Constellation Brands (NYSE: STZ) appears undervalued despite shortfall
After a new historic record, Constellation brands, Inc. (NYSE: STZ) has gone a few months without incident on the downside. Still, the company is holding above critical support at US $ 210 despite a slight shortfall today.
In this article, we’ll reflect on those findings and examine the intrinsic value of the business.
- Non-GAAP EPS: US $ 2.38 (US $ 0.41 shortfall)
- GAAP EPS: $ 0.01
- Returned: $ 2.36 billion (vs. $ 70 million)
- Adjusted EPS for fiscal year 2022: US $ 10.15-10.45 vs US $ 10.14 consensus
While the summer’s decline is partly attributed to disappointing seltzer growth, Credit Suisse recently rated Constellation Brands as one of the top stock picks for the fourth quarter. The bank cited high profit margins on beer and a rise in the wine sector.
Meanwhile, the company declared a quarterly dividend of US $ 0.76 per share, yielding a forward yield of 1.43%. The dividend is payable on November 19, the ex-date being set for November 4.
Looking back, the first annual payment went from $ 1.2 in 2015 to $ 3 in 2020. This works out to a compound annual growth rate (CAGR) of around 16% per year over that time period. In addition, the company has been rather conservative with a payout ratio, keeping it modest at 46%.
However, the growth in earnings per share has been less than satisfactory at 2.9% per year over the past 5 years, which is less impressive.
Check out our latest review for Constellation brands
Estimation of intrinsic value
We would like to warn that there are many ways to assess a business and, like DCF, each technique has advantages and disadvantages in specific scenarios. Anyone who wants to learn a little more about intrinsic value should read the Simply Wall St.
This approach uses a two-stage DCF model, which considers two growth stages as the name suggests.
The first stage is usually a period of higher growth which stabilizes towards the terminal value, captured in the second period of “steady growth”.
First, we need to estimate the cash flow of the business over the next ten years. Where possible, we use analyst estimates, but when these are not available, we extrapolate the previous free cash flow (FCF) from the last estimate or stated value.
We assume that companies with decreasing free cash flow will slow their rate of contraction, and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect the fact that growth tends to slow down more in the early years than in subsequent years.
A DCF is all about the idea that a dollar in the future is worth less than a dollar today, we therefore need to discount the sum of these future cash flows to arrive at an estimate of the present value:
10-year Free Cash Flow (FCF) estimate
|Leverage FCF ($, Millions)||US $ 1.54 billion||1.87 billion US dollars||2.12 billion US dollars||US $ 2.28 billion||2.61 billion US dollars||2.82 billion US dollars||US $ 3.00 billion||3.15 billion US dollars||US $ 3.28 billion||3.39 billion US dollars|
|Source of growth rate estimate||Analyst x6||Analyst x6||Analyst x6||Analyst x2||Analyst x2||Est @ 8.08%||Est @ 6.24%||Est @ 4.96%||Is 4.06%||East @ 3.43%|
|Present value (in millions of dollars) discounted at 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|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = US $ 19 billion
After calculating the present value of future cash flows over the initial 10 year period, we need to calculate the terminal value, which takes into account all future cash flows beyond the first step.
For a number of reasons, a very conservative growth rate is used which cannot exceed that of a country’s GDP growth. In this case, we used the 5-year average of the 10-year government bond yield (2.0%) to estimate future growth.
Similar to the 10-year “growth” period, we discount future cash flows to their present 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)ten= US $ 92 billion ÷ (1 + 5.7%)ten= US $ 53 billion
The total value is the sum of the cash flows for the next ten years plus the present terminal value, which gives the total value of equity, which in this case is US $ 72 billion. The last step is then to divide the equity value by the number of shares outstanding.
Compared to the current share price of US $ 213, the company seems relatively undervalued with a 43% discount from the current share price. The assumptions in any calculation have a significant impact on the valuation, so it’s best to think of this as a rough estimate, not precise down to the last penny.
The above calculation is very dependent on two assumptions. One is the discount rate, and the other is the cash flow. The DCF also does not take into account the possible cyclicality of an industry or the future capital needs of a company, so it does not give a full picture of its potential performance.
Because we view Constellation Brands as potential shareholders, cost of equity is used as the discount rate rather than cost of capital (or weighted average cost of capital, WACC), which takes debt into account.
We used 5.7% in this calculation, which is based on a leveraged beta of 0.856. Beta is a measure of the volatility of a stock relative to the market as a whole. We get our average beta from the industry beta of comparable companies globally, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.
Although our model shows that Constellation brands could indeed be undervalued, just as institutions say, DCF models are not the alpha and omega of investment valuation.
Preferably, you would apply different cases and assumptions and see their impact on the valuation of the business. If a business grows at a different rate, or if its cost of equity or risk-free rate changes sharply, output can be very different.
For the Constellation brands, we have put together three essential aspects you should consider:
- Risks: To do this, you need to know the 3 warning signs we spotted with Constellation Brands.
- Future benefits: How does STZ’s growth rate compare to that of its peers and the market in general? Dig deeper into the analyst consensus count for years to come by interacting with our free analyst growth expectations chart.
- Other strong companies: 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 trading fundamentals to see if there are other companies you might not have considered!
PS. Simply Wall St updates its DCF calculation for every US 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 positions in any of the companies mentioned. This article is general in nature. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative material.
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