Fitch Affirms Constellation at 'BB+'; Outlook Stable
A full list of ratings is at the end of this release.
KEY RATING DRIVERS
Leading Market Positions
Constellation's ratings consider the company's leading market positions and well-known portfolio of wine, spirits and beer brands. According to the company, Constellation is the third largest U.S. beer company overall with 50% volume share in the import segment due to its Mexican beer portfolio that contains five of the top 15 U.S. imported beers.
Constellation is also one of the world's largest wine producers, with a good position in growing premium brands, and the producer of one of the fastest growing premium brand vodkas, Svedka. Constellation will need to focus though on improving wine growth as the company's performance declined in fiscal 2015 as the wine portfolio lagged the overall U.S. category causing wine dollar market share to erode slightly, driven by competition in the super-premium price segment. Fitch's forecast assumes modest growth in wine revenue for fiscal 2016 after a 1.2% decline in fiscal 2015.
Premiumization Driving Growth
The \$4.7 billion Modelo acquisition which closed in fiscal 2014, materially increased Constellation's diversity, scale and exposure to above average market growth rates in the beer segment. For fiscal year 2015, Constellation generated 60% of segment operating income from the beer business compared to approximately 40% in fiscal 2013 and grew beer depletion volumes by 8.3%. Fiscal year 2016 expectations for beer shipment volume growth is in the 6% range.
Comparatively, the overall U.S. beer industry increased in the low-single digits for 2014 after generally experiencing low-single digit declines during the past several years due to share loss as the millennial generation shifted preferences into wine and spirits along with a recessionary macroeconomic environment. As premiumization continues to affect the beer market, consumers are trading up for higher-quality, flavorful products in above-premium, super-premium including hard cider and flavored malt beverages, craft and import offerings. While several imported beer segments are experiencing declines, Mexican imports continue to grow and have been the primary imports growth driver during the past several years.
As such, Fitch believes Constellation is better positioned to capture long-term growth in the beer industry due to several factors including the expected sizeable increase in Hispanic consumers reaching the legal drinking age. Additionally, the company expects to grow distribution and expand drinking occasions by significantly increasing draft and can consumption. Constellation currently has low single digit penetration in these packaging formats, substantially lower than industry average.
Thus, Fitch expects Constellation will generate increased cash flows driven by the above strong underlying fundamentals, further leverage of new product development innovation, and the potential for increased cost of goods sold efficiencies as the company brings expansion capacity on-line. Fitch's forecast assumes gross margin expansion of 40 basis points in fiscal 2016 and another 70 basis points in fiscal 2017.
Leverage In-line with expectations, Improvement Anticipated
While total debt levels increased in fiscal 2015 due to sizeable new capital investment initiatives and the glass plant acquisition, the effect on leverage remained neutral. Leverage (total debt-to-EBITDA) was 4.2x at the end of fiscal year 2015, which is in-line with Fitch's expectations at the time of the Modelo acquisition closing for leverage at the lower end of the 4.0x-4.5x range.
Constellation is on-track to further reduce leverage through EBITDA growth to the upper 3x range during fiscal 2016. The substantial investments in the beer segment reflect stronger underlying growth in revenue, profitability and cash flows than previously anticipated. Lease adjusted funds from operations (FFO) gross leverage was approximately 5x as of Feb. 28, 2015. Fitch also expects FFO adjusted leverage to gradually improve over the forecast to the mid 4x range by fiscal 2017.
Solid Liquidity and Profitability Underpin Financial Profile
Free cash flow (FCF; defined as cash from operations less capital spending less dividends) for the latest 12 month (LTM) period ending Feb. 28, 2015 was \$362 million which was above Fitch's expectations of approximately \$300 million. Fitch's FCF expectations in fiscal year (FY) 2016 are for a deficit of \$100 million due to the peak in brewery investment for the Nava brewery and the initiation of a dividend (\$240 million in fiscal 2016). In FY2017, Fitch expects FCF of at least \$350 million as expansion capital spending ramps down.
The company had a cash position of \$67 million as of Nov. 30, 2014. Constellation had approximately \$606 million of availability under its \$850 million revolving secured credit facility that matures in 2018 as of Dec. 31, 2014. Constellation also has two accounts receivable securitization facilities that provide additional borrowing capacity from \$190 million up to \$290 million and from \$100 million up to \$160 million structured to account for the seasonality of the company's business. Availability on the facilities was \$275 million and \$110 million respectively as of Nov. 30, 2014.
Upcoming debt maturities in fiscal 2017 include \$700 million of 7.25% notes. Annual amortization requirements for the next three fiscal years are approximately \$129 million in FY2016, \$172 million in FY2017 and \$172 million in FY2018.
Constellation's profitability metrics are strong and relatively consistent, reflective of an investment grade profile. Metrics include FFO margin, EBIT, EBITDAR, FCF margin and profit volatility although FCF is under substantial pressure in fiscal 2016 before rebounding in fiscal 2017. Constellation estimates operating margins within the beer segment will increase to the mid-30s range from 31.9% for fiscal 2015 as production is consolidated to the more efficient Nava brewery beginning at the end of 2015 and continuing through mid-2016. Fitch believes this margin expansion opportunity is reasonable although timing could vary depending on execution. Constellation will leverage natural freight cost opportunities and the decrease in sourcing from non-owned breweries to better enable the operating leverage inherent within its fixed-cost structure.
Initiation of Quarterly Dividend
In April 2015, Constellation announced the company's first ever quarterly dividend. The initial quarterly cash dividend will be \$0.31 per share of class A common stock and \$0.28 per share of class B common stock. Over the longer term, Constellation will target its dividend payout ratio in the range of 25%-30% of net income, which Fitch views as an appropriate dividend payout.
Constellation had suspended share repurchases at the time of the initial announcement of the Modelo transaction to manage the company's financial metrics post-acquisition. Fitch expects Constellation will begin repurchasing shares in fiscal 2017 as FCF generation returns and leverage is less than 4x.
Assignment of Recovery Ratings
Fitch has assigned recovery ratings (RRs) to the various debt tranches in accordance with criteria, which allows for the assignment of recovery ratings for issuers with IDRs in the 'BB' category. Given the distance to default, recovery ratings in the 'BB' category are not computed by bespoke analysis. Instead, they serve as a label to reflect an estimate of the risk of these instruments relative to other instruments in the entity's capital structure.
Fitch has upgraded and assigned recovery ratings on CIH International's secured Euro term loans at 'BBB-/RR1' and for Constellation's secured revolving credit facility and term loan A facilities at 'BBB-/RR2' from 'BB+'. Constellation's bank obligations and the European borrower's bank obligations are secured by a 100% pledge of certain material U.S. subsidiaries and a 65% pledge of certain foreign subsidiaries and foreign holding companies. The European Borrower's obligations are additionally secured by a 100% direct pledge of certain other foreign subsidiaries which includes the Mexican brewery held by CIH Holdings Mexico and the IP rights at the CI Cerveza subsidiary.
Fitch believes the additional stock pledge for the European borrower reflects a superior recovery position at 'RR1'. Unsecured debt will typically achieve average recovery and the senior unsecured note at Constellation are therefore rated 'BB+/RR4'.
KEY ASSUMPTIONS
Additional key assumptions within Fitch's fiscal 2016 rating case for the issuer include:
--Consolidated revenue growth of almost 5% supported by shipment volume growth in the beer segment of approximately 6% and in the wine and spirits segment of approximately 0.5%;
--Gross margin improving 40 basis points to 44.2% in fiscal 2016 and another 70 basis points in fiscal 2017;
--Operating income margin improvement for the beer segment of approximately 100 basis points to 33%; slight decline in operating income margin in the wine and spirits segment to the low 23% range;
--EBITDA growth of 8% to \$1.9 billion;
--FCF deficit of approximately \$100 million with FCF improving in fiscal 2017 to approximately \$350 million for a FCF margin of approximately 5%;
--Total debt to EBITDA leverage of 3.8x-3.9x by the end of FY2016 with the potential for further improvement to the mid 3x range in FY2017 depending on capital allocation decisions.
RATING SENSITIVITIES
While a ratings upgrade is not anticipated over the next 12 months, future developments that may, individually or collectively, lead to a positive rating action include:
--Leverage such that total debt-to-operating EBITDA is under 3.5x or FFO adjusted leverage is under 4.5x on a sustained basis;
--Stable volume trends for their primary brands;
--Maintain EBIT margin in the mid 20% range and EBITDAR margin of at least 30%;
--Demonstrated ability to improve and sustain FCF margin above 3.5%.
Future developments that may, individually or collectively, lead to a negative rating action include:
--Deterioration in volume trends leading to market share losses;
--Significant and ongoing deterioration in profitability due to competitive activity;
--Increased leverage such that total debt-to-operating EBITDA moves above the low 4x range or FFO adjusted leverage that moves above the low 5x range on a sustained basis.
Fitch has taken the following actions, including assigning recovery ratings as follows.
Fitch has affirmed the following ratings:
Constellation (Parent)
--Long-term IDR at 'BB+';
--Senior unsecured notes at 'BB+/RR4'.
CIH International S.a.r.l. (Wholly Owned Subsidiary)
--Long-term IDR at 'BB+'.
Fitch has upgraded the following ratings:
Constellation
--\$850 million senior secured revolver facility to 'BBB-/RR2' from 'BB+';
--\$477 million senior secured term loan A to 'BBB-/RR2' from 'BB+';
--\$243 million senior secured term loan A-1 to 'BBB-/RR2' from 'BB+';
--\$624 million senior secured term loan A-2 to 'BBB-/RR2' from 'BB+.
CIH International S.a.r.l.
--\$463 million European senior secured term loan A to 'BBB-/RR1' from 'BB+;
--\$985 million European senior secured term loan B-1 to 'BBB-/RR1' from 'BB+.
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