Constellation Brands, Inc.

Greetings and welcome to Constellation Brand's third quarter full year 2023 earnings conference call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mr. Joseph Suarez. Thank you. You may begin.

Thank you, Rob. Good morning, all, and happy new year. Welcome to Constellation Brands' third quarter fiscal 2023 conference call. I'm here this morning with our CEO, Bill Newlands, and our CFO, Garth Henderson. As a reminder, reconciliations between the most directly comparable GAAP measures and any non-GAAP financial measures discussed on this call are included in our news release or otherwise available on the company's website at www.cbrands.com. Please refer to the news release and Constellation's SEC filings for risk factors, which may impact forward-looking statements made on this call. Before turning the call over to Bill, in line with prior orders, I'd like to ask that we limit everyone to one question per person, which will help us to end our call on time. Thank you, Ben, and now here's Bill.

Thank you, Joe, and good morning, everyone. Happy New Year to everyone, and welcome to our fiscal third quarter call. Since our last call in October, Constellation Brands reached a notable milestone in its history as a public company. As most of you know, in November, our shareholders approved the elimination of our Class B common stock. With that came the transition of our company to a single class of publicly listed stock, our Class A common stock, which provides our shareholders with equal one share, one vote rights. I want to thank everyone. who supported this support and enhancement to our company's corporate governance profile and capital structure. We believe that our leadership team now has an even stronger foundation to continue to build shareholder value through the strategic initiatives we adopted and have steadily advanced over the past nearly four years since I assumed the role of CEO. Since fiscal 2020, we agreed to focus on and put in place plans to, number one, continue to build powerful brands that people love. Number two, develop consumer-led innovations aligned with emerging trends and consistently shape our portfolio for growth. Number three, deploy capital in line with disciplined and balanced priorities. And number four, operate in a way that is good for business and good for the world. I'm pleased to say that we continue to build on a strong track record we have established quarter of leading share gains across the entire U.S. beer category and IRI channels that was primarily driven by our two largest brands, Modelo Especial and Corona Extra. In the third quarter, Modelo Especial maintained its position as the top share gainer and as the number one high-end beer brand, and Corona Extra was the third largest share gainer and the number three high-end beer brand. our beer business delivered 3.5 points of share gains and 54% in dollar sales growth when comparing the 52-week period that ended with our latest fiscal third quarter against the 52-week period that ended with our fiscal 2019. And comparing the same periods, the business contributed the highest dollar sales growth in the category, amounting to over $2.5 billion. In our wine and spirits business, our largest higher-end brands, Naomi, Kim Crawford, The Prisoner, and High West, all delivered dollar sales growth and share gains in the third quarter. And comparing the 52-week period that ended our latest fiscal third quarter against the 52-week period that ended our fiscal 2019, these brands achieved 72% dollar sales growth. Moving on to number two. consumer-led innovation and shaping our portfolio for growth. Many of you may be surprised to know that in our beer portfolio, our SKUs introduced over the past three years have driven 20% of the growth delivered by the business since the start of fiscal 2020. An important part of this growth has come from our Modelo Gelato brands, which have evolved from a niche business to a sizable platform. In fiscal 2023 year to date, it has delivered 13.6 million cases of depletions, which already exceeds the brand's total depletions for all of last fiscal year. And in the third quarter, Modelo Chilada Limani Sal moved up nine spots to become the sixth largest share-gaining brand in IRI track channels. Beyond the Chilada brands, we continue to build on the opportunities within the Modelo family, with a clear focus on maintaining brand essence. We're excited about the national launch of Modelo Oro in March, which has surpassed internal and external benchmarks in test markets. In our wine and spirits business, innovation has also yielded strong results, increasing its contribution to net sales from 1% in fiscal 2020 to approximately 8% in fiscal 23 year to date. This expansion has been primarily driven by extending our largest higher end brand. Once again, Naomi Kim, The Prisoner and High West. Notably, extensions in the Prisoner brand family, Blindfold, Saldo, and Unshackled have contributed significant growth, especially Unshackled, which has grown to be half the size of the Prisoner brand in just four years. In addition, since the beginning of fiscal 2020, We have added five brands to our acquisitions, Langlois Bronco Wines, My Favorite Neighbor, Empathy Wines, Copper and Kings, and Austin Cocktails, all of which are in the higher-end segments of the wine and spirits categories that are contributing growth. And we divested 36 brands, the vast majority of which were in the mainstream segment, which has mainly been in decline due to consumer-led premiumization trends. Given this reshaping of our portfolio, including the recent additional divestiture, 62% of net sales in fiscal 23 year-to-date were from our higher-end brands. This is a dramatic shift from the 34% higher-end brands represented at the end of fiscal 19. Now turning to number three, capital allocation. In fiscal 2020, we introduced a thoughtfully structured approach designed to consistently deploy capital with discipline and balance. We made maintaining our investment-grade credit rating our top capital allocation priority and reduced our net leverage ratio, excluding canopy equity and earnings, from 4.5 times at the end of fiscal 19 to three times by the end of the second quarter of this fiscal year. This was partly driven by a $3.2 billion reduction in our debt levels and partly by strong earnings growth in our beer business. And in the third quarter, these efforts gave us the flexibility to both accommodate the $1.5 billion financing for the elimination of our Class B shares and to maintain our investment grade rating. As our net leverage ratio remained in line with our prior 3.5 times target, our ability to previously achieve that target and the continued strong cash flow generation capabilities of our businesses. Our second priority became delivering cash returns to our shareholders, and we set a goal to return $5 billion in dividends and buybacks between fiscal 2020 and 2023. We virtually completed that goal ahead of schedule in the third quarter, and we're now on track to exceed the $5 billion target fourth quarter dividend payment announced today. As to our third priority, we sought to advance brewing capacity expansions to support the strong growth in our beer business. Since the start of fiscal 2020, we added approximately 9 million hectoliters of capacity through growth investments and another 2 million through brewery optimization and productivity initiatives. We are also on track to further footprint with the development of our new brewery in Veracruz, where we have recently broken ground. And last in our capital allocation priorities was M&A. And since the start of fiscal 20, we have judiciously deployed excess cash through acquisitions with a strict focus on small, gap-filling, higher-end brands. And the key strategic acquisitions we have executed over the last nearly four years are delivering top-line growth. All in, we believe we have unquestionably upheld our capital allocation priorities and have even exceeded some of the associated targets we set out to achieve. Moving on to strategic initiative number four, operating the way that is good for business and good for the world by advancing ESG goals. Our ambitions are to protect the environment and natural resources by serving as a model for water stewardship in our industry while reducing greenhouse gas emissions, to champion the professional development and advancement of women within our company, industry, and communities, to enhance the economic development and prosperity in disadvantaged communities, and to promote responsible beverage alcohol consumption. While we still have much work to do, I am proud to say we are making good progress towards our goals. To that end, in the third quarter, we released our 2022 ESG Impact Report, which included several enhancements on the information shared on these important topics and our work towards our targets, including, for the first time, references aligned to the Sustainability Accounting Standards Board Framework and taking into consideration the recommendations from the Task Force on Climate Related Financial Disclosures. So, as with our capital allocation priorities, we have been consistently working to deliver against our strategic initiatives. We have done, we have said what we do, and we have done what we said. And despite current inflationary pressures and the risk of recessionary headwinds, we remain confident in our ability to continue to advance and create value through these initiatives. And on that note, let's move on to a more fulsome discussion of our performance in the third quarter. Depletion growth for our beer business decelerated to 5%. a recent series of headwinds that developed toward the latter part of the quarter. First, as we shared on our last call, we decided to introduce fall pricing changes above our usual algorithm due to cost pressures across the chain, and historically the impact of these types of notable pricing actions take a few months to settle in. Second, distribution growth is returning to more normalized levels after lapping a softer summer period last year, when we were managing supply constraints. That said, distribution growth remains at exceptionally healthy levels, as well as aligned with our full-year expectations. And third, some of these headwinds were particularly accentuated in a few key regions for our brands, such as California, where we left double-digit depletion growth rates and better weather in November of last year, as well as more favorable economic conditions. All of that said, our bear business continues to perform strongly relative to the wider market and to resonate with consumers who continue to shift to higher-end brands. In IRI channels, we gained 1.5 points across the entire category and 2.3 points in the higher-end segment in the third quarter, which is higher, let me repeat that, which is higher than the share gains in the same quarter last fiscal year. And when looking at depletion, fiscal 23-year-to-date, our beer business achieved growth of 7.8%, which continues to be in line with our annual expectations. Importantly, based on the prior activity we have seen in retail as they adjust to the continued inflationary environment, we expect trends to return to more historical rates over the next few months. Now shifting to the performance of our beer brands. The Delaware Special delivered depletion growth of 4.4% in the third quarter, lapping a tough 13.2% depletion growth comparison in the corresponding period of the last fiscal year. That said, the brand has achieved depletion growth of 9.9% over fiscal 23 year-to-date. In the recent quarter, it continued to strengthen its position in the five states where it is already the number one beer brand in dollar sales. delivering another approximately 0.2 points in share gains. Importantly, in the other 39 states tracked by IRI data, Modelo Especial delivered more than four times the share gains at over 0.8 points. More broadly, Modelo Especial's depletion growth in its secondary markets outpaced the growth in its top five states by over 10 points. As such, we continue to see significant incremental opportunities to maintain the momentum of Adelo Especial, particularly through distribution gains in the states where it is underrepresented. Corona Extra delivered depletion growth of 1.3% in the third quarter and 4% in fiscal 23 year-to-date. As noted earlier, the brand has maintained its momentum as the number three share gainer in track channels. We continue to invest in the growth of Corona Extra the brand's market, such as the augmented reality addition to our O-Tan and Palm campaign, which is one of the more enduring holiday-themed commercials running for over 30 years now. And we continue to see growth potential for Corona Extra with younger legal drinking age and multicultural consumers. Pacific O's depletion growth accelerated in the third quarter to 40.7%, and over fiscal 23 year-to-date, its depletion growth was 32.9%. The brand remains a top 10 share gainer in track channels in the third quarter, mainly supported by its growing footprint in states like California, Nevada, Utah, Colorado, and Arizona. We continue to see fantastic growth runway for Pacifico as one of our new wave brands. with significant distribution potential relative to Modelo and even more so relative to Verona Extra, particularly as the brand also continues to build momentum by shifting east in the U.S., building on the 26% depletion growth delivered in our eastern business unit in the third quarter. Lastly, our Modelo Gelato brands achieved depletion growth of 44% in the third quarter, and a 48% over fiscal 23 year-to-date. Our Modelo Chilada brands remain the number one set in the Chilada space, and the brands gain nearly half a sharepoint across all U.S. beer and track channels. For perspective, that is as much as Corona Extra's gain. In fact, these gains were largely driven by innovations launched this fiscal year, including Naraha Pocosa flavor, the Limani Cell 12-ounce 12-pack, which is a top 10 new package SKU, and our new variety pack, which is among the top 15 new brands. We continue to expect significant growth from the Modelo gelato brands as we invest in marketing to the general market consumer to broaden the demographic appeal of this product. All in, the strong demand for our brands in the third quarter supported a net sales increase of approximately 8% for our beer business. And despite the impact of inflationary headwinds on operating income, we were able to maintain operating margin at 37.5%. This gives us the confidence to once again raise guidance for our beer business this fiscal year, lifting the low end of our growth outlook. We now expect to achieve 9% to 10% net sales growth and 4% to 5% operating income growth for fiscal 23. Moving on to Wine and Spirits. Our Wine and Spirits business continues to advance its vision to be the high-end market leader. As noted earlier, our largest higher-end brands delivered strong performance. In our Espira portfolio, which includes our fine wine and craft spirits brands, over the third quarter in track channels, the prisoner brands grew dollar sales by 4.3%, while the fine wine segment contracted by 5.7%. And high west grew dollar sales by 22%, while high end spirits segment grew by only 3.4%. And in our premium and mainstream wine and spirits portfolio, Both Naomi and Kim Crawford gained share in the U.S. wine category. Depletions for our wine and spirits business declined by 5.5% in the third quarter, mainly driven by continued headwinds faced across our mainstream brands. However, our Aspera portfolio delivered strong performance with 8.5% depletion growth in the quarter. And in fiscal 23 years to date, our Aspera portfolio has now achieved an overall 6.3% increase in depletions, supported by strong double-digit depletion growth for the prisoner and high west. Among Ignite friends, Naomi and Kim Crawford have also delivered solid depletion growth in fiscal 23 year-to-date, supporting an overall 2.3% increase in depletions for our premium wine portfolio. Our wine and spirits business also continued to expand its global omnichannel footprint, advancing its growth in direct-to-consumer and three-tier e-commerce channels as well as international markets. Wine & Spirits' DTC net sales grew 23% in the third quarter, and we continued to perform particularly well in three-tier e-commerce, which delivered dollar sales growth nine points above the competition. These results were undervalued facility upgrades and talent development, and our own e-commerce website platforms, as well as our continued leadership in three-tier e-commerce through marketing innovations like launching video ads on Instacart and a strategic focus on major omni-channel national accounts, third-party marketplaces, and digitally native retailers like Amazon, where we were the number one overall supplier and number one gross supplier in higher-end wines in the third quarter. International markets accounted for 9% of the total net sales in the wine and spirits business in the third quarter as our strategically focused approach continued to target select metropolitan markets, including London, Tokyo, Seoul, Sydney, Mexico City, Zurich, and Toronto, with some of our most renowned premium and fine wine brands Prisoner and Schrader, as well as more recently acquired brands like Lingua Franca and My Favorite Neighbor. And with our craft spirits portfolio, which includes brands like Casanova and the Campo high-end tequilas that delivered international shipments five times greater than the third quarter of the prior year. We are also pleased that our efforts to establish a leading global higher-end wine and spirits portfolio are gaining recognition with several of our brands receiving remarkable accolades, including Trader Sellers winning its 37th 100-point score and its Double Diamond brand being recognized by the Wine Spectator as its number one wine of 2022. Our Topalon Vineyard was being recognized again as the top vineyard in North America for the fourth consecutive year among top vineyards in the world. And I'm pleased to report that our Tokalon Vineyard has now also been certified as organic, expanding the appeal of its wines to a broader set of consumers and adding to its differentiation. And in our spirits portfolio, our recently launched Nelson Brothers Bourbon Reserve was ranked among whiskey advocates top 10 most exciting whiskeys of 2022. So all in, our wine and spirits business continues to make meaningful progress on its transformation. And while net sales and operating margins net of recent divestiture were slightly lower relative to the third quarter of last fiscal year due to volume shifts from shipment timing only being partially offset by mix of pricing benefits, we did see a significant sequential uplift in operating margins of 55 basis points relative to the second quarter of this fiscal year. This gives us confidence to reaffirm our fiscal 23 guidance for our wine and spirits business of stable to 2% lower net sales and 3% to 5% operating income growth, which we are providing against a fiscal 22 baseline adjusted for the recent divestiture. Looking further ahead, we are also confident that over the medium term, both our beer business and our wine and spirits business remain well-placed to deliver strong growth and best-in-class operating margins. That said, given continued inflationary pressures and the potential impact of recessionary environment, we remain mindful of balancing the momentum of our brands against near-term cost challenges. To that end, based on our current expectations of the pressures that the consumer will continue to face in the near term, we are given even more careful consideration for our pricing actions for fiscal 24. In particular, we currently expect pricing actions for our beer business to be more muted in fiscal 24 as our pricing actions in the current fiscal year were ultimately above our medium term algorithm. While input costs remain at historically elevated prices, we strongly believe that additional consideration in our approach to pricing in fiscal 24 is warranted to sustain healthy growth for our brands. In addition, While some input costs are below the peaks from earlier this fiscal year, we now anticipate inflation to remain above historical trends in the high and single-digit range for fiscal 24. As always, we will continue with our disciplined approach to manage these evolving conditions with cost-saving initiatives, but these persistent inflationary headwinds will be compounding on the double-digit cost uplift we have faced in fiscal 23. As such, we now expect operating margins for our beer business in fiscal 24 to be more in line with our anticipated margin structure for this fiscal year and therefore below our stated 39 to 40 medium term range. We are still refining our outlook for 24 and will provide more detailed guidance at our next earnings call, but we wanted to share some context today now that our annual planning process is underway. With all that said, Let me be clear. Our beer business continues to have best-in-class operating margins, and our wine and spirits business continues to make progress toward achieving that same differentiation. We are also confident that over the medium term, our beer business remains well-positioned to deliver leading operating margins supported by the sustained momentum of our Cormodello Especial and Corona Extra brands, a lot of brands, the incremental upside from our broader existing portfolio, and the continued development of our innovation lineup, particularly from exciting, imminent additions like Delaware. And we continue to expect our wine and spirits business to make progress on its operating margins, supported by continuing to pursue the exciting runway for growth of our higher-end brands and ensuring these brands represent an even greater portion of our mix over time. Enhancing the performance of our mainstream portfolio through a greater focus on brands and initiatives with higher returns, including through relevant and innovative products, and growing on omnichannel and international leadership, particularly as an incremental opportunity for higher end growth. Now, before I conclude, I wish to quickly touch on Canopy. We remain supportive single entity. To that end, our intention continues to be to transition our existing common share ownership interest in Canopy growth into new exchangeable shares once its shareholders approve this transaction. We believe that the conversion of our ownership interest will maintain our ability to realize the potential upside of our investment in Canopy. At the same time, this transaction and the surrender of our warrants are expected to eliminate the impact of to our equity and earnings, mitigate risk to our organization, and further reinforce our intent to not deploy additional investment in Canopy in line with our capital allocation priorities. In closing, I'd like to reiterate three main takeaways today. First, nearly four years ago, we committed to a series of strategic initiatives aimed at delivering profitable growth and shareholder value. And I'm pleased to say that we are delivering against those initiatives, and in many cases, even exceeding the goals we set out to achieve. Second, our third quarter results demonstrate that we continue to execute against these strategic initiatives and that our company remains in a strong position to deliver best-in-class results. Despite the headwinds in the quarter due to macroeconomic pressures and tough comps for the prior year, strong performance of our beer business has put it on track to deliver better than expected results in fiscal 23. And the transformation of our wine and spirits business is also yielding results. And third, we remain confident we will continue to build on our track record of solid growth and value creation through our strategic initiatives. And with that, I turn the call over to Garth.