Constellation Brands Inc (STZ) 2022 Q1 法說會逐字稿

Welcome to the Constellation Brands Q1 Fiscal Year 2022 Earnings Conference Call.

(Operator Instructions)

I will now turn the call over to Patty Yahn-Urlaub, Senior Vice President of Investor Relations.

Please go ahead.

Thanks, Gigi.

Good morning and welcome to Constellation's First Quarter Fiscal '22 Conference Call.

I'm here this morning with Bill Newlands, our CEO; and Garth Hankinson, our CFO.

As a reminder, reconciliations between the most directly comparable GAAP measure and any non-GAAP financial measures discussed on this call are included in our news release are otherwise available on the company's website at www.cbrands.com.

Please refer to the news release and Constellation's SEC filings for risk factors, which may impact forward-looking statements we make on this call.

Before turning the call over to Bill, similar to prior quarters, I would like to ask that we limit everyone to one question from person, which will help us to end our call on time.

Thanks in advance, and now here is Bill.

Thank you, Patty.

Good morning and welcome to everyone to our first quarter conference call.

Picking right up where we left off in Q4, our Constellation Brands team, with the help of our distributors and retailers, delivered another strong performance in Q1 of fiscal '22.

While we overlap the pantry-loading phase of the pandemic, which led to record trends in off-premise track channels last year, our continued focus on brand building, aggressive investments in growth and the continued efforts of our team and trade partners position us to deliver another strong year of performance, consistent with our long-term goals.

As Garth and I detail some of the highlights from Q1, there are several key factors we'd like you to keep in mind that constitute our points of differentiation, our competitive strengths and reasons to continue to believe in the future growth potential of our business and our ability to drive industry-leading total shareholder returns over the long term.

Number one, our strong portfolio of core brands across beer, wine and spirits continues to gain momentum while offering significant runway for growth in the years ahead.

Nowhere is this more evident than in our beer business, which is off to an exceptional start, delivering double-digit depletions, shipments, net sales and operating income growth due to ongoing strong consumer demand.

Number two, we continue to be relentless about keeping consumers at the forefront of our decision-making, and this is nowhere more apparent than in the strides we're making to strengthen our innovation capabilities and ensure we're capturing our fair share of growth in emerging categories.

Number three, our investment in Canopy Growth, along with the continued efforts of the Canopy team, are positioning this business to emerge as a leader in the global cannabis market as it comes to fruition and we inch closer to legalization in the U.S.

And number four, our continued strong operating performance and cash flow generation enabled us to resume share buyback activity with significant repurchases of more than $500 million during the first 4 months of our fiscal year.

In addition, we announced this morning that we will execute an accelerated share repurchase program throughout the remainder of the second quarter to repurchase an additional incremental $500 million of shares.

We believe this demonstrates our strong commitment to maximize shareholder value, and we are on our way to achieving our $5 billion goal, of which about 50% will be in the form of share repurchases.

This activity is also driving an increase in our EPS guidance for this year.

Let's transition to a more detailed discussion of our performance in the quarter.

As mentioned, our beer business is off to an exceptional start, delivering double-digit net sales and operating income growth as well as depletion growth of almost 11% in the quarter.

Excellent execution during the Cinco de Mayo and Memorial Day holidays led to market share gains as Constellation remains a leading growth driver in the high end of the U.S. beer market.

Modelo Especial led the way as the #1 share gainer in the entire U.S. beer category and solidified its position as the #1 brand in the high-end.

It also became the #2 brand in dollar sales in IRI channels, posting depletion growth of 12% for the quarter.

Modelo Especial continues to fire on all cylinders, with no signs of letting up, driven by ongoing strong execution at retail, impactful execution of high-profile marketing activations and a significant increase in digital, social and e-commerce media for properties like UFC, Gold Cup Soccer and the Summer Olympic Games, to name just a few.

Corona brand family growth was driven by a return to growth in on-premise channels, which now represent approximately 11% of our beer business volume, which accelerated and nearly doubled since fiscal '21.

During the quarter, we launched Corona Hard Seltzer Variety Pack #2, which continues to gain shelf space and is already more than half the size of Variety Pack #1 in dollar sales and appears to have about the same incrementality as Variety Pack #1 has to the entire portfolio.

Meanwhile, Variety Pack #1 has held its distribution and velocity levels since the launch of Variety Pack #2, and our Hard Seltzer family remains in the #4 market position.

Earlier this month, we launched Corona Hard Seltzer Limonada.

And while it's early in the launch cycle, initial consumer response has been very favorable.

Ultimately, we believe the hard seltzer category will be dominated by a few large brands in the long run, similar to the light beer category, and we are positioning Corona Hard Seltzer to be one of those brands.

We have plans to more than double our seltzer and ABA capabilities this fiscal year and expect to bring another 5 million hectoliters of capacity online next fiscal year, giving us the flexibility to continue to expand with new flavors, new packages and even new platforms in this space.

Overall, the seltzer category remains competitive.

We believe it's an important part of the high-end, and we plan to drive for success with our ambition to ultimately be a top 3 player in this space.

Pacifico continued its strong momentum, posting depletion growth of more than 35% for the quarter as the #4 share gainer within the import segment driven by our focus on Gen Z consumers.

As expected, during the quarter, Constellation's consumer takeaway trends in the off-premise IRI and Nielsen channels were muted due to lapping last year's pantry-loading behavior at the start of the pandemic.

Conversely, we experienced robust growth, especially in some of the more sizable nontrack channels, including the on-premise, which grew depletions 250% versus last year when this channel was essentially closed, and the liquor chains, which grew almost 13% in the first quarter.

These levels of robust consumer demand are impacting availability for certain package sizes in certain geographies.

We are working with our distributor partners to ensure consumers can continue to find our brands on shelf throughout the summer, and we plan to make up some of this impact beginning in the third quarter.

As a reminder, beginning in April of last year, our beer business had to significantly slow down production in Mexico due to COVID-19 restrictions.

This led to out of stocks in the U.S. marketplace during the summer month.

Therefore, as we progress through our second quarter, which runs June through August, we'll start to lap these out-of-stock issues, and we're already beginning to see improving IRI trends.

Despite the short-term supply challenges we're facing, the momentum of our portfolio is stronger than ever, and our outlook for the remainder of the year remains extremely bullish.

Our view is reinforced by recent 4-week IRI trends that show Constellation's beer business is outpacing the high-end and continues to significantly outpace the total U.S. beer industry.

Now moving on to wine and spirits.

Our transformation of this business to a higher-growth, higher-margin operation continues to gain traction, and we made additional progress during the first quarter on a number of fronts, including furthering our fine wine and craft spirit strategy, building a robust innovation pipeline, advancing our DTC e-commerce and digital capabilities while also implementing disciplined pricing actions, taking out stranded costs and executing other costs and efficiency improvements.

During the quarter, we made progress with the evolution of our fine wine and craft spirits business, especially as consumers return to bars and restaurants in the on-premise channel.

Our fine wine and craft spirits performance in the quarter was driven primarily by The Prisoner Wine Company, Robert Mondavi Winery and High West, and we expect our enhanced capabilities in this space to begin to meaningfully inflect our wine and spirits business towards the higher end.

Impactful innovations were also a driving force for growth during the quarter, including Meiomi cabernet sauvignon, Kim Crawford Illuminate and The Prisoner Unshackled, which were among the top 10 innovations across the high end of the U.S. wine segment in IRI channels during the quarter.

And we have a strong innovation pipeline planned for the remainder of the year, which includes the introductions of Woodbridge wine seltzers, The Prisoner Saldo, Red Blend and Unshackled sauvignon blanc, plus Robert Mondavi Private Selection 100, a new lineup composed of 100% cabernet sauvignon and chardonnay varietals.

We've also been investing to build a world-class 3 tier e-commerce team by expanding our sales and marketing resources, building new selling capabilities, investing millions of dollars where consumers shop and integrating our teams to put focus and expertise closer to our accounts.

While our 3 tier e-commerce business is cycling the tremendous acceleration that was experienced last spring at the beginning of the pandemic, it is still growing 3 to 4x compared to the spring of 2019 across beer, wine and spirits.

And the DTC portion of our e-commerce business saw impressive growth of 45% versus last year in the first quarter.

We continue to forge partnerships with existing and emergent pure-play retailers like Amazon, Gopuff and wine.com, omnichannel retailers like Walmart, Kroger and Albertsons and third-party marketplaces like Instacart and Drizly, so that our consumers can shop whenever and wherever on their own terms.

In addition, as part of our commitment to invest $100 million over 10 years in Black, Latinx and minority-owned small businesses, we recently made investments in La Fête du Rosé and Sapere Aude sparkling line.

Both of these brands aligned with Constellation's premiumization strategy and presents significant growth opportunities with differentiated high-end brands and growing sectors of the market.

La Fête du Rosé has taken a consumer-first approach to building a distinctive, authentic rosé brand that appeals to multicultural consumers.

And Sapere Aude has taken an entrepreneurial approach to build a uniquely Californian sparkling wine with no residual sugars, low alcohol content, fine bubbles and a refreshing brand identity that is simple and clean.

We look forward to working with these brands and their dynamic founders to expand their access to key markets and consumers and to help realize their full potential.

At the same time, our wine and spirits results for the quarter were impacted by a convergence of isolated factors.

First, our international brands like Kim Crawford and Ruffino, which are produced in their respective regions but sold primarily in the U.S., are experiencing global supply chain logistics issues, including shipping delays and transport interruptions like so many other imported products.

Second, we've experienced some start-up issues in certain markets associated with our route-to-market transition to Southern Glazer's Wine & Spirits, which now has distribution responsibility across 70% of our U.S. wine and spirits brand portfolio.

This transition became effective April 1, and we expect the transition issues to be resolved in the second quarter.

Lastly, like many ERP system implementations, with a cutover to SAP, we have encountered a few transitional challenges, which we don't see as a prolonged issue.

Collectively, these issues caused some supply challenges at retail for some of our larger key brands, which drove the negative depletion trend during the quarter.

And while we're seeing lower inventory levels than normal for Kim and Ruffino, they continue to drive growth.

Despite these temporary challenges, we are confident in our ability to accelerate the growth and profitability of this higher end portfolio of industry-leading brands and achieving our targeted goal of 2% to 4% organic sales growth for the fiscal year.

Moving on to Canopy Growth.

The synergies between Constellation and Canopy Growth continue to create value for both companies.

Canopy recently signed a U.S. distribution agreement with Southern Glazer's Wine & Spirits for Canopy's Quatreau CBD beverage portfolio, which will be launched across 7 U.S. states with additional states to be added later this year, as well as their Martha Stewart CBD product lineup, which has seen early success extending into top-selling gifts for occasions, including Mother's Day and Valentine's Day, which sold out prior to the holidays due to high consumer demand.

Constellation and Canopy will continue to work closely together to develop Canopy's route-to-market strategy in the U.S. We remain optimistic about the prospects for Federal U.S. legalization during this congressional session and are bullish about Canopy's growth prospects and their ability to achieve profitability by the end of their fiscal year.

As I close, I want to take a minute to thank our Constellation team members and our distributors and retailers for an excellent first quarter business performance.

Thanks to all of you, our strong portfolio of core brands across beer, wine and spirits continues to gain momentum.

And we are well positioned to deliver another strong year of performance, consistent with our long-term goals.

Our beer business continues to be a top growth driver within the U.S. beer market, and we're delivering market share gains and accelerating depletion trends as consumer demand and takeaway remains extremely strong.

Our higher end wine and spirits brands continued to outpace the overall U.S. market.

We continue to strengthen our innovation capabilities to ensure we're capturing our fair share of growth in emerging categories.

Our continued strong operating performance and strong cash flow generation allowed us to make significant share repurchases in line with our commitment to return $5 billion to shareholders by fiscal '23 and drove an increase in our EPS guidance for the year.

And with that, I would like to turn the call over to Garth, who will review our financial results in the quarter.

Garth?

Thank you, Bill, and hello, everyone.

Our fiscal 2022 is off to a great start, demonstrated by our strong segment operating results and cash flow generation.

As Bill highlighted, our beer business achieved double-digit depletion volume, top line and operating income growth.

Our wine and spirits business is nicely positioned to drive accelerated growth and profitability from its portfolio of higher end industry-leading brands.

And our robust cash flow generation enabled us to resume share buyback activity, reaffirming our commitment to execute our goal of returning $5 billion to shareholders through dividends and share repurchases through our fiscal 2023.

As Bill outlined, through June, we've repurchased 2.2 million shares of common stock for $523 million.

In addition, this morning, we announced that we entered into an accelerated share repurchase, or ASR, agreement to purchase $500 million of incremental shares, which is expected to be completed no later than October of 2021.

Please note that the ASR agreement constitutes the $500 million incremental share repurchase referenced in this morning's earnings release.

As a result, we've increased our full year comparable basis diluted EPS to be in the range of $10 to $10.30.

This range excludes Canopy equity earnings impact and reflects the decrease in weighted average diluted shares outstanding driven by the year -- the June year-to-date share buyback activity as well as the ASR agreement or approximately $1 billion of share repurchases.

As such, we are forecasting weighted average diluted shares outstanding of approximately 193 million for our fiscal 2022.

We plan to repurchase additional shares during the back half of the fiscal year in excess of the $1 billion of share repurchases previously outlined.

However, we do not know the timing and cadence.

And as such, these expected share repurchases have been excluded from our guidance assumptions.

We will continue to update our outstanding shares accordingly when we report quarterly earnings throughout the fiscal year.

Now let's review our Q1 fiscal 2022 performance in more detail where I'll generally focus on comparable basis financial results.

Starting with beer.

Net sales increased 14% driven by shipment volume growth of over 11% and favorable pricing.

The increase in beer net sales was impacted by some missed shipping days and supply shortages as a result of severe weather events impacting Texas and Northern Mexico early in the first quarter of our fiscal year.

Depletion volume accelerated from fiscal 2021 year-end trends and achieved nearly 11% growth for the quarter despite overlapping the peak of last year's pandemic-related pantry-loading behavior driven by continued strong demand in both track and nontrack off-premise channels as well as the return to growth in the on-premise channel.

On-premise volume accounted for 11% of total beer depletions during the quarter, which accelerated and nearly doubled since fiscal '21.

As a reminder, the on-premise accounted for approximately 15% of our depletion volume pre-COVID and accounted for only 3% of our depletion volume in Q1 fiscal 2021 as a result of on-premise shutdowns due to COVID-19.

Lastly, when adjusting for 1 extra selling day in the quarter, the beer business generated nearly 10% depletion volume growth.

And in Q2, depletion selling days are flat year-over-year.

Due to continued robust consumer demand and muted shipment volume driven by supply challenges due to severe winter weather early in the quarter, depletion volume exceeded shipment volume during the first quarter, resulting in lower-than-normal distributor inventory on hand at the end of Q1.

Let me assure you that we are fully producing and shipping product out of our breweries.

However, inventories will remain tight throughout the second quarter as we enter our peak summer selling season.

As a result, we expect distributor inventory levels to return to more normal levels during the second half of the fiscal year.

Moving on to beer margins.

Beer operating margin increased 110 basis points versus prior year to 42.8%.

Benefits from favorable pricing, SG&A as a percent of net sales and foreign currency were partially offset by unfavorable logistics and operational costs and increased marketing.

The increase in logistics cost was driven primarily by increased obsolescence, resulting from initial conservative expiration dates on new SKUs, partially offset by the transition of a portion of our co-packing capabilities to our Nava Brewery.

The increase in operational costs was driven primarily by brewery costs, largely due to labor inflation in Mexico and increased headcount and incremental spend to bring the additional 5 million hectoliters online at Obregon.

These headwinds were partially offset by favorable fixed cost absorption related to the overlap of reduced production in the first quarter of fiscal 2021 due to COVID-19 safety measures.

Depreciation expense had a minimal impact during the quarter as we began to depreciate the incremental 5 million hectoliters at Obregon late in Q1, but expect depreciation expense to ramp up during Q2.

Marketing as a percent of net sales increased 70 basis points to 9.4% versus prior year as we have returned to our typical spending cadence, which is weighted more heavily towards the first half of the fiscal year.

As a reminder, marketing spend in the first half of the prior year was significantly muted, resulting from COVID-19-related sporting and sponsorship event cancellations and/or postponements.

As communicated last quarter, given the current state of activities in Mexicali, we will be unable to repurpose this site for future use.

As such, an impairment of approximately $665 million was recorded for the quarter, which was excluded from our comparable basis results.

For full year fiscal 2022, we continue to target net sales growth of 7% to 9%, which includes 1 to 2 points of pricing within our Mexican product portfolio and operating income growth of 3% to 5%.

This implies operating margin to land in the low to midpoint of our stated 39% to 40% range.

As previously discussed, we continue to expect our gross margins to be negatively impacted for the fiscal year as benefits from price and our cost savings agenda are expected to be more than offset by the following headwinds: first, a significant step-up in depreciation expense and other brewery expansion costs relating to the incremental 5 million hectoliters that was completed at Obregon earlier in the fiscal year; second, substantial inflationary headwinds across numerous cost components; and lastly, negative mix as we expand our ABA and hard seltzer portfolios.

As it relates to timing and cadence.

As mentioned earlier, during the second quarter, we will begin to see an impact from depreciating the incremental 5 million hectoliters at Obregon, which will be a significant margin headwind for the balance of the fiscal year.

Additionally, due to benefits from our commodity hedging program, we did not experience the expected cost inflationary pressures during this quarter.

However, we expect significant inflation headwinds to ramp up during the second half of our fiscal year as current hedges roll off.

In addition, we believe the depth and duration of inflationary pressures are becoming more uncertain as the year unfolds.

Lastly, we continue to expect marketing as a percent of net sales to be in the 9% to 10% range for full year fiscal 2022, which is in line with fiscal 2021 spend of 9.7% of net sales.

We expect to invest significantly during Q2 of fiscal 2022 to support strategic initiatives and continue generating strong marketplace performance throughout the key summer selling season.

As such, 2Q marketing as a percent of net sales is expected to be in the range of 10% to 11% versus Q2 fiscal '21, which came in at 8.4%.

Moving to wine and spirits.

Q1 fiscal 2022 net sales declined 22% and shipment volume down 38%.

Excluding the impact of the wine and spirits divestitures, organic net sales increased 16% driven by organic shipment volume growth of 6%, smoke-tainted bulk wine sales and favorable price and mix, while depletion volume declined approximately 8%.

There are several dynamics to point out as it relates to organic net sales as well as shipment and depletion volume trends for the quarter.

Starting with organic net sales and organic shipment volume.

Growth of 16% and 6%, respectively, was impacted by the following: first, smoke-tainted bulk wine sales accounted for approximately 4 points of the year-over-year organic net sales growth in the quarter; second, from an organic shipment volume perspective, we undershipped depletions in Q1 fiscal 2021 as we were unable to fulfill excessive consumer demand driven by pantry loading, creating an easy shipment volume compare to Q1 fiscal 2022.

Conversely, we overshipped in Q1 fiscal 2022 as a result of the distributor transition to Southern Glazer's in order to ensure that they had ample inventory during the quarter as there was a delay in transitioning Constellation inventory from canceled distributors to Southern Glazer's.

Moving to depletion volume trends, down approximately 8%, which were impacted by the following: first, we are experiencing a challenging overlap due to last year's pandemic-related consumer pantry-loading behavior; second, as a result of the SAP transition, we experienced challenges that impacted the shipping process early in the quarter.

While we were able to rectify the situation during the quarter, the timing of shipments throughout Q1 negatively impacted depletions and created out of stocks for some of our larger key brands.

Lastly, global supply chain logistics issues, including shipping delays and transport interruptions, have also created out of stocks in certain areas for Kim Crawford and Ruffino, which are imported from New Zealand and Italy, respectively.

As Bill mentioned, we believe these challenges are temporary and continue to improve, and we expect to refill retailer inventory in Q2.

Moving on to wine and spirits margins.

Operating margin decreased 540 basis points to 22.9% as mix benefits driven by the wine and spirits divestitures and favorable price were more than offset by margin dilutive smoke-tainted wine -- bulk wine sales and increased marketing and SG&A as a percent of net sales.

Keep in mind that we're lapping lower marketing and SG&A spend in Q1 fiscal 2021 due to COVID and have a smaller business post the divestitures, resulting in significant marketing and SG&A deleveraging, impacting operating margins.

For full year fiscal 2022, the wine and spirits business continues to expect net sales and operating income to decline 22% to 24% and 23% to 25%, respectively.

This implies operating margin to approximate 24%, which is flattish to prior year on a reported basis, which shows significant margin expansion on an organic basis.

Excluding the impact of the wine and spirits divestitures, organic net sales is expected to grow in the 2% to 4% range.

Lastly, please keep in mind that we will continue to lap significantly reduced marketing spend during Q2 as many of our planned media and event sponsorship investments were suspended or canceled in Q2 fiscal 2021.

Furthermore, we continue to expect marketing and SG&A deleveraging as a result from the wine and spirits divestitures.

As such, we expect marketing and SG&A to continue to be a significant drag to operating margins in Q2 fiscal 2022.

Now let's proceed with the rest of P&L.

Q1 corporate expenses came in at approximately $55 million, up 8% versus Q1 fiscal 2021.

The increase was primarily driven by higher consulting services and compensation and benefits, partially offset by a favorable foreign currency impact.

We continue to expect full year corporate expenses to approximate $235 million.

Comparable basis interest expense for the quarter decreased 13% to approximately $87 million, primarily due to lower average borrowings as we continue to decrease our net leverage ratio and ended the quarter at 3.06x, excluding Canopy equity earnings.

Our previous guidance assumed free cash flow would be used to pay down debt versus share repurchases.

However, as discussed earlier, updated guidance now reflects approximately $1 billion of share repurchases through the first half.

As such, fiscal to interest expense is now expected to increase and be in the range of $360 million to $370 million.

Our comparable basis effective tax rate, excluding Canopy equity earnings, came in at 21.1% versus 19.3% last year, primarily driven by higher effective tax rates on our foreign businesses.

We expect our Q2 fiscal '22 comparable tax rate, excluding Canopy equity and earnings impact, to approximate 20%.

However, we continue to expect the full year to approximate 19%.

As expected, stock-based compensation benefits are weighted more towards the second half of the fiscal year.

Moving to free cash flow, which we define as net cash provided by operating activities less CapEx.

For Q1, we generated free cash flow of $602 million, which represents an 11% increase versus prior year, reflecting strong operating cash flow and lower CapEx.

CapEx totaled $114 million or 21% last year's spend.

This included approximately $86 million of beer CapEx, primarily driven by expansion initiatives at our Mexico facilities.

Lower CapEx spend is primarily due to timing as we have significant spending planned for the balance of the fiscal year.

As such, our full year CapEx guidance of $1 billion to $1.1 billion, which includes approximately $900 million target for Mexico beer operation expansions, remains unchanged.

Furthermore, we continue to expect fiscal 2022 free cash flow to be in the range of $1.4 billion to $1.5 billion.

This reflects operating cash flow in the range of $2.4 billion to $2.6 billion and the CapEx spend previously outlined.

Moving to Canopy.

In Q1, we recognized an unrealized loss of $745 million from the decrease in the fair value of our Canopy investments.

This was excluded from our comparable basis results.

The total pretax net gain recognized since our initial Canopy investment in November of 2017 is $366 million.

In closing, I want to reiterate our expectation to continue to have significant capital allocation flexibility throughout our fiscal 2022, which will enable ongoing progress in returning cash to shareholders while making strategic investments to support long-term growth opportunities.

We believe the combination of strong cash flow and future growth prospects in both our beer and wine and spirits businesses positions Constellation for success.

The growth and margin profile of our high-end beer business is best in class, and we expect it to remain as such well into the future, while the transformation of our wine and spirits business is underway and we expect to continue to achieve margin expansion as we migrate operating margins of approximately 30%.

And with that, Bill and I are happy to take your questions.

(Operator Instructions) Our first question comes from the line of Bonnie Herzog from Goldman Sachs.

I was actually just hoping to get a little more color on the out-of-stock pressures you've been facing.

We're aware that you guys had temporarily capped orders during the end of May given how strong demand was in relation to your forecasted supply.

So first, are these caps still in place?

And then specifically, have you seen these pressures maybe get better or worse in June?

And finally, are there any specific impact on certain SKUs or pack sizes?

Or was this just more broad-based in your portfolio?

Sure.

Obviously, I'd say the 2 main things driving the tightness of inventory are, first and foremost, robust consumer demand.

Our consumer demand has been well in excess of what we anticipated.

And I -- in my opinion, that's always good news.

The second piece of it, obviously, was the point that Garth made and I made in my script, which is the power outage that occurred at the end of February, which was made for somewhat tighter inventory position than we would normally want to hold.

With that said, all of that will take care of itself over the course of the fiscal year.

We -- it's quite different, quite frankly, from last year where we mainly produced the SKUs that represented 75% of our total portfolio.

This year, we're producing all of our SKUs.

So it's very different from what we saw last year.

And while we do expect tightness during the course of the summer, we're working actively with our distributors to make sure that we are providing the right mix of product, to make sure that we continue to supply the very strong demand we're seeing against our portfolio.

Our next question comes from the line of Nik Modi from RBC Capital Markets.

So just a quick housekeeping.

Bill, if you wouldn't mind sharing perspective on June depletions.

I know the month isn't over yet, but any early color would be helpful.

And then the broader question is, during the pandemic, many brands, including Constellation's portfolio of beer brands, gained a lot of new households.

And I was just wondering if you've done a postmortem on what those new households look like, have you recruited new consumers into the portfolio that you weren't recruiting prior?

I mean any context around that would be really interesting.

Certainly.

So first -- your first part of your question are June, and you're correct.

Well, it isn't over yet.

We're very enthused by how June is setting up, and it is certainly consistent with our long-term algorithm assuming we finish the last couple of days strongly.

So we think June is going to look pretty good.

Secondly, relative to household, Nik, we obviously are continuing to develop and broaden our reach across our core brands, particularly in beer.

If you think about Modelo -- and Garth and I think said this in prior quarters, we are rapidly increasing our penetration in the non-Hispanic community.

It's a little difficult for us at this point to break that out of how much of that was COVID versus non-COVID because we're just seeing such an acceleration of Modelo, not only in its core Hispanic market, but in the broader market as well.

So it's a little difficult for us to put an exact percentage on any of those things.

What I would say is we are gaining consumers in our portfolio, that has been obvious, and we expect that trend to continue.

Part of that has been driven by our innovation agenda where we're meeting more consumer needs, more consumer-drinking occasions than we ever have before because of our successful innovation agenda across the whole portfolio across the company.

So I would expect that we're going to continue to see some acceleration of bringing new consumers in because we're opening up occasions for those people to come into our franchise.

Our next question comes from the line of Lauren Lieberman from Barclays.

I was curious about the beer pricing.

Its price/mix was north of 2%.

And I was just curious if you could talk a little bit about how much of that was driven by mix or if there's some greater pricing starting to come through in the market and your thoughts broadly on pricing for beer this year.

Sure.

We continue to keep our algorithm about beer pricing, as we have said on prior calls.

We see it as a 1% to 2% growth profile over the course of the year, and we're sticking with that.

We think that's appropriate given all the factors that we weigh when we decide about what we're going to do with our pricing.

I think it's also important to say, our #1 growth driver in our business continues to be Modelo, which is very accretive on a mix basis.

So as we continue to see all of our businesses grow, when you see that kind of acceleration in Modelo, it certainly is mix accretive to us as well.

So I think both of those things were additive in the quarter, and we would expect them to be additive over the course of the year.

Our next question comes from the line of Kaumil Gajrawala from Credit Suisse.

Digging into the supply -- or maybe connecting the supply issues with depletions and how you're thinking about inventory is getting better in the back half, does that -- will you think about you being running at a 10 -- looks like you continue to run at a 10-cell day adjusted, do you need depletions to really start to come off, maybe back to that high single-digit range to get inventories back to where you want them to be or do you feel like just the abatement of any of the supply pressures will be able to get you to where we want to be?

We'd expect that the abatement of supply issues to take care of themselves over the course of the year.

Remember, I think we probably made this reasonably clear.

We lost several points of top line growth because of the power outage that occurred at the end of February in Northern Mexico and Texas.

So we certainly had a muted shipping scenario.

We will expect to pick that up over the course of the remainder of the year, and we're still expecting demand to be very solid.

So we are fully expecting to meet the demand that we'll see in the marketplace, which we continue to say will be in that 7% to 9% range over the course of the year.

Our next question comes from the line of Sean King from UBS.

Yes.

Appreciate the color you gave on the on-premise at 11% and, I guess, greater than 250% growth for beer.

Was that at the close of the quarter?

Or is that like the average of the quarter overall?

And inside that, what are you seeing in terms of draft demand?

Yes.

That's the average over the course of the quarter.

As Garth pointed out in his remarks, that still is below what we were pre-pandemic, but it's a really big increase of what it was last year.

So we still think certain markets are developed more quickly than others, as we've said in prior discussions as well.

So we certainly expect that, that's going to continue to be an accelerator over the course of the summer.

And let's face it, I think it would be fair to say there's a lot of pent-up consumer demand to simply go out of your home that people are looking forward to the opportunity as some of the COVID restrictions come off.

We would expect to see some continuing acceleration in the on-premise channel as we progress through the summer, recalling that the on-premise channel was a fraction of what it was last year versus the prior year.

So we think that's all going to take good care of itself as the year goes on.

Our next question comes from the line of Bryan Spillane from Bank of America.

A question for Garth.

Just wanted to follow up on the commentary around inflation becoming more uncertain.

So just maybe if you can comment on 2 things related to that.

What areas -- so what types of inputs are becoming more certain?

Is it freight?

Is it packaging, labor costs?

Just trying to understand kind of where the potential pressure points could be.

And then if you could tie to that as well, if we step back today versus where we were at the beginning of the fiscal year, can you give us a sense of just how much flexibility has been eaten up by inflations coming higher?

Or are you in the same place in terms of just flexibility to hit your profit growth goal this year?

Yes.

Thanks, Bryan.

Right.

And just as a reminder, when we issued our Q4 guidance, we talked about inflation, and we said that overall, we were expecting inflation kind of in the low to mid-single-digit range.

And that was taking into account that any given line item within our cost structure, we were seeing inflation in kind of the low to high single-digit range.

We have -- as we talked about it at that time, we have a pretty effective hedging policy in place, and we entered the year in a good position, as I said.

So as we look out this year, first of all, the outlook for inflation still kind of remains the same.

Our outlook as well as some of the external advice we get on this is still that inflation is going to have a bit of a spike, but it's going to be temporary in nature.

The question just is like how temporary, right?

And it seems as though that kind of blip, it might take a little bit longer to kind of come down from there.

And so the things that we're watching mostly right now really are around, as you indicated, logistics and transportation and labor.

And those things are somewhat intertwined, if you will.

The labor market has made it difficult to get dedicated trucking lines.

And so that's becoming more and more competitive.

So that's absolutely a concern.

We continue to watch aluminum.

And then we look at natural gas -- or glass, right, glass because glass is impacted by natural gas.

So those are the areas that we're kind of most watchful for as we go through the year.

I say that as we sit here today, we're feeling like we're in a similar position to be able to cover our inflationary headwinds as long as they don't get significantly worse as we go through the year.

Our next question comes from the line of Eric Serotta from Evercore.

Bill, hoping to get a little bit more granularity as to what you're expecting from the hard seltzer category and the broader ABA category -- or the ABA category more broadly.

And related to that, you reiterated that you're more than doubling Corona seltzer capacity this year, and you'll have the additional 5 million hectoliters of the ABA capacity at Nava, I believe, for next year.

If your forecast on ABA growth don't pan out, how flexible is that capacity to produce traditional beer?

So related to the hard seltzer capacity point, we're still expecting that the hard seltzer category is going to grow somewhere in the 30% to 50% range, somewhere in that range this year overall.

And obviously, we did roughly 10 million cases last year with one SKU.

We've introduced our second variety pack.

We're very excited about that process so far, and Limonada is just hitting the market really as we speak.

I got to remind you again what I said earlier, which is despite doubling the size of our ABA and hard seltzer capability for this year, the #1 growth driver in our portfolio will remain Modelo, irrespective of that significant growth.

So we're very comfortable with our growth profile across the business.

What I would say is this, is we do have significant flexibility around the capacity that we put in and how that can be used within the business, and many of the things like packaging and so forth really service the entire business anyway.

So we do have a fair amount of flexibility, depending on if there's any changes in any of the particular subsegments of the beer category at any point in time.

We've worked very hard to make sure there is flexibility within our production capacity capabilities so that we can adjust to any change in consumer demand.

Our next question comes from the line of Chris Carey from Wells Fargo Securities.

So I actually have a question just about wine and spirits.

Price/mix has been a good story in the business that's accelerated this quarter.

Obviously, margins got hit.

I'm just trying to frame where you think we are on the path to the medium and longer-term margin targets here.

We knew there was always going to be a step back before recovery.

And certainly, it seems like the price/mix and premiumization of the portfolio can deliver what you think it can, but we also have a much more inflationary backdrop, and things are evolving.

So I wonder if you can just maybe take a look at this quarter and how it informs how you're continuing to look at the capacity of this business to deliver those margin targets over time and perhaps the time line on which you think that can happen.

Yes.

Chris, thanks for the question.

So as you indicated, the top line is doing quite well.

So we're very pleased with our transformation as it relates to top line growth.

In terms of the margin journey, what we've always said around that is it was going to take us about 2 years post divestiture to get to 30% operating margins.

And in order to get to that 30% operating margin, it was going to take a number of different things.

There was pricing.

There's mix.

There's the cost takeout that we've talked about previously -- stranded cost takeout of around $130 million, not all of which will fall to the bottom line, some of that we will reinvest behind the brands to make sure that we have strong brands that can generate the top line growth as well as other initiatives around footprint optimization as a result of the Gallo divestiture, not only did we shed a large number of brands, but we also sent 7 wineries, 7 facilities with that transaction.

So there's a footprint optimization as well as doing some cost optimization to make sure that the products we're putting in the bottle most reflect what the consumers are looking to get when they pick up those brands.

So that -- we're well underway.

We certainly didn't sit back and wait for the transaction to close to identify those cost savings and those initiatives.

So we're just now executing against those.

But as you say, we're at that interim period where the business is a bit deleveraged.

And so until the rest of those costs comes out, we -- you'll see that kind of that downward blip, as you noted this year, as we move to the 30% operating margins at the end of -- sorry, 2 years post divestiture.

Our next question comes from the line of Kevin Grundy from Jefferies.

This is actually Greg on the line for Kevin.

Just one quick follow-up question on some of the on-premise channel trends that you guys have been seeing.

Many of your peers have noted that it's been running in front of plan so far in terms of the number of reopenings, the velocity that they've seen.

You guys gave some helpful context on what you've seen over the last quarter, but maybe could you talk about how your expectations for the full year have changed?

Have you seen the reopening pace faster than you thought it would be and maybe how you think that would impact full year results?

Sure.

Let me take that one, Greg.

The -- we have seen it accelerate tremendously.

But as we've seen over the course of the last 18 months around the pandemic, you often see some things where you get starts and stops, and things improve in certain states and don't improve in other states and so on and so forth.

I think the important thing from our perspective to look at is while we've seen 250% growth in our depletions in the quarter versus prior year, the overall percentage of our business that the on-premise represents is still a bit less than it was in fiscal year -- or in calendar -- excuse me, calendar year '19.

So we still think there's still some opportunity and acceleration to come.

We also have had an exceptional -- and our distributor network does an exceptional job of winning the times that matter, things like the Fourth of July, Labor Day.

We did it with Cinco de Mayo.

We did it with Memorial Day.

So we still think there's going to be some good opportunities for acceleration.

The challenge to predict, how much of the channel shifting that occurred, there was a massive amount of channel shifting that occurred a year ago when you went heavily to the off-premise.

You're now seeing the on-premise comes back on, and the IRI and Nielsen data has been somewhat muted.

So we also have seen, as we noted in our scripts, a significant increase in our 3 tier e-commerce and direct-to-consumer across the business.

So how all those channels sort of shake out is a real question.

I think the encouraging part remains that consumer demand against our business across all channels that we can track has been extraordinarily strong.

And we're excited, and we think that will continue, irrespective of which channel the consumer chooses to engage in.

Our next question comes from the line of Andrea Teixeira from JPMorgan.

So I wanted to just follow on this one -- on this last commentary, Bill, on where consumers are engaging.

And it seems as if you just said now that it's still below the calendar '19 level.

So can you comment a little bit on how you see that transition?

Like your consumers are still engaging at home and the consumption of your -- obviously, your big brands is still very strong at home despite the shift and how you're seeing that?

And then just a clarification on -- also in the inventory and shipments.

Is it fair to say that given that you have a very easy comp on the production in April, right, so going to have a lot of like inventory that you haven't built yet, but it is due on transit from Mexico, is that something that gives you some comfort that -- even though you said, you only see the normalization by the third quarter, that the second quarter is still going to be a very strong shipment quarter?

Sure.

So let's start with the question around the on-premise.

Keep in mind, based on what we can see, per capita consumption has remained pretty steady throughout the pandemic.

It's just that where and how people consume has moved around quite a bit.

So it's really difficult to precisely predict how consumers are going to operate.

And I think it's going to vary, as I said a moment ago, quite a bit by state, depending on the individual restrictions and whether or not certain states are still allowing takeaway from a restaurant environment for alcoholic beverages, some are not.

So until all this dynamic plays itself out, I think it's going to be very difficult to predict exactly how the consumer will land.

Other than I would say, some of the sheer shopping behavior where you see 3 tier e-commerce and direct-to-consumer changes are going to continue.

As we said in prior calls, we have made major investments to increase our capability in 3 tier e-commerce and direct-to-consumer, and I'm very glad that we did.

It's playing out well, and it's showing tremendous takeaway in those sectors, which have grown around the pandemic.

As it relates to inventory, we continue to believe we're going to have a very solid year.

We're in a good position to make up the challenge that was the onetime challenge around the power outage that occurred in February.

And we expect to have, as we've said, a very strong year, and that I would expect would include the second quarter, which is a premise.

Our next question comes from the line of Steve Powers from Deutsche Bank.

I know you've gotten a lot of questions already, Bill, but just to round out that last topic on beer supply.

I guess is there a ceiling we should think about in terms of how much you're just physically able to ship in 2Q?

And I think consensus has you shipping around 100 million cases in the second quarter relative to 85 million in the first quarter.

And I guess just given all you said, I'm just trying to understand or dimension whether that kind of step-up is doable in broad brush strokes or is in the back half.

And then what I really wanted to ask about was for Garth.

Just -- you ran through a number of items very helpfully that will kind of weigh and explain the beer margin trajectory sequentially and what will weigh on beer margins over the remainder of the year.

If you could provide any more detail there, maybe a rank order just in terms of the items that we should be focusing on is having the biggest impact there, that would be very helpful.

Yes.

You bet.

So let me start with the first half, and then Garth will cover the second half.

The one thing that we haven't mentioned today, but it's an important one is -- but we did mention in prior quarters, our Obregon opening of the extension of Obregon was delayed roughly a quarter last year -- at the end of last year because of we weren't able to construct during COVID.

So that is certainly going to help our inventory position as we move forward as that's now up and running.

It's not running as efficiently as it will -- once we get everything locked and loaded because it's just normal start-up, but it's certainly helping the situation.

And we certainly expect to be able to meet consumer demand during our key summer selling season, as I said earlier.

We're being -- we're working very carefully with our distributor network and our retail partners to make sure that we are able to meet the demand.

Admittedly, the demand has been robust and continues to be very strong, but we're expecting to be able to meet that demand.

And certainly, Obregon is a big helper in that area.

Garth, do you want to take the other half?

Yes.

Just to follow up on the margin question.

So as we stated in Q4, really, it's those 3 big drivers of depreciation, inflation and mix.

And those are really kind of equally weighted in terms of the impact on margins.

So on the depreciation front, that was -- we have an increase of about $65 million this year.

And that's comprised of Obregon, full year first 5 in the glass joint venture, depreciation as well as some other things.

Inflation I think we've covered and the fact that, that hit us more in the second half of the year as our hedges kind of roll off.

And then mix, I think mix is also something that's going to impact us again more as we go through the year.

We started the year really with kind of one SKU in Corona Hard Seltzer Variety Pack #1.

Corona Hard Seltzer Variety Pack #2 was just launched at the beginning, and then we launched Limonada here in June.

So there will be more mix impact as we go through the balance of the year as well.

But really, it's equally -- the impact is equal across those 3 buckets.

Our next question comes from the line of Laurent Grandet from Guggenheim.

(inaudible) in the Hispanic household, I mean, about 15% for the white kinds where to I recall as the test was not pleasing their palate.

So now with new bolder flavors, seltzer and brands like Topo Chico, targeting specifically Hispanic, we are seeing household penetration within Hispanic going up to 25% to 35%.

So my question is, do you see that as a risk to your portfolio of Mexican beer?

And if not, why?

And what are you doing to reach more Hispanic consumer with your current seltzer portfolio?

Certainly.

Well, as you know, we are very fortunate with our Mexican beer portfolio to have the strength of brands that we do.

These are iconic authentic brands from Mexico that our Hispanic community is very much behind, and we continue to see strength and growth.

As I've said to you, I think -- or not to you, but I've said in prior calls, we continue to see opportunities with Modelo, the household penetration with Modelo despite the rapid growth of Modelo.

It's still not at the level of Corona, as an example.

We're also seeing overdevelopment in the Hispanic community with our Corona Hard Seltzer.

So we are reaching into that community by, again, meeting new occasions and meeting new consumer needs with those particular products.

So we're very comfortable with the growth profile that we see in the Hispanic community with our iconic portfolio for Mexico, and we think the seltzer element is going to be an important and a helpful part of continuing the relationship with the Hispanic community, recognizing that we're also doing a great job of expanding those brands into the non-Hispanic community as well.

Our next question comes from the line of Trevor Stirling from Bernstein.

Two quick questions from my side, please.

First, as you sit today and you compare with 3 months ago, what -- have anything changed to change your point of view either for F '22 or the outlook?

So the second thing related to that, given the cadence of inflation you've talked about given the aluminum spot price staying as high as it is and those hedges rolling off, historically, you've had that 1% to 2% pricing algorithm.

Do you think that might need to change 12 months out?

I'll take the price part.

Garth, maybe you take the first part.

The -- relative to the price, we continue to believe 1% to 2% is going to be our long-term expectation.

We think that balance is appropriately the dynamics that occur with price sensitivity when you raise your price and recognizing it does obviously help you cover any inflationary effects during the course of the year.

So we're pretty comfortable that, that algorithm of 1% to 2% is the right answer.

The balance is all of those factors, and we would see that continuing well into the future.

Yes.

In terms of the first part of that question, does Q1 change our point of view for the full year?

And I would say that at this time, it's too early for us to make any changes to our outlook for the year given 1 quarter in.

The one thing that I would highlight, right, as Bill noted in his script, depletions in our beer business exceeded our expectations as well as the expectations of our distributor, our retail partners.

So that's something that we'll watch very, very closely as we move through Q2 and through the balance of the year.

And look, when -- as we go through the year and we do see changes to our business, we'll be sure to update you all on our guidance expectations.

But as of right now, we're very comfortable with the guidance that we've provided and reaffirmed today with a bit of a tick up on our EPS related to the share repurchase program.

Thank you.

At this time, I'm showing no further questions.

I would like to turn the call back over to Bill Newlands for closing remarks.

Thank you, everyone, for joining our call today.

I think it should be clear that fiscal '22 is off to a strong start, providing us with continued momentum as we head into our key summer selling season.

Our powerful collection of consumer connected brands across beer, wine and spirits continues to gain traction, and we are well positioned to deliver another strong year of performance consistent with our long-term goals.

Our robust cash flow generation allowed us to make significant share repurchases in line with our commitment to return $5 billion to shareholders by fiscal '23, and we look forward to updating everyone throughout the fiscal year as we expect to make continued progress during fiscal '22.

In closing, I'd like to wish all of you a happy Fourth of July and hope that your celebrations with family and friends include our fantastic beer, wine and spirit products.

Thank you again, everyone, and have a good summer.

This concludes today's conference call.

Thank you for participating.

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