Beer Still Flows, Recession or Not

Around 5,300 BCE in Mesopotamia, the first beer came into being...

Today, beer is the most popular alcoholic beverage and the third most popular drink of any kind in the world (after water and tea). Not only does beer have staying power, it also has loads of brand loyalty. Folks tend to like the beer they like, and it doesn't change much during their lifetimes – even during pandemics.

And in February, the U.S. economy officially entered a pandemic-driven recession, according to the National Bureau of Economic Research. Unemployment soared, and consumer spending plummeted.

But the alcoholic-beverage industry is generally recession-resistant. People will always find a way to drink, no matter what's happening with the economy. This was true in both 2001 and 2008. And we could see the same in 2020.

And today's company showed strength throughout those difficult times...

Constellation Brands (NYSE: STZ) owns several market-leading brands, including the No. 1 imported beer in the U.S. (Corona), the No. 1 sauvignon blanc in the U.S. (Kim Crawford), the No. 1 pinot noir in the U.S. (Meiomi), and the No. 1 imported vodka in the U.S. (Svedka).

It's a fantastic business that gushes free cash flow ("FCF"), has an excellent balance sheet, strong margins, and high returns on equity. And we expect that once the COVID-19 pandemic passes, Constellation will continue to raise its dividend and possibly buy back shares.

The company has a history of performing well in tough times...

Constellation didn't miss a beat during the past two recessions. It strengthened, just as you'd expect from a great company.

Constellation entered the 2001 recession with 31.6% gross margins, 11.5% operating margins, and 2% FCF margins. It exited the recession with all margins slightly higher at 32.1%, 12.1%, and 5.3%, respectively.

The Great Recession lasted twice as long (December 2007 to September 2009), but the result was largely the same. Constellation's gross margins grew from 32.6% to 36.6%, and its operating margins grew from 13.1% to 17.1%. Its FCF margins fell slightly (from 10% to 8.3%), but they did average 10% across the entire period.

What's more, roughly 85% of Constellation's business is done "off premise" – at places like grocery stores, liquor stores, and outlets. As hundreds of millions of Americans sheltered in place during this crisis, folks had to do their drinking at home instead of in bars and restaurants.

And we just got an idea of how the pandemic is boosting business...

Last week, Constellation reported its first-quarter results. Both earnings and sales topped Wall Street's expectations. It grew gross margins to 50.3%, from 49.1%. It also increased its operating margins to 31.1%, from 29.7%. Constellation produced FCF margins of 27.6%, up from 20.8% in the same quarter of 2019.

So just like the last two recessions, Constellation improved its already strong business this time around.

The company also made comments on how demand has been impacted by the coronavirus outbreak...

CEO Bill Newlands said the company continues to see strong demand despite the pandemic's headwinds on consumer spending.

In Constellation's beer business, which makes up 67% of sales, off-premise sales grew by 20% in the quarter. And so far in 2020, off-premise sales are up 16%. As we noted above, this represents people buying Constellation products at grocery stores and liquor stores.

So people stocked up on beer and wine as coronavirus lockdowns went into effect. And this segment should continue to show strength as fears rise of a "second wave" of coronavirus cases across the U.S.

On the company's earnings call, CFO Garth Hankinson said that the strong at-home consumer demand "more than offset" the steep declines in "on-premise" (bar and restaurant) sales. This led to the company saying it believes both the short-term and long-term outlooks for sales are "extremely bright."

The report sent Constellation shares 6% higher on the next trading day. This continued the stock's impressive recovery after the initial market sell-off in February and March. Since hitting a multiyear low on March 23, Constellation's stock has soared more than 75%.

Constellation has some of the top beer and wine brands in the U.S., which have incredible customer loyalty. And its recent earnings report shows that it continues to deliver strong performance during tough times. That should remain a tailwind for the company's shares.

Sometimes investing is simple.