About the paper
The paper is commissioned to conduct financial analysis for Constellation Brand Inc. As part of analyzing the financial performance of the company, we will be using the tool of financial ratios and will then analyze trends over the past two years. However, since the objective of this paper is to achieve a comprehensive analysis of the company, multiple financial ratios will be used to achieve the objective.
However, before initiating with the quantitative work, we will perform a brief environmental scan for the company and will discuss the factors that must be contented by the company in order to assure that the business model is successful.
The paper will finally be culminated with a recommendation over the overall standing of the company and whether it is suitable to be included in the portfolio.
Environmental Scan
Founded in the year 1945, Constellation Brand at present,enjoys the status of largest wine producer in the world with sales volume of $6028 million as of 2015. Moreover, aggressive geographic expansion to 100 countries, has enhanced the brand equity of the company. In addition, as part of its business model, the company has largely relied on acquisitions and internal expansion to leverage its vintage presence amongst all the segments of the beverage and alcohol industry.
However, as the company enters new markets, it will need to ensure compliance with the regulation of the local government and norms. Hence, if any overseas government regulation requires the company to alter the product feature or its composition, it will need to adhere accordingly in order to ensure the presence of the brand in the target market.
Similarly, as the company sticks to its old business model of generating growth through acquisitions, it needs to be sure that management tussle should not affect the brand performance and the policies should run smoothly.
Ratio Analysis
This is the core section of this report as part of which, we will be using the raw financial figures of the company for the past two years and will run them through the microscope of financial ratios to analyze the past-year trend. Calculated below are the financial ratios of the company followed by a discussion after each ratio section:
a)Liquidity Analysis
-Current Ratio: Current Assets/ Current Liabilities
2014: 2747/2026= 1.35
2015: 2911/1131= 2.57
-Quick Ratio: (Cash+ Receivables)/ Current Liabilities
2014: (64+626)/2026=0.34
2015: (110+599)/1131= 0.62
Referring to the above figures, we can see that over the period, the liquidity position of the company has improved significantly. We analyzed the liquidity position using the current ratio and quick ratio and both the ratios indicated an increasing trend. As for current ratio, the multiple surged from 1.35 to 2.57 on account of 5.97% increase in the current assets of the company while the current liabilities decreased by -44.18%. On the other hand, quick ratio, which is a more stringent measure of the liquidity assessment of the company, also increased from 0.34 to 0.62 on account of 71.88% increase in the cash position during 014-5, while the current liabilities plummeted by -44.18% during the same period.
b) Efficiency Analysis
-Inventory Holding Period: (365*Inventory) / Cost of Goods Sold
2014: (365*1744)/2876= 221.33 days
2015: (365*1827)/3449= 193.34 days
-Average Collection Period: (365* Receivables)/ Revenue
2014: (365*626)/4868= 46.93 Days
2015: (365*599)/6028= 36.26 Days
The above two ratios were calculated to access the efficiency of the management of the company and how well they are utilizing the asset base of the company. As for the inventory holding period, the multiple decreased from 221 days to 193 days, thus confirming that during 2015, it took less time for the company to sell its inventory relative to 2014. On the other hand, the average collection period also decreased from 46 days to 36 days. This indicates that during 2015, the company was able to collect its receivable at a lesser period of time compared to 2014.
Therefore, the above trend confirms that the management of Constellation Brands Inc. has been efficient in terms of the utilization of the asset base.
c) Solvency Ratio:
Debt Ratio: Total Debt/ Total Assets
2014: (6374+590)/14302= 0.48
2015: (7136+158)/15144= 0.48
Solvency ratios assist the analyst in understanding the risk level embedded in the capital structure of the company. In order to access the solvency position of we calculated the debt ratio of the company. This ratio indicates the percentage of total assets financed with the debt borrowings. Our calculation revealed that over the year, there has been no change in the debt ratio multiple and it stands constant a 48%.
d) DuPont Analysis:
ROE: (Net Income/Revenue)*(Revenue/ Total Assets)* (Total Assets/ Total Equity)
2014: (1943.1/4867.7)*(5411/14302.1)* (14302.1/4981.3)
= 39.91* 0.37*2.87
= 42.38%
2015: (839.3/6028)*(6028/15144.5)*(15144.5/5881.3)
= 13.92*0.39*2.57
= 13.97%
Unlike the traditional method of analyzing the ROE multiple as the ratio of net income to total assets, we decoded the ROE multiple using the Dupont Identity to analyze the real avenues of profitability of the company.
Our calculation revealed that during the year, the ROE multiple declined from 42.38% to 13.97%, largely on account of a significant fall in the net profit margin from 39.91% to 13.92%. However, a meticulous observation of the income statement of the company revealed that during 2014, the company made a one-time profit of $1642 million on the remeasurement of equity investment. Therefore, eliminating the adjustment, the net profit margin was still strong in 2015.
Other than this, the asset turnover ratio of the company has also increased from 0.37 to 0.39. This indicates that over the year, the management was efficiently using its asset base and generated higher revenue per unit of the asset available.
Lastly, we witnessed that the equity multiplier of the company has also decreased from 2.87 to 2.57. This confirms that the company has now adopted a lower leverage capital structure and has thus generated profitability with lower risk level.
d) Other Calculations:
i)Dividend Yield: Dividend per share/ Market Price per share
*Constellations Brand Inc. does not pay any dividend
ii) Free Cash Flow: Cash Flow from Operations+ Interest(1-tax rate)- Changes in Fixed Capital Investments
2014: 826+323.2*(1-0.1177)- (2939-2047)= $219.15 million
2015: 1081+337.7*(1-0.2911)-(3732-2939)= $527.39 million
iii)Return on Equity: Risk free rate+ beta(Equity Risk premium)
= 1.88+ 0.84(6)
= 6.92%
Here:
Risk free rate= 10-year US treasury bond yield
Beta= Volatility of the stock against the market index
Equity Risk Premium: Excess returns of the market index over the risk free rate
iv) Market Value Added: Market Value of Debt and Equity - Book Value of Capital Investment(Debt and Equity)
= (5400+27116.5)-(6963.3+5770.7)
= 32516.5-12734
= $19782.5 million
Calculative Notes:
-Market Value of Debt: $5400 million
-Book Value of Debt= Short-term debt+ Long-term debt
= 590+6373
= $6963.3 million
-Market Value of Equity: Total Shares outstanding* Market Price/ share
= 193* 140.50
= $27116.5 million
-Book Value of Equity: $5770.7 million
v)Economic Value Added: Net Operating Profit after taxes- (Capital Employed* Cost of Capital)
2015: 1500.2*(1-0.2911)- (14013.8* 0.0633)
= 1063.49+ 887.07
= 1950.56 million
Calculative Notes:
-Capital Employed: Total Assets- Current Liabilities
= (15144.5- 1130.7)
= $14013.8 million
-Cost of Capital: Weight of Debt* Cost of Debt(1-tax rate)+ Weight of Equity* Cost of Equity
= 0.1617*0.0463(1-0.2911)+ 0.8383* 0.0692
= .0053+ 0.0580
= 6.33%
-Market Value of Debt: $5400 million
-Market Value of Equity: Total Shares outstanding* Market Price/ share
= 199.24* 140.50
= $27993.22 million
-Weight of Debt:
=5400/(5400+27993.22)
= 16.17%
-Cost of Debt: Interest Expense/ Total Debt
= 337.7/(158.1+7137.5)
= 4.63%
-Effective Tax Rate= 29.11%
-Weight of Equity: 1-Weight of Debt
= 1-0.1617
= 83.83%
-Cost of Equity: Risk free rate+ beta(Equity Risk premium)
= 1.88+ 0.84(6)
= 6.92%
Here:
Risk free rate= 10-year US treasury bond yield
Beta= Volatility of the stock against the market index
Equity Risk Premium: Excess returns of the market index over the risk free rate
Analyzing New Project through Capital Budgeting
During January, 2016, Constellation Brands Inc. announced that under the plan of expansion of its production capacity, the company will construct a new, start-of-the-art brewery in Mexicali, Mexico. The company announced that while initially, the brewery will have the production capacity of 10 million hectoliters, but the company may scale to 20 million hectoliters in the near future. Highlighted below are the costs related to the project:
The construction at site will cost $1.5 billion and the construction is expected to be completed in 4-5 years
Additional investment of $500 million will be required for land, water rights and other site related expenses
In addition to the detailing the costs related to the project, the company also cites that the investment is expected to generate high returns as the beer business of the company have strong profit margins and offers a high Return on Invested Capital(ROIC). On these basis, we forecasted following cash flows for the company, assuming that suitable projections can be made for 5-years only:
Therefore, using the above information, and cost of capital(6.33%), calculated in the preceding section, we calculate the NPV of the project:
As we can see from the above table, the NPVof the project is positive and this confirms that the project will enhance the wealth of the shareholders, and should be accepted by the entity.
CVP Analysis
Assuming that the company is interested to understand the break-even sales volume to be derived from the production units of the new facility. In this case, the company can use Cost-Volume-Profit (CVP) Analysis to evaluate the problem:
Sales price per unit: $15
Variable cost per unit: $7
Fixed Cost of Production: $3000000
Break-Even Volume will be: Fixed Cost/ (Sales- Variable Costs)
= 3000000/(15-7)
= 375000 units
Henceforth, in order to achieve the break-even level,the company must sell 3,75,000 units.
Recommendation: Excellent
After considering the outcome of all the calculations, we believe that Constellation Brands Inc. is operating with a bullish financial standing. The company has displayed a strong performance in terms of liquidity, profitability, solvency and efficiency. Apart from this, the increasing free cash flow and positive market value added and economic value added also validates our conclusion that the company deserves a recommendation of ‘Strong buy’ as vintage brand equity, strong financial standing, optimistic future forecasts and profitable capital projects will allow the company to maintain the momentum and will eventually benefit the shareholders in term of strong profitability.
References
CNBC. (n.d.). US 10 year treasury yield. Retrieved December 3, 2015, from http://data.cnbc.com/quotes/US10Y
Constellation Brands Inc. (2015). Annual Report 2015. Constellation Brands Inc.
Cost Volume Profit Analysis. (n.d.). Retrieved February 26, 2016, from http://accountingexplained.com/managerial/cvp-analysis/
Damodaran, A. (n.d.). Equity Risk Premium. Retrieved October 27, 2015, from http://pages.stern.nyu.edu/~adamodar/
Key Statistics: Constellation Brands Inc. (n.d.). Retrieved March 11, 2016, from Reuters: http://in.reuters.com/finance/stocks/overview?symbol=STZ.N
Martin, A. (2016, January 7). Constellation Brands To Build New 10 Million Hectoliter Brewery In Mexicali, Mexico. Retrieved March 11, 2016, from http://www.cbrands.com/news-media/constellation-brands-build-new-10-million-hectoliter-brewery-mexicali-mexico-and-further-
Profile: Constellation Brands Inc. (n.d.). Retrieved March 11, 2016, from Yahoo Finance: https://in.finance.yahoo.com/q/pr?s=STZ
Appendix:
Common Size Income Statement
Common Size Balance Sheet
