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Leading wine and spirits distributor, Constellation Brands Inc. (STZ - Analyst Report) delivered adjusted earnings of 71 cents per share in the second quarter of fiscal 2013, surpassing the Zacks Consensus Estimate of 54 cents but falling short of the prior-year period earnings of 77 cents. On a reported basis, the company registered earnings of 67 cents per share.

Net sales in the quarter increased 1% to $698.5 million from the year-ago quarter. However, sales missed the Zacks Consensus Estimate of $710 million. On an organic basis, the company’s wine and spirits sales remained almost flat with the year-ago quarter. Net sales gained on account of higher volumes offset in part by elevated promotional costs.

Cost and Margin Performance

Cost of products sold escalated 1.5% year over year to $413.4 million in the quarter, and based on revenues, it expanded by 20 basis points to 59.2%. Adjusted gross profit inched up 1.2% to $286.6 million, while gross margin remained flat compared with the prior-year quarter at 41%.

Selling, general and administrative expenses increased 11.6% to $154.3 million in the quarter, and based on sales, it increased 210 basis points to 22.1% from the prior-year quarter, primarily due to increased promotional and marketing expenses to support innovation initiatives at the company’s U.S. wine and spirits business.

As a result, Constellation Brands' adjusted earnings before interest and taxes (EBIT) declined marginally to $211.1 million from $212.6 million in the year-ago quarter, leading to a contraction of 60 basis points in EBIT margin to 30.2%.

During the quarter, the company’s interest expense rose 28% to $55 million, primarily driven by the shooting up of the company’s average borrowings as well as increased average interest rates. Effective tax rate in the quarter was 16.3% versus 3.1% in the year-ago quarter.

Financial Position

Constellation Brands’ cash and cash equivalents as of August 31, 2012 was $178.5 million. During the six months of fiscal 2013, Constellation generated $368.5 million of cash from operations compared with $517.4 million in the previous year. Through the first half of fiscal 2013, the company generated a free cash flow of $333 million compared with $478 million reported in the prior-year period.

Fiscal 2013 Outlook

Constellation Brands updated its fiscal 2013 guidance to now project adjusted earnings per share guidance in the band of $2.00 to $2.10 per share compared with $2.34 in fiscal 2012. The guidance factors in an interest expense expectation in the range of approximately $225–$235 million, an approximate tax rate of 30% and weighted average diluted shares outstanding of approximately 190 million. Moreover, the company anticipates generating a free cash flow in the range of $450 million to $500 million.

On a reported basis, the company expects earnings per share in the range of $1.87-$1.97 per share compared with $2.13 in fiscal 2012.

Constellation Brands is the largest wine company in the world with a strong portfolio of premium wine brands complemented by spirits, imported beer and other select beverage alcohol products. Constellation Brands competes with Beam Inc. and privately held E. & J. Gallo Winery and Jackson Family Wines.

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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