STZ: In-line quarter but quality weaker; FCF guidance disappointing

What's changed - FY4Q09 of $0.21 was 1c below our estimate

Constellation Brands reported February 4Q2009 EPS of $0.21, a penny shy of our forecast, but in line with the range preannounced a couple of weeks ago. The quality was weaker than our forecast, with a $0.03 EPS miss on the EBIT line with offset from taxes and interest expense. Management essentially reiterated EPS guidance for FY2010 of $1.60-$1.70, and gave formal free cash guidance of $230-$270 mn.

Implications - Lowering FY2010 EPS by 2c to $1.62

We see the update as a modest negative despite the recent preannouncement. On the fundamental side, divisional trends were on balance worse than we expected. Wine margins collapsed 190 bp in the quarter despite the benefit from margin accretive net acquisitions. The margin behavior in the period puts risk around the improved margin and returns story of the business. Beer sales also disappointed, declining 6% in the period and turning in a roughly flat performance for the full year. We remain concerned about revenue prospects across the year given consumer weakness, competitive pressure from the FEMSA portfolio, and Crown's limited pricing power. With respect to cash flow, next-year guidance of $230-$270 mn is disappointing. Over the past ten years including 2010E, STZ's free cash conversion ratio has been 75%-80% on average, which raises concerns about earnings quality. We are lowering 2010E EPS by $0.02 to $1.62, largely due to the quarterly miss. We are also lowering our long-term profit assumption to a mid-single digit sustainable EBIT growth rate, which should drive EPS of $1.81 in 2011, $1.99 in 2012, and $2.19 in 2013 versus our $1.86, $2.08, and $2.32 prior forecasts.

Valuation
We are lowering our 12-month P/E- and DCF-based price target by $1 to $13 to reflect a 7X forward P/E multiple and 13% FCF yield.

Key risks

• Wine demand weakness
• down-trading
• restructuring mis-steps.