Constellation Brands' Expectations Are Too Low

Morgan Stanley continues to like Constellation Brands, Inc. (NYSE: STZ) as its top pick in beverages, as it believes the market is not appropriately discounting the company's strong long-term growth prospects in the beer market.

Analyst Dara Mohsenian expects beer revenue upside versus consensus, as Constellation's retail takeaway momentum continues, in addition to expecting upside from the recent Ballast Point acquisition in beer.

Furthermore, the analyst sees wine upside, as Constellation's heritage wine trends are rebounding with its focus on its higher margin focus brands, and should be augmented by the high growth Meiomi acquisition.

"We also expect beer margin expansion above STZ guidance as Nava brewery production ramps up, although we are probably more in-line with consensus and market expectations here," Mohsenian said in a client note.

Not Without Risk

However, the analyst also highlighted two short-term sentiment risk factors in Constellation's stock:

First, the midpoint of Constellation's initial full-year guidance range with fourth quarter EPS due to be reported in early April, to be below consensus, given the issue's typical conservatism, which is accentuated by lower than typical visibility this upcoming year on beer margins as Nava brewery production ramps up.

"This could impact near-term sentiment when STZ reports Q4 EPS, but given we expect STZ will actually post upside versus consensus in FY17 and guidance to be overly conservative, this is more of a short-term sentiment issue," the analyst said.

In early January, Constellation guided full year comparable EPS of $5.30–$5.40. For fiscal 2016, the beer business is expected to generate net sales growth of approximately 12–14 percent and operating income growth in the 22–24 percent range before any benefit from the Ballast Point acquisition.

For the wine and spirits business, the company continues to expect net sales and operating income growth to be in the low to mid-single-digit range excluding any benefit from the Meiomi acquisition.

The second near-term risk to the stock is that Constellation's beer business is highly likely to slow over the next few quarters in both reported results and scanner data as it laps much more difficult comparisons. This is a non-issue longer term in the analyst's mind, as it is merely comparison driven, but may hurt near-term sentiment.

"To be clear, we still like STZ's stock today and would be buyers, but did want to highlight that investors should be aware of these two near-term sentiment risk factors," Mohsenian added.

Valuation Remains Attractive

The analyst said Constellation's valuation remains attractive. The stock trades at a CY17 estimated EV/EBITDA discount to beverage peers such as The Coca-Cola Co (NYSE: KO), PepsiCo, Inc. (NYSE: PEP) and Dr Pepper Snapple Group Inc. (NYSE: DPS).

"We believe STZ deserves to trade at a greater valuation premium to the group given much higher topline growth, along with company specific margin levers, which drive LTEPS growth at nearly 2x the rate of peers," said Mohsenian who has an Overweight rating on the stock, with a target price of $173.

Shares of Constellation were up 24 percent in the last one year, while the broader S&P 500 index is down 7 percent in the same period.