Fitch Rates Constellation's $400MM Sr. Notes 'BB+'; Outlook Stable

CHICAGO--()--Fitch Ratings has assigned a 'BB+/RR4' rating to Constellation Brands, Inc.'s proposed $400 million senior unsecured notes offering due 2025. The Rating Outlook is Stable.

The company intends to use the net proceeds from this offering to fund a portion of the consideration for Constellation's pending acquisition of Ballast Point, which is expected to close before Dec. 31, 2015. Constellation expects to use cash on hand and borrowings under their senior credit facility or other credit facilities to pay for the balance of its pending Ballast Point acquisition.

As of Aug. 31, 2015, Constellation had $7.4 billion of debt outstanding and $330 million in cash. A full list of rating actions follows at the end of this release.

BALLAST POINT TRANSACTION HIGHLIGHTS

Fitch views the acquisition as highly complementary with a robust portfolio that is innovation focused, which has been a modest weak point in the past for Constellation. The portfolio includes more than 40 different styles of beer and increases Constellation's exposure to the faster growing, high end craft beer and spirits segments. Ballast Point has grown its revenue base almost threefold to $49 million in 2014 from $14 million in 2012 and during the first nine months of 2015, revenue grew 166% to $86 million. Fitch estimates a transaction multiple in the upper-20x range based on Ballast's 2015 EBITDA.

While relatively modest at only 2% of overall revenue, Ballast Point's operations should materially leverage Constellation's distribution, marketing scale, supply chain and market research over time and should become a key aspect of Constellation's overall growth strategy.

KEY RATING DRIVERS

Leverage Will Increase Slightly, Further Improvement Expected in FY2017

The acquisition will increase leverage (total debt/EBITDA) to slightly greater than 4x at the end of fiscal 2016 (year ending February 2016). This would be flat to fiscal 2015 year-end level and within Fitch's sensitivities for the ratings. Leverage had decreased to 3.8x as of Aug. 31, 2015.

Year to date, Constellation has generated better than expected operating cash flow (OCF) and margin expansion given industry leading comparable sales. Fitch now expects OCF to be more than $100 million higher than initially forecast for fiscal 2016 to $1.3 billion. Given the strong operating trends in Constellation's beer business, which generates more than 60% of the company's operating income, Fitch expects leverage should decrease to the upper 3x range in fiscal 2017 as growth in EBITDA should more than offset any increased borrowing to fund beer capacity expansion and a growing dividend.

Hispanics, Premiumization Driving Growth

Fitch believes Constellation is well positioned to capture long-term growth due to its strong appeal to the Hispanic consumer coupled with the ongoing trend toward premiumization in the beer industry driven by Mexican imports and craft beer. Other growth factors include the expected sizeable increase in Hispanic consumers reaching the legal drinking age, growth in distribution, and expansion of drinking occasions due to increased draft and can consumption.

The $4.75 billion Modelo acquisition (an additional true-up payment of $543 million was made at the beginning of fiscal 2015) that closed in fiscal 2014, materially increased Constellation's diversity, scale and exposure to above-average market growth rates in the beer segment. For the last 12 months, Constellation generated more than 60% of segment operating income from the beer business compared to approximately 40% in fiscal 2013, and grew beer depletion volumes by approximately 9.5% which significantly outperformed the U.S. beer industry.

Comparatively, the overall U.S. beer industry has increased in the low single digits during the past two years after generally experiencing low single-digit declines for several years prior due to share loss as the millennial generation shifted preferences into wine and spirits along with a recessionary macroeconomic environment. As premiumization continues to affect the beer market, consumers are trading up for high-quality, flavorful products in above-premium, super-premium categories including hard cider and flavored malt beverages, craft and import offerings. While several imported beer segments are experiencing declines, Mexican imports continue to grow and have been the primary imports growth driver during the past several years.

Thus, Fitch expects Constellation will generate increased long-term cash flows driven by the above strong underlying fundamentals, further leverage of new product development innovation, and the potential for increased cost of goods sold efficiencies as the company brings expansion capacity on-line. The Ballast Point acquisition allows Constellation to more effectively target different demographic segments that are attracted to craft beer and spirits and should minimize potential cannibalization of its existing Mexican beer and spirits portfolio, thus supporting a slightly improved growth profile.

Leading Market Positions

Constellation's ratings consider the company's leading market positions and well-known liquor portfolio. According to the company, Constellation is the third-largest U.S. beer company with approximately 50% volume share in the import segment due to its Mexican beer portfolio that contains five of the top 15 U.S. imported beers. Constellation is also one of the world's largest wine producers, is focused on growing premium brands, and is the producer of one of the fastest-growing premium brand vodkas, Svedka.

Constellation has begun to improve wine growth during the first half of fiscal 2016 with focus brand depletion growth of more than 6% during the second fiscal quarter of 2016. Fitch's forecast assumes modest growth in wine revenue for fiscal 2016 after wine sales declined 1.2% in fiscal 2015. The wine portfolio had lagged the overall U.S. category in fiscal 2015 causing wine dollar market share to erode slightly, driven by competition in the super-premium price segment. The luxury/ super luxury wine segments have witnessed strong volume and dollar sales growth since 2010 as consumers continue to trade up to wine priced $20 and above. Constellation's recent acquisition of the luxury wine brand, Meomi, highlights the company's focus on improving the price mix in the wine portfolio.

CFO Growing, FCF Pressured Due to Elevated Capital Intensity

Fitch expects Constellation will generate increased cash flow from operations (CFO) driven by strong underlying fundamentals, further leverage of new product innovation, and increased efficiencies as expansion capacity comes online. Fitch has increased its expectations for CFO in FY2016 by more than $100 million to almost $1.3 billion due to higher operating earnings growth. The company expects capital expenditures for FY2016 will be in the range of $1.05 billion to $1.15 billion, with capital expenditures related to the Nava brewery expansion in the range of $950 million to $1.05 billion.

Fitch expects a free cash flow deficit of $50 million to $75 million in fiscal 2016, which compares to previous deficit expectations of approximately $200 million. Constellation initiated a dividend of approximately $240 million for fiscal 2016. With accelerated investments for additional growth related beer capacity likely required due to continued high demand growth, Fitch believes Constellation's deficit will rise in FY2017 to approximately $225 million although EBITDA growth should more than offset increased borrowing, resulting in moderate leverage improvement.

Recovery Rating Notching

Constellation's bank obligations and the European borrower's bank obligations are secured by a 100% pledge of certain material U.S. subsidiaries and a 65% pledge of certain foreign subsidiaries and foreign holding companies. The European Borrower's obligations are additionally secured by a 100% direct pledge of certain other foreign subsidiaries which includes the Mexican brewery held by CIH Holdings Mexico and the IP rights at the CI Cerveza subsidiary. Fitch believes the additional stock pledge for the European borrower reflects a superior recovery position at 'RR1'.

KEY ASSUMPTIONS

Additional key assumptions within Fitch's fiscal 2016 rating case for the issuer include:

--Consolidated revenue growth of 7.5% supported by depletion growth in the beer segment of approximately 9%;

--Operating income margin improvement for the beer segment of approximately 200 basis points to 34%; modest increase in operating income margin in the wine and spirits segment to the high 23% range;

--Operating cash flow of almost $1.3 billion;

--FCF deficit in the range of $50 to $75 million. With accelerated investments for additional growth related beer capacity likely due to demand growth, Fitch believes Constellation's deficit will rise to approximately $225 million in FY2017;

--Total debt to EBITDA leverage of approximately 4.1x versus previous expectations of 3.8x - 3.9x by the end of FY2016. For FY2017, EBITDA expansion should drive improvement to the upper-3x range.

RATING SENSITIVITIES

While a ratings upgrade is not anticipated over the next 12 months, future developments that may, individually or collectively, lead to a positive rating action include:

--Leverage such that total debt-to-operating EBITDA is under 3.5x or FFO adjusted leverage is under 4.5x on a sustained basis;

--Demonstrated ability to improve and sustain FCF margin above 3.5%;

--Growing volume trends for their primary brands;

--Maintain EBIT margin in the mid-20% range and EBITDAR margin of at least 30%.

Future developments that may, individually or collectively, lead to a negative rating action include:

--Deterioration in volume trends leading to market share losses;

--Significant and ongoing deterioration in profitability due to competitive activity;

--Increased leverage such that total debt-to-operating EBITDA moves above the low 4x range or FFO adjusted leverage that moves above the low 5x range on a sustained basis.

LIQUIDITY

Constellation had a cash position of $330 million as of Aug. 31, 2015 with nearly full availability ($15 million of outstanding letters of credit) under its $1.15 billion senior secured revolving credit facility that matures in 2020. Constellation also has two accounts receivable securitization facilities that provide additional borrowing capacity from $235 million up to $330 million and from $100 million up to $190 million structured to account for the seasonality of the company's business. Both facilities were extended an additional 364-day term in September 2015 and moderately upsized to provide additional liquidity capacity. The facilities were undrawn as of Aug. 31, 2015.

Upcoming debt maturities in fiscal 2017 include $700 million of 7.25% notes, which Fitch expects will be refinanced. Annual amortization requirements for the term loans over the next three fiscal years is approximately $35 million remaining in FY2016, $138 million in FY2017 and $138 million in FY2018.

FULL LIST OF RATING ACTIONS

Fitch has assigned the following rating to Constellation:

--$400 million senior unsecured notes offering due 2025 'BB+/RR4'.

Constellation's existing ratings are as follows:

Constellation Brands, Inc.

--Long-term Issuer Default rating (IDR) 'BB+';

--Senior unsecured notes 'BB+/RR4';

--$1,150 million senior secured revolver 'BBB-/RR2';

--$1,271.6 million senior secured term loan A 'BBB-/RR2';

--$241.9 million senior secured term loan A-1 'BBB-/RR2'.

CIH International S.a.r.l.

--Long-term IDR 'BB+';

--$1,430.1 million European term loan A 'BBB-/RR1'.

The Rating Outlook is Stable.

Date of Relevant Committee: July 8, 2015.

Additional information is available on www.fitchratings.com

Applicable Criteria

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869362

Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers (pub. 12 Jun 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=867275

Additional Disclosures

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=994437

Endorsement Policy

https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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Contacts

Fitch Ratings
Primary Analyst
William Densmore
Senior Director
+1-312-368-3125
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Carla Norfleet Taylor, CFA
Senior Director
+1-312-368-3195
or
Committee Chairperson
Monica Aggarwal, CFA
Managing Director
+1-212-908-0282
or
Media Relations:
Alyssa Castelli, +1-212-908-0540
alyssa.castelli@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
William Densmore
Senior Director
+1-312-368-3125
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Carla Norfleet Taylor, CFA
Senior Director
+1-312-368-3195
or
Committee Chairperson
Monica Aggarwal, CFA
Managing Director
+1-212-908-0282
or
Media Relations:
Alyssa Castelli, +1-212-908-0540
alyssa.castelli@fitchratings.com