Summary

• Warren Buffett's Berkshire Hathaway acquired a $1.24 billion stake in alcoholic beverage producer Constellation Brands, likely valuing the company's long and stable earnings growth track record.

• Despite the strong history, Constellation's earnings have major risks as the U.S. spirit industry is struggling and Trump's potential tariff on Mexico would have major implications on Constellation.

• Overall, earnings should still stay stable with Constellation's extremely high margins, and I estimate a $178 fair value - as the stock has fallen, the concerns are likely priced in.

Corona Extra Beer

Constellation Brands, Inc. produces and sells a portfolio of alcoholic drinks, including the Modelo and Corona beer brands, spirits like Casa Noble Tequila and Mi Campo, and a number of wine brands. The stock has recently attracted Warren Buffett’s interest, as Buffett’s investment giant Berkshire Hathaway (BRK.B) (BRK.A) bought a $1.24 billion stake in the company during Q4.

The bought position follows a downward trend for Constellation’s stock. Constellation’s financial performance has mostly remained stable amid weakness in the industry, but the most recent quarterly report did show increasing signs of weakening demand in the spirit & wine category. Combined with major concerns over a potential 25% tariff on Mexican imports, the stock has lost -34% of its value after I upgraded my rating to Hold in my previous July 2024 article on the stock, titled “Constellation Brands: Now Fairly Valued As Q1 Continues Growth Momentum”. The return compares to S&P 500’s return of 10% in the same period.

My Rating History on STZ (Seeking Alpha)

Warren Buffett’s Berkshire Hathaway Buys a Stake in Constellation Brands

With institutional investment managers filing 13-F filings to disclose fund holdings at the end of Q4, Warren Buffett’s investment giant Berkshire Hathaway revealed a notable stake in Constellation among the company’s other trades. The company has acquired around 5.6 million shares in Constellation during Q4, making the position worth around $1.24 billion at the end of Q4. Of Berkshire Hathaway’s holdings in publicly traded stocks, the new stake in Constellation is the 19th largest, worth 0.5% of the company’s combined portfolio. The stake represents around 3% of Constellation’s outstanding shares.

Interestingly, Constellation isn’t Berkshire Hathaway’s only position in an alcohol producer. Berkshire Hathaway previously bought a stake in major alcohol conglomerate Diageo (DEO) in Q1 of 2023, which the company has since held on to. Notably, though, Berkshire Hathaway seems to hold much better conviction in Constellation – the stake in Diageo is only worth $29 million.

Tariff Concerns, Industry Weakness Weigh on Historically Stable Earnings Growth

After very stable earnings growth in the long term, Constellation’s financial performance has had very slight shadows against a weak industry backdrop. After still stronger previous quarters, the most recent fiscal Q3 report turned more sour – revenues declined -0.4% to $2.46 billion after historically moderate but stable growth, and operating income declined -2.0% to $802 million with both sales and earnings missing Wall Street’s expectations and causing the stock’s most wide single-day decline in a decade.

Author's Calculation Using TIKR Data

Notably, the company’s beer portfolio has still performed very well as Pacifico sales continue to grow, and the larger beer brands continue to defend and even expand already significant market positions. In Q3, beer category sales grew 3% to $2.03 billion and earnings stood strong at a 37.9% operating margin, down a slight 0.6 percentage points year-on-year due to increased marketing spend. Total industry beer sales are still expected to grow going forward in the US, albeit at a slow pace, and Constellation has performed very well in the category. According to Nielsen’s data, Constellation’s good beer category performance has continued into the fiscal Q4 period as well.

Causing the financial slowdown and a weaker outlook, Constellation’s spirit & wine portfolio has performed very poorly against an already weak industry. The category’s sales declined -14% in Q3 to $431 million, and the operating margin declined 3.3 percentage points to 22.1%. The category’s results have already been weak previously, but the Q3 performance deepened along with industry-wide issues; younger people are drinking less and consumers have generally been cautious, for example leading to Brown-Forman’s (BF.B) declining sales and recent layoffs, and Diageo’s recently declining US sales among other spirit producers’ struggles.

While the overall earnings performance has so far still been quite stable, as a more notable threat, the potential tariff on Mexico could have a major impact on Constellation. Around 85% of the company’s revenues are generated from Mexican imports, and the company generates almost all of its revenues from the US – a 25% tariff by President Donald Trump on Mexican goods would cause major pressure on Constellation’s earnings, as the tariff would impose major cost pressure on Constellation with an additional 25% payment on input costs from Mexican imports to the US. Although Constellation could push some of the additional cost onto consumers, the company’s brands would likely lose ground against US-produced beers and spirits. The tariff on Mexico is still currently on hold as implementation is being postponed amid political discussions; the tariff may ultimately never come into effect, which would be a major positive for Constellation as the tariff risk is significant for the company.

Ultimately, despite the looming risks in industry-wide sales and tariffs, Constellation should continue to generate very healthy earnings. The company’s Q3 operating margin still stood high at 32.5%, making overall minor sales turbulence not as large of a threat. Constellation’s great beer portfolio has also continued to show strong momentum against industry trends, and the severely weak spirit and wine portfolio only represents less than a fifth of Constellation’s overall sales. The tariff risk seems more notable than the spirit industry’s weakness, but its implementation and impact on Constellation largely remain uncertain.

Berkshire Hathaway’s currently disclosed position in Constellation was built during Q4, prior to the most recent quarterly report and recent tariff discussions – the company likely valued Constellation’s longstanding, stable earnings growth at a historically quite low valuation, as Constellation’s forward P/E now stands moderate at 12.1. The stake did still defy Trump’s tariff proposals that were already previously announced in late 2024.

Constellation’s Valuation Remains Balanced Due To The Uncertainties

I updated my discounted cash flow (DCF) model for Constellation’s stock, now estimating a slightly worse long-term industry performance and pricing in potential tariff impacts.

Due to uncertainties in the spirit industry and from tariffs, I estimate Constellation’s revenue growth to have a slight hiccup in the next couple of years with growth of just 1.5% in FY2026, and slightly slower 3.6% growth in FY2027. Afterwards, I still expect Constellation’s strong beer portfolio to drive growth, contributing to a 3.3% CAGR from FY2024 to FY2034. After FY2034, I lowered my perpetual growth estimate to 2% due to industry concerns.

The tariffs look to add margin pressure on Constellation as the full price impact may not be passed onto consumers. I estimate the EBIT margin to fall to 31.5% from an estimated 34.0% in FY2025, still staying high despite spirit margin concerns also contributing towards margin pressure.

Constellation’s free cash flow should be relatively stable, but likely to be somewhat pressured by heightened capital expenditures and working capital increases.

DCF Model (Author's Calculation)

The estimates put Constellation’s fair value estimate at $177.6, 9% above the stock price at the time of writing. Although the stock has fallen very notably after my previous article, I again believe that the stock is roughly fairly valued with a fair margin of safety. The weaker industry outlook and potential tariff on Mexico are priced in as considerable risks for a reason, while I believe that Constellation’s earnings should overall stay quite stable regardless. The potential tariff’s impact is still very uncertain, and could also cause a much smaller or higher earnings hiccup.

The fair value estimate is down from $235.66 previously.

CAPM

The DCF model uses a cost of capital [WACC] of 7.24%, derived from a capital asset pricing model:

CAPM (Author's Calculation)

I estimate a 3.61% interest rate, annualized from the most recent quarter’s interest expenses and debt. As Constellation’s equity valuation has declined, I now estimate a slightly higher 30% long-term debt-to-equity, still being moderate.

For cost of equity, I use the 10-year bond yield of 4.48% as the risk-free rate. The equity risk premium of 4.33% is Professor Aswath Damodaran’s most recent January estimate for the US. I have kept the beta estimate at 0.56. With an ESG add-on of 1.5% and a liquidity premium of 0.2%, the cost of equity stands at 8.60% and the WACC at 7.24%.

Takeaway

Berkshire Hathaway bought a notable stake in Constellation during Q4, likely valuing the company’s long history of stably growing earnings. At the same time, though, the current earnings outlook has two weak points after recent developments – especially the spirit industry has shown weakness in the US, carrying onto Constellation’s already weak performance in the relatively small segment. At the same time, Constellation manufactures the clear majority of its products in Mexico, and Trump’s potential tariffs could add considerable pressure on either sales volume or margins, depending on Constellation’s pricing strategy.

The stock has fallen considerably and already prices in the noted risks to a good degree. As such, I remain at a Hold rating for Constellation Brands.