After a new all-time high, Constellation Brands, Inc. (NYSE: STZ) spent an uneventful few months drifting downwards. Yet, the company is keeping above the critical support at US$210 despite a slight miss on the earnings today.
In this article, we'll reflect on those results and take a look at the company's intrinsic value.
- Non-GAAP EPS: US$2.38 (miss by US$0.41)
- GAAP EPS: US$0.01
- Revenue: US$2.36b (beat by US$70m)
- FY2022 adjusted EPS: US$10.15-10.45 vs. US$10.14 consensus
Although the summer decline is partially attributed to the underwhelming seltzer growth, Credit Suisse recently noted Constellation Brands as one of the leading stock picks for Q4. The bank quoted high beer profit margins and an upside in the wine business.
Meanwhile, the company declared a quarterly dividend at US$0.76 per share, giving a forward yield of 1.43%. The dividend is payable on November 19, with the ex-dividend date set for November 4.
Looking back, the first annual payment has grown from US$1.2 in 2015 to US$3 in 2020. This works out to be a compound annual growth rate (CAGR) of approximately 16% a year over that time. Furthermore, the company has been rather conservative with a payout ratio, keeping it modest at 46%.
However, earnings per share growth have been less satisfying at 2.9% per annum over the last 5 years, which is less impressive.
Estimating the Intrinsic Value
We would caution that there are many ways of valuing a company, and, like the DCF, each technique has advantages and disadvantages in specific scenarios. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.
This approach uses a two-stage DCF model, which considers two stages of growth as the name states.
The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second "steady growth" period.
In the first stage, we need to estimate the cash flows to the business over the next ten years. Where possible, we use analyst estimates, but when these aren't available, we extrapolate the previous free cash flow (FCF) from the last estimate or reported value.
We assume companies with shrinking free cash flow will slow their rate of shrinkage and that companies with growing free cash flow will see their growth rate slow over this period. We do this to reflect that growth tends to slow more in the early years than in later years.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we need to discount the sum of these future cash flows to arrive at a present value estimate:
10-year free cash flow (FCF) estimate
|Levered FCF ($, Millions)||US$1.54b||US$1.87b||US$2.12b||US$2.28b||US$2.61b||US$2.82b||US$3.00b||US$3.15b||US$3.28b||US$3.39b|
|Growth Rate Estimate Source||Analyst x6||Analyst x6||Analyst x6||Analyst x2||Analyst x2||Est @ 8.08%||Est @ 6.24%||Est @ 4.96%||Est @ 4.06%||Est @ 3.43%|
|Present Value ($, Millions) Discounted @ 5.7%||US$1.5k||US$1.7k||US$1.8k||US$1.8k||US$2.0k||US$2.0k||US$2.0k||US$2.0k||US$2.0k||US$1.9k|
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$19b
After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond the first stage.
For a number of reasons, a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case, we have used the 5-year average of the 10-year government bond yield (2.0%) to estimate future growth.
In the same way, as with the 10-year "growth" period, we discount future cash flows to today's value, using a cost of equity of 5.7%.
Terminal Value (TV)= FCF2031 × (1 + g) ÷ (r - g) = US$3.4b× (1 + 2.0%) ÷ (5.7% - 2.0%) = US$92b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$92b÷ ( 1 + 5.7%)10= US$53b
The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is US$72b. The last step is to then divide the equity value by the number of shares outstanding.
Compared to the current share price of US$213, the company appears relatively undervalued at a 43% discount to where the stock price trades currently. The assumptions in any calculation significantly impact the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.
The calculation above is very dependent on two assumptions. The first is the discount rate, and the other is the cash flows. The DCF also does not consider the possible cyclicality of an industry or a company's future capital requirements, so it does not give a complete picture of its potential performance.
Given that we are looking at Constellation Brands as potential shareholders, the cost of equity is used as the discount rate rather than the cost of capital (or the weighted average cost of capital, WACC), which accounts for debt.
We've used 5.7% in this calculation, which is based on a levered beta of 0.856. Beta is a measure of a stock's volatility compared to the market as a whole. We get our beta from the industry average beta of globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.
Although our model shows that Constellation Brands might indeed be undervalued, just like the institutions are saying, DCF models are not the be-all and end-all of investment valuation.
Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. If a company grows at a different rate, or if its cost of equity or risk-free rate changes sharply, the output can look very different.
For Constellation Brands, we've put together three essential aspects you should consider:
- Risks: To that end, you should be aware of the 3 warning signs we've spotted with Constellation Brands.
- Future Earnings: How does STZ's growth rate compare to its peers and the broader market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
- Other Solid Businesses: Low debt, high returns on equity, and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!
PS. Simply Wall St updates its DCF calculation for every American stock every day, so if you want to find the intrinsic value of any other stock, search here.
Simply Wall St analyst Stjepan Kalinic and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.