Constellation Brands increases debt, vows to bring leverage back down

By Paul Deckelman

New York, July 2 - Constellation Brands, Inc. sharply increased its debt balance during its recently ended 2014 fiscal first quarter to finance a major acquisition - but its chief financial officer said Tuesday that the Victor, N.Y.-based wine, spirits and beer producer, importer and marketer expects to use the additional revenues and earnings that will accrue from its purchase to start bringing its leverage ratio back down into more normal territory.

CFO Robert "Bob" P. Ryder, who also is the company's executive vice president, told analysts on its conference call following the release of Constellation's latest quarterly results that as of the end of the fiscal quarter on May 31, its debt balance had grown to just over $5 billion, a $1.8 billion increase from its debt level at the end of fiscal 2013 on Feb. 28, due to the debt that it took on during the quarter to fund the complex $4.75 billion acquisition transaction.

Bonds help fund purchase

That deal, which closed on June 7, gave Constellation full control of the Crown Imports joint venture it formerly operated as a 50-50 partner with Mexican brewer Grupo Modelo SAB de CV, for which it paid $1.85 billion. As a result of global brewing giant Anheuser Busch InBev NV/SA's efforts to acquire the 50% of Modelo it did not already own without running afoul of U.S. antitrust regulators, Anheuser Busch InBev also agreed to sell all of Modelo's U.S. beer rights and operations, as well as a state-of-the-art Mexican brewery, to Constellation for another $2.9 billion, a transfer that also closed in early June.

Ryder said that the increased debt load included $500 million of 3¾% notes due 2021, $1 billion of 4¼% notes due 2023 - both of those junk tranches priced at par in a quick-to-market deal on April 30 - as well as about $221 million drawn from the company's accounts receivable securitization and other revolving facilities. Constellation funded the remainder of the purchase price with cash, term loans and borrowings under its revolving credit facility, "which were not drawn or utilized until after the close of the first quarter," Ryder said.

During the question-and-answer portion of the conference call that followed the formal presentations by Ryder and by Constellation's president and chief executive officer, Robert "Rob" S. Sands II, the CFO refused to disclose the specific amount drawn on the revolver during the opening days of the current fiscal second quarter in order to complete the acquisition.

As of the end of the first quarter in May, Ryder said that the company had $609 million of cash on its balance sheet and a little over $1.5 billion of restricted cash. He said that the higher-than-normal cash balance primarily relates to building funds and a drawing against the A/R securitization for the beer acquisition activities, while the restricted cash relates to April's senior note issuances.

Debt ratio to rise, then fall

After factoring in the cash and restricted cash, the company's net debt at the end of May was $2.9 billion, and its leverage ratio of net debt as a multiple of comparable-basis EBITDA came in at about 3.2 times.

"Although our leverage will move above the 5 times range when factoring in a full year of acquisition earnings, we expect to focus on debt paydown, to de-lever at a good pace," Ryder said.

He said that the combination Crown/Modelo deal "is truly transformational for us, as it diversifies our consumer base, essentially doubles annual sales and significantly enhances operating profits and operating margins. The brewery expansion activities over the next three years should position us for additional beer margin enhancement opportunities."

With the prospects of greater sales revenue and operating profits, he said that "we expect to be below 4 times [on leverage] in approximately two years. As we de-lever and complete the brewery expansion, we expect to see a dramatic increase in our free cash flow generation. This should provide us with substantial financial and capital allocation flexibility."

Better-than-expected rates

Fiscal first-quarter interest expense was $55 million, up 8% from $50.7 million during the year-ago quarter, with the increase primarily due to higher average debt balances following the big bond sale and the draw on the A/R securitization facility.

However, Ryder noted that "the timing of this financing activity could not have been better," as it came when junk bonds and the fixed-income markets generally were at or near their strongest levels for the year - before things started to go into a tailspin in mid-May on investor worries about a possible Federal Reserve wind-down of its expansive quantitative easing program and what impact this might have on interest rates.

He said that Constellation's "improved credit profile, combined with the favorable interest rate environment, helped us to put in place an attractive financing package with an all-in interest rate just under 3%."

Besides the bonds sold at the end of April, the company also tapped the bank-loan market around that same time for a $1 billion seven-year term loan B, priced at 200 basis points over Libor with a Libor floor of 0.75%. The interest rate could step down to Libor plus 175 bps when consolidated leverage is less than 4.25 times -although this step would only be available after the delivery of financials for two full quarters following closing. The term loan priced with an original issue discount of 99¾ and 101 soft call protection for one year.

Ryder said that the 3% effective interest rate on its financing for the Crown and Modelo purchases "was better than our original expectations," and as a result, the company now expects interest expense for the full year to be in a range of $325 million to $335 million - down considerably from its original $345 million to $355 million projection.

The CFO also said that the company raised its guidance for full-year diluted earnings per share by a nickel, to a range of $2.60 to $2.90, due to the anticipated lower interest costs while affirming its previous projection for full-year free cash flow of between $475 million and $575 million.

However, he cautioned that "we still do not have full visibility to the timing of the brewery cash flows, and the current interest rate outlook remains quite volatile. Right now, this is our best estimate."

During the quarter, Constellation used $19 million of free cash flow, versus $77 million of free cash flow generation during the year-earlier quarter. Ryder attributed the decrease primarily to funding costs related to the beer transaction and higher interest expense payments, among other factors.

The company reported net earnings for the quarter of $52.9 million, or 27 cents per diluted share, on sales of $766 million, versus $72 million, or 38 cents per share, in the year-ago quarter on sales of $725 million. Ryder attributed the lower earnings figure in the latest quarter despite higher sales to "some timing items." He cited greater selling, general and administrative expenses and an increase in grape costs.

The company reported 38 cents per share of earnings on a comparable basis, excluding one-time items and unusual factors, although this missed Wall Street expectations by around 3 cents per share.

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