All right, welcome, everyone. I'm Darragh Mooney, Morgan Stanley's Beverage and Household Products analyst. Just before we get started, I'll give you the research disclosures, which are: Please see Morgan Stanley's research website at www.morganstanley.com. With that, I'm very pleased to welcome Constellation Brands here today, and Garth Hankinson, Constellation's CFO. Constellation's had a great track record of growth over the last really decade, driven by their beer business. Modelo Especial has become the number one beer in the U.S. in off-premise retail sales this year. Very pleased to have Garth here with us. Thank you for being here.
Thank you, Darragh.
So, first, I thought, clearly, Constellation's been through a period of very pronounced change over the last couple of years. You've had a collapse of the dual share structure, board changes, shift away from the Sands family, emergence of an activist investor with a stake. And, you know, really a lot of those changes were frankly underway sort of internally, before the external, announcements or manifestation of some of them. But I'm curious, sort of taking a look back and thinking about the last couple of years, what do you think has changed during that timeframe? How is the way you manage the business maybe different today than it was a couple of years ago? Maybe what hasn't changed. How do you sort of think through all those changes?
Yeah, well, thanks for the question, Darragh, and before I get started answering that question, let me start with my disclaimer, my own. As is every year with your conference, given the timing of it, we just ended our fiscal Q3. So during today's discussion, I won't be providing any information related to the fiscal or to the financial or operational performance of the company, again, for our fiscal Q3. So let's start with what has been what we think is the most significant change. And you kind of alluded to it, I believe, which was the changes in governance which have been multi-year in nature, as you suggested.
You know, certainly, as we sit here today, a big change has been that, you know, we now have a one-share structure, so that all shareholders have the same economic and voting, you know, rights, if you will. So it's the same governance for all shareholders. In many ways, that was the first of changes as it relates to governance. Since that was approved by shareholders back in November of last year, we've had two of our longest tenured board members resign from the board. We've added two additional board members with strong financial backgrounds, as well as backgrounds in retail and CPG. So again, good additions to the board from an experience standpoint. And there's been a change in the chairmanship of the board.
Certainly, we're in a period right now where we have an interim board chair, but we're looking for or in the process of identifying a permanent replacement, and that process is going well. And there'll be more news on that hopefully in short order, but that's, you know, continuing to evolve. And then more broadly, you know, our board continues to assess itself around the capabilities and diversity to ensure that we've got a board that really is the best board that we can possibly have. Certainly, all of those changes again, as you indicated, were multi-year in nature, and we heard from all of our investors around the importance of having a more modern governance structure.
And so we appreciate the feedback that we got from all of our investors, and we appreciate the support that we've gotten from all our investors in making these changes happen. What hasn't changed, what's remained consistent, really is the strategy and the capital allocation priorities of this current management team, and this management team has been in place for roughly, you know, five years, give or take, depending on who it is, you know, on the executive team.
Over the course of this period of time, you know, we've delivered on our capital allocation priorities of strengthening our balance sheet, of returning capital to shareholders, of investing in our core business, or the organic growth of our business, and, you know, and in layering in incremental, smaller scale tuck-in acquisitions. And what you heard at Investor Day, a month ago is that, you know, we remain committed to the disciplined approach, and to being very principled, and we remain committed to getting our leverage ratio to a 3.0 target, which we expect to be in our fiscal year 2025. We remain committed to a 30% dividend payout.
We remain committed to delivering capital or returning capital to shareholders through share repurchases, and we now have $2.8 billion of authorization at our disposal to use, and we will continue to assess, you know, bolt-on acquisitions as opportunities arise.
Okay, great. And turning to the beer business, you reiterated this 7-9% midterm top-line growth algorithm for beer at Analyst Day. Obviously, you guys went into a ton of detail there, but for the benefit of those who missed it, 40%-50% of volume growth from distribution, 20-30 from demographics, 20-40 from innovation. I think I got those right. Just give us your sense of the level of confidence in each of those buckets as you look at the business and as you think about volume growth going out over the next couple of years. You've delivered upside over time, where might that come in terms of those specific buckets, if that were to emerge over time in your mind, or what's most likely?
Yeah, well, I'll go through each of those, you know, one by one, but let me start by saying we've got good confidence, good conviction in really all three of them. And let's just start with distribution. And over the last five years, we've consistently delivered against our aggressive distribution initiatives. Over this period of time, if you look at the top 25 retailers, we've increased our category captaincy positions from 2 to 11. We've executed against, you've heard us talk about our Shopper First Shelf initiative on many instances. But in FY 2019, we executed against about 1,500 Shopper First Shelf resets. In this fiscal year, we're anticipating the end of fiscal year, executing against 21,000 Shopper First Shelf resets.
And again, you know, at Investor Day, you heard us articulate the opportunities and the target, the opportunities we have on the targeted 500,000 incremental points of distribution over the next 5 years, you know, really against just our core, you know, product offering. Then as it relates to demographics, I think it's important to note that about 50% of our net sales comes from the Hispanic consumer as it relates to our beer portfolio. And while the total legal drinking age population growth is expected to grow about 1%, 60% of total population growth is expected to come from the Hispanic segment.
You know, that's an important segment, you know, for us, obviously, just given, as I said, about 50% of our performances is due to the Hispanic consumer. This is a consumer that controls about $2 trillion of spend. And it's the largest affluent subgroup amongst Gen Z, so, you know, a real opportunity for us. And it's a group that tends to over-skew towards beverage alcohol and has a real preference for, and affinity for our brands. And so, given the expected growth and given the resonance that our brands have with the Hispanic consumer, we expect that this to continue to be a very favorable tailwind for us, as we go forward.
And then, you know, the last component there is innovation. I think it's important, again, for everyone to note that when we talk about innovation, innovation includes, you know, both liquid, if you will, as well as, you know, packaging innovation or price pack architecture initiatives. And as you noted, this is the category, if you will, the driver, if you will, that has the widest range. It has the widest range, really, that's reflective of sort of the approach we take on test and learning in the marketplace. And certainly, you know, based on what we learn in the marketplace, we'll be more or less aggressive.
But we feel like this is the appropriate range for us, because if you look at the last five years, we've really, you know, operated at about the midpoint in terms of the impact on our overall growth rate coming from innovation.
Great. Then on the distribution side, obviously, we've had some major changes in the beer category over the last few quarters here. In theory, you always had this shelf space argument of growth and velocity relative to the peer set, but with the struggles on Bud Light and some of the ABI brands, obviously, that argument has been strengthened. How much of that was sort of realized as you think about the ability for shelf space gains from that in fall resets, which usually aren't as significant in the beer category, versus maybe upcoming this spring, where traditionally it's a larger percentage of your mix that's reset? Just help us think through the benefits from that and sort of when it's fully felt by your organization, and compare and contrast upcoming spring versus last fall.
Yeah. So you know, this is probably, you know, a good opportunity for me to sort of just reiterate what our full year expectations are for our business, right? And we continue to expect to achieve, you know, top-line growth of about 8%-9%. And, you know, as is typical with our algorithm, we're expecting 1%-2% of that to come from pricing initiatives. Just to give a little bit of context in terms of shelf resets, you know, our last fiscal year, fiscal 2023, was, you know, our best year to date as it relates to gaining shelf space. We gained about 2% or 2 share points of the cold box, and we executed against about 17,000 shelf resets.
So compare that to FY 2024, year to date, we've already picked up an incremental 3 share points of the cold box, and we've already executed it on 18,000 shelf resets, you know, on our way to 21, what we expect to be 21,000 shelf resets, on the full year, as I indicated earlier. In terms of a little bit of the cadence, in between fall and spring, you know, about 20% of shelf resets are done in the fall. And that results for us in, you know, a high single-digit growth rate in terms of distribution on a year-over-year basis. But we still expect that the vast majority of shelf resets are done in the spring. You know, obviously, the balance of that is 80%-ish%, or 80%....
which will result in sort of low double-digit distribution gains for us.
Okay, that's very helpful. Thank you. And, part of that beer top-line target is 1%-2% pricing. Give us a sense of how consistent that will be looking forward over the next couple of years. We are coming off a period of. Well, we're in a period of theoretically greater consumer stress, greater inflation in beer, but in broader CPG, even more. And in theory, ABI maybe isn't pushing the needle as much on pricing as they have previously. So should we expect pretty consistent 1%-2% pricing from you guys going forward? How do you sort of think through that strategically, given all those factors that I mentioned?
Yeah, I think that for, you know, for those of you that follow us closely, which looking across this room is quite a few, you know, you'll hear a similar response to this question, which is, you know, we take a very, very methodical approach and disciplined approach, you know, to pricing. And on this 1%-2% pricing algorithm, you know, we, we don't, we don't take necessarily a, a pricing action across the the entire country, right? So it's never that we're experiencing, 1%-2%, again, across the broad, the broad swath of the country. Rather, what we do is we look at markets on a market-by-market basis. We look at brands, and we look at SKUs.
In any one given year, you might see that in a particular region or particular brand, there's a higher than 1%-2% pricing increase. And then there's another area where we have something less than that, and again, across the portfolio, that averages out to that 1%-2%. In some markets, we won't take pricing multiple times a year, nor will we take pricing in back-to-back years in order to make sure that we're managing the impact that any pricing has, you know, on our consumers.
If you've heard us say before, you know, we always have the consumer front of mind when we're making pricing decisions, because what we don't wanna do is ever price our consumers out, and we don't wanna do anything that slows the momentum of the brands. So, you know, we'll continue on with that very, very methodical and disciplined approach. That approach does give us a lot of flexibility, obviously, Dara. And you saw in both FY 2022 and FY 2023, given the economic conditions, given the inflationary environment, we were able to take, you know, incremental pricing over and above that 1%-2%. Again, I think that shows the strength of the disciplined approach.
And when we did that, you know, we very much took into account, you know, elasticities. You know, again, always making sure that, you know, we have a good sense for what the impact is going to be on our consumer, you know, and overall, for the portfolio. So, it's a discipline that's served us well over the past, and one that, you know, we think we can, you know, we can rely on, you know, going forward.
Okay. And then maybe some near-term perspective. Since that February quarter lull, we've seen your business really come back pretty strongly in terms of market share performance over the last nine months. We've also seen some periods of sort of beer industry malaise from a volume standpoint. So just curious for your perspective on both those areas, how sustainable they are as you think going forward. Is there anything sort of occurring from a beer industry standpoint you think is depressing trends here, or is it more just the numbers bounce around month to month? And then your own market share performance and that strengthening we've seen, can you talk about what's behind that sequential improvement and how sustainable that might be?
Yeah, well, you know, broadly speaking, you know, we've kind of gone through the drivers for our business, you know, going forward in terms of, you know, distribution, you know, innovation, and demographics. But we feel good about our ability to continue to deliver the growth that we've outlined. Now, as it relates to the, you know, broader category, if you will, and there has been a little bit of volatility in the broader beer category. But if you look at various segments, if you look at the high end, for instance, the high end continues to be, you know, quite healthy.
And if you look at Circana data, for instance, you know, in any given period, really, you're seeing the high end growing quite nicely. Certainly, the overall beer category is a bit weighted down by the declines you're seeing, you know, at the more, you know, value-priced, if you will, or sub-premium price, you know, price segments. But overall, the high end, you know, remains to be, you know, again, pretty healthy. We also look at, as it relates to the high end, one of the key metrics we look at, you've heard us mention this before, is buy rate. And, you know, the buy rate has actually, you know, gone slightly up year-over-year.
So we think that that's an indication that the premiumization trends at the high-end demand, you know, remains fairly, fairly stable. Looking at... You know, you asked about, you know, our ability to continue to deliver on the growth profile, and again, over and above what we talked about in terms of the drivers that we're counting on. If you look at some of the opportunity we have from, you know, a share perspective, and I'm gonna try to get these numbers roughly right for you. But you look at a brand, for instance, like Modelo Especial. You know, overall, across the whole country, that brand has about a 9.2% share. But if you look at that in a state like California, that share is closer to 20-...
So obviously, there's a good opportunity there to, you know, increase the share of that across the rest of the country, if you can close that gap even somewhat with what you see in California. And then similarly, across, you know, the broader portfolio, you know, the broader portfolio has a share of about 19.4%, I think, is what the number is. But if you compare that to California, our largest market, the total portfolio has share of about 34.9%. So again, I mean, that's a real, you know, opportunity for us, you know, it to be able to replicate that type of performance. And then again, we've touched upon the innovation and the demographic opportunities for us to continue to deliver outsized growth.
Okay. You touched on the high-end strength. Maybe put that in context of the macro environment we're in across broader CPG. We've started to see package and channel shifts be pretty pronounced, which is occurring in the beer category. We've also started to see some brand trade down, which we really haven't seen in beer. So just as you think about your business, in beer, and then maybe you can also touch a little bit on wine and spirits, what are your thoughts around the threat from the macro environment, consumer trade down, why you're not seeing it, and how much of a risk point that is in the current consumer environment we're in?
Yeah, I mean, again, you know, and it's a little bit similar to the last answer, which is, you know, we remain confident in the high end, just given the performance of the high end, you know, and the period after period growth that we see in the high end. And again, the strength that we see in buy rate, which gets us to believe that the high end is relatively, you know, stable overall. And while there is some concern around the macroeconomic condition, you know, consumer sentiment seems to be rather positive, you know, relative to where it was last year, in terms of where, in terms of, you know, both how the consumer is feeling and the relative, you know, strength, if you will.
And certainly, specifically to beverage alcohol, you know, we see a little bit of an opportunity for us or benefit for us, or if you will, or maybe a little bit less of a headwind. Because if you look at something like, you know, food, you know, broader food is, you know, price increases are up kind of 4%-5% over sort of norms. Meanwhile, beverage alcohol is only up kind of 1%-2%. So the impact that the consumer is feeling on beverage alcohol is lower relative to something like the food category, if you will.
And you've heard us reference a couple of these stats before as well, but certainly beverage alcohol as a percentage of the total basket, if you will, for consumers, is still relatively low. It's less than 2%, so this is not a big drain on a consumer's overall budget. So when consumers are going to look at ways to make trade-offs to save dollars, this is not a big driver of their cost. So probably not a place where they're gonna compromise, if you will. Additionally, you've heard us say before that beverage alcohol tends to be a bit of an affordable luxury. So even during times of a little bit of economic tightness, if you will, consumers still will purchase beverage alcohol.
They might change where they, you know, the channel in which they purchase it. They might change where they purchase it, meaning, is it, you know, are you going out for dinner and having drinks, or are you buying that bottle of wine and have it at home? But they still, you know, they still tend to drink. Now, there are some things that we've seen, as you mentioned, some channel shift. Certainly, we've seen that, specific to the beer category. That shift, as you've seen, that there's been a shift towards convenience for more immediate consumption, and with single serves. Fortunately, you know, we're quite strong in the convenience channel, and we have a full offering of single-serve SKUs.
So not necessarily something we're seeing as a significant risk to us. And then one of the other things that we're seeing a bit of a change in is just in larger pack sizes. Consumers are looking for, you know, more value, you know, per ounce, if you will. Again, this is why we've had a bit of a focus and why we'll continue to have a focus on our price pack architecture initiatives, to ensure that we've got, you know, a product at every price point on which a consumer is shopping at.
Okay. Speaking of that channel shift, package shift, we saw sort of a mid-single-digit gap open up between Circana scanner data growth and your beer business last quarter. That's a bit above where it's been historically. Is your view that's a more sustained type of level going forward, just because there has been these macro impacts? Could it ramp up even more from here, as you think about macros going forward and consumer shift, you know, using your crystal ball, where do you see that sort of going forward versus what happened last quarter?
Specific to Circana data?
Yeah, sure.
Okay.
We have to use something as a reference point.
Sure, sure. Sure, as you know, as we—I think we talked about this at the, you know, at the end of our Q2 earnings, and this was a point that we talked about at Investor Day as well, right there. There has been a widening in that gap between Circana and depletions, for sure. You know, historically, that's been more in the low single-digit range, and then over recent quarters, that's been more in the mid-single-digit range. You know, that seems to be tied to the fact that Circana data doesn't have as much exposure to independent convenience retailers, so it's overrepresenting the impact of the shift towards the convenience channel. So that's why you're seeing that bit of a skewing, if you will.
We expect that you're gonna continue to see this sort of mid-single digit, you know, gap between Circana data and our depletion data until the second quarter of our FY 2025. You know, that's when, that's when kind of the lap will occur. Specific to our Q3, you will see that that gap has been closer to the higher end of that range than it was even in Q2. So we are, we are expecting that that will continue.
Okay.
It is important, I think, for folks to remember that Circana really only captures about 50% of our overall performance, which is why, you know, we always say that, you know, to really... If you're really looking to track our business, you gotta look at both our, you know, our shipments and depletions, you know, information to get a sense for how we're performing. Certainly for us, when we look at syndicated, syndicated data, you know, in this case, Circana, we're doing that so that we can measure our relative performance against the categories in which we compete or the competitor, set in which we compete against, you know, as well as, you know, longer-term trends. So, you know, you need to try to look at our, our depletion and shipment data in a, in a combination when you're looking at our performance.
Right. Okay. And speaking of shipments, it's been a few abnormal years here during the COVID periods, right? And a lot of the summers you've had specific supply constraints and then sort of ramped up shipments post the summer. Just as we think about the quarterly cadence of shipments going forward in the back half of this year, next year, should we sort of be using shipments as a percent of the full year, looking at a pre-COVID level? Is that sort of... Are we back to normal or comping up against the last year or two is reasonable? How do you sort of think about that from a shipment standpoint, just given there's been so much volatility year-over-year in the last few years?
Yeah, and to answer that question, I'll touch on both shipments, you know, and depletions a little bit. And we'll start, you know, with shipments. And, you know, as I indicated, you know, we continue to feel good about how we're performing against our full year, our full year guidance, as well as, you know, the quarterly cadence, against our plan for the year. Now, as it relates specifically to shipments, as we said at the outset of the year, we're anticipating or expecting about 45% of our shipments to occur in the second half of the year. And that continues to be true. That continues to be our expectation.
Specific to Q3, if you, if you take out fiscal years 2021 and 2022, which, as you noted, you know, we had some, disruption in there, if you will, due to, you know, first COVID and then some, some weather-related disruptions, to our business. If you take those two years out, Q3 has typically accounted for about 23%-25% of our overall shipments in any given fiscal year. You know, that range is, is impacted by the number of weekend days in a particular quarter. You know, obviously, the more weekend days you have, the fewer shipping days you have. And so Q4, or Q3 rather, of FY 2024 has more weekend days than, say, Q3 of last year has.
So for this year, you think about that 23%-25% range, we're expecting to be somewhere in the midpoint of that range, around 24%, versus last year, we were closer to the high end of that range, or around 25%. Now, as it relates to depletions, you know, the second half of the year, you know, we typically see about 46% of our depletions occur in the second half of the year. And in Q3, you know, there's less of an impact on weekend days, right? So you have a little bit more sort of consistency, if you will, and so the range for depletions for Q3 is more in the 24%-25%. So it's again a bit of a tighter range.
And this year, we're expecting to again, kind of come in someplace in the midpoint from a depletions perspective.
Okay. That's helpful. And maybe shifting to wine and spirits, at Investor Day, you did adjust your longer-term targets. What gives you confidence in delivering these new targets, particularly with some of the struggles on the lower end from a category standpoint in wine, and after the portfolio shift you've seen in recent years, do you feel like you now have visibility that, that this business can deliver consistently going forward on your goals? And talk about your level of visibility.
Yeah, I mean, I mean, like, look, you know, I do think that we feel confident in our ability to deliver against the new revised, you know, goals. Certainly, you've seen that over the last several years, the transformation of the portfolio that we've been underway has really taken root and shown some positive results. You know, five years ago, about 68% of the net sales of the wine and spirits division came from brands in the mainstream price segment. And today, about 63% of our net sales comes from brands that are, you know, premium priced and above. So you know, that shift is underway.
What's underpinned that shift is the impact or the benefit of some of the M&A activity that we did, as well as divesting the majority, almost all of our mainstream, you know, brands. As we think about the impact that those M&A transactions have had, you look at brands like Meiomi and The Prisoner, for instance, and since we've acquired those, they've had a compound annual growth rate in the mid- to high 20% range. So we're, you know, we've gotten, you know, obviously good performance from those brands, and we expect that performance, you know, to continue into the future, as the consumer-led premiumization in wine, spirits, really across all beverage alcohol and consumer packaged goods, you know, continues.
We expect, you know, over the medium term, that the amount of, or the percentage of net sales derived from the high end will be, you know, 70, 70+% . Obviously, you know, we've talked about the renovations that we have underway with brands like Woodbridge and Svedka. And certainly we feel good about the path that they're on and the ability to stabilize those brands. That being said, they are large volume brands, and given some of the near-term challenges, they have weighed down, you know, our overall growth. Beyond the changes that we've made and are making to the portfolio, you know, Wine and Spirits has continued to invest in higher growth opportunities outside of the U.S. wholesale market.
U.S. wholesale is really where we've been participating almost exclusively, you know, for in the recent past. And we've invested in, like I say, higher growth opportunities in DTC and international. And, you know, in FY 2019, DTC and international only comprised about 10% of our overall performance. That was about 14% in FY 2023, and we expect that to be around 30% over the next several years, you know, FY 2028. Again, that's taking advantage of some of the consumer-led premiumization that's going on.
You know, that being said, you know, we, we did reduce, you know, guidance at our Investor Day, giving some of the near-term headwinds we're facing, and we lowered guidance to being down 1%-2% this year, but we maintained our operating margin target of +2%, or operating margin of +2% to +4%. You know, some of the, some of the near-term challenges that we're facing are, are primarily, but not exclusively, in the mainstream price segments. Certainly, we've seen the weakness that we've been experiencing in U.S. wholesale start to expand in some of the more mature international markets, like Canada and New Zealand and Australia and Italy. We've also seen some, some increased pricing competitiveness.
We've tried to be very disciplined, or we are being very disciplined from a pricing perspective, taking some targeted pricing actions on brands that we feel can hold that pricing. And once we take that pricing, we're looking to maintain that pricing. But we've seen a number of our competitors get more and more competitive on price in order to, you know, to drive, you know, to drive volumes. And then we've recently, you know, kind of back to some of the international headwinds we faced is we've seen in a market like Canada, where, you know, given some of the softness there, liquor control boards, in an effort to manage, you know, their inventory levels, have started to destock a little bit.
So those are all headwinds that we're facing, you know, in the near term and what drove our reduction in guidance for this year.
Okay. From here, the macro impact on the wine and spirits business, any thoughts there? How much risk that might pose, or is that sort of reflected in the revised guidance in your mind?
Look, I think that's, you know, reflected in the revised guidance for sure. You know, obviously, we're seeing, you know, we talked about the resiliency we're seeing in beer, but the premiumization trends in wine and spirits, you know, continue. And again, we now have a portfolio that's better, you know, oriented towards these consumer trends, and so we feel, you know, we feel good about the revised guidance.
Okay. Did I mention in the introduction that Modelo has become the number one off-premise brand in sales this year? Can you talk about growth opportunities for that brand going forward? What are the biggest growth opportunities, whether it be geographic, demographic, you know, channel expansion? How you think about the biggest growth opportunities from here? And also maybe give us a bit of a review in some of the areas where it's highly penetrated in those areas. How is the brand performing, that can sort of inform where longer-term share can go for the brand?
Yes, so we touched a little bit about this, but, you know, obviously, you know, the same drivers we have for the broader portfolio are there for Modelo Especial as well. You know, we talked about the 500,000 points of incremental distribution. You know, roughly half of those, slightly less than half of that, I should say, will be for Modelo Especial. Again, there certainly continue to be opportunities for us to expand that brand in terms of, you know, Texas, the Mid-South and the Southeast from a distribution perspective. Obviously a little bit less of an opportunity, you know, out West for that brand. While it's a smaller overall market for us, but the Northeast is an opportunity for Modelo Especial.
So, you know, again, distribution will be a big driver for Modelo Especial. You know, the demographic trends that we touched on, that's a brand that's still about 55% of the overall performance of that brand is tied to Hispanic consumers. So the demographic trends we outlined earlier will continue to be a driver of growth. You know, as we look to grow that brand, the 45% of that brand that is with the general consumer is another opportunity, because that's still, you know, under indexed relative to, say, Corona, where Corona does about 70% in the general market.
So, you know, we're able to hit the general market as well as continue to grow with the Hispanic consumer. And then if we look at things like household penetration or brand awareness, you know, while this brand has become the number 1 brand in the U.S. on a dollar sales basis, it still under indexes against Corona and some of its larger non-CBI beer competitors. So again, opportunity there. And then we've talked about innovation, building off the broad shoulders of Modelo is an opportunity for us.
Great! Well, we really appreciate you being here again. Thanks very much. It was very informative. Thank you.
Thank you, Darragh. Thank you. Thanks, everyone.