A Sobering Situation: Constellation Brands & NAFTA Renegotiations

Constellation Brands produces some of the most famous Mexican beers in the world. Its Mexican beer portfolio, comprised of Corona, Pacifico, and Modelo, brings in the lion’s share of revenue for the $42.5B market cap business and is produced and packaged within Mexico. Under the Trump administration, the United States faces major changes to terms of trade with other countries. What do potential border tariffs and NAFTA renegotiations mean for Constellation, a U.S.-based conglomerate with a Mexican-based supply chain that brings in 52.6% of the company’s revenue?

Trump’s Election Plummets a Beer Brand’s Stock

On November 9, 2016, the Constellation Brands stock plummeted 8%. In January 2017, the alcohol conglomerate, which produces Corona, Modelo, and Pacifico, had not recovered – its stock hovered at 10% below its pre-election value.[1]

Figure 1: Constellation Brands Stock from 11/9/2016 to 1/30/2017[2]

Why would a beer brand have a negative reaction to the election? The answer lies in one of President Trump’s key campaign pillars: to renegotiate trade agreements with Mexico and bolster American industry. President Trump threatened to impose an up-to 35% tax on companies importing goods from Mexico – and Constellation was doing just that.[3]

Constellation entered Mexico in 1993 with its acquisition of Corona and solidified its position in 2013 by acquiring Modelo’s U.S. business.[4] Today, Constellation’s Mexican beer business accounts for 52.6% of its total net sales and 63.5% of its total earnings.[5] In order to maintain its authenticity and legal standing as a Mexican beer, Constellation centers its entire supply chain for brands like Corona and Modelo in Mexico.[6],[7]Approximately 60% of the COGS for these brands are attributed to Mexico and 40% to the U.S.[8]

In a post-Trump world, Constellation must decide how to mitigate potential tariff costs and avoid passing them on to U.S. consumers, which could cause a drop in sales. How does CEO Rob Sands protect the crown jewel of his company without acting too rashly in the face of unconfirmed legislation?

Figure 2: Corona’s supply chain map showcases the path from the brewery in Mexico to consumption in the United States[9]

Post-Election: Constellation Reacts – Without Overreacting

By January 2017, the executive team had developed a measured strategy to protect the company, and Sands attacked concerns about tariffs to calm analysts. From an external (short term) perspective, Sands stressed that Constellation was in discussions with key legislators.[10] As a result of these conversations, Constellation was confident that it did not need to rush to overhaul its supply chain. Rather, the company took a medium term approach, dedicating internal resources towards conducting dynamic political scenario analyses. These models would allow Constellation to activate a decision tree if legislation passed placing tariffs on Mexican beer. Potential actions within that tree included shifting packaging or the purchase of natural gas to the U.S. to reduce Mexican COGS on glass production and gain tax breaks at home.

What I appreciated about this approach was that Constellation remained calm despite uncertainty – they took steps to mitigate risk, but did not uproot their entire manufacturing process. CFO David Klein reiterated Sands’ plan on CNBC’S Closing Bell, explaining that Constellation had analyzed potential effects of the border tax on its business. He stressed that Constellation was prepared to make changes to its manufacturing if, and only if, absolutely necessary.[11]

Future Proofing: Is Constellation Complacent?

Constellation does, however, seem to be placing a bet that election rhetoric rarely plays out as truth.[12] Will they really be able to act as quickly as they say if they need to? Below are steps Constellation can take to help protect their powerhouse Mexican beer business more completely:

  • Short term:
    • Push legislators to consider a future tariff exemption for Constellation’s Mexican beers given this portfolio resulted from acquisitions by a U.S. based brand that created more U.S. based jobs
    • Partner with Molson-Coors, which recently signed an import deal to distribute Mexican-made Sol beer in the U.S., to place consolidated pressure on those legislators
  • Medium term:
    • Reinstate joint venture agreements within Mexico, like Constellation used to have with Modelo prior to 2013.[13] These partnerships would allow Constellation to prepare for tariffs by removing some production cost burden from its balance sheets
    • Preemptively shift glass production for one of its Mexican beer lines (i.e. Corona or Modelo or Pacifico) to the U.S. to help prepare the company and decrease the learning curve if the supply chain does need to change
  • Long term:
    • Double down on acquisitions. In its 2018 FY Q2 investor presentation, the company outlines targeted M&A as a priority.[14] To mitigate the risk facing their Mexican beer portfolio, Constellation should look at investing further in craft beer, a trend-forward category growing at 5%[15]

What Next?

Constellation is methodically preparing to protect their bottom line as they wait to see how international trade agreement changes play out under President Trump. Given this approach, I was surprised to find that they are simultaneously investing in Mexico, funneling over $2B into plant/brewery expansions.[16]

Does this make sense? What will they do with their Mexican work force if tariffs do occur – especially given the labor force will need to be cut should elements of the Constellation Brands supply chain shift to the U.S.?

(Word count: 779)

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[1] “Constellation Brands Inc. (STZ, U.S.: NYSE),” http://quotes.wsj.com/STZ/advanced-chart, accessed November 13, 2017.

[2] Ibid.

[3] Matt Egan, “Corona has a Trump-Mexico Problem,” CNN Money, January 17, 2017, [http://money.cnn.com/2017/01/17/investing/corona-trump-constellation-brands/index.html], accessed November 13, 2017.

[4] Constellation Brands, “Our Heritage,” http://www.cbrands.com/about-us/our-heritage, accessed November 13, 2017.

[5] Laura Berman, “Constellation Brands Sells Off As Investors Brace for Trade Turbulence,” The Street, November 9, 2016, [https://www.thestreet.com/story/13886931/1/constellation-brands-sells-off-as-investors-brace-for-trade-turbulence-with-mexico.html], accessed November 13, 2017.

[6] Rob Sands, CEO, remarks made on Constellation Brands Q3 FY 2017 Earnings Call, January 5 2017. From transcript provided by Seeking Alpha, https://seekingalpha.com/article/4034667-constellation-brands-stz-ceo-robert-sands-q3-2017-results-earnings-call-transcript, accessed November 2017.

[7] “Map: This Is How Your Corona Is Made,” January 30, 2017, Vinepair, https://vinepair.com/articles/how-corona-is-made-map-nafta/, accessed November 13, 2017.

[8] Sands, remarks made on Constellation Brands Q3 FY 2017 Earnings Call.

[9] Vinepair, “This Is How Your Corona Is Made.”

[10] Egan, “Corona Has a Trump-Mexico Problem,” CNN Money.

[11] David Klein, interview by Kelly Evans and Bill Griffeth, CNBC Closing Bell, CNBC, May 5, 2017, https://www.cnbc.com/video/2017/05/05/constellation-brands-cfo-we-did-a-lot-of-work-on-effect-of-a-bat-on-our-business.html, accessed November 13, 2017.

[12] Rob Sands, CEO, remarks made on Constellation Brands Q4 FY 2017 Earnings Call, April 6 2017. From transcript provided by Seeking Alpha, https://seekingalpha.com/article/4060920-constellation-brands-stz-ceo-robert-sands-q4-2017-results-earnings-call-transcript, accessed November 2017.

[13] Constellation Brands, “Our Heritage,” accessed November 13, 2017.

[14] Constellation Brands, STZ Investor Presentation Q2 FY 2018, p 61, October 5, 2017, http://www.cbrands.com/investors/events-presentations, accessed November 13, 2017.

[15] Jeff Daniels, “Overall Beer Market To See Lower Volumes, But Craft Should Enjoy 5 to 6 Percent Growth,” CNBC, November 10, 2017, https://www.cnbc.com/2017/11/10/overall-beer-market-to-see-lower-volumes-but-craft-to-see-5-to-6-percent-growth.html, accessed November 13, 2017.

[16] Constellation Brands, “Constellation to Build New 10 Million Hectoliter Brewery in Mexico,” http://www.cbrands.com/news-media/constellation-brands-build-new-10-million-hectoliter-brewery-mexicali-mexico-and-further-, accessed November 13, 2017.

Cover image: https://www.marketwatch.com/story/mexican-beer-deserves-a-voice-at-the-super-bowl-2017-02-02, accessed November 13, 2017.

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5 thoughts on “A Sobering Situation: Constellation Brands & NAFTA Renegotiations

  1. Well-written piece!

    While an import tariff on Mexican goods would certainly increase Corona prices in the US, I believe that the $2 billion investment in Mexican plant or brewery expansion would still make sense for a couple of reasons. First, Corona is one of the most popular beers throughout the entire world (#10th most popular in 2016) [1], so it still makes sense for the rest of the export market. Second, it seems that the primary reason that Corona is made in Mexico is so that it can be branded a “Made in Mexico” beer, something absolutely crucial to it’s brand identity. Even if the tariff increased Corona prices in the US, I don’t think that Corona would shift all of its productions to the US, as it would destroy much of the brand equity.

    Unfortunately, if Constellation Brands shifts part of their supply chain to the US, I think they would have to fire a portion of their workforce. However, as stated above, I believe that they will keep a significant portion of their operations in Mexico so that they can continue to call their beer “Mexican.” Possibly, they could move some of their workers from closing plants to these expansion sites.

    Finally, it is interesting to see that the stock of Constellation Brands is now over $220 per share, a 52% increase since January! [2] It looks like they are definitely doing something right!

    [1] Hines, N. (2017). The 10 Best Selling Beers In The World – 2017. [online] VinePair. Available at: https://vinepair.com/articles/10-biggest-beer-brands-world-2017/ [Accessed 26 Nov. 2017].

    [2] Finance.google.com. (2017). Constellation Brands, Inc.: NYSE:STZ quotes & news – Google Finance. [online] Available at: https://finance.google.com/finance?q=NYSE:STZ [Accessed 26 Nov. 2017].

  2. My sense here is that Constellation is right to perceive the risk to its business is relatively low. As you imply in your incredibly well-written analysis, the market has also picked up on this and the stock has done extremely well- largely due to the continued success of Corona particularly in the US.

    Agreeing with ABuck above- it comes down to branding and being able to be “made in Mexico”. This has two implications- the first being, as ABuck states, that Constellation is inelastic when it comes to actually having part of the supply chain in Mexico. On the other hand, the political risk is lower that this is actually a business on “America First” high alert- it makes no sense to demand that a Mexican beer be manufactured in the US to bring jobs back to the domestic beer industry.

    Since Constellation essentially has a de-facto monopoly on Mexican beer (no one drinks Sol), any tariff action taken against the business would be passed along to consumers or restaurants. There aren’t that many American competitors in the same strata in terms of flavor / lifestyle affiliations- we can assume customers aren’t likely to switch away from Constellation as prices rise.

    I even go so far as to wonder whether there is a structural reason to locate manufacturing in Mexico beyond branding. The labor content of beermaking has to be extremely low on the commercial scale that Constellation is producing- this makes the labor cost arbitrage opportunity relatively low.

  3. This was a really fascinating read, JoJo. To echo a comment made above, I believe Constellation has accurately predicted the risk of potential tariffs as particularly low given its primary U.S. business status. Even if they face these tariffs, I believe they can build a case for an exception to these tariffs given the origins of the business and the split in their supply chain.

    If they’re not able to evade these tariffs, I believe it’s still advantageous enough for them to base their production operations in Mexico and potentially pass on a portion of the tariffs onto their consumers. In Mexico, they can benefit from relatively cheaper labor and raw materials costs which justifies their increased investment in the region. If they were to move their supply chain to the U.S, they would face significant capital investments as well as a long term increase in labor costs. Also, given the loyalty to the brand and the relatively low alternatives (as stated above), I believe that consumers would absorb an increase in costs and continue purchasing the beer.

  4. Jojo – this is a very well thought out view on the risks our current regulatory environment poses to Constellation Brands and many similar US-based companies who depend on an international supply chain and global brands.

    It is interesting to read about Constellation’s outwardly calm reaction. To me, this re-iterates the importance of the leadership’s stated concern (or non-concern) as a signal to the market — something we talk about often in our courses. That said I do think it is critical that Constellation invest time and resources in understanding how they will respond to changes in NAFTA and tariffs. It is plausible that the Trump Administration will follow through on its promises despite pressure on legislators.

    To me, it does make sense that Constellation is simultaneously investing in expansions in Mexico given the low-cost advantages it offers as well as the need to keep a significant amount of production “local” for their Mexican brands. I would argue that this investment should be coupled with a marketing and distribution push to expand access to their Mexican brands in countries outside of the US, potentially in LatAm and Asia where there is economic growth and the market is less saturated than Europe.

  5. Jojo,

    This is a great post.

    I agree with Zack and at2019 as it relates to Constellation effectively quantifying the level of risk. It was wise for them to not overreact after Trump’s election because decisions to over-haul their supply chain would have had adverse effects on their business long-term.

    As at2019 points out, moving manufacturing to the U.S. would require expensive upfront investment as well as a heightened variable cost due to labor wagers being higher in the U.S. rather than Mexico. Furthermore, as ABuck and Zack allude to, there are branding benefits of having beer that is made in Mexico.

    Overall, what I really enjoyed about your piece was that it shows the way in which management can respond calm to situations which could be perceived as a crisis. After Trump’s elections, there was so much volatility. At Morgan Stanley, I witnessed the frantic nature of some of the clients we covered that were unsure to what extent they needed to drastically overhaul aspects of their business. It was reassuring to see how a company was able to proceed with poise and I think the benefits of them having done so will become clear with time.

    Once again, thank you for a well-written, interesting post.
    Best,
    Triston

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