S&P Upgrades Constellation Brands (STZ) to 'BBB-'; Outlook Stable

November 11, 2016 2:49 PM EST

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S&P Global Ratings raised its corporate credit rating on Constellation Brands Inc. (NYSE: STZ), to 'BBB-' from 'BB+'. The outlook is stable.

At the same time, we raised the ratings on the company's U.S. senior secured bank debt and senior unsecured bonds to 'BBB-' from 'BB+'. We are withdrawing the recovery ratings, in accordance with our methodology for investment-grade ratings.

Also, we affirmed the 'BBB-' issue level rating on the secured European bank debt issued by CIH International S.A.R.L and CIH Holdings S.A.R.L.

Constellation has about $8.4 billion in debt outstanding pro forma for its recent $400 million European term debt issuance in October.

"The upgrade reflects our expectation that Constellation Brands will maintain credit measures near trailing-12-month levels, including debt to EBITDA near or below 3.5x," said S&P Global Ratings analyst Stephanie Harter. "Although we expect the company will remain acquisitive following its recently announced financial priorities, including a target dividend payout ratio of 25% to 30% of earnings, ongoing capital expenditures to expand beer production capacity in Mexico, and growth acquisitions, the company has indicated it expects to manage these priorities while targeting a debt-to-EBITDA ratio of 3.5x. Given the favorable growth prospects of its beer portfolio and steadily performing wine and spirits portfolio, we expect organic sales to grow by more than 5% annually. We also forecast the company will further boost sales growth by making ongoing acquisitions without materially increasing leverage."

The stable outlook reflects our opinion that the company will maintain stable credit measures, including debt to EBITDA near 3.5x while it continuing to invest in its beer capacity expansion projects to ensure it can grow sales volumes to meet demand, make periodic strategic acquisitions, and fund ongoing dividend payments. If the company increases debt-leverage above 3.5x temporarily for an acquisition, then it is our expectation that the company would reallocate cash to debt reduction as necessary following the transaction to restore debt leverage to 3.5x or below within 24 months.

We would consider lowering the ratings either because of a significant operating misstep or a material change in financial policies that leads to debt to EBITDA staying above 4x on a sustained basis. We believe leverage could exceed 4x if a material production disruption occurs such that gross margins fall by more than 200 basis points on a sustained basis. Leverage could also remain materially above 4x on a sustained basis if the company were to make a debt financed acquisition of more than $3 billion and does not direct internally generated funds to reduce debt.

We would consider upgrading the company once it completes its capacity expansion projects and captures the economies of scale it anticipates by producing its beer exclusively in-house. In our opinion, once this occurs the company's free cash flow generation will materially improve closer to $1 billion, which would afford the company better discretion over its cash uses to mange to its target 3.5x debt-to-EBITDA ratio.

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