Constellation Brands (STZ), the maker of Corona and Modelo beers, will likely hike its dividend on April 10 when it announces fiscal year-end earnings. STZ stock looks undervalued. This is based on its average yield over the past five years and the company's strong free cash flow (FCF).
STZ is at $184.01 today, well off its 6-month high of $244.31 on Dec. 9, 2024, although up from a low of $161.05 on Feb. 12. STZ is down based on fears of tariffs, as its beer plants are located in Mexico, and the effect this will have on future sales.
But have these fears gone too far? After all, it's highly likely that the company will continue to produce strong free cash flow (FCF) and can afford to raise its dividend.
Free Cash Flow
Constellation Brands has already announced it expects to make strong free cash flow for its fiscal year ending Feb. 28, 2025. I discussed this in my Barchart article on January 10, “Constellation Brands Stock Tanks on Earnings, But FCF Stays Strong - Is It a Bargain?”
For example, look at this guidance it provided on page 17 of last quarter's earnings release.
This shows that Constellation expects between $1.6 and $1.8 billion in free cash flow this year. Moreover, analysts expect that revenue will be $10.18 billion. That means that its expected FCF margin will be almost 17% this year, using the midpoint:
$1.7 billion midpoint FCF / $10.17 billion sales FY 2025 = 0.167 = 16.7% FCF margin
Dividend Hike
Therefore, we can project its FCF next year and see if that will be enough to cover a dividend hike. That might lead us to a conclusion about whether STZ is undervalued.
For example, despite fears of tariffs, analysts still expect to see the company with higher sales in FY 2026. For example, Seeking Alpha's survey shows 22 analysts have an average revenue estimate rising 3.6% to $10.55 billion. This is the same at Yahoo! Finance.
So, if we apply a 16.7% FCF margin estimate against these revenue forecasts, we can estimate its future FCF:
0.167 FCF margin x $10.55 billion FY 2026 sales = $1.762 billion FCF
That will be more than enough for the company to pay its existing dividend per share (DPS) of $4.04, since there are 180.7 million shares outstanding:
$4.04 DPS x $180.7m shs = $730 million annual dividend cost.
Moreover, Constellation might conservatively raise its DPS by half of last year's 13.5% dividend hike (from $3.56 per share to $4.04) - or +6.756%:
$4.04 DPS x (1+(0.5 x .135)) = $4.04 x 1.0675 = $4.312 DPS
Constellation could afford this, since the cost would be less than its expected FCF:
$4.312 DPS x 180.7 m shares = $779.2 million dividend cost
$1.762 b FCF / 0.7792 b dividend = 2.26x dividend cover
In other words, the 6.75% higher dividend would still be only take up 44% of its expected FCF (i.e., $0.779b dividend cost/ $1.762b FCF).
So, what does this mean for the stock price? Let's look at its average dividend yield.
Price Targets
Right now, STZ stock has a 2.196% annual dividend yield:
$4.04 DPS / $184.01 = 0.02195 = 2.196% yield
However, Morningstar reports that STZ's average dividend yield has been lower at 1.43% over the last 5 years. Moreover, Yahoo! Finance reports that its 5-year average has been 1.46%.
Therefore, if STZ stock were to trade at this dividend yield, it would be worth considerably more:
$4.04 DPS / 0.0146 yield = $276.71, i.e., +50% from today's price
But, just to be conservative, let's use a higher yield of 2.0% and apply it to the expected new DPS of $2.312:
$4.312 DPS / 0.02 = $215.60 - i.e., +17.2% higher than today.
This is close to analysts' price targets. For example, Yahoo! Finance reports that 26 analysts have an average price target of $229.24 per share. Similarly, Barchart's mean survey is $229.74 per share.
Moreover, AnaChart.com reports that 24 analysts have an average target of $230.63 per share. The bottom line is that most analysts see the stock as too cheap here.
What if There is No Dividend Hike?
If we assume that the market will eventually value Constellation Brands' FCF with a 5.0% FCF yield (i.e., 20x FCF), its market cap will rise to $35.24 billion, or 6% more than today:
$1.762b / 0.05 = $35.24 b est. mkt cap
$35.24b / $33.23 b mkt cap today = 1.06 = +0.6% higher
That implies, on a minimum basis, even if the company doesn't raise the dividend, that its value is worth 195.05 per share:
1.06 x $184.01 price = $195.05 price target, even with no DPS hike
The bottom line here is that STZ stock looks too cheap. But there is no way to know when it has bottomed out. After all, the tariff saga between the U.S. and Mexico could continue for some time.
As a result, one way to conservatively play STZ is to set a lower buy-in target price by shorting out-of-the-money (OTM) puts.
Shorting OTM Puts
For example, the $175 strike price puts expiring April 25, 2025, has a high premium of $4.55 in the midprice. That strike price is over 4% below today's price, so it is well out-of-the-money (OTM) for an expiry date that is about three weeks from now.
This means that a cash-secured short-seller of the puts can make an immediate yield of 2.60% (i.e., $4.55/$175.00) over the next 24 days to expiry (DTE).
That is a very good yield, especially since it means that the investor will have a much lower breakeven price of $175.00 - $4.55, or $170.45 even if STZ falls further. That is over 7.3% below today's trading price.
Moreover, the delta ratio is low at just 31%, implying less than one-third chance that the stock will fall to $175.00. However, more risk-averse investors can sell short the $170 strike price puts and still make a good yield of 1.85% (i.e., $3.15/$170) over the next 3 weeks.
Investors should study the risks associated with shorting OTM puts by going to the Barchart Learning Center, such as the Options Trading Risk tab.
The bottom line is that STZ looks deeply undervalued here. One way to play this is to buy STZ shares and/or short OTM puts in nearby expiry periods.
