Constellation Brands Inc. Earnings Call Nuggets: Spending, EBIT and Sales Growth

On Thursday, Constellation Brands Inc. Class A (NYSE:STZ) reported its fourth quarter earnings and discussed the following topics in its earnings conference call. Take a look.

Spending

Kaumil Gajrawala – UBS: I guess first question on the step-up in spending. Is this a fiscal ’13 one-time step-up, should we be thinking of it as part of the base or something that you’re going to be stepping up spending in fiscal ’13 and then as we look forward from that point, it starts to come down?

Robert Sands – President and CEO: Kaumil, it really depends – all I can say is that, certainly, we’re putting more investment behind brand building in 2013. As to what we’ll do in the future, a lot will depend upon the competitiveness and the marketplace, what happens with grape supply and pricing. So, it’s hard to say what we’ll do past 2013, but obviously our intention is to translate our sales growth into good earnings growth in the future.

Kaumil Gajrawala – UBS: Then maybe if I could ask in a slightly different way. Given the success of some of the new products in the wine industry over the last couple of years and how much they’ve contributed to growth in the wine industry, do you feel that maybe structurally, it’s changed, the cost of growth is perhaps higher than it used to be?

Robert Sands – President and CEO: Well, I think that sort of post the recession, the market has been very competitive. Promotional expense in wine in particular has been higher and has remained higher over the last several years. The consumer is definitely looking for a bargain when it comes to the buying of product. On the other hand, I’d say the growth has been pretty robust and there is a lot of good activity in terms of consumers and new consumers in the wine markets. So, I think that bodes well for the future.

Kaumil Gajrawala – UBS: Then also in the same context of marketing there was a step up in marketing at Crown, we know the numbers are for the year, can you talk about your need or desire to spend on Crown for fiscal 2013, and then also I may have missed it, I don’t know, in your commentary, did you provide us with what current depletions were at Crown as well?

Robert Sands – President and CEO: For which year, Kaumil?

Kaumil Gajrawala – UBS: I don’t know if you gave us a quarter-to-date after giving us what your current reported quarter was on Crown trends?

Robert Sands – President and CEO: Yeah, in fiscal ’12 depletions were like up mid single digits. For fiscal ’13 they’re going to be low single-digits and for the fourth quarter both shipments and depletions were up quite a bit, that’s in the press release and really as you know, the beer industry really had a good fourth quarter, it kind of surprised everyone in the industry. I think we are all happy about it, may be the warmer weather, may be some economic recovery helped the beer industry come back a little bit. As far as marketing spend in Crown, I think the big increase in marketing spend is behind us. That would have been fully realized in fiscal ’12. In fiscal ’13 the marketing spend will be more business as usual. So we don’t expect a big increase in marketing spend in fiscal ’13. We continue to expect some great advertising and some great new media behind our products, but it won’t be an absolutely increase in spend.

Kaumil Gajrawala – UBS: Okay got it and then Bob, also for you and this is kind of a little bit back in the envelope as for the, based on your commentary on taking advantage of the business, current state of the debt market, at least to me it sounds like you could be raising up to $1 billion. Looking at your leverage, looking at the buyback, the amount of free cash flow that you are guiding towards, there will be quite a bit of cash, I think, sitting there. What would be – could you maybe talk about what the uses of that cash would be?

Robert Ryder – EVP and CFO: Yeah, I think depending on when we go in the market and how rates move, I think we might be sitting on a little bit of cash for a short period of time, but I think right now the use of cash will be to reinvest in the business, and outside of reinvesting the business, the primary use will be to buy back shares.

EBIT and Sales Growth

Judy Hong – Goldman Sachs: Rob and Bob, I guess, you’ve talked about how the Company is now in a better position to grow profitably on an organic basis. I sort of looked at your P&Ls in the last two or three years, your EBIT has been essentially flat, and you have another year where EBIT is barely going to grow. So, I guess conceptually and structurally speaking when you look at your business, is this a business where you think you can at best grow in line with the category growth and pretty much get no leverage in terms of growing EBIT above your sales growth, or do you think that this is still a business where you can still potentially get pretty healthy sales growth, and that potentially translates to healthy EBIT growth, and how do we get confidence that that would be the case overtime?

Robert Sands – President and CEO: Judy, I think what’s going on, first of all this year, or last year I should say, 2012 was a little disappointing in terms of our overall growth and we felt that the healthiest thing to do for the business was to increase our investment behind brand building to really keep the momentum that we developed in the fourth quarter going throughout 2013. And that is what is resulting in I’ll say the muted EBIT growth; although we are growing EBIT. Now, to your specific question, we definitely think that we can leverage the P&L so to speak. It’s not going to occur overall in 2013 but as we introduce new products, take advantage of some of the new trends in the marketplace, continue the kind of the underlying sales growth momentum that we’ve achieved relative to consumer takeaway, we definitely think that we can we can leverage the P&L and grow EBIT therefore faster than sales.

Robert Ryder – EVP and CFO: This is Bob. Just to follow up on that; there is a bit of timing involved here. So, remember, we did fall short of our sales expectations in fiscal ’12. At the beginning of the year we said we expected to grow with the U.S. wine market. We did not do that. Yet, we pretty much – we actually blew our EPS estimate away but most of that was due to taxes. But we pretty much hit the EBIT number. Now, that was due to some fortuitous SG&A outcomes which I talked about I think in the third quarter call some positives there in the SG&A item and some belt-tightening. So, I think the Company said, hey, we’re not hitting the sales numbers; let’s really try to go after the EBIT. In fiscal 13, we do expect to grow with the market and we are making some increased brand investments; but remember we got those SG&A overlaps which is holding back our EBIT growth. So, I wouldn’t say, if you’re just saying Constellation is a wine industry in general, I would hope that in a normal year with a lot of strange overlaps that you could grow EBIT at least very close to what you’re growing your net sales number and as you know, the net sales growth in the wine category is pretty healthy.

Judy Hong – Goldman Sachs: Maybe two follow-up on that Bob, so can you quantify the SG&A overlap and then the brand investment step-up?

Robert Ryder – EVP and CFO: Yeah, for ’13 over ’12, I think we told the SG&A overlaps were $7 million to $10 million, were positives in ’12 that were nonrecurring. I don’t have a number on the top of my head for the brand building initiatives because it’s in a lot of different areas. Its increased sales costs, increased marketing costs and some of the increased promotion costs. Some of the increased brand building costs kind of go with the mix shift in the business, because the higher-priced wine tends to carry with it higher brand building costs. So, some of that’s natural and some of it is, a little bit of a ramp-up in the stuff because, we’re playing a little bit of catch-up after fiscal ’12, but I think the fourth quarter show that we are very close to being caught up and we’re pretty confident about the top line estimates for fiscal ’13.

Judy Hong – Goldman Sachs: Bob, the 7% depletion growth in Q4, you said that there was some channel fill that helped that number. Can you quantify how much that is? When you said the sales growth in fiscal ’13, I think you said low to mid single-digit, is that incorporating I guess the negative impact as the channel fill is reversed?

Robert Ryder – EVP and CFO: Yes, so that the guidance would incorporate kind of the reversal of those channel fill for the new product because you just have to make sure everything is loaded before the commercial activities kick in. So in general, I’d say the channel fill might have added to the top line growth may be 2% or 3% in the fourth quarter.

Judy Hong – Goldman Sachs: Bob, just in terms of ongoing tax rate, so obviously 2012 was a good year, it’s back up to 34%, I was under the impression that over time you also had the opportunity to lower your effective tax rate, is that not the case anymore, how should we think about your long-term tax rate?

Robert Ryder – EVP and CFO: Yeah, so really the last few years from a tax rate perspective have been anomalous because we believe to take advantage of some opportunities from some international tax planning, now going forward as we are primarily an North American business and really most of our sales and most of our people are in pretty high tax states, mostly California and New York, probably the statutory rate for us would be around 38%, so a 34% rate next year also has some positive tax planning in it and we have a very good tax department. So I presume that we’ll always have some positive tax planning. I would say on an ongoing basis, we should assume a statutory tax rate, probably 34% to 37%. Cash tax rate is slightly below that because of some timing benefits.

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