the consensus growth forecast

for STZ is almost half that of the peer group (3.40% versus 6.73%), and STZ‟s ROIC also lags the peer group

(6.68% and 10.80%, respectively). Additionally, since we believe Constellation‟s 7.18% WACC is

downward biased; any adjustments to increase WACC would further justify a lower EV/EBITDA. Based on

an EV/EBITDA multiple of 7.84 for Constellation and a peer group EV/EBITDA multiple of 10.18, our

EV/EBITDA assumptions of 8, 9, & 10 for our terminal value calculations are realistic and justified. This

range was utilized to demonstrate the sensitivity of using different EV/EBITDA multiples in calculating

a terminal value for our model.

Leverage: Based on a sustainable cash flow generation of approximately $500m, which has been

communicated by the company, and a target EV/TTM EBITDA multiple of 3-4, and a current position as of

end of Q3 of 3.4, we feel as if the EV/TTM EBITDA multiple will increase due to decreased TTM EBITDA

at the end of FY2012. Therefore, this would require the company to pay down a significant portion of its long

term debt in order to maintain this optimal leverage position. This is based on the notion that there is

approximately $200m left on the current board authorized repurchase program, and a target cash flow

generation of $700-750m for FY2012. This would leave ample room to decrease the leverage of the firm and

maintain the optimal structure.

Summary Compensation Table

Name and Principal, Position Year Salary $ Stock Awards $ Option Awards $ Non-Equity

Incentive Plan

Compensation $

All Other

Compensation $

Total $

Robert Sands, 2011 1,129,647 2,261,452 2,144,153 2,624,397 273,748 8,433,397

President and Chief Executive Officer 2010 1,102,298 1,103,235 3,096,311 1,269,847 200,684 6,772,375

2009 1,080,289 1,082,192 3,027,296 904,850 266,449 6,361,076

Richard Sands, 2011 1,136,329 - 3,495,502 2,639,919 522,007 7,793,757

Chairman of the Board 2010 1,135,472 1,136,415 3,189,486 1,308,064 328,850 7,098,287

2009 1,112,800 1,114,696 3,117,908 932,081 583,330 6,860,815

Robert Ryder, 2011 554,013 665,466 792,479 750,798 63,079 2,825,835

Executive Vice President and 2010 540,600 324,690 1,062,970 363,283 41,716 2,333,259

Chief Financial Officer 2009 529,615 319,304 1,039,540 258,770 35,464 2,182,693

W. Keith Wilson, 2011 505,652 607,454 723,286 685,260 52,681 2,574,333

Executive Vice President and Chief Human 2010 493,410 296,369 970,194 331,571 38,042 2,129,586

Resources and Administrative Officer

Thomas J. Mullin, 2011 497,663 597,786 711,862 674,433 61,006 2,542,750

Executive Vice President and 2010 485,914 291,629 954,850 326,332 57,374 2,116,099

General Counsel

Source: SEC DEF 14A


24

Contractual Obligations: The company has significantly more contractual obligations than their LT debt

picture paints on the Balance Sheet. Investors should also consider $6.1 billion when looking at LT debt of

$3.1 billion.

Source: SEC filing form 10-K, 2011 pg. 48


25

Hispanic and Latino Population Growth

Source: U.S. Census Bureau

According to data compiled by the U.S. Census Bureau in 2010, 308.7 million people resided in the United

States. That population is 16 percent comprised, or 50.5 million, of people of Hispanic or Latino origin. This

is a 15.2 million person increase from the year 2000, when the U.S. population was comprised 13 percent by

Hispanics and Latinos. This population growth in the Hispanic and Latino communities accounted for over

half of the overall U.S. population growth. This 43 percent growth in the Hispanic and Latino community

was greater than four times the growth rate of the overall U.S. population.

These facts are significant because as Crown Imports looks to drive sales of the Modelo Brands, it will need

to increase market penetration in areas which have already been established and located by the company as

high growth areas, but also in areas of growing Hispanic and Latino communities. Crown Imports has

modeled the increased roll out of Corona Familiar and Victoria brands to areas where the Hispanic and Latino

population has identified with the brands and use that trend to facilitate the brands into new and existing

markets.

As seen by the pie chart and map, the Hispanic

population is growing in terms of overall

population growth, but is also highly focused in a

few key geographic markets. These markets offer a

strategic opportunity for Crown Imports to increase

market share through increased distribution efforts

in those areas. Key states include California,

Texas, Florida, New York, and Illinois.


26

Canisius College Valuation


27

Scenario 2


28


29

Scenario 3


30

Scenario 6, Leading into Sum of the Parts


31


32

Cash Early Scenario

5-Year Valuation of Crown Equity Payments


33

5-Year Cash Later

Scenario 4


34


35


36


37

PVGO Analysis


38

CAPM WACC


39

Build-up WACC


40

Historical Common Size and FCFF Analysis


41

Restated Quarterly Earnings, 2009-2012


42

Disclosures:

Ownership and material conflicts of interest:

The author(s), or a member of their household, of this report does not hold a financial interest in the securities of this company.

The author(s), or a member of their household, of this report does not know of the existence of any conflicts of interest that might bias the content or

publication of this report.

Receipt of compensation:

Compensation of the author(s) of this report is not based on investment banking revenue.

Position as an officer or director:

The author(s), or a member of their household, does [not] serves as an officer, director or advisory board member of the subject company.

Market making:

The author(s) does not act as a market maker in the subject company‟s securities.

Ratings guide:

Banks rate companies as either a BUY, HOLD or SELL. A BUY rating is given when the security is expected to deliver absolute returns of 15% or greater

over the next twelve month period, and recommends that investors take a position above the security‟s weight in the S&P 500, or any other relevant index. A SELL rating is given when the security is expected to deliver negative returns over the next twelve months, while a HOLD rating implies flat returns over

the next twelve months.

Disclaimer:

The information set forth herein has been obtained or derived from sources generally available to the public and believed by the author(s) to be reliable, but

the author(s) does not make any representation or warranty, express or implied, as to its accuracy or completeness. The information is not intended to be used

as the basis of any investment decisions by any person or entity. This information does not constitute investment advice, nor is it an offer or a solicitation of an offer to buy or sell any security. This report should not be considered to be a recommendation by any individual affiliated with The CFA Society of

Buffalo, CFA Society of Rochester, CFA Institute or the CFA Institute Research Challenge with regard to this company‟s stock.

canisius college student research - cfa institute...january 2012: constellation brands reported q3...

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