Welcome to the Constellation Brands Third Quarter 2018 Earnings Conference Call. At this time, all participants have been placed in a listen only mode. Following the prepared remarks, the call will be opened for your questions. Instructions will be given at that time. I will now turn the call over to Pati Jan Urlob, Senior Vice President of Investor Relations.
Please go ahead.
Thank you, Laurie. Good morning, and welcome to our Q3 fiscal 2018 conference call. I'm here this morning with Rob Sands, our President and Chief Executive Officer and David Klein, our Chief Financial Officer. As a reminder, reconciliations between the most directly comparable GAAP measure and any non GAAP financial measures discussed on this call are included in our news release or otherwise available on the company's website at www.cbrands.com. Please refer to the news release and Constellation's SEC filings for risk factors, which may impact forward looking statements we make on this call.
Before turning the call over to Rob, similar to prior quarters, I would like to ask that we limit everyone to 1 question per person, which will help us to end our call on schedule. Thanks in advance. And now here's Rob.
Thank you, Patty, and good morning and Happy New Year. I hope you enjoyed the holidays and had the opportunity to include some of our fine Constellation products in your celebrations with family and friends. As I reflect on 2017, I am reminded that it has been a dynamic time for our business. We posted another year of exceptional stock price performance with Constellation stock increasing almost 50% for the calendar year 2017 versus the S and P 500, which grew about 20% for the year. Overall, Starz Constellation was one of the best performers among the S and P 500 consumer staple stocks.
I believe our excellent stock price performance continues to be driven by our strong financial results and the ongoing growth prospects for our business. The confidence in our future business prospects compelled us to seek Board authorization for a new multiyear $3,000,000,000 share repurchase program subsequent to the recent repurchases of more than 200,000,000 of our outstanding shares. I'm also excited about our recent investment in Canopy Growth Corporation, the largest publicly traded cannabis supplier in the world and a leader in the medical cannabis market in Canada. Founded in 2014 and based in Ontario, Canopy Growth is one of the earliest commercial players in Canada's legal cannabis market and has a global presence via numerous joint ventures and partnerships. Canopy is traded on the Toronto Stock Exchange and currently has a market cap in the $5,000,000,000 range.
This investment provides Constellation with a 1st mover advantage for a potentially significant emerging consumer opportunity and aligns with our long term strategy to identify meat and stay ahead of evolving consumer trends and market dynamics, while maintaining focus on our core total beverage alcohol business. Our plan is to jointly collaborate with Canopy in a number of areas. Initially, we will be learning the cannabis business and the related consumer space and route to market while building and developing a successful cannabis beverage business. Now recreational cannabis is scheduled to become legal in Canada this coming summer with recreational edibles, including beverages expected to become legal in the summer of 2019. We have no current plans to sell cannabis products in the U.
S. Or any other market, and we will not consider doing so until it is legal at all levels of government. Our initial investment of approximately $190,000,000 represents an ownership interest of 9 point 9% of Canopy Growth plus warrants, which give Constellation the option to purchase an additional ownership interest in the future. In a few moments, David will review how we are accounting for this investment. And speaking of growth prospects, we posted another great quarter for our beer business, which generated 80% of the total U.
S. Beer category growth and claimed 4 of the top 10 share gainer positions with Modelo Especial, Corona Extra, Modelo Echilada, Tamarindo Picante and Pacifico. Overall, Constellation's beer business remains the leader in the high end of the U. S. Beer market and was the clear winner for the Labor Day and Thanksgiving holidays with excellent execution that drove share gains led by Corona Extra and Medall Especial.
These brands continued to drive the growth of the portfolio with ongoing distribution and velocity gains. Throughout the quarter, Corona Extra maintained strong media support and became the official imported beer of 4 NFL teams, while also featuring Jon Gruden in football promotions during the season. Corona Extra also increased relevance with Hispanic consumers through its partnerships with Latin Music Superstars Enriqui, Inglesis and Mana. The Modelo Especial Fighting Spirit campaign continued throughout our Q3, including national TV and promotional activities during the NFL schedule. In addition, national Spanish language TV support ran through November, including a strong presence with live soccer program and top rated Spanish language TV networks.
Social media on Facebook and Instagram also supported NFL, Mexican Independence Day and the Dio de los Muertos for this brand. Collectively, these initiatives drove depletion growth of almost 17% for the Modelo Especial family of brands for our Q3. Pacifico continues to make its mark within our portfolio and recently was named Impact Beer Brand of the Year by MarketWatch. In addition, Pacifica has become the fastest growing beer brand among the top 40 beer brands based on 52 week IRI dollar growth of nearly 24%. Our plans for Corona Premier and Corona Familiar continue to evolve as we finalize our launch strategies for next year.
Corona Premier is the 1st national corona line extension in more than 25 years, and we plan to make our largest ever launch investment of more than $35,000,000 to support the effort. This includes a robust media plan with general market and Spanish language TV advertising beginning in April. Additional support will include print, social media and Hispanic targeted advertising as well as on premise sampling and new point of sale materials. Corona Familiara will roll out during the same time frame to major Hispanic markets, a key demographic for this brand. Now turning to the operations side of the beer business.
During the quarter, we continued to make progress as we put the finishing touches on our Nava capacity addition to complete the 27,500,000 hectoliter expansion, while also nearing the finishing line with our 4th glass furnace, both of which are expected to come online in the coming months. Glass furnace 3 is now fully operational and running at peak efficiency levels. The Overground Brewery continues to perform at a very high utilization level, and we remain on track with our brewing and packaging capacity additions, which are expected to be completed before the end of the fiscal year. And construction continues in Mexicali with Brewhouse tank fabrication and installation currently underway. During the quarter, we reached agreement with Owens Illinois to restructure and expand our contracts for glass supply, including our joint venture agreement.
As you know, the joint venture operates a glass production plant in Nava, Mexico and provides bottles exclusively for Constellation's adjacent brewery, which is our lowest cost source of supply for glass. The original joint venture agreement included the expansion of the glass production plant from 1 furnace to 4 furnaces and initial expansion plans have been progressing as scheduled, as I just mentioned. The expanded relationship with OI provides for the addition of a 5th furnace, which is expected to come online by the end of calendar 2019 and will be included in our future capital investment plans. Following the installation of the 5th furnace, the Nava plant will be the largest, most modern glass container facility in the world. In recognition of the value added contributions from both partners, the term of the joint venture agreement has also been extended for an additional 10 years to 2,034.
David will discuss the high level details of this new contract in a few moments. Now turning to the wine and the quarter, hurricanes hit some of our key markets. And shortly thereafter, we were faced with 1 of the worst natural disasters in California state history as we dealt with widespread wildfires in Northern California. Overall, we are fortunate that these events are expected to have only a minor impact in our business both near term and in the future. To put things in perspective, about 80% of the harvest was already completed when the wildfires started and less than 5% of our wine portfolio is Napa or Sonoma appallated.
The constellation has a long history in Napa and Sonoma, and we're committed to helping our neighbors and our communities rebuild by driving consumer engagement and continuing to encourage purchase and consumption of Napa and Sonoma Wines. Please help us support this effort. 3rd quarter wine and spirits depletions were a bit muted following a strong finish to our Q2. Key focused brands drove depletion growth led by double digit trends for Kem, Crawford, Meiomi, Black Box, Ruffino, Robert Mondavi Private Selection and High West Whiskey. Throughout the quarter, our focused investments for some of these brands were visible in the marketplace and drove excellent results, including the first ever national TV advertising campaign for Kim Crawford, which drove accelerating growth trends for this brand during the key holiday selling season.
Now on a year to date basis, the business is expanding margins, generating positive mix, driving innovation and seeing excellent results from acquired brands, including Miami, The Prisoner, Charles Smith and High West. And our innovation efforts are paying off with successes like Cooper and Steep, which has become the number 2 super luxury red blend and Robert Mondavi Private Selection Bourbon Barrel Aged Cabernet and Chardonnay, which together are growing more than 120% in IRI channels. I'm also pleased to report that Constellation Ventures has been busy recently making 2 minority investments, both of which align with our strategy of investing in emerging unique and distinctive brands. The first is The Real McCoy, high end rum aged in American oak bourbon barrels. This line of 3, 5 12 year aged rum is produced by Richard Steele, a legendary 4th generation master distiller and made at Foursquare Distillery in Barbados.
This product has a premium price point of the $20 to $50 range and uses an authentic farm to glass production process using high quality blackstrap molasses with no added sugars, flavors or aromas. The second is Cooper and Kings, a high end American craft brandy founded in 2014 in Louisville, Kentucky. These brandies are naturally distilled in copper pot stills and the liquid is matured in Kentucky, bourbon barrels and retails for $35 a bottle. While the U. S.
Wine industry remains healthy overall with trends that continue to exceed U. S. CPG category growth, we have seen a bit of a slowdown in the market growth rate versus what we anticipated when we set our original guidance estimates earlier this year. In addition, our SKU rationalization efforts are creating a headwind as we continue to carefully rationalize our portfolio of tail brands. Despite these challenges, we are targeting wine and spirits net sales and EBIT growth for fiscal 2018 at the low end of our previous stated guidance ranges of 4% to 6% and 5% to 7%, respectively.
Before I call the turn over to David, I'd like to take a moment to address the topic of tax reform. As a U. S.-based beverage alcohol company, Constellation has been supportive of tax reform that allows U. S. Companies to remain competitive globally.
While we continue to review the legislation, we are very pleased with the outcome of this historic legislation and believe that it will be very positive for us going forward. David will provide additional details in a few minutes. In closing, it is certainly shaping up to be yet another eventful year at Constellation with the fiscal year quickly drawing to a close. I am very pleased with our progress to date. We established a 1st mover advantage in an emerging consumer category with our Canopy Growth investment, and we continue to make smart investments, including the planned addition of a 5th furnace at our glass plant in Nava.
We continue to build shareholder value through ongoing share repurchases and stock appreciation driven by our strong results and future business prospects. And I am pleased with the outcome of tax reform legislation. We look forward to leveraging the opportunities that this will bring for our business and continue to thrive. With that, I'd now like to turn the call over to David, who will review our financial results
for the Q3. Thanks, Rob, and good morning, everyone. I'm pleased to be here with you today to discuss another quarter of strong execution. On a year to date basis, we've grown market share, expanded margins and improved our capital structure while investing in growth initiatives that will benefit us as we go forward. Our fiscal 2018 year to date comparable basis diluted EPS is up 29% versus last year.
Q3 comparable basis diluted EPS increased 2%. The low Q3 EPS growth rate was primarily due to timing as we're increasing our full year comparable basis diluted EPS guidance to a range of $8.40 to $8.50 from $8.25 to $8.40 This improvement is primarily due to anticipated favorability in our full year tax rate and better margin performance in our beer business, which I'll talk about in a moment. We now expect our fiscal 2018 comparable effective tax rate to approximate 20% versus our previous 21% guidance. Our EPS and tax rate guidance excludes any impacts from recently enacted tax reform. Before I move further into our results, let me provide some comments on the new tax legislation.
First of all, we're pleased with the bill that was enacted and want to thank our friends in Congress for their work to reform the corporate tax code. Like most companies, we're in the process of evaluating the specific impacts of tax reform, but it is clearly favorable to our previous low to mid-20s long term effective tax rate guidance. For fiscal 2018, we expect the benefit in our U. S. Federal statutory tax rate.
The new 21% corporate tax rate will apply for the last 2 months of our fiscal year, resulting in a lower blended statutory tax rate versus the historical 35% rate. We expect the new tax legislation, including the impact of the tax rate deduction or reduction and the transition to a territorial system of taxation, will result in a reduction in our existing net deferred tax liabilities by $300,000,000 to $400,000,000 This onetime noncash benefit will be reported in our Q4 fiscal 2018 results and will be excluded from our comparable basis financial results. We expect to provide an update to our long term effective tax rate guidance as part of our upcoming investor presentation at the CAGNY conference in late February. Now let's take a closer look at Q3 performance and our full year outlook, where I'll generally focus on comparable basis financial results. For beer, we continue to see strong operational performance and robust marketplace momentum.
Depletion growth came in at 9 percent as we won the Labor Day and Thanksgiving holidays. This result was in line with our depletion growth performance year to date and our high single digit depletion growth target for fiscal 2018. Net sales increased 8% on volume growth of 6%. Depletion growth ran ahead of shipment growth, primarily due to timing. Year to date shipments grew more than 8%, putting us on track to meet our net sales target for fiscal 2018 as we continue to expect net sales growth to be in the 9% to 11% range.
This includes 1% to 2% of pricing benefit in our Mexican beer portfolio. Beer operating margin increased 2 90 basis points to 37.7 percent, primarily due to lower COGS and favorable pricing. The lower COGS reflect operational driven by glass and material sourcing along with foreign currency favorability. These benefits were partially offset by a $12,000,000 increase in depreciation expense, which totaled $42,000,000 for Q3. We now expect beer operating margin beer operating income growth to be in the range of 18% to 19%.
Although we're increasing our guidance to the upper end of our previous range, our Q4 operating margin is expected to moderate primarily due to lower seasonal production volume combined with the continued ramp up in depreciation, line commissioning costs and headcount additions. In addition, SG and A leverage is expected to be impacted by the seasonality of the business. For Wine and Spirits, organic net sales were flat due primarily to mix benefits being mostly offset by lower volumes. Operating margin decreased 110 basis points to 26.2% as mix benefits from portfolio premiumization efforts were more than offset by higher COGS and marketing investments. The higher COGS primarily reflect higher operational costs, including increased transportation supplier cost reimbursement in Q3 last year.
We expect to realize benefits from the increased marketing spend on brands like Kim Crawford, Ruffino and Charles Smith over the next several quarters. For the year to date period, organic net sales are up 1% and operating margin has expanded 170 basis points. Excluding the impact of the Canadian wine business divestiture, net sales are up 4% and operating income grew 5% for the 1st 9 months of fiscal 2018. For fiscal 2018, when excluding Canadian Wine Business divestiture, we expect net sales and operating income growth rates to be at the low end of our targeted 4% to 6% and 5% to 7% ranges, respectively, for the reasons Rob mentioned. As a reminder, as part of our premiumization efforts, we've been rationalizing lower margin value brand SKUs.
These actions are expected to impact Wine and Spirits revenue growth by almost 100 basis points for fiscal 2018 while improving operating margin and ROIC. Interest expense increased 5% primarily due to higher average debt balances. We also continue to benefit from our investment grade status. In October, to improve short term borrowing costs, we implemented a commercial paper program, which provides for the issuance of up to $1,000,000,000 of commercial paper. In November, we issued $2,000,000,000 of senior notes at attractive fixed rates and used the proceeds to repay amounts outstanding under our variable rate European Term A loan facility.
Our net debt to comparable basis EBITDA leverage ratio moved down to 3.4x at the end of November from 3.7x at the end of fiscal 2017, while we invested in our Mexican operations, our portfolio and Canopy Growth and returned cash to shareholders with $301,000,000 worth of dividends paid and $239,000,000 of stock repurchases during the first 9 months of the year. The stock repurchases represent a little over 1,100,000 shares at an average price of $2.13 with most of this activity occurring during the Q3. At the end of Q3, there was $308,000,000 remaining on our existing share authorization. As Rob mentioned, we're pleased that our Board of Directors authorized an additional $3,000,000,000 for share repurchases, which we expect to utilize over the next several years. Our significant capital allocation flexibility allows us to continue to invest in our business and return cash to shareholders, while remaining committed to our 3.5x leverage target.
Our comparable basis effective tax rate came in at 18.9% versus 16.4% last year. This increase reflects the overlap from recording the year to date impact of our election of indefinitely reinvested foreign earnings under APB 23 in the Q3 of fiscal 2017, partially offset by the fiscal 2018 adoption of ASU 20 sixteen-nine, which requires excess tax benefits from stock based payment award activity to be recognized in the income statement. We now expect the fiscal 2018 effective tax rate to approximate 20% versus our previous guidance of 21%. The lower projected rate is primarily due to an increased benefit from lower taxes on foreign earnings. As noted earlier, our updated guidance doesn't include any impact from tax reform.
I'd also like to note for fiscal 2018, we continue to expect weighted average diluted shares outstanding to approximate 201,000,000 shares and net income attributable to non controlling interest to approximate $10,000,000 to $15,000,000 As mentioned earlier, we're now projecting our full year comparable basis diluted EPS to be in the range of $8.40 to $8.50 dollars The midpoint of this guidance has us targeting 25% year over year growth. Our comparable basis guidance excludes comparable adjustments, which are detailed in the release. I'd like to highlight 2 significant comparable adjustments that occurred in Q3. The first is a $217,000,000 pretax gain from the change in fair value of the Canopy investment and Canopy warrants. This gain is primarily based upon CAD18.43 share price for Canopy at the end of our 3rd quarter as compared to a CAD 12.98 share price at the time of our initial investment.
The Canopy share price has moved significantly higher since the end of the third quarter as well. Going forward on a quarterly basis, we will continue to record a comparable adjustment for the change in fair value of this investment in warrants and update reported EPS guidance accordingly. Our current reported guidance assumes that the Canopy share price at the end of our 4th quarter will equal the share price at the end of our 3rd quarter. The second is related to glass sourcing initiative highlighted by Ron, where we reached an agreement with Owens Illinois to restructure supply contracts and expand our joint venture agreements for the operation of the Nava Glass plant by 10 years to 2,034. The expanded relationship provides for a 5th furnace to be added at an estimated cost of $140,000,000 This will be financed by equal contributions from both partners and will be included in Constellation's future capital investment plans.
The 5th furnace is targeted to come online at the end of calendar 2019. During Q3, we reported a $59,000,000 pretax charge associated with the restructuring of our agreement with OI. This initiative will result in more glass being efficiently provided to the Nava Brewery from our lowest cost source of glass supply, providing Constellation additional opportunities for margin enhancement and a higher return on our investment. Moving to free cash flow, which we define as net cash provided by operating activities less CapEx. For the 1st 9 months of FY 'eighteen, we generated $763,000,000 of free cash flow versus $824,000,000 for the same period last year as operating cash flow growth was more than offset by an increase in CapEx.
We continue to expect fiscal 2018 free cash flow to be in the range of 7 $25,000,000 to $825,000,000 Our free cash flow guidance reflects operating cash flow in the range of $1,900,000,000 to 2,100,000,000 dollars and CapEx of $1,175,000,000 to $1,275,000,000 including approximately $1,000,000,000 of CapEx targeted for our Mexican beer operations. At this point, I'd like to highlight ASU 20 fourteen-nine, the new revenue recognition accounting standard, which will be effective for Constellation at the beginning of fiscal 2019. Upon adoption, certain sales incentives will be recognized earlier than they are currently and will make an adjustment to increase accrued expenses with an offset to retained earnings as of the end of fiscal 2016. We will recast the full year of fiscal 2017 and fiscal 'eighteen along with fiscal 'eighteen quarters. We're in the process of quantifying the changes, but we don't expect there to be a material impact to net sales.
We expect to provide recast information when we file our fiscal 18 10 ks. In closing, we're well positioned to deliver another year of top tier financial performance as we close out fiscal 2018, and we're excited about our financial prospects heading into fiscal 2019. And with that, Rob and I are happy to take your questions.
Thank Your first question comes from the line of Dara Mohsenian of Morgan Stanley.
Hey, good morning, guys. Hi, Dara. My question is on the beer division. First, David, you mentioned a number of reasons behind the expected large year over year decline in beer operating margins in Q4. Are those more discrete factors in Q4 causing the year over year compression?
Are you comfortable those factors don't linger and you get back to expansion beyond Q4? And then also on the top line front in beer, can you help frame the magnitude of contribution you expect from Premier next fiscal year based on what you're seeing in test markets so far and in light of the heavy investment of more than $35,000,000 that you mentioned earlier in the call? Thanks.
Yes, Derek. So in terms of Q4 margins for beer, the real issue for us is that we haven't seen a full seasonality picture of our business really until this year because of being under the interim supply agreement prior to this. And so in Q4, it's our lowest net sales quarter of the year. So we get a bit of a delevering effect at the fixed cost line in the plant as well as on the SG and A line. And then on top of that, we're bringing in employees.
So we're adding headcount in Q4 that we will be able to deploy when we get into the big production season and we have some line commissioning costs. So I think there's just a bit of a seasonality built in, but we're pretty confident in the margins and being able to deliver strong margins going forward. I'd also say there that we had concerns both for Q3 and Q4 about some headwinds from FX in within our beer margins. But with the peso sitting around 19, we're just not seeing those headwinds this year. And then from a top line perspective, we expect the majority of the benefit from the Premier launch will be seen in Q1 of next year versus Q4 of this year.
And so we simply expect to have our distributor inventory kind of at our normal 30 ish days at the end of the quarter when we get to the end of the fiscal year, which is why we expect our net sales to be a net 9% to 11% range for the year.
Your next question comes from the line of Nik Modi of RBC Capital Markets.
Thanks. Good morning, everyone. Just as we kind of approach the February shelf set resets and obviously you're launching some new products into the marketplace. I'm just curious on what the retailers and distributors are saying in terms of incremental space, because I know that's been a big initiative that you guys have been pushing for a number of years now. Can you just provide some context on kind of how it looks now and how it's changed from where you were a year ago?
Yes. So I think that in general, we're making good progress on our efforts to increase our space commensurate with how we're growing at retail and our contribution from a profitability point of view at retail. So we continue to see good distribution growth. And so I'd say everything is on track. We've also made some significant organizational additions to bolster our category management activities and brought in some really great people to continue to drive those efforts.
So in general, we're pleased with the progress that we're making, but we start from a position, as I've stated a number of times, of not being where we think we should be or would like to be from a space allocation point of view at retail.
Nick, I'd also add that on a year to date basis, our effective points of distribution are up double digits. So we continue to do really well in gaining distribution.
Your next question comes from the line of Vivien Azer of Cowen. Hi, good morning.
Hi, Vivien.
So I was hoping to get your thoughts on the outlook for the beer category. The results from a category perspective, despite your very good depletion growth, continue to look increasingly sluggish in Nielsen. That's also mirrored in the deceleration we're seeing in PCE growth. And so with your largest market, California, transitioning to legal cannabis, how are you thinking about the overall beer category for calendar 'eighteen and any impact from cannabis? Thanks.
Yes. So number 1, I think that we think that the beer category is fundamentally going to continue to perform as the beer category in general has been performing. It's a flat to slightly down volumetrically market with all of the growth in the market being in the high end and then the premium end, in particular, giving up share. So I don't think we see anything different there as we move into calendar year 2018 or our next fiscal. And then on cannabis in California, we don't really expect to see any impact from that.
I think that one of the things that people don't necessarily appreciate is that cannabis has been generally available as medical marijuana and pretty accessible to almost everybody for 16 years. And therefore, the, I'd say, official legalization on a state level of it for recreational purposes is probably a nonevent is the truth of the matter. And then also, we've as we track what everybody else is tracking and we look at the numbers, we really can't see any real impact in terms of how it's affecting beverage alcohol in general, even in the states, the 6 states or now 6 states, including California, where it's been legalized. As I guess I've said in the past, it's probably not worth getting into a big debate right now about whether it's cannibalistic or complementary. There's just not enough information, I think, to really say how that's going to affect beverage alcohol in general going forward.
What we do know is that it's going to be a big market, however, worldwide.
Your next question comes from the line of Robert Ottenstein of Evercore ISI.
Great. Thank you very much and congratulations on another good quarter. Just following on the last question, I'm wondering if you could give us any details or further details on your plans in Canada in terms of building out a sales team there, the sort of products you would be looking to develop or co develop and kind of the general strategy. And I understand this is very early days and it's still very much a learning process, but we'd just love to get a sense of how you're thinking about it and what sort of investments on the ground that you'd be looking to put in place and thoughts on route to market? Thank you.
Yes. So we are making investments. We have started building an organization in Canada. I'd characterize it more as a marketing organization than a sales organization because our partner Canopy has a sales organization and will continue to build their sales organization as well, and we expect to partner with them. But we have put a team in place to work with Canopy.
Generally, in evolving, a lot of what they do in terms of consumer research, marketing, a lot of the standard sort of CPG stuff that we have a fairly deep knowledge and expertise in. And they, as a newer company, really focused on a totally emerging category and anticipated extremely high growth haven't become fully developed in yet. So we've got our team working with their team, and we expect to attack that market together really when, in our case, beverages become legal, which is either going to be with the initial recreational legalization in 2018 or in 2019. I think the sort of the right now the official government stance is that edibles will come in 2019, but it's kind of unclear whether they're lumping beverages into that or what they might do in 2018. But I would say the best guess we have right now or the official word is probably beverages in 2019.
And then in terms of what we're developing with Canopy, it is, as it relates to Constellation, beverages. Non alcoholic beverages, which would include cannabis, so or be infused with cannabis. So it's we're working on the development of those products and things like branding, etcetera, at this time. But given sort of the time frame, we don't have everything fully baked nor should we or would we at this point in time as to exactly what the product is in terms of flavors, in terms of packaging, in terms of branding. Canopy has got a strong brand of its own, even currently, which it uses in the medical marijuana side of the business called Tweed, T W E E D.
And I think that brand has a lot of potential as well.
Great. And just following up on that, any what sort of organization would you need in Quebec?
Well, we haven't really, I'd say, gotten that far that we're thinking about organizations by province. But as I said, in terms of like a larger sales organization, that will really be done through Canopy as it specifically relates to Canada. So I wouldn't see it building a huge sales organization necessarily, but we will build some significant capabilities and make some investments next year.
Yes. So Robert, when we provide guidance for the year on our next call, we'll talk about investments in cannabis, but clearly there will be some.
Your next question comes from the line of Bryan Spillane of Bank of America.
Hey, good morning everybody and happy New Year.
Thank you.
Just had a couple
of follow-up questions, David, I guess on the comments on tax. One was just I wanted to clarify the benefit that you're expecting. Is that relative to the fiscal 2018, 20% rate? Or is it benefit relative to your long term guidance on tax rate?
Well, Brian, what we said
in the script was that
it would be beneficial to the low to mid-20s kind of long term guidance rate. But we'll have a lot more specifics when we get to CAGNY, because as you can imagine, it's complicated to even understand what's in the regs as well as working through how to apply it to our business. But I can say that we're pretty confident that it's going to be below the long term guidance and likely in line with the 20% rate that we threw out for the remainder of this year or for this year.
And then do you think that it will have a positive effect on free cash flow? So as you kind of look at cash taxes, cash tax rates, any sense yet as to in terms of whether there's a real tangible cash benefit that you'd expect to receive?
So there again, we're still working through this. But before we said we provided guidance on an effective tax rate and we said that the cash tax rate would be somewhere around 500 basis points less than that, while we're continuing to amortize some of our intellectual property over time. We suspect that that will actually expand a little bit from 500 basis points, but we haven't we don't have final answers. We'll have those in several weeks at CAGNY.
But there's a chance that, that relationship between your cash tax rate and your new lower effective tax rate would be maintained?
Correct.
Okay, great. Thank you.
Your next question comes from the line of Mark Swartzberg of Stifel Financial.
Thanks and morning everyone. A question on wine and spirits, Rob, but just as a point of information, this group called Smart Approaches to Marijuana points out that alcohol consumption has risen in Colorado post legalization. There's a lot of just really useful data there I found. But wine and spirits, your year to date organic revenue is like plus 1%. Your fiscal 2018 through fiscal 2020 target is mid single digits annually and I hear you on the SKU rationalization.
But how are you thinking about what's necessary to deliver that mid single digits? Or do you think the mid single digits is too high?
Well, what we expect is mid single net sales growth for the year. That was our initial guidance range, and we feel pretty confident given sort of where we are right now and how 4th quarter we'll go that we will be in that range. Year to date, we're at about 4% growth on net sales, excluding the impact of Canada, so the Canada sales. So we feel pretty good. The market has slowed down a little bit, probably 100 basis points to 200 basis points versus where we thought the market would be for the year.
That's probably the biggest factor that's impacting us relative to where we are in our range. We said that we think that we're more towards the low end than the high end of the range. It's probably the market that's impacting that. Lower end wines below premium seem to be being impacted, which actually could turn out to be good news because I think that we continue to see an acceleration of premiumization. And we're seeing all of the growth really in the wine business start to coalesce around price points which are substantially higher than they have been in the past.
It used to be sort of the $8 to $12 range. And now we're seeing very strong growth, which is, I'm sure, hurting the lower end between the $15 $20 price points, which is still well within the commercial segments of the business. And we are particularly well positioned in some of those price points, and we'll continue to focus on those price points. And so over the last several years, we've become much more focused, not so much on that $8 to $12 but now in the $15 to even plus $20 range where we think all the growth is going to be in the future. We expect the wine category in general, there's a little bit of a slowdown in the second half of this year, as I said, to be a couple of 100 basis points.
We think that the category will continue to be one of the faster or fastest growing consumer products categories, outperforming consumer products in general. The whole the growth rate's been mid single digits, almost 4%. We were at 4%. So we'd prefer to be at the high end of the range than the low end of the range. But we don't see anything happening here that is unusual or should constitute any kind of a warning sign.
And in fact, as I said, the kind of growth we're seeing at the higher end of the commercial premium range, 15% to 20%, I'd say, is extremely encouraging for a lot of brands in our portfolio in particular.
I could have been clear. I was thinking about your fiscal 2018 through fiscal 2020 objective of mid single digits. And in the current fiscal year, you're getting about 300 basis points from acquisitions. So the underlying business is doing a 1. So I was really thinking about, is it just keeping up the pace of acquisitions because mid single digits is not how your business is growing on
an organic basis?
Yes. I would say that the excluding acquisitions, the underlying business has been a bit softer than we'd like to see it. And the numbers that you quoted are essentially correct. But I don't think that we see the short term or the quarter really being indicative of anything. And in fact, it's probably just timing, whether we're talking about the market or whether we're talking about our business overall, which we expect to be in line with those numbers that you quoted, mid single digits.
Yes. We don't think we need to continue to add to the portfolio to hit those numbers. We expect that our portfolio can hold or grow share as it stands.
And so do you think you can get margin expansion next year if you want that lift in organic growth?
Yes.
Great. Thank you, guys.
Your next question comes from the line of Judy Hong of Goldman Sachs.
Thank you. Good morning.
Hey, Judy.
So on the $3,000,000,000 share buyback announcement, it's a multiyear program. So it seems to leave you still with plenty of room for additional cash usage, especially with your free cash flow stepping up in fiscal 2019 and with some of the tax benefits also accruing. So I guess I'm just wondering why the Board came up with this number. And to the extent that you don't have a big M and A opportunity, do you think that you can complete the program earlier than you expected? Just kind of thoughts around that program.
Yes. So, Judy, we asked the Board for the authorization so that we could be opportunistic, and we didn't want necessarily a time horizon on it. And so they gave us a multiyear authorization, which is consistent with the way that we've always done it in the past. As we've said before, after we've invested in our for our expansion needs, in particular in beer. It's our intent to keep the business somewhere in that 3.5x leverage ratio range and we'll do that through returning cash to shareholders through dividends and share repurchases and then some M and A activity that's probably looks a lot like the M and A activity we've done over the past few years.
So I would say that we were looking for flexibility in the multiyear repurchase and we'll be opportunistic.
Okay. And then just a quick follow-up on beer depletion. Can you comment at all on the December trend just because obviously last year we had a pretty weak December and just wanted to see if you get you have any color just in terms of what you saw this December?
You're talking beer, right?
Yes, beer.
Yes. We're expecting a pretty strong Q4 on beer depletions. It is the bottom line.
And December is performing in line with us getting to that strong quarter. So we're comfortable.
I would say in general, our beer depletions are pretty much right where we expected them to be and right where they should be, sort of around that 10% number. So it's good. This quarter was 9.1%. Percent. We're expecting a strong 4th quarter in beer.
Got it. Okay. Great. Thank you.
Your next question comes from the line of Bonnie Herzog of Wells Fargo. Good morning.
Hi, Bonnie.
Hi. Hi. I just want to stay on this topic just in terms of depletions versus shipments. And certainly recognize there's usually seasonality, timing differences, but there's still a decent delta between the 2 during this quarter and even last quarter or 2. So could you help us better understand the dynamic?
And are these 2 then tracking more closely right now? Or is there still a pretty big delta? And then curious if you could comment on the end or consumer demand and how you expect this to progress throughout the year given the planned marketing campaigns that you mentioned as well as your new innovation?
So in the quarter, shipments were below depletions quite considerably, I think around 6% versus 9%. That would be entirely a timing of shipment matter, And we don't expect that delta to be anything like that as we approach the year end. Year to date, ships are up 8.4 and depletions are up 9.5. So on a year to date, we're seeing it a lot closer. But definitely, Q3, there was a timing of shipment matter that and I'd say a matter, there was nothing unusual.
It's just that shipments lagged a little bit more than usual behind depletions in Q3. But we don't expect that to be a trend or that there'd be anything or that there's anything unusual. I mean, it could be how we shipped in the last day. I mean, so it's not there's nothing going on there. And then your other question, Bonnie?
Just trying to get a sense of the current consumer demand right now. You kind of touched on that with the previous question. But I'm more curious how you expect that to drive
throughout the year.
If you're talking about our business, we think that it's very strong. And that would be evidenced by the very strong measured consumer takeaway with IRI, for instance, which is was more like at 16.5% for the quarter. So we don't see any issue with the consumer whatsoever. In fact, consumer takeaway is very strong right now, especially in the measured channels.
Okay. Thank you.
Your next question comes from the line of Tim Ramey of Pivotal Research Group.
Good morning. Thanks so much and congratulations on yet another amazing year.
Great.
I kind of wanted
to press on the tax issue, not from the perspective of what it will do to your rate, but particularly in the wine industry, there's a lot of goodies there for the industry. And since many of your competitors or most of your competitors are privately held, do you expect this will sort of fall to the bottom line in perhaps accelerated promotion or maybe leaving prices alone when because you'll have a margin benefit?
How do you
think this will play through the market is kind of thrust of my question?
Well,
for us, I would say that we wouldn't plan on letting sort of the
Ladies and gentlemen, I apologize. There will be a slight delay in today's conference. Please hold. The conference will resume momentarily. Ladies and gentlemen, please hold the line.
Ladies and gentlemen, please continue to hold. Ladies and gentlemen, please hold.
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was
We're
back online.
Yes, you may resume the call.
We believe it's going to be positive. People are going to have more money in their pocket. We believe it's going to be positive. People are going to have more money in their pocket. And we think that certainly as it relates to premium products, that's going to be very healthy for the industry.
So all good news, no bad news on that front.
Thanks so much.
Your next question comes from the line of Stephen Powers of Deutsche Bank.
Yes. Hey, good morning. David, if I could, I want to come back to, I think it was Dara's original question on beer margins for Q4 and just reframe it in sequential terms versus Q3. I think your comments on seasonality implies some lessening P and L leverage in Q4. But by my math, your Q4 your implied Q4 guidance really doesn't show any fall off in sales versus Q3.
So you just maybe bridge the difference between Q3 and Q4 as you see it. I know you mentioned some hiring ahead of kind of first half twenty nineteen demand. Is there anything else going on? Because I guess depreciation comes into continues to ramp. So I get that.
But on the other side, the peso seems cooperative. Glass benefits should continue to build, I assume, and so on. So is it really just the incremental hiring that forms the delta between Q3 and Q4? Or is there something else?
So it's all of the above. So it's incremental depreciation as we bring more assets online. It's continued line commissioning costs. Again, as we bring assets online and remember, once we put something into production, the incremental costs go through the P and L as opposed to getting capitalized. We're hiring employees.
I think we have like 100 employees that we're bringing in, production employees in Q4 to be prepared for the ramped up production season. And then there is historically and in this year, there is seasonality at the net sales level in the beer business. So again, we're not expecting we're not I don't want to sit here and really apologize for the margins in the Q4. I'm just suggesting that the margins will be a little bit lighter than they were in, say, when we hit an all time high. But understanding where we're going to end up in the with the margins is actually why we took up our guidance in at least tighten the guidance to the top end of the EBIT growth range year over year.
Okay, fair enough. Thank you.
Your next question comes from the line of Andrea Teixeira of JPMorgan.
Hi, good morning, everyone, and happy 2018. I would like to follow-up on the beer volumes commentary. I just wanted to clarify, did you mean that the Q4 shipments will be more in line with depletions or just for the year as you do the year to date, as you correctly pointed out, the difference year to date is definitely narrower. But you're talking about Q4 coming up to be obviously catching up with depletions and with shipments against depletions accelerating above shipments accelerating above depletions to match the year to date? And then I also would like to follow-up on the capital structure.
Is your new buyback plan an indication that the uses of capital will be more heavily weighted on towards cash return to shareholders or compared to strategic M and A? Thank you.
So on the billings and depletions kind of alignment,
First of all, in terms of at the
end of the year, we'll deplete and ship about the same number of cases. The percentages will be off a little bit just because of the starting point from last year. But we I think the best way to do your math is to come back in line with the 9% to 11% net sales growth and the 1% to 2% pricing algorithm kind of putting you in the very high single digits in net sales. And again, that's kind of where we are year to date on a depletion basis. In terms of capital structure, Andrea, I would say that what the authorization represents is that we're getting closer to the time where we have more and more free cash flow to deploy.
And we're saying that we're going to use that in all the ways we have before. But clearly, we're going to buy back a lot of our stock because we continue to believe that the company is undervalued.
Fair enough. Thank you, David.
Your next question comes from the line of Caroline Levy of Macquarie.
Good morning. Thanks so much and congrats on your results. My question is around Corona, your flagship brand. If you could talk about what the trends were like in the last quarter, in Q3? And how you're thinking about potential cannibalization with Corona Premier or with Familiar on your existing brands?
And is that something you're going to be watching very closely where you don't want to see your flagship corona even if it is a positive margin trade. So just to talk a little bit about how we should be thinking about that April launch.
Yes. So we think corona remains healthy, very healthy. In fact, given its maturity, it was up about 3% in the quarter. On depletion, sorry. Yes, on depletion.
And that's pretty consistent with what it's tracking. So we see good growth there and good continued growth. Corona Extra per se is the most mature of the brands in the portfolio. But given its state of maturity and the large market shares it has in particular places, we think it's doing very well, and we think that it will continue to do well. And then you asked about Premier, and I think that your question was on cannibalization.
And yes, I mean, we're looking at that. We tested it. The cannibalization was probably less than we thought that it would be, in fact, which was encouraging. The cannibalization is not a problem per se because it's not a lower margin product. But we nevertheless wanted everything to be more we want 1 plus 1 to add up to 3, which is what all indications were in our test market.
So yes, we'll be looking at the cannibalization. But you can imagine that it's 2 different consumers to a certain degree, meaning the people that are going to be attracted to a premier are going to be people who are already drinking some version of a light and low carbohydrate beer like a McUltra and people that are drinking Corona are obviously doing so without regard to it being not a light or low carbohydrate beer. So just logically, we don't expect there to be a lot of cannibalization there.
Your final question will come from the line of Bill Chappell of SunTrust.
Thanks for squeezing me in. And I will try to do 2 quick ones. One, just follow-up on tax. I understand you're still trying to figure out the final benefit. But has there been any discussion from the Board or the company of kind of how much of that will be spent back or reinvested or how you would spend the extra money in your pocket?
And then my other question just on the business. Any kind of update on on premise and kind of how that's trending? I mean, you've heard from different sources that there have been a lot of taps added for craft and all types of brands on premise and it seems to maybe you're not getting the volume terms and so maybe there's some reversal there. So if you could give us some update there, that would be great. Thanks.
So in terms of tax, unlike a lot of companies that have that are sitting on piles of cash overseas and they're looking for something to do with it in the next several months. Our situation is a little different in that. We've already heavily invested the cash that we generated overseas into things like our breweries in Mexico as well as our Canopy investment in Canada. And so for us, I think the cash flow benefits that we think accrue over time get deployed along the lines of the rest of our or our previously stated capital allocation strategy, which is continue to invest in the business, return cash to shareholders through dividends and share repurchases And occasionally, where we can get a growth accretive and ROIC accretive sort of M and A transaction, we'll look at that as well. So I would say that, that piece doesn't change.
And then in terms of on premise, our beer business continues to do really well. I think for the last this quarter, we're up high single digits. I think that's been a consistent trend over the last several quarters. And so we're just seeing continued strong performance of our brands in the on premise, even while during the same time. Overall trends in the on premise have been down, call it, low single digits.
Got it. Thank you.
Thank you. I'll now return the call to Rob Sands for any additional or closing remarks.
Okay. Well, thank you, everybody, for joining our call today. We certainly we apologize for the line going dead for a few minutes, but we rectified that. I would say that our business has performed exceptionally well for the 1st 9 months of fiscal 'eighteen, and we are very confident that we'll continue to sustain our profitable growth by executing on our TBA premiumization strategy. Just as a reminder, during our next quarterly call, we will be providing guidance for the upcoming fiscal year.
Prior to that, we look forward to seeing many of you at the Beer Industry Summit Conference in a couple of weeks and at the CAGNY Conference in late February, where we'll be providing updates on our strategic business initiatives. So thanks again everybody for joining the call and have a great day.
Thank you. That does conclude the Constellation Brands 3rd quarter 2018 earnings conference call. You may now disconnect.