Constellation Brands (STZ) stock dropped over 13% after the producer of popular beer brands like Corona and Modelo beer posted lower-than-expected fiscal Q3 sales. However, its free cash flow (FCF) remained strong and management raised the FCF outlook. Could STZ stock be a bargain here?
STZ was trading at $189.23 in late morning markets, down over 13.5% from its closing price of $219.28 yesterday. A month ago on Dec. 9, it was at $244.31, a $55 drop or -22.5%.
Investors were disappointed that sales were lower than last year and lower than expected. Nevertheless, management raised its outlook for FCF for the year ending Feb. 28.
So, what is going on here? Could STZ be a bargain here for value investors? This article will delve into that, as well as a way to play it.
Lower Revenue But Strong Free Cash Flow
Constellation reported that sales for the quarter ending Nov. 30 were slightly lower (less than 1%) than last year. According to Seeking Alpha's estimates, investors were expecting a 2.7% higher sales figure for the quarter (i.e., $2.53 billion vs. $2.46 billion actual).
However, year-to-date (YTD) sales were 2.8% higher than last year's YTD figures (i.e., $8.0445 b vs. $$7.8226 b). Moreover, the company reported higher free cash flow (FCF) both YTD and for its outlook for the full year.
For example, in the nine months ending Nov. 30, FCF hit $1.63 billion vs. $1.434 billion last year - a +13.3% YoY gain. In Q2, its FCF YoY gain was just 12.4% gain.
However, look at the table below that was not in the earnings release. This is an analysis of the company's FCF margins I put together.
It shows that the YTD FCF margin was significantly higher than last year. That means that the YTD $1.6 billion in free cash flow (FCF) represented 20.2% of YTD sales, vs. 18.2% of sales a year ago.
In other words, after reporting 2.8% higher YTD sales, Constellation Brands also squeezed out higher free cash flow: i.e., 20% of sales vs. 18% last year.
This is an example of operating leverage - higher sales lead to accelerating cash flow profitability. That should imply that Constellation's market value is improving, not falling as today's stock price shows.
So, what is STZ stock worth?
Valuing STZ Stock
First, let's estimate the annual free cash flow figure using FCF margin analysis. Then we can value STZ stock using an FCF yield metric.
Fortunately, management has already given us a range for FCF this year. In today's earnings release, Constellation provided a range of between $1.6 billion and $1.8 billion for the year ending Feb. 28, 2025 (which was higher than last quarter's $1.4 b to $1.5b FCF guidance).
Using a midpoint of $1.7 billion of FCF and analysts' revenue estimates of $10.37 billion this year represents an annualized FCF margin of 16.4%:
$1.7b / $10.37b = 0.1639 = 16.4%
But that is lower than its 20% FCF margin already achieved YTD (see above), so it seems too low. Moreover, the markets look forward so we should factor in next year's sales estimates of $10.99 billion:
0.20 x $10.99 billion 2025 sales (year ending 2/28/26) = $2.198 billion
So, let's average these two estimates: $1.7 billion for this fiscal year ending Feb. 28, 2025, and $2.2 billion next year: i.e., $1.95 billion or roughly $2 billion FCF
Next, let's assume that the market would give the stock at least a 5.5% dividend yield were it to pay out 100% of its FCF. (This is because its FCF payout ratio is about one-third and its yield was 1.84% before today, so the inverse of ⅓ is 3 times 1.84% = 5.52%).
Therefore, we can value STZ stock by dividing the FCF estimate by 5.5%:
$2b / 0.055 = $36.4 billion market cap estimate
That is +7% higher than today's market cap of $34 billion. That implies STZ could be worth $202 per share (1.07 x $189).
Moreover, using next year's FCF estimate of $2.2 billion raises the market cap estimate to $40 billion (i.e., $2.2b/0.055), or 17.6% higher (i.e., $222 per share). On average our price target estimate is $212 per share.
Shorting OTM Puts
One way to play this, setting a lower buy-in target price and also getting paid to wait, is to sell short out-of-the-money (OTM) put options in nearby expiry periods.
For example, look at the Jan. 31 expiration period, which is 21 days to expiry.
The $180 strike price puts have a bid-side premium of $1.95. That means that a short seller who secures $18,000 in cash can enter an order to “Sell to Open” this strike price put option and immediately receive $195.00
As a result, the yield to the cash-secured put seller is 1.0833% for the next 3 weeks: (i.e., $195/ $18,000 = 0.010833).
This is also a cheap way to buy into STZ stock. For example, if it falls to $180 in the next 3 weeks, the investor has net buy-in price of $180-$1.95, or $178.05. That is 4.3% below today's price.
More risk-averse investors can short the $175.00 strike price put options for a lower yield of 0.66% (i.e., $1.15/$175.00 = 0.00657). Moreover, their net buy-in price could potentially be $173.85, or 6.5% below today's price.
The bottom line is that these investors will have an even higher upside potential as well as a higher dividend yield. For example, at $178.05, the investor has an expected return of 11.8% (i.e., $212/$178.05 -01 = 0.1179, or +11.8%). Moreover, their dividend yield would now be 2.269% vs. 2.17% today.
The bottom line is that STZ stock looks cheap today. Value investors may want to sell short cash-secured puts to set a lower buy-in price target and to get paid while waiting.
