Constellation Brands Hikes Dividend 42%, Here's Why

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Brewer and distiller Constellation Brands (NYSE: STZ) has only paid a dividend since 2015, but on average it has increased the payout by 33% each year. Its latest dividend hike of 42% was its biggest increase yet, and there's one very good reason why Constellation Brands has been able to post such impressive numbers.

An old country music song called "I like beer" may as well serve as Constellation's theme song, because ever since acquiring from Anheuser-Busch InBev (NYSE: BUD) the U.S. rights to Mexican brewer Grupo Modelo, in particular, its Corona brand, Constellation has seen beer sales soar.

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Keeping the beer flowing

It was a timely acquisition, as the taste for imports really took off at the same time and still today shows no signs of going flat. Anheuser-Busch needed to satisfy antitrust concerns when it acquired the Modelo family of beers, and selling the U.S. rights to Modelo, along with its Piedras Negras brewery and its 50% stake in Crown Imports, which gave Constellation complete, independent control of its beer business, fit the bill.

Constellation Brands hit the ground running with beer sales in 2014, jumping 12% and accounting for 53% of total revenue. The next year they were up over 13% and accounted for 55% of sales, and in 2016 they were up almost 17% and represented 58% of sales. While beer sales last year only rose 10%, they accounted for 61% of the company's total and represented a 20% increase in operating income.

The beer and wine distributor's beer portfolio was the top growth contributor to the U.S. beer market, with all of its import-brand families achieving record volume levels. The Modelo family exceeded 110 million cases and saw depletion growth of 18%. Depletions are shipments by distributors to retail customers and are considered by the industry as a proxy for consumer demand.

There's more where that came from

This is a remarkable achievement. According to the Brewers Association, the trade group that represents the craft beer industry, U.S. beer sales volume was down 1% in 2017 to 196.3 million barrels. Craft beer sales volume, on the other hand, was up 5% this year, while imported beer as a whole rose 3.2%. It's clear much of the growth that was achieved came as a result of Constellation Brands' efforts.

Constellation is now the third-largest brewer in the country behind Anheuser-Busch and MillerCoors, the U.S. distribution subsidiary of Molson Coors.

While heady beer sales have given Constellation Brands the financial wherewithal to continuously expand its dividend, the downside is that its dividend yield isn't nearly as frothy as other well-established brewers and distillers. Constellation's yield of 0.9% is well below those of Anheuser-Busch at 3.7%, Brown-Forman at 1.2%, Diageo at 2.5%, and Molson Coors with 2.2%.

Yet a good case could be made that Constellation Brands makes up for yield with the rapid hikes it has instituted. The payout has now already more than doubled since it was first initiated, and investors can expect the dividend to continue rising. There are three reasons why:

1. Free cash flow growth: Constellation Brands grew free cash flow (operating cash flow minus capital expenditures) by 10.8% last year, but forecasts it will achieve anywhere from 37% to 49% growth in free cash flow in the current fiscal year.

2. A low payout ratio: With the dividend increase, Constellation Brands increased its dividend payout ratio target to 30%, a very low rate and one that leaves lots of room for future growth. The payout ratio is a way to assess the sustainability of the dividend; a lower rate is better.

3. Healthy earnings growth: The brewer and distiller is forecasting earnings growth of anywhere from 8% to 11% this year and, with planned expansion of its Mexico beer operations, is calculating it will realize long-term benefits and growth from the sector.

Investors who chase yield will likely miss a rare opportunity in Constellation Brands. Others willing to take the time to dig deeper may find the brewer and distiller an excellent dividend stock to own.

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Rich Duprey has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Anheuser-Busch InBev NV. The Motley Fool owns shares of Molson Coors Brewing. The Motley Fool recommends Diageo. The Motley Fool has a disclosure policy.