Constellation Brands Stock Looks Even More Compelling Now

There has been a lot of talk about Canadian cannabis companies over the past several months. Most of that talk has been positive, and a lot of it has centered around Canadian cannabis leader Canopy Growth (NYSE:CGC). Consequently, over the past year, CGC stock has rallied more than 75%.

STZ Stock Looks Even More Compelling Now

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But, no one ever seems to talk about the company behind Canopy — Constellation Brands (NYSE:STZ). To kick-start the entire cannabis craze, Constellation Brands poured $4 billion into Canopy in 2018 to gain ample exposure to the cannabis industry. Despite that big investment, while CGC stock is up 75% over the past year, STZ stock is down 25%.

That’s 100 points of divergent performance. That doesn’t make sense, considering Constellation owns more than 30% of outstanding common CGC shares. It also doesn’t make sense considering that the global alcohol industry will keep growing over the next several years, even as the cannabis market goes global.

As such, CGC looks compelling on this dip. I’m a buyer here and lower, all else equal.

The Alcohol Industry Is Stable

The big reason behind the recent selloff in STZ stock has to do with cannabis. Namely, the consensus thesis out there is that as the recreational cannabis market becomes increasingly legal, convenient and large, it will take share from the alcoholic beverage market. As that happens, STZ’s sales will drop, margins will come under pressure, and profit growth will fall flat. That’s why STZ stock has dropped 25% over the past month, as the cannabis craze has picked up steam.

But, that thesis is flawed.

To be sure, there is an overlap between the pot smoking and beer drinking crowds. And, as weed becomes more easily accessible and legal, there will be a handful of consumers who choose to smoke weed rather than drink beer. But, data suggests that this is a small portion of the market, and that most adult users will both drink beer and smoke pot.

According to detailed data from the National Survey on Drug Use and Health (NSDUH), marijuana usage rates among U.S. adults age 18 or older have climbed from 6% in 2002 to nearly 10% in 2017. During that same stretch, cigarette smoking usage rates among the same cohort have dropped from 27.5% to below 20%. Meanwhile, alcohol consumption rates have actually increased from 54.9% to 55.9%.

There are many things at play here, but the broad takeaway is clear. As marijuana consumption has risen, it has taken share from the tobacco industry, not the alcoholic beverage industry. Instead, alcohol consumption rates have actually slightly risen over the past two decades as marijuana usage has become more prevalent. From this perspective, it shouldn’t be surprising that alcoholic beverage sales are not down in U.S. states that have legalized cannabis.

If you extrapolate this out, it’s easy to see that fears related to a big slowdown at STZ as a result of widespread cannabis legalization and usage are overblown. Constellation’s alcohol sales will be just fine over the next several years. Meanwhile, the company will win big thanks to its 30%-plus ownership stake in Canopy as the cannabis market grows by leaps and bounds. Altogether, then, Constellation actually has healthy growth prospects over the next several years.

Valuation Is Anemic

The opportunity in STZ stock is that healthy growth is far from priced in today. Thus, as healthy growth materializes over the next several years, it will converge on a discounted valuation, and result in a pop in STZ stock.

At the current moment, STZ stock trades nearly 30% off all-time highs. It’s also well below all of its major moving averages, and trades at just 17X forward earnings, versus a five-year average forward multiple of nearly 23. All other major valuation multiples are also currently at a discount to their five-year averages.

In other words, what you have with STZ is a really beaten up and lowly valued stock with depressed investor sentiment. That is the sort of set up that lends itself to a big rally in the event that fundamentals improve, which they will over the next several quarters and years.

Bottom Line on STZ Stock

Constellation Brands has been unfairly beaten up on irrational concerns that the alcoholic beverage market will be eaten alive by the cannabis market. These irrational concerns won’t last forever, so investors should take advantage of this near-term disconnect between price and reality.

As of this writing, Luke Lango was long CGC and STZ.

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