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In a strategic move to enhance its presence in the U.S. beer market, Constellation Brands Inc. (STZ - Analyst Report) has entered into an agreement with Anheuser-Busch InBev (BUD - Snapshot Report) to acquire the remaining 50% stake of Crown Imports.

Constellation Brands has a 50-50 joint venture with Grupo Modelo S.A.B. de C.V. (Modelo) in Crown Imports. Previously, AB InBev has completed its proposed acquisition of Modelo.

Per the agreement, Constellation Brands will pay $1.85 billion to complete Crown Import acquisition and will hold the right of distribution, marketing and pricing of Modelo brands in the U.S. AB InBev will be responsible for maintaining the supply and quality of products along with innovations.

At the end of first-quarter fiscal 2013, Constellation Brands had $69.1 million of cash and cash equivalents. Moreover, the company generated $96.4 million and $76.8 million of cash from operations and free cash flow, respectively. Furthermore, the company has remaining $850 million under its revolving credit facility.

We believe the financial condition of the company is not solid enough and so it will require bridge financing to complete the transaction or may also opt for permanent financing including revolving credit facilities, term loan and senior notes if market conditions remain favorable.

It is anticipated that the acquisition will increase Constellation Brands’ debt-to-EBITDA ratio to mid-four times. However, in next 12 months, Constellation Brands is expecting to generate strong free cash flow which will bring leverage ratio at its targeted range of three to four times.

Moreover, the company notifies that it is going to suspend its ongoing $1.0 billion share repurchase program. Currently, Constellation Brands’ has nearly $700 million remaining under its share repurchase authorization.

Crown Imports is the largest beer importer in the U.S. and markets Modelo brands, such as Corona Extra, Corona Light, Modelo Especial, Pacifico, Negra Modelo and Victoria. After the completion of the deal, Constellation Brands will become the largest multi-category supplier of beer, spirits and wine and on a volume basis third-largest total beverage alcohol company in the U.S.

During fiscal 2012 Constellation Brands earned $215 million of equity earnings from Crown Imports which was 50% of the total earnings. Therefore, Constellation Brands believes acquisition will be significantly accretive to its earnings per share and free cash flow.

The company reiterates its fiscal 2013 adjusted earnings per share guidance in the band of $1.93 to $2.03 per share. The guidance excludes any impact of acquisition, however, we expect the transaction will have a positive contribution to the fiscal 2013 earnings performance. The current Zacks Estimate of $1.99 per share is approximately at the midway of the company’s guidance range.

Our Recommendation

Constellation Brands is the largest wine company in the world and commands a dominant position in the premium wine segment in the U.S. The company is also a leading producer of wines in Canada and New Zealand. This provides a competitive edge to the company and bolsters its well-established position in the market.

Moreover, continued focus on brand building and promotion along with strategic acquisitions will accelerate its growth opportunities while strengthening its market position. Moreover, in an effort to generate strong margins, Constellation Brands is also focusing on higher priced segment across all key categories. Moreover, the company recently acquired a California based wine company Mark West, which we believe will enhance its presence in Wine market.

However, the company faces intense competition from other well-established players in the industry, including Beam Inc. , Brown-Forman Corporation (BF.B - Analyst Report) and Diageo plc (DEO - Analyst Report). Moreover, Constellation Brands also encounters competition from local and regional players in the respective countries. Consequently, this may dent the company’s future operating performance.

We currently have a Zacks #3 Rank (short-term Hold rating) on the stock. Our long-term recommendation on the stock remains Neutral.

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