Welcome to Constellation Brands' second quarter fiscal year 2016 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. If you would like to ask a question during this time, simply press star, then the number 1 on your telephone keypad. If your question has been answered and you wish to remove yourself from the queue, press the pound key. We ask that you please pick up your handset to allow optimal sound quality. Thank you. I will now turn the call over to Patty Yahn-Urlaub, Vice President of Investor Relations. Please go ahead.
Thank you, Jackie. Good morning, everyone, and welcome to Constellation's second quarter fiscal 2016 conference call. I'm here this morning with Rob Sands, our President and Chief Executive Officer, and David Klein, our Chief Financial Officer. This call complements our news release, which has also been furnished to the SEC. During this call, we may discuss financial information on a GAAP, comparable, organic, and constant currency basis. However, discussions will generally focus on comparable financial results. Reconciliations between the most directly comparable GAAP measure and these and other non-GAAP financial measures are included in the news release or are otherwise available on the company's website at www.cbrands.com. Please also be aware that we may make forward-looking statements during this call. While those statements represent our best estimates and expectations, actual results could differ materially from our estimates and expectations.
For a detailed list of risk factors that may impact the company's estimates, please refer to the news release and Constellation's SEC filings. Before turning the call over to Rob, I would like to ask that we limit the number of questions asked during the Q&A session today to two questions per person. We received investor feedback in the past indicating that the call ran long because we allowed questioners to ask unlimited questions. I would appreciate your cooperation in helping us end our call on schedule this morning. Thanks in advance, and now here's Rob.
Thank you, Patty, and good morning, and welcome to our discussion of Constellation's second quarter 2016 sales and earnings results. I am very pleased with our excellent quarterly results. Our beer business continues to deliver industry-leading results. Our wine and spirits business is on track to meet its goals for the year, and we continue to progress as planned with our Nava Brewery and glass plant expansions. Let's dive right into the commercial and operational results we saw this quarter for our beer business. During the second quarter, the beer business generated double-digit depletion growth, driven by exceptional consumer demand for our products across the beer portfolio. In fact, the second quarter marks the 22nd consecutive quarter of volume market share growth for our beer portfolio.
Constellation beers represented 45% of total U.S. beer industry volume growth during the quarter, as all of our beer brands grew across most channels and package sizes. Excellent execution by the beer team during the peak summer selling season with the 120 Days of Summer marketing campaign drove market share gains during the Fourth of July, which continued throughout the heart of the summer and into the Labor Day holiday. This performance was led by Corona Extra and Modelo Especial. Corona Extra posted accelerating depletion and consumer takeaway trends during the summer months, driven by continuing velocity growth and distribution gains, including the can launch and ongoing investments in media and merchandising with the new Always Summer marketing campaign. The new Corona cans continue to expand consumption occasions for the brand and are a hit with consumers.
Cans represented more than 40% of the growth of the Corona Extra brand during the quarter. Throughout the summer, we dedicated significant media support behind the can launch with English and Spanish language TV and digital advertising, especially during the July 4th and Labor Day holidays. We see great opportunity with this format, as it currently represents only about 5% of total Corona Extra volume. Modelo Especial delivered depletion growth of nearly 20% during the second quarter, driven by continuing velocity and distribution gains. The brand's increased media investments, including the continuation of Modelo Especial's national English language TV and video campaign, continued throughout the summer months, reaching the general market and bicultural Hispanic beer drinkers through targeted entertainment and sports programming. National Hispanic media included the Gold Cup broadcast sponsorship on Univision throughout the month of July, including in-game advertising and sponsorships.
Corona Light continued to gain share with all core Corona Light packages posting growth during the quarter. Three new brand TV spots were showcased on national TV throughout the summer, and the brand-sponsored Kenny Chesney tour continued with 29 tour dates from June through August. For the remainder of the year, we have solid marketing programs in place in order to maintain the excellent brand momentum we are experiencing across the portfolio. For Corona Extra, the football season continues to grow in importance through our returning partnership with Coach Jon Gruden and maintenance of key investments with the NFL, the number one program on TV. Boxing also remains a priority with Corona Extra through an integrated marketing plan to support highly anticipated fights. The momentum of the Corona canned format will be supported through general market and Hispanic TV support into the fall football tailgating season.
You should expect to see our iconic Corona Feliz TV spot leading into Thanksgiving holiday, which will be accompanied by robust on and off-premise promotional programs designed to drive brand affinity for Corona during the holiday season. For Modelo Especial, we have added six weeks of live TV sports program on national English language TV during the start of the NFL season across CBS, Fox, ESPN, and ESPN2. National Hispanic media will also continue for Modelo Especial with the weekly TV exposure to Spanish language consumers. Before moving on to a discussion of our beer operations, I am pleased to announce today that we are launching our new Tocayo Hominy White Ale, a craft Belgian-style wheat beer inspired by the culture and flavors of Mexico. The idea for this new beer brand was developed by our beer team working in conjunction with Chef Rick Bayless.
It will be available beginning next week at several of Rick Bayless' Chicago Frontera restaurants and other key Chicago area on-premise accounts. Our beer operations continue to run smoothly. The brewery and glass plant expansions are proceeding as planned. All key performance metrics related to cost, quality, capacity utilization, and service are better than target this quarter. New bottling lines are currently being commissioned and will become fully operational by year-end. Support for the expansion, such as cogeneration, wastewater, engine room, and fire protection are all on schedule. Work continues on the next expansion phase as we increase production capability from 20 million to 25 million hectoliters and continue to expand the rail and logistics capabilities around the site. Overall, the strong results that the beer business achieved in the second quarter are the primary driver of the upward revision to Constellation's EPS guidance for 2016.
We are now targeting EBIT growth for the beer business in the 15%-18% range, which is expected to drive an enhanced operating margin of approximately 34% for the segment in fiscal 2016 versus our previous margin estimate of 33%. While we are currently experiencing favorable commodity and foreign currency benefits, which combined are the most significant drivers of the revised beer margin for fiscal 2016, we have also experienced better-than-planned operational results driven by our glass plant performance. We are on track to bring the first 5 million hectoliters of capacity online at Nava by calendar year-end. Once this capacity is operational, we will be positioned to bring the next 5 million hectoliters into service by next summer.
Upon completion of this 10 million hectoliter expansion, the interim supply agreement with ABI for finished goods will no longer be required, as we will be fully self-sufficient from a supply perspective to fulfill our needs for the U.S. market. We expect to receive the full benefits of our targeted mid-30% operating margin goal on a more sustainable basis once we are fully operational at 20 million hectoliters at Nava. Longer-term margin target, we will still have much to accomplish. I would like to remind everybody that the 5 million hectoliters of capacity that will increase Nava capacity from 20 million to 25 million hectoliters is expected to be completed by calendar 2017.
Finally, given the continued strength of our beer business, we continue to make progress in evaluating plans for our future capacity needs beyond 25 million hectoliters, and we will have more to say as we finalize our plans in coming months. Now I would like to discuss the business results for our wine and spirits business. In the wine and spirits business during the second quarter, we achieved earnings growth and solid margin expansion while delivering strong spirits performance and excellent overall results for our Canadian business. In the U.S., our net sales are benefiting from positive mix trends, and we are maintaining IRI volume share in the U.S. wine market. We have successfully integrated our new Meiomi wine brand into our existing wine portfolio and are working to expand distribution to drive incremental growth for this brand.
The most recent four-week IRI trends show that Meiomi is growing more than 80% in multi-outlet and convenience channels, which is contributing to the fact that our premium plus dollar growth improved in recent periods. Throughout the quarter, our focused investments within wine and spirits could be seen in the marketplace. As a reminder, we are concentrating our investments and our resources on a key subset of our focus brands because we believe they have the right combination of scale, higher margins, and growth potential to drive our overall business results. Let's talk about a few examples of these programs. Our TV advertising for Woodbridge aired over the summer and helped drive strong IRI growth for this brand during this timeframe. This program will rev up again in advance of our winter holiday selling season.
Our Kim Crawford brand is the unrivaled leader of the New Zealand category, with its distinct flavor profile and Undo Ordinary marketing platform. This summer, it kicked off its exclusive national campaign with Cirque du Soleil and executed promotional programs with co-branded advertising offers, sweepstakes, and sampling events. Kim Crawford posted dollar growth of more than 30% in the recent IRI periods. Mark West, America's number one Pinot Noir and five-time consecutive winner of Impact's Hot Brand Award, is harnessing the power of its unique majority male shopper base with targeted digital Facebook ads and expanded print media in conjunction with its healthy grilling campaign. This month, we're launching Mark West Black to take further advantage of the Pinot Noir craze. Overall, we experienced depletion trends of more than 6% for our focus brands during the second quarter, which demonstrates that this strategy is paying off.
We've also taken some exciting steps towards our goal of developing new brands that have potential to win big with consumers. The newest wine brand in the portfolio, Tom Gore, is named for Tom, a second-generation grape farmer who has a passion for cultivating fruit with exceptional flavor and quality from his vines. This brand resonates with consumers' search for authenticity of the origin, ingredients, and people involved in what they eat and drink, and we are very pleased with its preliminary results. During the quarter, our spirits portfolio experienced excellent net sales growth of 19% and solid depletion growth across the portfolio, driven by Paul Masson Grande Amber Brandy and the success of its peach flavor offering, as well as SVEDKA Vodka, led by its hit flavors mango, pineapple, strawberry lemonade, and grapefruit jalapeno.
Casa Noble Tequila is exceeding our expectations so far this year with continuing share gains after particularly strong depletion growth during Cinco de Mayo. We continue to make focused Casa Noble marketing investments in four key local markets, L.A., New York, Chicago, and Texas, where activation programs include tasting, cocktail features, and collaboration with our beer portfolio for local events. Print ads targeting millennial consumers are also running in regional publications. This quarter, we launched the national rollout of Serpent's Bite, a bold whiskey infused with apple cider flavors. This product targets the intersection of three of the hottest trends in alcoholic beverages, flavored whiskey, hard cider, and the shot occasion. Though it is too early to comment on long-term expectations for this brand, our retailer and consumer feedback has been very positive, and we are pleased with what has been a fantastic start to the development of this brand.
As we head into the key holiday seasons for our wine and spirits business, we will be executing programming designed to ensure that we continue to drive growth, especially for our focus brands. Our expectation is that you should see improving depletion trends as we progress throughout the remainder of the year. As is typical at this point in the year, I would like to provide an update relative to the California grape harvest, which is currently more than 80% complete and is expected to be completely finished by mid-October. The current California industry estimate is for total harvest yield of 3.6-3.8 million tons versus approximately 4 million tons last year. While the crop is down this year versus last, quality looks to be very good with excellent color and flavors, and our winemakers are smiling.
From a pricing perspective, we continue to expect grape pricing to be flat to down slightly versus last year depending on the variety, location, and demand, with the exception of Cabernet, which continues to be in high demand. In closing, we are at the halfway point in the year, and I am very gratified with our impressive results so far this year. We are working diligently on the Nava Brewery and glass plant expansions while maintaining the strong momentum of the beer commercial business. Within our wine and spirits business, we are making good progress overall, and I believe we are well positioned to drive our great portfolio of brands during the upcoming holiday selling season. This December marks the 70th anniversary of our company's founding.
We are proud of our heritage and look forward to positioning our company for the next 70 years of living our vision to elevate life with every glass raised. With that, I would now like to turn the call over to David Klein for a financial discussion of our second quarter results.
Thank you, Rob, and good morning, everyone. Let's start with some Q2 highlights. Comparable basis diluted EPS was up 41%. Stellar execution by the beer business drove strong marketplace and financial results during the key summer selling season. The strong beer performance, along with some favorability in our interest expense, are driving our full year comparable basis diluted EPS projection up $0.20 to a range of $5 to $5.20 per share for fiscal 2016. The beer performance, along with lower than previously expected payments for taxes and interest, are also helping to push our fiscal 2016 free cash flow projection up $100 million to a range of $200 million to $300 million. Our glass plant and brewery expansion activities continue to progress as planned, as we are positioned to bring the first 5 million hectoliters of additional capacity online during the second half of fiscal 2016.
Let's take a closer look at our Q2 results, where my comments will generally focus on comparable basis financial results. Consolidated net sales on an organic constant currency basis grew 9% for the quarter. We continue to see robust marketplace momentum for our beer business with depletion growth of 10%. Beer net sales increased 14% on volume growth of 13%. As a reminder, during Q2 fiscal 2015, we estimated that beer recall activities resulted in the reversal of approximately 2 million case shipments to wholesalers and a $37 million reduction in net sales. If you adjust last year's second quarter for the impact of this activity, volume growth in this year's second quarter would've been closer to 9%, and net sales growth closer to 10%. We replenished the Q2 fiscal 2015 recall volume with shipments to wholesalers during the third quarter of fiscal 2015.
In addition to that activity, wholesalers also increased their inventory position during the third quarter of last year to bring inventory more in line with historical levels. As a result of these activities, we will be facing a difficult beer sales and EBIT growth comparison for Q3 fiscal 2016. Beer sales growth for the first half of fiscal 2016 totaled 13%. However, the difficult third quarter comparison is a primary driver of why we continue to expect full year fiscal 2016 beer net sales growth to approximate 10%. We continue to expect solid third quarter depletion growth. Wine and spirits net sales on an organic constant currency basis increased 3%. This primarily reflects higher spirits shipment volume. For the quarter, consolidated gross profit increased $93 million, up 13%, with gross margin increasing 220 basis points.
Beer gross profit increased $89 million, primarily due to volume growth, lower COGS, and favorable pricing, and our beer gross profit margin increased 310 basis points to 48.4%. Wine and spirits gross profit was up slightly as volume and COGS benefits were partially offset by unfavorable foreign currency translation. Gross margin increased 60 basis points to 41.6%. Consolidated SG&A for the quarter increased $5 million. Due to the factors just mentioned, consolidated operating income increased $88 million, and consolidated operating margin improved 320 basis points. Beer operating margin increased 450 basis points. This improvement reflects the gross profit benefits that I just highlighted, plus favorability in marketing spend on a per case basis for the quarter. The marketing spend benefit is timing related, as we expect to see higher marketing spend during Q3 and for the full year.
Wine and spirits operating margin improved 90 basis points, primarily due to the gross profit benefits discussed earlier. Interest expense for the quarter was $77 million, down 9%. The decrease was primarily due to lower average interest rates. At the end of August, our total debt was $7.4 billion. When factoring in cash on hand, our net debt totaled $7.1 billion, a decrease of $144 million since the end of fiscal 2015. This activity primarily reflects our free cash flow generation, partially offset by the funding for the Meiomi acquisition. We now expect interest expense for fiscal 2016 to be in the range of $310 million-$320 million. The improvement in this target reflects favorability in short-term interest rates and timing of our CapEx spend versus our original plan. Our effective tax rate for the quarter came in at 24.6% and compares to a 32.3% rate last year.
The decrease was primarily driven by the favorable outcome of various tax items that were effectively settled in connection with IRS examinations. We still expect our full year tax rate to approximate 30.5%. As a result, we expect our tax rate for the second half of the year to run above our projected full year rate. Now let's review free cash flow, which we define as net cash provided by operating activities less capital expenditures. For the first half of fiscal 2016, we generated $508 million of free cash flow compared to $360 million for the same period last year. Operating cash flow totaled $803 million versus $668 million for the prior year period. This increase was primarily due to the higher earnings generated by the beer business.
Given higher projected earnings for the beer business and lower projected tax and interest payments, we now expect to generate operating cash flow in the range of $1.25 billion-$1.45 billion for fiscal 2016. CapEx for the first half of fiscal 2016 totaled $295 million and was slightly below our CapEx spending during the same timeframe last year. Our brewery expansion activities continue to progress as planned, but we have seen some shifting in the timing of our CapEx, with a higher level of spending expected to come in the second half of the year. Overall, we are still targeting CapEx of $1.05 billion-$1.15 billion for fiscal 2016, which includes $950 million-$1.05 billion for beer. Due to the factors just mentioned, we now expect fiscal 2016 free cash flow to be in the range of $200 million-$300 million.
Now let's move to our full year fiscal 2016 P&L outlook. As discussed earlier, due to continued strong results for our beer business and lower than expected interest expense, we are increasing our comparable basis diluted EPS projection to $5-$5.20 per share versus our previous $4.80-$5 range. The beer business continues to target mid to high single digit volume growth and net sales growth of approximately 10%. As a reminder, fiscal 2015 beer shipments ran ahead of depletions as distributors brought inventories back to historical levels. As a result, we expect our fiscal 2016 depletion growth rate to be in the high single digit range and above the shipment growth rate of mid to high single digits. We are currently experiencing favorable commodity and foreign currency benefits, along with better than expected glass plant performance that are helping to drive improved operational results.
We now expect the beer business to generate 15%-18% operating income growth. This guidance has us targeting a beer operating margin of approximately 34% for fiscal 2016. For the wine and spirits business, we continue to expect net sales and operating income growth to be in the low to mid single digit range before any benefit from the Meiomi acquisition. While we anticipate improving depletion trends in the second half of fiscal 2016, we expect to see most of the wine and spirit sales growth to be driven in Q4 versus Q3 due to shipment timing and comparisons versus the second half of fiscal 2015. Our fiscal 2016 comparable basis guidance excludes comparable adjustments, which are detailed in the release.
Overall, we're very pleased with our results for the first half of the year and our projected sales, earnings, and operating cash flow growth for the full year of fiscal 2016. With that, we're happy to take your questions.
At this time, I would like to remind everyone, if you would like to ask a question, please press star, then the number 1 on your telephone keypad. Our first question comes from the line of Dara with Morgan Stanley.
Hey, good morning.
Good morning.
The fiscal 2016 beer guidance implies near 34% margins already with the FX and cost favorability. You're really at the mid-30s long-term target rate. I guess, why haven't you raised the long-term guidance, and when can we expect more clarity on that guidance?
We don't typically provide the long-term guidance. We provided the medium-term guidance, if you will, so we could give people a sense of our beer business. I would say that we still intend to have beer margins that are in line with the industry leaders in North America. In fact, we would likely be the benchmark if we achieve our mid-30s guidance on the midterm. I'd also say that we're early on in the process of bringing our capacity online with Nava. Dara, to really answer your question specifically, once we get that production capacity in place, we'll be in a better position to make an adjustment, if any, to our medium-term guidance.
Okay. That makes sense. I was hoping you could discuss the level of cannibalization you're seeing on Corona with the can business doing so well. Doesn't look like it's had much impact, and also maybe conceptually, can you discuss where you think can mix for Corona can move over time versus the 5% level you had highlighted earlier?
Yeah. We do know there's cannibalization between the can and the bottle. When we pick apart our business and we look at the drivers and drags of our business, we see a little cannibalization. You have to look at our numbers year to date, and you see that our bottle depletions are up mid-single digits, while our cans have expanded, from 3% of our mix last year to 6% of our mix this year. We are seeing some cannibalization, but we're not seeing it affect the overall brand of Corona. In terms of where we think the mix can get to, you know our Modelo brand is more of a can-centric brand. We don't really see Corona becoming a can-centric brand. The purpose of the can is to just provide incremental consumption occasions for our consumers.
All right, great. Thanks.
Our next question comes from the line of Nik Modi with RBC Capital Markets.
Hi, Nik.
Yeah, thanks. Good morning. Two questions from my side. Just a quick update on the Corona draft test that you've been running, just any early thoughts on that. Then, I guess, the bigger picture question is on wine. Just tell me if I have this right in terms of thinking about the long-term strategy. Effectively, given you still have a big chunk of your portfolio in the low end of the wine category, it's more about harvesting those brands for profit and reinvesting in the premium end of the portfolio so you can rebalance the portfolio over time. Am I thinking about that in the right way?
Nik, I guess I'll start with the wine question first. In volumetric terms, it's a large chunk of our portfolio that's sort of sub-premium, but in actuality, in terms of what's really generating our profits and the bulk of our sales, it's our focused brands, and that's all largely premium. To your question, the answer is basically yes. As to what you have described, the strategy is definitely about not worrying too much about the non-strategic part of the portfolio, which is the sub-premium. We did take some pricing very successfully this year in that part of the portfolio, and we are reinvesting against, as I mentioned in my script, a smaller subset of our focus brands. We think that sort of that mix of activity will drive stronger overall results, which I believe that it is, and I believe that it will.
We're pretty optimistic about the wine and spirits business in general this year. It's going to be a good year. What was your question on beer?
On the Corona draft test.
I think we continue to test Corona draft in a number of places. I would say that the Corona draft test is proving to be very successful, and I guess you could ask, well, what do we mean by that? What we do mean by that is we see it thus far as being additive, as opposed to just sort of a pure swap out on premise. Where we do have it, we see some positive effects in the marketplace around it, meaning in the off premise. There seems to be a positive effect when we have Corona on draft on the on premise and then our off premise sales in the area.
The test is positive, at the same time Corona's our, by far, most important brand, we're going to be very thoughtful about how we proceed, basically with anything new with that brand. The good news is the brand's performing better than ever right now, or at least as it relates to shorter-term history. Again, beer business extremely strong.
Great. Thanks, guys.
Our next question comes from the line of Judy Hong with Goldman Sachs.
Thank you. Good morning.
Hi, Judy.
First, on the beer depletion, the second quarter performance, 10%, a pretty healthy number, but I guess it's a little bit softer than what the Nielsen or some of the measured channel data has shown. First, can you talk about maybe what the disconnect is there? Your full year guidance also implies some slowdown in the back half, which also seems to be at odds with very strong acceleration that we're seeing in the measured channel data. Just wanted to get a little bit more color just in terms of the depletion trend in the second quarter and then the growth in the back half.
Yeah. Well, Judy, basically our guidance has called out high single-digit for beer depletion performance, and obviously, we're outperforming that at 10%. I would say that our beer depletion performance exceeds our expectations, but realizing that we continue to have tough overlaps in terms of strong growth last year, too. We can only be relatively cautious as to the kind of growth that we're willing to predict. Hey, I hope we far exceed those numbers, but I think that high single-digit depletion growth remains a good estimate. We do have some pricing that we're taking right now in the marketplace, in the 1%-2% range like we've talked about historically. While we feel that the brand is in an extremely strong position to take that pricing, it's not as if it will have zero impact on depletion growth.
Then in terms of IRI and the disconnect, I think that IRI only measures about half of the business. The half that it doesn't measure is the half that's not necessarily industry-wide performing very well, like the on-premise, for instance, and liquor stores as an example, that are the more sluggish part of the industry. That said, we're performing, of course, better than anybody else in those channels, but those channels are not the highest performing channels. Whereas the IRI channels, being grocery and convenience, are some of the strongest channels at the current time. I'd say that's where the disconnect is.
David, just in terms of the glass cost, I think in your prepared comment, you had called out gross margins on beer benefiting from better glass plant performance. Number one, I just wanted to get clarification on what that means. Secondly, just in terms of your mix of what you're now sourcing from the O-I JV as well as the Vitro arrangement, if you can just get a mix of where the sourcing of glass comes from as of the second quarter, then the O-I's proposed acquisition of Vitro, does that have any impact on your glass sourcing arrangement going forward?
Okay, Judy. Yeah. When I referenced the glass joint venture performance, what I'm really talking about, and you'll see this in our Q, which we intend to file today, which is a first for us to file our Q on the same day as our earnings call. You'll see that we have a profit at the glass joint venture level, which was not in our expectations for the year because there were a fair number of startup costs. The joint venture team on the ground in Nava, as well as our partners at Owens-Illinois, have done an outstanding job of smoothly getting our furnace at Nava functioning well.
As a result of that, we're seeing better profit performance from the joint venture. That allows us to shift our mix just a little bit. I don't have the exact numbers, Judy, but to shift our mix a little bit toward our own glass plant as opposed to third-party providers, which gives us near-term, in particular, freight benefits as it relates to the glass plant. To get onto the Vitro acquisition question, we have a very strong relationship with Owens-Illinois. We have the separation, if you will, that comes from owning the joint venture with O-I. We're not concerned at all about O-I taking or acquiring Vitro because, again, we control our own destiny along with O-I at our own joint venture.
Got it. Okay. Thank you.
Our next question comes from the line of Bryan Spillane with Bank of America.
Hi, good morning.
Hey, Bryan. Morning.
Just wanted to ask one question or one topic, just capital allocation. Maybe, David, if you could sort of remind us or update us on your current thinking in terms of share repurchases, kind of where you're comfortable in terms of leverage on the balance sheet. I guess as you're contemplating additional brewing capacity, just how we should think about kind of where cash is going to go, whether it's dividends, repurchases, or CapEx over the next couple of years.
As we position this business for total shareholder return for the medium term, the most important thing that we can do is ensure that we have enough capacity to service our high-margin beer business. When we think about capital allocation, number one in line is that capital expenditure required to build out Nava and to build out a second site at some point in the future. That's really number one. I would say beyond that, our capital allocation strategy hasn't changed. We remain committed to our dividend as well as share repurchases and tuck-in acquisitions. I would also say we're pretty happy coming out of the quarter with a net debt leverage ratio of about 3.7 times, which is in our range of 3-4 times.
I guess where I would just caution on that leverage ratio range, provide a little bit of caution in that we have a lot of spend to complete the Nava build-out in the second half of the year. We're just going to be very careful with our capital decisions as we go through the build-out.
Just two follow-ups to that. One is, in terms of a potential build-out, could you remind us, just rough idea, how much the cost per hectoliter is to build out brewery expansion? Then, I guess, based on that scenario or the potential to have to allocate more to CapEx, should we be thinking about share repurchases as more just covering stock options at this point and as opposed to real share count reduction as a P&L lever?
As it relates to a new greenfield facility, what we've stated in the past is that we haven't made a decision on specific location, although we are planning for Western Mexico. We haven't made a decision on size of the build-out. Then we've provided a really large range of $100-$150 a hectoliter, recognizing that a greenfield will be completely starting from scratch with no basic infrastructure, which we benefited from at the Nava facility. We will come back to you within the next several months with definitive plans around our build-out. I would say, based upon our volume growth numbers that we demonstrated this quarter, and for the last while, we will be spending the capital on a greenfield sooner than later, because it's going to take four years to build out another brewery.
With these kind of growth rates, we will need it to keep up with capacity. I think to answer your question on share repurchases, again, we are going to evaluate our circumstances as we go forward, and depending upon the capital requirements and our leverage ratio, and understanding the requirements from our dividends, we will then consider share repurchases. I do not see anything in the very near term, though, and we have said this publicly as well, around a large accelerated kind of program. It is likely to be methodical, and it is likely to start out with absorbing dilution.
Excellent. Thank you.
Our next question comes from the line of Caroline Levy with CLSA.
Good morning, everyone. Thank you. I just want to check that the delay in the capital spending that you talked about is not in any way a reflection that there is a delay in when the plant might open.
None whatsoever. We're actually pretty happy with the progress we've made in the build-out at Nava. In fact, we've now run beer down our premium glass line. For the first time, we've put labels and foil on bottles because our previous production had been Corona, primarily Corona Extra and Corona Light, using the applied ceramic label bottles. Now our premium glass line, which is Modelo Especial, has run beer down the line, which is a little bit ahead of where we thought we would be at this moment. We're very pleased with our progress on the brewery build-out.
That's great. On the wine side, we never really discussed CapEx there, but do you see any significant needs in the next couple of years?
I think you'll continue to see our wine CapEx in the range it has been for the past several years. We don't expect a big change in that regard.
Okay, thank you. The peso benefit, any way you could call that out and tell us what you think it'll do in the back half of the year?
Yeah. See, that's the problem with the FX and commodity-related items. There's a fair amount of variability when you're trying to predict it. You know what I will say about our peso exposure, it's about 15% or so of our COGS, and from that, you have to exclude the COGS that are attributable to ABI. We generally run a three-year layered hedging program across our currency and commodities. For the remainder of this year, we are roughly 80% hedged on FX.
Okay, thank you. One of the big drivers of your business has clearly been the big incremental advertising spend behind your brands. You mentioned in the second quarter that as a percent of sales, it wasn't up a lot, but I think it was down a bit. Basically, do you see keeping that pressure on the brands? Because I think that's going to be critical to the ongoing momentum. Do you have budgets to go up significantly on ad spend going forward?
Yeah. We expect, in our beer business, for our marketing expense to be somewhere between 8.5%-9% of net sales, which implies we will continue spending at kind of the second quarter rate as a percent of net sales. Our case rate, I think, goes up a little bit in Q3. I will also say that that's going to be Q3 weighted as we take advantage of the fall sports season, which we found to be a successful platform for driving our brands. We measure and are very pleased with the returns we get from our marketing investment in our beer brands, and we will continue to keep that pressure on.
Right. Because, yeah, I think that's going to be critical. Your returns have obviously been incredible. Would you see going to the higher end then, the 9%?
Caroline, I think that's the longest two questions I think we've ever had.
Sorry.
That's okay. No worries. I guess we'll take the next question, operator.
Our next question comes from the line of Mark Swartzberg with Stifel.
Hey, good morning, everyone. A couple here, both beer-related. One is, this year has been called the year of the can, and I'm trying to understand. It's clear you have a lot of opportunities for share within your portfolio, what might be the priority from here? I heard you, David, just mention premium glass for Modelo Especial, and putting an SKU into an existing account is easier than trying to add accounts, which is part of the job with Especial. What might be your next priority, if you will, after the year of the can for Corona?
I would say that you're right on in calling out distribution. We know, for example, that Modelo Especial roughly has 65 ACV across the market. We also know that we have packs like our 12-pack bottle, which is more like a 45, right. We have a lot of ground that we can cover from a distribution standpoint. I do want to come back on the year of the can, however. We've seen a lot of growth in Corona Extra from our year of the can program. We've also seen a lot of growth on Corona Light, which was a bit of an ancillary benefit that came from our focus on cans and Corona. Yeah, I think there are a lot of opportunities for future growth in our brands.
We're all looking at these 10 numbers and wondering, is next year going to be an eight? Is it going to be at a 12?
We all are.
I'm not asking for a crystal ball. I know we all are. I'm just trying to get a sense of where's the real shoulder going to be from here. Is it going to remain against the can? I think Especial has actually slowed this year in terms of rate of growth, which, of course, large numbers. Again, I'm just trying to understand where you guys are deciding to make that next priority, if you will, after the can for Corona.
Yeah, I think, around Modelo Especial, on your particular point, we have year-to-date depletions that are in the high 20% on the bottle itself. That's a package that's growing really well for us. The momentum behind the brand continues. I see us continuing our strategy of focusing on building out our strong distributor network, gaining more distribution at retail, getting our brewery completed, and continuing to execute across the entire portfolio of beers that we have.
Okay. I know I'm pressing here, I do want to understand, the brand Modelo overall, Especial, that is, rate of growth has slowed overall, all packages. Is that right? You're saying the glass is a priority there?
No. In the recent 12-week IRI, Modelo Especial is up 30%.
It has not slowed. Where are you getting that idea?
Okay, great. I'm just referring to some of the materials you put out back in early September, 16% in fiscal 2015 and accelerating this year. Got it. Okay. Then, the brewery expansion or the added brewery, you're saying the next several months. Can you be more specific? Should we think about that as third quarter?
In terms of spend?
When you would give us detail on that plan.
I would say, roughly by the end of the calendar year. Likely on our third quarter earnings call.
Got it. Okay, great. Thank you, guys.
Our next question comes from the line of Vivien Azer with Cowen and Company.
Hi, Vivien.
I have one question on wine and spirits, please. Given the diverging trends that we continue to see between those two sub-segments, can you offer a little color around the margin profile of those two independent businesses?
Yeah. I think when we look at our wine and spirits business, I think it's important that we are focused on the U.S. business, which amounts to 80% of our net sales, by the way, overall. When you break down our wine versus spirits margins, they're roughly in line across the portfolio.
Okay, that's helpful. David-
That's largely because our spirits business is really sort of mid-premium, as opposed to higher premium. The margins are roughly the same as the wine business.
Terrific. Thank you. My second question has to do with the outlook for the tax rate. David, if I think back, a couple of years ago, we've seen these tax benefits before, over time, the step-up in the tax rate doesn't actually happen, your overall tax rate ends up coming in lower than previously expected. I'm just curious, what gives you confidence that the step-up in the back half?
Yeah. In the back half, the further you get in the year, obviously, you know what sorts of settlement opportunities you might be working on. I'll also say that our initial 30.5% guidance for the year actually included the benefits that we realized in the second quarter. What we didn't provide, and we didn't have clear line of sight into, was the timing at which we would receive those benefits.
Understood. Thank you.
Our next question comes from the line of Robert Ottenstein with Evercore.
Great. Thank you, congratulations on a terrific quarter. I'm wondering if you could give us a little bit of your thinking on pricing strategy for beer. I think you talked about you're in the market now for 1% to 2%. I'm wondering, given your tremendous success in the market, have you changed your strategy? I'm asking that also because it appears that you led price increases in California and Texas at a minimum, and that may be a little bit of a divergence from in the past when, and correct me if I'm wrong, where you were perhaps more of a follower. Is there a change in strategy? Is there the potential, given again, the strong demand for your product, for perhaps more aggressive pricing to really further your premium image and get back to some of the price gaps of 10 years or so ago?
How are you thinking about your overall pricing architecture between the brands? Thank you.
First of all, as it relates to pricing, it is pretty much what we have said all along throughout the year, which is that we've expected to take in the 1%-2% pricing range, and that's what we're doing. The strategy really hasn't changed. Like every other business, we've got costs to cover, and our brands are strong enough to bear that kind of pricing. If there's any change in our strategy, I would say that the marketplace is changing somewhat in terms of sort of the makeup of the types of products that are out there. The market, meaning the industry, is definitively premiumizing while volume remains sort of flat so that there's a shift internally towards more premium products.
I would say that probably has given us the opportunity to be less focused on what's going on with competitive products and to be more focused on what do we think is good for our brand and what do we think will work and won't work. We continue to be very strategic in our pricing. We're doing it on a market-by-market, brand-by-brand basis. Our guidance nevertheless hasn't changed. We're still looking at the 1%-2% range. You can call it leading or not leading. We're sort of, I'll say, marching to our own beat as opposed to too worried about what some of our competitors are doing overall. That's sort of up to them. We'll do what we think the market will bear for our brands and what's good for the health of our brands.
In some cases, that will mean that we will lead pricing. As I said, the market's changed. It's premiumizing. 10% of the industry now is craft, selling at very high prices. The other 10% of the market is basically us. Those are the two segments. That 20% obviously taking share from the other 80%. Things are a little different out there than they have been in the past.
It's interesting. If you look at the Corona brand outside of U.S. and Mexico, ABI is taking a very strong strategy of really making it a super premium brand, generally priced significantly higher than Heineken, for instance, in most areas. Obviously, the reference point in Mexico is paramount. Do you think perhaps there is a way to kind of increase the gap with U.S. mainstream brands, with Corona, and just develop a little bit longer kind of pricing architecture for your brands, a little more differentiated than it is now?
Yeah. I would say in general we're not overly focused on the pricing gap with the domestic premiums. The domestic premiums have sort of taken on a life of their own. I'm not sure how relevant it is at this stage.
All right. That definitely sounds like a departure in strategy than what you would've said a few years ago.
Yeah.
Great.
I would say that you've identified that nuance correctly.
Great. Terrific. Thank you very much.
We're less concerned about that gap today than we were several years ago.
Thank you very much.
Our next question comes from the line of Tim Ramey with Pivotal Research Group.
Thanks. Congratulations. Rob, your family must be incredibly proud, too. In 70 years, you've built a $26 billion company. That's amazing.
Well, thank you.
David, just a clarification on the ending point of the TSA. I think I heard you say, is it end of calendar 2016 that you expect that to be largely wound down?
We have, in terms of supply chain procurement, not finished good procurement, we have largely separated ourselves from reliance on ABI. Separately, we will continue to procure finished goods from ABI's breweries until June of next year, of 2016.
Great. Rob, on the wine outlook, you cited the overall harvest. Ultra premium was a little bit short in Napa and Sonoma. I'm just wondering if you think that might provide somewhat of a pricing umbrella for mid-tier premium priced products. Any challenges you foresee in terms of Pinot Noir sourcing or some of the-
Yeah
grapes that are more.
I don't think we see any issues with Pinot Noir sourcing, which doing quite a bit of it between Mark West, Robert Mondavi, the various tiers, and Meiomi. I would say that our supply chain is very well nailed down. I think to your question on the pricing, in the marketplace, I think the answer to your question is maybe yes. I think that even in the higher end, I certainly don't see pricing going the other way. It hasn't been a very robust market over a number of years in terms of pricing. If you listen to the talk out there in industry type circles, I think everybody's sort of Meaning the market in general is probably more favorable to some pricing than it has been in quite a number of years. Probably holding well.
Great. Thanks so much.
Our next question comes from the line of Bill Chappell with SunTrust.
Hey, thanks for taking my question. Just clarification on the 34% margins. Did you quantify just how much FX and commodity benefited that number? Am I right in what you said with the hedges, we won't see any incremental benefit in the back half? This is probably the watermark for the rest of the year.
Yeah. Clearly implied in a guidance that brings us back into the 34% range, margins will compress a little bit in the back half of the year as a result of several headwinds, if you will. Those being, bringing assets into service, our depreciation number will go up, line commissioning costs, incremental employees for training as well as throughput lowering as we go into the back half of the year at Nava, just based on the seasonality of our production. I would say that built into the 34% is our current estimate of FX and commodity rates for the rest of the year.
Okay, just trying to understand, especially on the commodity front, would you expect as we move past the hedges, that you would see an incremental benefit as we move into next year? Or is it more on productivity benefits than it is straight commodities?
Well, it's a little bit of both. From a hedging perspective, we run a three-year layering program, we kind of stabilize our returns a little bit, which means you leave some money on the table when commodity prices and FX values are falling and you gain on the other side. I would say that we will get, assuming commodity rates were to stay where they are today, and primarily for us, we're talking about benefiting from diesel rates as well as aluminum. Assuming those rates were to stay as they are today, there would be some benefit that we would experience next year. It's just far too early to call what that is at this point.
Got it. Thanks so much.
Our next question comes from the line of Pablo Zuanic with SIG.
Good morning, everyone. Look, I have a couple of questions on Modelo Especial. The first point is that to me, the brand, the bottle, and the can are really totally different products. It's a different demographic, it's a different price point, and obviously, it's a different packaging. I'm just trying to understand, how can that work in the long term? The person buying the cheap Modelo Especial can is very different from the one that you're advertising to the detective for the bottle. The second question, which is related to this also. Obviously, Modelo Especial is driving the growth. You provided ACVs for cans and bottles. Can you give some color in terms of what's the growth in bottles? What's the growth in cans? I understand the bottles are starting from a lower base.
The reason I ask the question is that when you say 65% ACV for Modelo Especial, I'm not so sure there's a big market for Modelo Especial in states like Alabama or South Carolina. Perhaps your ACV has already capped on Modelo Especial on the cans, or maybe not. Obviously, given the growth rate, it hasn't. Just give some color there. I find the brand is a fascinating brand, worth a business school case study, but it has its own challenges because of the way the cans and the bottles are marketed. Thanks.
Well, the first thing I would say that from a consumer experience standpoint, our research and the feedback that we receive is that, as more people in the U.S. become exposed to Modelo Especial, they tend to continue to drink it. It's a very high-quality, well-respected, authentic brand from Mexico. To address the can versus bottle component, we had depletions year-to-date on cans that are 12-ish% on the can part of the portfolio. Bottles, we were in the high 20% growth rate from a depletion standpoint. We're seeing growth coming across the spectrum of offerings on Modelo Especial.
Yeah, I would say that as far as the consumer goes, I'm not sure that we agree with you that it's two completely different consumer bases. I think that we've seen a shift somewhat, at least in the growth from cans to bottles. The can is only slightly priced less than the bottle. It's really almost irrelevant, the pricing difference. Interestingly enough, cans have, in general, taken out a very premium image, since it's becoming the package of choice in the craft segment of the market. The whole view towards cans in general, I would say, is shifting quite significantly from a consumer perspective. We don't see any difficulties in marketing the cans and the bottles together, like everybody else does, markets cans and bottles.
That's not a particularly unique aspect of our Modelo Especial business, which, as we said it earlier, is actually growing more than it ever has on an incredibly large base. The strength of that brand is phenomenal at this stage, without it really having fully transitioned to a general market product. It is transitioning to a general market product, again, with our own help as we've turned on general market TV advertising, which has been very successful. We know that there is huge room for distribution growth in that brand, and you will see it. You will see it as we continue to move forward and execute with that brand. You'll see the ACV continue to go up. That's simply going to be the case as we believe quite strongly at the current time. The cans are strong, the bottles are strong.
It's following the same pattern as many brands that have become major brands, and Corona is probably the best example of that.
That's very helpful color. Can I just ask you a quick follow-up? With all this talk about the Anheuser-Busch InBev, SABMiller transaction, if it happens, if I recall, about 65% of your volumes in the U.S. go through MillerCoors wholesalers. Obviously, they are independent. The balance mostly Anheuser-Busch InBev. I know it's very hypothetical and speculative, but if Heineken were to be involved in any way in the future with MillerCoors and/or Molson Coors, there could be some changes there at the wholesaler level, right? I would assume that they would want the MillerCoors wholesalers to carry their portfolio of Mexican brands. Of course, the wholesalers will have their own say, and your business is much larger. Is there a risk there, number one?
The second question would be, in terms of your volume in the U.S. at the wholesaler level, what percentage would overlap with the FEMSA brands? Pretty much wholesalers that carry your brands don't carry the FEMSA brands? Thanks, and sorry about the detail there.
Yeah. There is some overlap of wholesalers that carry the FEMSA brands or the Heineken/FEMSA brands and ourselves. Quite a bit of overlap, in fact. I would say that that is totally irrelevant to us. The FEMSA brands are small, okay? In terms of Growth, they have some growth in their Dos Equis brand, which is less than half the size, for instance, of Modelo Especial, and the growth has slowed down. Tecate, I think, is in negative territory, and they've had some growth in Tecate Light, which basically sells at the domestic premium price point. We don't really view that as particularly strong competition, and we don't really care whether they're in MillerCoors or ABI or frankly, where they go, because we don't focus on that portfolio very much. Heineken's a whole different animal, obviously.
Right
that I think is competing with a different consumer base in general than our Mexican portfolio. Again, it's not something that we really focus on. In general, our modus operandi is to worry more about our portfolio and the opportunities there, and execution is gonna be the key on our portfolio in the future. Which is going to be about taking advantage of distribution opportunities and basically increasing the number of SKUs per account. That's really where the opportunity lies for us, because we actually generate a huge amount of growth for ourselves and our retailers with a relatively small amount of shelf presence. We're under-SKU'd, given our velocity and our dollar volume at retail. There's just a big opportunity there for us and our retailers. Our retailers are and should be interested in increasing their sales and margin per unit space of shelf space.
That's what they're all about. Probably their biggest opportunity to do that, and to get dollar sales turns and even more importantly, margin, is through increased SKU and shelf space for our portfolio. When we talk to retailers about that, I think they realize it because the statistics are just overwhelming for them as a way to increase their profitability. Building our SKU count per retail account is gonna be one of our primary focuses going forward.
Thank you. That's very helpful.
Our final question comes from the line of Brett Cooper with Consumer Edge Research.
Thanks, guys. Two questions on the beer business. Can you talk about what your volume assumption is for capacity planning for the beer business going forward? We've seen the cans come in, and if memory serves, ACV has gotten pretty stable over the last few months, but where you see the potential for distribution on Corona cans in the medium term?
Yeah, I think in terms of capacity, it's sort of like high single digits is what we have said in the past, or you can infer that from our comments about doubling the business over a long period of time, 10 years. That's just sort of simple math. Our real guidance for the year continues to be high single digits for the beer business in general. Your second question was?
How much more room is there for distribution on Corona cans?
Oh, a lot. We've just introduced it really and made it a priority over the last relatively short period of time. I think that there's a big opportunity for more distribution on that. It's only about 5% of our volume at the current time, and we should be growing that to more like 15 or 20%. That'll be achieved through continuing to build distribution and doing what I said, focusing on SKUs per account.
Perfect. Thanks.
That was our final question. I'd now like to turn the floor back over to Rob Sands for any additional or closing remarks.
Okay. Well, thanks everybody for joining our call today. As we close the discussion of our second quarter results for fiscal 2016, I am very, very pleased with what our business has achieved so far. Though the year is far from complete, our new guidance reflects the confidence we have in our ability to execute in the second half and achieve our goals for the full year. We look forward to the next time we speak with you in early January, when we will share the results of our third quarter. Until then, we wish you a safe and happy holiday season. This time of the year is a great opportunity to share our fine beer, wine, and spirits products with friends and family, and we encourage you to make Constellation Brands a part of your celebrations this holiday. Thanks again, everybody, and have a great day.
Thank you. This concludes today's conference call. You may now disconnect.