Constellation Brands, Inc. (NYSE:STZ) Q3 2023 Earnings Call Transcript

Constellation Brands, Inc. (NYSE:STZ) Q3 2023 Earnings Call Transcript January 5, 2023

Constellation Brands, Inc. misses on earnings expectations. Reported EPS is $2.83 EPS, expectations were $2.9.

Operator: Greetings, and welcome to Constellation Brands’ Third Quarter Full Year 2023 Earnings Conference Call. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mr. Joseph Suarez. Thank you. You may begin.

Joseph Suarez: Thank you, Rob. Good morning, all, and Happy New Year. Welcome to Constellation Brands third quarter fiscal 2023 conference call. I’m here this morning with our CEO, Bill Newlands; and our CFO, Garth Hankinson. As a reminder, reconciliations between the most directly comparable GAAP measures and any non-GAAP financial measures discussed on this call are included in our news release or otherwise available on the company’s website at www.cbrands.com. Please refer to the news release and Constellation’s SEC filings for risk factors, which may impact forward-looking statements made on this call. Before turning the call over to Bill, in line with prior quarters or like last, let me limit everyone to one question per person, which will help us to end our call on time. Thanks in advance, and now here’s Bill.

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Bill Newlands: Thank you, Joe, and good morning, everyone. Happy New Year to everyone, and welcome to our fiscal third quarter call. I hope you all had a great holiday season and that our products were able to play a role in some of your special moments with your family and friends. Since our last call in October, Constellation Brands reached a notable milestone in its history as a public company. As most of you know, in November, our shareholders approved the elimination of our Class B common stock. With that came the transition of our company to a single class of publicly listed stock, our Class A common stock, which provides our shareholders with equal one share, one vote rights. I want to thank everyone who supported this important enhancement to our company’s corporate governance profile and capital structure.

We believe that our leadership team now has an even stronger foundation to continue to build shareholder value through the strategic initiatives we adopted and have steadily advanced over the past nearly four years since I assumed the role of CEO. Since fiscal 2020, we agreed to focus on and put in place plans to: number one, continue to build powerful brands that people love; number two, develop consumer-led innovations aligned with emerging trends and consistently shape our portfolio for growth; number three, deploy capital in line with disciplined and balanced priorities; and number four, operate in a way that is good for business and good for the world. I’m pleased to say that we continue to build on a strong track record we have established against all of these strategic initiatives.

Starting with number one, building our powerful portfolio of brands. Our beer business, despite a more recent series of headwinds, which we’ll address in a few minutes, delivered its sixth consecutive quarter of leading share gains across the entire U.S. beer category in IRI channels that was primarily driven by our two largest brands, Modelo Especial and Corona Extra. In the third quarter, Modelo Especial maintained its position as the top share gainer and is the number one high-end beer brand, and Corona Extra was the third largest share gainer and the number three high-end beer brand. In fact, our beer business delivered 3.5 points of share gains and 54% in dollar sales growth when comparing the 52-week period that ended with our latest fiscal third quarter against the 52-week period that ended with our fiscal 2019.

And comparing the same periods, the business contributed the highest dollar sales growth in the category, amounting to over $2.5 billion. In our Wine & Spirits business, our largest higher-end brands Meiomi, Kim Crawford, The Prisoner and High West, all delivered dollar sales growth and share gains in the third quarter. And comparing the 52-week period that ended our latest fiscal third quarter, against the 52-week period that ended our fiscal 2019, these brands achieved 72% dollar sales growth. Moving on to number two, consumer-led innovation and shaping our portfolio for growth. Many of you may be surprised to know that in our beer portfolio, our SKUs introduced over the past three years have driven 20% of the growth delivered by the business since the start of fiscal 2020.

An important part of this growth has come from our Modelo, Chelada brands, which have evolved from a niche business to a sizable platform. In fiscal 2023 year-to-date, it has delivered 13.6 million cases of depletions, which already exceeds the brand’s total deflations for all of last fiscal year. And in the third quarter, Modelo Chelada Limon y Sal moved up nine spots to become the sixth largest share gaining brand in IRI tracked channels. Beyond the Chelada brands, we continue to build on the opportunities within the Modelo family with a clear focus on maintaining brand investments. We are excited about the national launch of Modelo Oro in March which has surpassed internal and external benchmarks in test markets. In our Wine & Spirits business, innovation has also yielded strong results, increasing its contribution to net sales from 1% in fiscal 2020 to approximately 8% in fiscal ’23 year-to-date.

This expansion has been primarily driven by extending our largest higher-end brand, once again, Meiomi Kim, The Prisoner and High West. Notably, extensions in The Prisoner brand family, Blindfold, SALDO and Unshackled have contributed significant growth, especially Unshackled, which has grown to be half the size of The Prisoner brand in just four years. In addition, since the beginning of fiscal 2020, we have added five brands through acquisitions, like Bronco Wines, My Favorite Neighbor, Empathy Wines, Halpern and Kings and Austin Cocktails, all of which are in the higher-end segments of the wines and spirits categories that are contributing to growth. And we divested 36 brands, the vast majority of which were in the mainstream segment, which has mainly been in decline due to consumer-led premiumization trends.

Given this free shaping of our portfolio, including the recent additional divestiture 62% of net sales in fiscal ’23 year-to-date were from our higher-end brands. This is a dramatic shift from the 34% higher-end brands represented at the end of fiscal ’19. Now turning to number three, capital allocation. In fiscal 2020, we introduced a thoughtfully structured approach designed to consistently deploy capital with discipline and balance. We made maintaining our investment-grade credit rating, our top capital allocation priority and reduced our net leverage ratio, excluding Canopy equity and earnings, from 4.5x at the end of fiscal ’19 to 3x by the end of the second quarter of this fiscal year. This was partly driven by a $3.2 billion reduction in our debt levels and partly by strong earnings growth in our beer business.

And then in the third quarter, these efforts gave us the flexibility to both accommodate the $1.5 billion financing for the elimination of our Class B shares and to maintain our investment-grade rating. As our net leverage ratio remained in line with our prior 3.5x target. However, we recently updated that set target to 3x, given our ability to previously achieve that target and the continued strong cash flow generation capabilities of our businesses. Our second priority became delivering cash returns to our shareholders, and we set a goal to return $5 billion in dividends and buybacks between fiscal 2020 and ’23. We virtually completed that goal ahead of schedule in the third quarter and we’re now on track to exceed the $5 billion target with the fourth quarter dividend payment announced today.

As to our third priority, we sought to advance growing capacity expansions to support the strong growth in our beer business. Since the start of fiscal 2020, we added approximately 9 million hectoliters of capacity through growth investments and another 2 million hectoliters through brewery optimization and productivity initiatives. We are also on track to further diversify our production footprint with the development of our new brewery in Veracruz, where we have recently broken ground. And last in our capital allocation priorities was M&A, and since the start of fiscal ’20, we have judiciously deployed excess cash through acquisitions with a strict focus on small gap filling higher-end brands. And the key strategic acquisitions we have executed over the last nearly four years are delivering top line growth.

All in, we believe we have unquestionably upheld our capital allocation priorities and have even exceeded some of the associated targets we set out to achieve. Moving on to strategic initiative number four, operate in a way that is good for business and good for the world by advancing ESG goals. Our ambitions are to protect the environment and natural resources by serving as a model for water stewardship in our industry while reducing greenhouse gas emissions, to champion the professional development and advancement of women within our company, industry and communities, to enhance the economic development and prosperity in disadvantaged communities and to promote responsible beverage alcohol consumption. While we still have much work to do, I am proud to say we are making good progress towards our goals.

To that end, in the third quarter, we released our 2022 ESG Impact Report, which included several enhancements on the information shared on these important topics and our work towards our targets, including, for the first time, references aligned to the Sustainability Accounting Standards Board framework and taking into consideration recommendations from the task force on climate-related financial disclosures. So as with our capital allocation priorities, we have been consistently working to deliver against our strategic initiatives. Net, we have done we have said what we do, and we have done what we said. And despite current inflationary pressures and the risk of recessionary headwinds we remain confident in our ability to continue to advance and create value through these initiatives.

And on that note, let’s move on to a more fulsome discussion of our performance in the third quarter. Depletion growth for our beer business decelerated to 5.7%, which, as I mentioned earlier, was largely due to a recent series of headwinds that developed towards the latter part of the quarter. First, as we shared on our last call, we decided to introduce all pricing changes above our usual algorithm due to cost pressures across the chain, and historically, the impact of these types of notable pricing actions take a few months to settle in. Second, distribution growth is returning to more normalized levels after lapping a softer summer period last year when we were managing supply constraints. That said, distribution growth remains at exceptionally healthy levels as well as aligned with our full year expectations.

And third, some of these headwinds were particularly accentuated in a few key regions for our brands, such as California, where we lapped double-digit depletion growth rates and better weather in November of last year as well as more favorable economic conditions. All of that said, our beer business continues to perform strongly relative to the wider market and to resonate with consumers who continue to shift to higher-end brands. In IRI channels, we gained 1.5 points across the entire category and 2.3 points in the higher-end segment in the third quarter, which is higher, let me repeat that, which is higher than the share gains in the same quarter last fiscal year. And when looking at depletions fiscal ’23 year-to-date, our beer business achieved growth of 7.8%, which continues to be in line with our annual expectations.

Importantly, based on the prior activity we have seen in retail, as they adjust to the continued inflationary environment, we expect trends to return to more historical rates over the next few months. Now shifting to the performance of our beer brands. Modelo Especial delivered depletion growth of 4.4% in the third quarter lapping a tough 13.2% depletion growth comparison in the corresponding period of the last fiscal year. That said, the brand has achieved depletion growth of 9.9% over fiscal ’23 year-to-date. In the recent quarter, it continued to strengthen its position in the five states where it is already the number one beer brand in dollar sales, delivering another approximately 0.2 points in share gains. Importantly, in the other 39 states tracked by IRI data, Modelo Especial delivered more than 4x the share gains at over 0.8 points.

More broadly, Modelo Especial’s depletion growth in its secondary markets outpaced the growth in its top five states by over 10 points. As such, we continue to see significant incremental opportunities to maintain the momentum of Modelo Especial, particularly through distribution gains in the states where it is under represented. Corona Extra delivered depletion growth of 1.3% in the third quarter and 4% in fiscal ’23 year-to-date. As noted earlier, the brand has maintained its momentum as the number three share gainer in track channels. We continue to invest in the growth of Corona Extra through a thoughtful and authentic evolution of the brand’s market such as the augmented reality addition to our O’Tannenpalm campaign, which is one of the more enduring holiday themed commercials running for over 30 years now.

And we continue to see growth potential for Corona Extra with younger legal drinking age and multicultural consumers. Pacifico’s depletion growth accelerated in the third quarter to 40.7%. And over fiscal ’23, year-to-date, its depletion growth was 32.9%. The brand remains a top 10 share gainer in tracked channels in the third quarter, mainly supported by its growing footprint in states like California, Nevada, Utah, Colorado and Arizona. We continue to see fantastic growth runway for Pacifico as one of our new wave brands with significant distribution potential relative to Modelo and even more so relative to Corona Extra. Particularly as the brand also continues to build momentum by shifting East in the U.S., building on the 26% depletion growth delivered in our Eastern business unit in the third quarter.

Lastly, our Modelo Chelada brands achieved depletion growth of 44% in the third quarter and 48% over fiscal ’23 year-to-date. Our Modelo Chelada brand remained the number one set in the Chelada space, and the brands gained nearly half a share point across all U.S. beer and track channels. For perspective, that is as much as Corona Extra’s gain. In fact, these gains were largely driven by innovations launched this fiscal year, including Naranja Picosa flavor, the Limon y Sal 12 ounce 12 pack, which is a top 10 new packaged SKU and our new variety pack, which is among the top 15 new brands. We continue to expect significant growth from the Modelo Chelada brands as we invest in marketing to the general market consumer to broaden the demographic appeal for this product.

All in, the strong demand for our brands in the third quarter supported a net sales increase of approximately 8% for our beer business. And despite the impact of inflationary headwinds on operating income, we were able to maintain operating margin at 37.5%. This gives us the confidence to once again raise guidance for our beer business this fiscal year lifting the low end of our growth outlook. We now expect to achieve 9% to 10% net sales growth and 4% to 5% operating income growth for fiscal ’23. Moving on to Wine & Spirits. Our Wine & Spirits business continues to advance its vision to be the high-end market leader. As noted earlier, our largest higher-end brands delivered strong performance relative to their categories in the third quarter.

In our Aspira portfolio, which includes our fine wine and craft spirits brands, over the third quarter in track channels, The Prisoner brands grew dollar sales by 4.3%, while the fine wine segment contracted by 5.7%. And High West grew dollar sales by 22%, while high-end spirits segment grew by only 3.4% In our premium and mainstream Wine & Spirits portfolio, which we refer to as Ignite, both Meiomi and Kim Crawford gained share in the U.S. wine category. Depletions for our Wine & Spirits business declined by 5.5% in the third quarter, mainly driven by continued headwinds based across our mainstream brands. However, our Aspira portfolio delivered strong performance with 8.5% depletion growth in the quarter. And in fiscal ’23 year-to-date, our Aspira portfolio has now achieved an overall 6.3% increase in depletions supported by strong double-digit depletion growth for The Prisoner and High West.

Among Ignite brands, Meiomi and Kim Crawford have also delivered solid depletion growth in fiscal ’23 year-to-date, supporting an overall 2.3% increase in depletions for our premium line portfolio. Our Wine & Spirits business also continued to expand its global omnichannel footprint, advancing its growth in direct-to-consumer, 3-tier e-commerce channels as well as international markets. Wine & Spirits DTC net sales grew 23% in the third quarter, and we continue to perform particularly well in 3-tier e-commerce which delivered dollar sales growth 9 points above the competition. These results were underpinned by our strategic DTC investments in both hospitality through facility upgrades and talent development and our own e-commerce website platforms as well as our continued leadership in 3 Tier e-commerce through marketing innovations like launching video ads on Instacart.

And a strategic focus on major omnichannel national accounts, third-party marketplaces and digitally native retailers like Amazon, where we were the number one overall supplier and number one growth supplier in higher-end wine in the third quarter. International markets accounted for 9% of the total net sales in the Wine & Spirits business in the third quarter as our strategically focused approach continued to target select metropolitan markets, including London, Tokyo, Seoul, Sydney, Mexico City, Zurich and Toronto with some of our most renowned premium and fine wine brands like The Prisoner, the Schrader as well as more recently acquired brands like Lingua Franca and My Favorite Neighbor. And with our craft spirits portfolio, which includes brands like Casa Noble and the CAMPO high-end tequilas, that delivered international shipments 5x greater than the third quarter of the prior year.

We are also pleased that our efforts to establish a leading global higher-end Wine & Spirits portfolio are gaining recognition with several of our brands receiving remarkable accolades including Schrader Cellars winning its 37th 100-point score and its Double Diamond brand being recognized by The Wine Spectator as its number one wine of 2022. Our To Kalon Vineyard was being recognized again as the top vineyard in North America for the fourth consecutive year among top vineyards in the world. And I’m pleased to report that our To Kalon Vineyard has now also is certified as organic, expanding the appeal of its wines to a broader set of consumers and adding to its differentiation. And in our spirits portfolio, our recently launched Nelson Brothers Bourbon Reserve was ranked among Whiskey Advocate’s top 10 most exciting whiskeys of 2022.

So all in, our Wine & Spirits business continues to make meaningful progress on its transformation. And while net sales and operating margins, net of recent divestiture, were slightly lower relative to the third quarter of last fiscal year due to volume shifts from shipment timing only being partially offset by mix and pricing benefits we did see a significant sequential uplift in operating margins of 55 basis points relative to the second quarter of this fiscal year. This gives us confidence to reaffirm our fiscal ’23 guidance for our Wine & Spirits business of stable to 2% lower net sales and 3% to 5% operating income growth, which we are providing against the fiscal ’22 baseline adjusted for the recent divestiture. Looking further ahead, we are also confident that over the medium term, both our beer business and our Wine & Spirits business remain well placed to deliver strong growth and best-in-class operating margins.

That said, given continued inflationary pressures and the potential impact of recessionary environment, we remain mindful of balancing the momentum of our brands against near-term cost challenges. To that end, based on our current expectations of the pressures that the consumer will continue to face in the near term, we are giving even more careful consideration to our pricing actions for fiscal ’24. In particular, we currently expect pricing actions for our beer business to be more muted in fiscal ’24 as our pricing actions in the current fiscal year were ultimately above our medium-term algorithm. While input costs remain at historically elevated prices we strongly believe that additional consideration in our approach to pricing in fiscal ’24 is warranted to sustain healthy growth for our brands.

In addition, while some input costs are below the peaks from earlier this fiscal year, we now anticipate inflation to remain above historical trends in the high-end single-digit range for fiscal ’24. As always, we will continue with our disciplined approach to manage these evolving conditions through cost-saving initiatives. But these persistent inflationary headwinds will be compounding on the double-digit cost uplift we have faced in fiscal ’23. As such, we now expect operating margins for our beer business in fiscal ’24 to be more in line with our anticipated margin structure for this fiscal year, and therefore, below our stated 39% to 40% medium-term range. We are still refining our outlook for ’24 and will provide more detailed guidance at our next earnings call, but we wanted to share some context today now that our annual planning process is underway.

With all that said, let me be clear. Our beer business continues to have best-in-class operating margins and our Wine & Spirits business continues to make progress toward achieving that same differentiation. We are also confident that over the medium term, our beer business remains well positioned to deliver leading operating margins, supported by the sustained momentum of our core Modelo Especial and Corona Extra brands, the significant opportunity being captured by our Pacifico, Modelo Chelada brands. The incremental upside from our broader existing portfolio and the continued development of our innovation lineup particularly from exciting imminent additions like Modelo Oro and we continue to expect our Wine & Spirits business to make progress on its operating margins supported by continuing to pursue the exciting runway for growth of our higher-end brands and ensuring these brands represent an even greater portion of our mix over time, enhancing the performance of our mainstream portfolio through a greater focus on brands and initiatives with higher returns, including through relevant and innovative products and growing our omni-channel and international leadership particularly as an incremental opportunity for higher-end growth.

Now before I conclude, I wish to quickly touch on Canopy. We remain supporter of Canopy sellers to create an exchangeable share structure designed to support the consolidation of all its U.S. cannabis assets into a single avenue. And to that end, our intention continues to be to transition our existing common share ownership interest in Canopy Growth into new exchangeable shares once its shareholders approve this transaction. We believe that the conversion of our ownership interest will maintain our ability to realize the potential upside of our investment in Canopy. At the same time this transaction and the surrender of our warrants are expected to eliminate the impact to our equity and earnings, mitigate risk to our organization and further reinforce our intent to not deploy additional investment in Canopy in line with our capital allocation priorities.

In closing, I’d like to reiterate three main takeaways today. First, nearly four years ago we committed to a series of strategic initiatives aimed at delivering profitable growth and shareholder value. And I’m pleased to say that we are delivering against those initiatives and in many cases even exceeding the goals we set out to achieve. Second, our third quarter results demonstrate that we continue to execute against these strategic initiatives and that our company remains in a strong position to deliver best-in-class results. Despite the headwinds in the quarter due to macroeconomic pressures and tough comps versus prior year, the strong performance of our beer business has put it on track to deliver better-than-expected results in fiscal ’23.

And the transformation of our Wine & Spirits business is also yielding results. And third, we remain confident we will continue to build on our track record of solid growth and value creation through our strategic initiatives. And with that, I turn the call over to Garth.

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Garth Hankinson: Thank you, Bill, and good morning, everyone. As Bill mentioned, we delivered another set of solid results in the third quarter and continue to make progress against our operating plans and strategic initiatives. Our beer business achieved high single-digit net sales growth and continue to deliver best-in-class operating margins. Our Wine & Spirits business made additional progress against its strategy with an even more premiumized portfolio further aligned with consumer trends following our recently completed divestiture. Additionally, we generated strong cash flow results and with yesterday’s declared dividend to be paid in February, we are on track to exceed our stated $5 billion goal of returning cash to shareholders in the form of dividends and share repurchases between fiscal ’20 and fiscal ’23.

I will now review our Q3 performance and full year outlook in more detail, where I will generally focus on comparable basis financial results. Starting with our beer business. Net sales increased 8%, primarily driven by higher average price increases and solid demand across our portfolio. Q3 shipment volumes were up 3% reflecting a difficult volume lap given the focus of replenishing product inventories in the same period last year. From a depletions perspective, we achieved growth in the quarter of approximately 6%, driven by the demand of our Modelo family of products, including the Modelo Especial and Modelo Chelada brand as well as double-digit growth from Pacifico. As Bill noted, depletions decelerated sequentially from Q2 to Q3. This was primarily due to: number one, incremental fall pricing that, as expected, will put us above our targeted annual average increase.

Notably the impact of our fall increases has been heightened by additional pricing actions across the value chain. That said, we expect the impact of incremental pricing will settle over the coming months as we have seen in prior similar circumstances. Number two, relatively lower distribution growth in Q3 versus Q2, where we lapped a softer prior year period when we were managing supply constraints. And while we are seeing distribution growth return to normalized levels, it remains aligned with our full year expectations. Importantly, it is worth noting that Q3 distribution growth remained well above the levels we achieved in Q4 last year and Q1 of this year. And number three, as Bill also referenced in the third quarter, particularly in the month of November, we lapped multiple tailwinds from last year such as double-digit depletion growth rates in key regions like California, which benefited from periods of warmer weather and a stronger macroeconomic environment.

All of that said, we expect depletion trends to continue to normalize as we move into fiscal 2024, and we remain confident in our fiscal year expectations. Selling days in the quarter were flat year-over-year, but please note that in Q4, there will be one less selling day. Operating income for the beer business decreased 2% and operating margins declined by 380 basis points to 38%. As expected, operating income and operating margins were negatively affected by ongoing inflationary pressures across raw materials and packaging, particularly as more favorable hedges rolled off. Increased logistics expenses related to higher fuel and freight costs, incremental operating costs and increased depreciation as a result of our brewery capacity expansions, and increased marketing spend, particularly from our media investments in sports sponsorships with NFL, NCAA Football, Major League Baseball, the NBA and the NHL.

Marketing as a percent of net sales increased 160 basis points to 9.6% in Q3. For fiscal ’23, we continue to expect that marketing as a percent of net sales will be in the 9% to 10%. More broadly, given the strong top line growth of our beer business year-to-date, we now anticipate it will grow net sales between 9% to 10% and operating income between 4% to 5% for the full fiscal year. This still implies an operating margin of approximately 38% for fiscal 2023. As expected benefits from our 2% to 3% average pricing increase for the full year and our cost-saving efforts will be more than offset by the same headwinds that have affected our margins year-to-date. I’d like to take a moment to reiterate some of the points Bill made earlier regarding fiscal ’24.

As mentioned, we are anticipating our beer business margins to be more in line with our anticipated margin for this fiscal year, and therefore, below our stated medium-term target range of 39% to 40%. This is driven by the fact that input costs remain at historically elevated levels due to ongoing inflationary pressures. As we have shared in some of our prior calls, we hedged about 10% of our beer business costs to help reduce volatility in the P&L. However, our commodity hedging program is managed on a multiyear rolling basis. So we currently do not anticipate our blended hedge rates to capture the favorability of recent declines in certain commodity prices until the second half of next fiscal year. In addition while prices have declined from their peaks earlier this year for commodities like aluminum and natural gas, which are part of our can and glass cost, they still remain above pre-pandemic levels.

Beyond our hedging program, most of our beer business input costs have a greater exposure to inflationary pressures, including raw materials, such as wood pallets, steel crowns and cartons. The majority of these input costs are subject to contractual agreements that tend to reflect negotiated prices that are based on existing inflationary conditions. So as we move forward with our annual planning and supplier cost determination process, we will develop a clearer view of these contractual prices and on the resulting margin expectations. Against that backdrop, with these processes now underway, we have greater visibility into the high single-digit cost segments that will continue to build off the double digit unfavorable cost outlook that our beer business faced in fiscal ’23.

In addition, we continue to see ongoing macroeconomic pressures on the consumer, which are leading us to plan to take more subdued pricing actions across our beer portfolio in fiscal ’24. That said, we expect a number of tailwinds that will partially offset some of these headwinds, including the continued momentum of our core brands, capitalizing on opportunities with emerging brands such as Pacifico and Modelo Chelada’s, winning with new and future innovation such as Modelo or Modelo Oro and through our consistent and disciplined cost savings actions, nevertheless, as Bill mentioned, we will continue to refine our outlook for next year, and we will provide detailed guidance during our Q4 earnings call. That said, it is important to reiterate that our expected fiscal ’23 and fiscal ’24 operating margins remained best in class.

And in fact, when considering our fiscal ’20 through our currently anticipated fiscal ’24 margins, we expect the average operating margin for that 5-year period to remain within our medium-term algorithm of 39% to 40%. Now shifting to Wine & Spirits. As a reminder, during our recently concluded third quarter, we divested a series of brands from our Wine portfolio. As such, third quarter of fiscal ’22, included approximately $17 million of net sales and $11 million of gross profit less marketing, that are no longer part of the Wine & Spirits segment results. When presenting today’s results, I will be discussing our top line results on an organic basis, excluding the contribution from those divested brands in the preceding periods. Starting with organic net sales.

The Wine & Spirits business decreased 1%, primarily driven by a 13% decrease in shipments, partially offset by a favorable product mix, which both related to consumer-led premiumization and mix improvements of our portfolio. From a depletions perspective, while the Wine & Spirits business saw a decline of approximately 6% on an organic basis in Q3 as Bill noted earlier, our higher-end brand delivered strong performance with our Aspira portfolio, which includes our fine wine and craft spirits brands, delivering depletion growth of 9%, driven by growth in our Prisoner Wine and High West brands. Meanwhile, our Ignite portfolio, which includes our mainstream and premium Wine & Spirits brands primarily faced headwinds from our mainstream brands, which was down 8%.

That said, in tracked channels, our largest higher-end brands continue to outperform their corresponding segments, and our peak premium brands portfolio actually gained share in the category with particularly strong performance from Meiomi and Kim Crawford in both volume and dollar sales growth. Moving on to Wine & Spirits operating income and operating margins. Wine & Spirits operating income declined by 7%, partly as a result of the divestiture and operating margin decreased 60 basis points to 24.8%. The decrease in operating margins was driven by higher transportation costs, including ocean freight shipping, unfavorable costs from higher drivers largely due to inflation and increased general and administrative expenses due to higher compensation and benefits primarily related to higher headcount from our continued strategic focus on expanding into direct-to-consumer channels and higher-end brands in our Aspira portfolio.

For full year fiscal ’23, we remain confident in our previously stated outlook for our Wine & Spirits business. We expect fiscal ’23 organic net sales decline of 0% to 2% and operating income to increase 3% to 5% implying a full year operating margin of about 24%. Looking ahead to fiscal ’24, we expect our Wine & Spirits business to continue to make progress on its operating margin. We believe our Wine & Spirits business is positioned to further improve its operating margins through growth of our higher-end brands, bolster performance from our mainstream portfolio through high-return brand initiatives such as innovation, and expansion of our omnichannel and international footprint. As I mentioned earlier, we are currently working through our annual planning process and we’ll provide a more detailed fiscal ’24 outlook during our Q4 earnings call.

Now let’s proceed with the rest of the P&L. Corporate expenses came in at approximately $75 million, up 70% versus Q3 last year. This increase in corporate expense was primarily impacted by costs associated with increased compensation and benefits, primarily related to a third quarter fiscal ’22 reversal of stock-based compensation and third-party services related to our ongoing investments in our digital business acceleration initiative. We now expect our total corporate spend to be between $290 million and $300 million for the full year, mainly driven by the incremental costs in Q3. Interest expense for the quarter was up 12%. Also, as we noted in our release, following the completion of the reclassification of our Class B common stock, we now expect interest expense for fiscal ’23 to be between $390 million and $400 million.

This includes the interest expense associated with the funding of the $1.5 billion cash consideration which is expected to be $80 million to $90 million on an annual basis based on current market rates. Our Q3 comparable basis effective tax rate, excluding Canopy equity and earnings, came in at 18.8% versus 14% in Q3 last year. The effective tax rate increased mostly due to the change in stock-based compensation benefits. As a result of these updates to our outlook, the increased interest expense due to the reclassification bonds, adjustments relating to our most recent divestiture in our Wine & Spirits business and increased corporate expenses that were only partially offset by the increased expectations for our beer business. We now expect comparable EPS guidance to be in the $11 to $11.20 range, which represents a $0.20 decrease to the bottom end and a $0.40 decrease at the top end of our prior guidance range.

Moving to free cash flow, which we define as net cash provided by operating activities less CapEx. We generated free cash flow of $1.6 billion for the nine months of fiscal ’23 reflecting strong operating cash flow partially offset by a 14% increase in CapEx investments as we continue to support the growth of our beer business through our brewery capacity expansion plans. And on that note, to echo Bill, we are excited by the progress we have made with our new sites in Veracruz in which we recently broke ground. Our fiscal ’23 free cash flow is now expected to be in the range of $1.5 billion to $1.6 billion and CapEx is now expected to be between $1.1 billion and $1.2 billion. Operating cash flow for fiscal ’23 remains unchanged and is expected to be between $2.6 billion and $2.8 billion.

Related to our uses of these cash flows, as we recently noted in December, our capital allocation priorities moving forward following the reclassification remain fundamentally aligned with the priorities we introduced in fiscal ’20. To achieve a disciplined and balanced and thoughtful approach to support growth and value creation. Our recently updated capital allocation priorities are as follows: first, we remain committed to our investment-grade rating and to targeting dividend growth in line with earnings as key elements of a disciplined financial foundation. We ended the third quarter with a net leverage ratio of approximately 3.5x when factoring in the financing for the cash payment associated with our recent transition to a single-class stock structure and excluding Canopy equity earnings.

That said, we have set a target net leverage ratio on that same basis of approximately 3x, which we are confident we can return to. Another important element of our commitment to a disciplined financial foundation is targeting an approximately 30% dividend and payout ratio. Second, we will continue to balance investments to support the growth of our business and deliver additional returns to shareholders through share repurchases. As we look ahead, we continue to expect adding another 25 million hectoliters to 30 million hectoliters of brewing capacity between fiscal 2023 and fiscal 2026. This will be supported by $5 billion to $5.5 billion of investment over that same period. We are developing this capacity through a series of expansion waves which is consistent with the modular approach we have adopted to maintain capital expenditure discipline and flexibility.

We remain committed to executing share repurchases targeted to at least cover dilution. While we also have approximately $1.2 billion of our repurchase capacity still under our current board authorization and plan to remain opportunistic, particularly since we achieved incremental cash flow flexibility. And third, we may deploy excess cash to smaller acquisitions. Again, we intend to remain disciplined in our pursuit of any M&A opportunities and we’ll continue to pursue transactions that we believe fulfill one or more of the following characteristics: are consumer led, they deliver growth momentum, providing compelling returns, fill portfolio gaps, and offer synergistic benefits. Lastly, on Canopy. As it announced in October, Canopy plans to consolidate all of its U.S. cannabis assets into a single entity, Canopy USA.

This U.S. holding company and new exchangeable share structure is designed to enable Canopy USA to trigger full ownership of Canopy’s U.S. cannabis investments and capitalize on the U.S. cannabis market opportunities. Assuming the completion of this transaction and approval by Canopy shareholders of a charter amendment we intend to transition our existing common share ownership interest in Canopy into new exchangeable shares, which is intended to protect Constellation shareholder value while retaining an interest in Canopy through nonvoting and nonparticipating shares. This share ownership transition and the surrender of our Canopy warrants is aligned with our focus on core beer and Wine & Spirits businesses and capital allocation priorities.

As a reminder, until this transaction is completed and we convert our holdings into exchangeable shares, Canopy will still be reported within our P&L consistent with past quarters. In closing, we continue to demonstrate strong execution in growing our core business and investments to enhance our portfolio of industry-leading brands. As we approach the end of the fiscal year, we remain committed to delivering against our stated goals to drive sustainable and profitable growth and build shareholder value. And with that, Bill and I are happy to take your questions.

Q&A Session

Operator: Thank you. At this time, we will be conducting a question-and-answer session Our first question comes from the line of Lauren Lieberman with Barclays. Please proceed with your question.

Lauren Lieberman: Thanks. Good morning. When you walk through the drivers of the change in trend for depletions that you saw towards the end of the quarter, one sort of mention was a comparison on macroeconomic trend versus the prior year and then also your comments on taking sort of more muted pricing as you look into ’24. So I’d love if you could just spend a little bit more time talking about what you’re seeing from your various kind of core consumer groups, it feels like I know you pointed out some share gain continues. But when we look at some of your brands relative to other high-end brands, core beer brands, not Seltzer, it does look like there’s underperformance, it’s specific to your brands. So just any further diagnostic you may have done would be really helpful to hear about?

And then also, I wasn’t entirely clear on why the slower CapEx spend, I know you just went through it across at the very end of your comments, but I was hoping you could just reframe that because I admittedly missed why is it $200 million lower this year?

Bill Newlands: Sure. So relative, Lauren, to the depletion trend scenario, we’re still seeing in our — all of our assessment and research suggests that we continue to have very strong support for our brands among our core Hispanic base as well as growing trends amongst the non-Hispanic community. I think a great example of that shows itself in that we actually had an increase in our share gain quarter-on-quarter from last year which reflects very well. Certainly, some of what we saw at the latter part of this quarter was driven by a couple of things. One is many businesses, including ours, took additional pricing over what we had planned. And that caused an overall softness in the market, particularly in the state of California.

It wasn’t limited to us. And frankly, that’s not an unusual reaction. We’ve seen that many times before. Frankly, what we were very pleased about as we then look into December and to see if this thing is beginning to go back to some normalcy, we see that it has been, we saw a 7.5% swing to the upside in dollars versus where it was in November and that compares to a category swing of 4.5%. So again, we saw a significant improvement in the market that was primarily the cause of a bit of deceleration in our depletion performance as we got into December, and we continue to gain share in that overall mix of swing. So we’re not — we — this is not an unusual event. It happens virtually every time you see significant pricing action taken and the fact that we continue to gain share at the clip that we are gives us great confidence going forward and the strength of the brands overall.

Garth, anything you want to say.

Garth Hankinson: Yes, Lauren, just on the CapEx, it’s important to note that we continue to progress with our expansion as planned. As we stated in the remarks, we’ve added 11 million hectoliters of capacity over the last several years, $9 million in growth, sort of $2 million through productivity initiatives. We are on track with our expansions at both Nava and Obregon. And as we mentioned, we’ve recently broken ground in Veracruz. So the reduction in CapEx for this year is not necessarily abnormal as we move through the year. It really has more to reflect the timing of when payments will be made and less to do with progress.

Operator: Our next question comes from the line of Nik Modi with RBC Capital Markets.

Nik Modi: Yes, good morning, everyone. Bill, I was hoping maybe you could talk about what’s actually happening with some of the pricing as it goes through the supply chain? Certainly, we’ve picked up some commentary within the trade that pricing was taken on top of what you actually took in the market. And I’m just curious what the state of that is, if it’s starting to get unwound? And have you seen any implication of that in some of the more recent weeks?

Bill Newlands: Yes. You bet, Nik. You’re absolutely right. One of the things that we saw that occurred after our pricing increase is that other players within the chain took more price on top of what our pricing increase was. And frankly, this often happens as well. The Board tends to happen, and we’ve already started to see it in certain some markets is that, that moderates over time as well because an attempt is made to see what the consumer is ready to accept. And if we find a spot that’s a bit more than they are ready to accept you see some moderation in that increase. You’ve already started to see that with some critical change in the state of California, which probably relates to my answer to Lauren a moment ago, which is why you saw the trends in December change quite a bit.

So you’re correct there was a lot more and it piled on, if you will, once it was out of us and into further down the chain, more was taken and as we often see that goes higher early and then moderates over time.

Operator: Our next question is from Nadine Sarwat with Bernstein.