It’s been nearly a full year since cannabis’ first massive deal that brought real investor money into the new and exciting industry. Unfortunately, so far, we’ve only learned that it will take a while longer before it pays off.
Constellation Brands (STZ) upped its stake in Canopy, the largest cannabis company, last August by investing an additional $4 billion. So far, that remains the largest single investment in this controversial industry.
Since then, Canopy has offered decent returns for investors – with two large spikes, one just after the deal and another to start this year. However, Constellation investors are still waiting. The company has rallied this year, but still sits below its pre-Canopy deal price.
STZ shares are down overall since it made news on this front, falling from about $213 to $196, as we write. Of course, its plans to eventually profit off the exploding cannabis market is only a portion of what it does.
The company announced its earnings for the first quarter of 2020 this morning. Net income per share fell sharply to a loss of $1.30. But investors expected that as it continues to eat losses from that Canopy investment.
What shareholders and analysts were actually watching for was what the company did excluding those Canopy losses. And here, the company shined.
Earnings per share excluding losses due to Canopy were $2.21 for the quarter – a full 14 cents higher than expectations. This comes as a great surprise as Constellation changes its core business around.
The alcohol conglomerate is shifting its strategy from quantity to quality. It will focus on just high-end wine and liquor to accompany its successful beer brands – which include Corona and Modelo.
This strategy change was announced earlier this year, but investors are only getting a chance to see it in action for the first time today. Clearly, they like what the see.
Shares of STZ are up 3.6% today, while the rest of the stock market holds its breath over the G20 summit meeting between Presidents Trump and Xi tomorrow.
For the long-term, it seems like higher share prices are justified. Once cannabis is able to mature into a profitable business, Constellation’s global distribution and brands combined with Canopy’s market dominance and expertise should turn into the steady profits (rather than losses) investors hope for. But is it the right time to get in now?
To answer this, we have to set aside all its long-term plans for things like marijuana infused beers and leveraged distribution channels for its cannabis investments.
Instead, we have to look at what the company is up to today.
Right now, even with this recent shift from quantity to quality, the company will continue to struggle making much money from its wine and spirits business. The company shipped 8.1% fewer products from this category vs. a year ago. And that’s before any of these selloffs close.
While not the company’s largest moneymaker, wine and spirits still bring in high margins. The group brought Constellation $161 million last year in operating income. Even with higher margins on the brands it plans to retain, that income will continue to decline as it sells off other ones.
Beer was the biggest highlight this quarter, showing $1.5 billion in sales – a 7.4% increase since last year. The company better hope for a never-ending string of these quarters for this segment to keep this ship afloat.
Constellation announced a huge outlook upgrade too. It expects earnings (excluding losses from Canopy) to be in the range of $8.65-$8.95 for the current fiscal year. That’s down from last year on both an overall and a comparable basis. But it’s still higher than analysts were expecting before this announcement.
Time will tell if it hits its goals. But one thing is for sure, its road over the next year and likely several years past that will be rocky. Canopy is, of course, a wildcard. But even if investors give the company a pass on that expecting that volatility, this transition in wine and spirits will likely be full of large swings.
Right now, following today’s jump in share price and this year’s relatively sizable rally for the company, we have an opportunity to play the first of these swings.
Investors should calm down by next week, certainly by mid July, about the company’s decent quarter in beer sales. Those looking to swing trade it higher on the news will drop out and wait for the next bit of info on its restructuring. That leaves us with a chance to ride a short-term retreat in price.
A Strategy For Short-Term Bears
A bear put spread is a type of options trade that lets us profit off short-term dips in share price, without as much risk as either buying puts outright or shorting a stock.
The way it works is by buying a put, but also selling a second one with a lower strike price. What this does is let the trader to profit an each cent the underlying shares decline through the range between the two strike prices.
The premium received from the sold put helps the trader offset his cost of the bought one. This does limit how much profit the trade can make, but it also significantly reduces the amount at risk.
You can see how this kind of trade works here:
Source: The Options Industry Council
When done right, you can usually find a pair of puts to trade that still offers higher potential profits than the total amount at risk. Today, in STZ, that’s exactly what we have.
A Specific Trade on STZ
Right now, a trader could buy an August 16 $195 put on STZ for $7.20 per share and sell an August 16 $190 put on STZ for $5.20 per share for a cost of $2 per share. Since each put represents 100 shares of STZ, that’s a total entry cost of $200.
That’s the most a trader stands to lose on this particular trade. But they’d only lose that if Constellation shares continue to rise. As noted, a summertime retraction is much more likely.
To find just how much this trade stands to gain if we’re right, take the difference in strike prices ($195 – $190), and subtract that cost ($5 – $2 = $3). On 100 shares, that’s $300.
So, if shares of STZ do fall, even a little (just 2.6%), by the middle of August, this trader would be looking at a return of $300 on the $200 he put down. In other words, he’d collect a 150% return on the amount he has at risk in just less than two months’ time.
Constellation is not a bad company by any means. But no stock goes straight up forever. Now’s an opportunity to take a little profits while investors jostle it around. And how often do you get to make $3 for every $2 you put down?