Constellation cut rates with bond deal, aims at leverage of 3x to 4x

By Paul Deckelman

New York, April 9 – Constellation Brands, Inc. saw its overall and net debt levels rise in its just recently concluded 2015 fiscal year from year-earlier levels.

But the giant Victor, N.Y.-based beer, wine and liquor producer, importer and distributor lowered its average cost of debt, particularly with a big junk bond deal late last year, and extended its maturities, getting rid of most of its short-term current-portion debt as part of that transaction.

With its continued robust operating results in the wake of a big beer transaction the company did in 2013 – Constellation acquired the valuable U.S. rights to the hugely popular Mexican beer brands Corona Extra and Modelo Especial plus a state-of-the-art Mexican brewery for producing the suds – the company has been deleveraging as its EBITDA measures and cash have risen faster than its debt load.

It closed out the 2015 fiscal fourth quarter and full year ended Feb. 28 with a leverage ratio of net debt as a multiple of comparable-basis EBITDA of 4.1 times.

While that was still well up from the svelte 3.2 times leverage level the company had boasted in early 2013, before it took on massive debt to fund the complex $4.75 billion two-part Mexican beer transaction, it was still down from levels above 5.0 times to which the leverage measure had subsequently risen as a result of the borrowings from that super-sized acquisition.

Poised to hit target range

During a Thursday conference call following the release of the quarterly and full-year results, Constellation’s executive vice president and chief financial officer, Robert P. “Bob” Ryder, told analysts that “our strong projected earnings and operating cash flow growth have us positioned to meet our targeted 3.0-to-4.0 times leverage range during fiscal ’16” – even after considering an anticipated ramp-up in capital spending this year and even with Constellation’s board having just declared the company’s first-ever stock dividend for its equity investors.

Constellation plans to boost capex for its beer division this year to between $950 million and $1.05 billion from around $600 million in fiscal 2015 as it continues to expand the Nava, Mexico brewery it bought in the 2013 transaction and also builds up production capacity at an adjacent beer-bottle manufacturing plant that it bought last year from industry peer Anheuser-Busch InBev SA/NV, which it will be running in a joint venture with Perrysburg, Ohio-based glass container manufacturer Owens-Illinois Inc.

Constellation’s board meanwhile on Thursday declared a 31 cent per share dividend on its class A common stock and a 28 cent per share dividend on its class B common stock, payable on May 22 to shareholders of record as of the close of business on May 8. Ryder said the company anticipates spending about $240 million on the dividend, initially targeting a dividend payout ratio of 25% to 30% of the company’s comparable-basis net income.

The CFO said that even with these two huge allocations of the company’s capital during the current fiscal year, “operating within our targeted leverage range, combined with our strong free cash flow-generating abilities provides us significant financial flexibility. Going forward, as our big capex spend normalizes,” – beer-segment capex should come down to a range of $250 million to $500 million over fiscal 2017 and fiscal 2018 – “this provides us the ability to evaluate opportunities to increase our dividend and resume our share buyback program.”

Cash to shareholders priority

During the question-and-answer portion of the conference call that followed the formal presentations by Ryder and by Constellation’s president and chief executive officer, Robert S. “Rob” Sands II, several analysts wanted to know – with leverage having come down to around the 4.0 times mark from over 5.0 times in the aftermath of the Mexican beer deal – whether the company has any plans to use its new cash-flow muscle to either raise the dividend further or else to buy back shares.

One analyst, noting that after this fiscal year capex is scheduled to ratchet down while cash flow is anticipated to continue to grow, actually asked whether Constellation has any plans for “levering up the balance sheet to either buy back stock in a more aggressive manner versus your free cash flow generation or paying the dividend?”

Ryder called such a situation “a good problem to have.”

He answered that “depending on what’s going on in the marketplace, my guess is we will probably increase the dividend, at least with how comparable the income increases.” He also said that “I would probably anticipate that we invigorate our stock buyback program. We still have about $700 million authorized by the board.”

Besides a combination of the two means of returning cash to shareholders, the CFO also suggested that opportunities for “various tuck-in acquisitions in the beverage alcohol category might also come up.”

Ryder said that “as you look at the numbers, the free cash flow generation – when we get past this real high tranche of [fiscal 2016] capital spending – is really significant for our business. So we have a lot of flexibility on how to reinvest that cash, and I would presume that a reasonable amount of it would go back to shareholders.”

There was no specific mention of any plans for deploying cash for debt reduction.

Another analyst asked where in the targeted leverage range of 3.0 to 4.0 times the company might want to end up.

Ryder said that within that context, “we’re trying to balance a lot of constituencies. Obviously, the ratings agencies would like us to be very low in that range, and probably shareholders would like us to be high in that range because they presume that what we would do is borrow money and give cash back to shareholders. We’re taking both into account. So the ideal is probably in between 3.0 and 4.0.”

Bonds improve capital structure

As of the end of fiscal 2015, Constellation had $7.30 billion of total debt on its balance sheet, up from $6.96 billion at the end of fiscal 2014. Some $7.14 billion of its debt was considered to be long term less current portion, versus $158 million of current-portion debt due within one year. That was in contrast to a year earlier, when it had $6.37 billion of long-term debt but $590 million of current-portion obligations.

With $110 million of balance sheet cash at the end of fiscal 2015, nearly double the $63 million of a year earlier, net debt was $7.19 billion, up from $6.90 billion a year earlier.

Constellation’s major foray into the capital markets in 2014 – which bulked up its overall debt and net debt loads but also cut its average cost of capital and got rid of most of its short-term debt – came in the fall, when the company sold $800 million of new junk bonds. They priced in a two-part, quick-to-market transaction on Oct. 20 – $400 million of 3 7/8% senior notes due 2019 and $400 million of 4¾% notes due 2024. Both tranches priced at par.

“We reduced our overall average interest rate by securing attractive long-term financing,” Ryder said, noting that part of the proceeds from the bond sale was used to redeem the company’s $500 million of 8 3/8% senior notes upon their maturity in December. The remaining proceeds from October’s bond deal helped fund the acquisition of the Mexican beer-bottle plant and related infrastructure.

Interest expense for the year was $338 million, which Ryder said was up 4% versus a year earlier. The increase was primarily due to higher average borrowings, which were partially offset by lower average interest rates. Interest expense for fiscal 2016 is expected to be in the range of $325 million to $335 million.

Free cash flow is expected to be in the range of $100 million to $200 million.

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