Constellation Brands - Q2 2024

Transcript

Operator (participant)

Greetings. Welcome to the Constellation Brands' Fiscal Year 2024 second quarter earnings call. At this time, all participants are in a listen-only mode. The question and answer session will follow the prepared presentation. If anyone should require operator assistance during the call, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. At this time, I would like to hand the call over to Joe Suarez, Vice President of Investor Relations. Thank you. You may begin.

Joe Suarez (VP of Investor Relations)

Thank you, Daryl. Good morning, all, and welcome to Constellation Brands Q2 Fiscal 2024 conference call. I'm here this morning with Bill Newlands, our CEO, and Garth Hankinson, our CFO. 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. Following the call, we'll also be making available in the investor section of our company's website, a series of slides which highlight the prepared remarks shared by Bill and Garth in today's call.

Before turning the call over to Bill, in line with prior quarters, I would like to ask that we 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.

Bill Newlands (CEO)

Thank you, Joe, and good morning, everyone. Welcome to our Q2 fiscal 2024 call. In terms of key headlines for the second quarter, I'm pleased to report that our team once again delivered solid overall performance. First of all, our beer business led the charge as the number one share gainer, with accelerating shares across the key summer holiday. We continue to invest in growth for this business as our team looks to seize opportunities to gain incremental awareness, shelf space, and household penetration for our brands in the back half and beyond. Secondly, our wine and spirits business continues to progress along its journey to realize the full benefits of its transformation.

Prioritized investments in our largest wine and spirits higher-end brands are yielding outperformance in their respective categories, while partially offsetting and helping to reduce headwinds from our mainstream brands as they continue to shift the mixed profile of our portfolio. And third, our continued discipline around capital allocation priorities contributed to a strong overall performance in the quarter and sets the stage for fiscal 2024, being another solid year of profitable growth and shareholder returns. That said, let me provide a little more color around our key performance drivers in the quarter. As noted, our beer team once again delivered remarkable results. Not only did we remain the top share gainer over the entire critical summer season, we also extended our leading position from Cinco de Mayo to become the number one share gainer in tracked channels during the Fourth of July holiday.

Although it falls slightly after our second quarter end, I'm also pleased to report that we further accelerated our share gains during Labor Day. Modelo Especial remained the key driver of our strong performance, achieving double-digit volume growth in tracked channels and an 8.6% increase in depletions, ultimately strengthening its position as the top brand across the entire U.S. beer market in dollar sales fiscal year to date. The broader Modelo brand family also delivered phenomenal results, with Cheladas achieving 50% volume growth in tracked channels and an increase in depletions of over 40%, while Oro continues to build on a solid launch, increasing its share gains in the overall beer category and performing in line with our plans for the fiscal year. Beyond Modelo, our Corona Extra and Pacifico core beer brands also continued to perform strongly.

Corona Extra delivered solid, low-single-digit growth in depletions and tracked channel volumes, and was the number six share gainer in the category, while Pacifico achieved 15% depletion growth, tracked channel volume growth of approximately 27% and was the number 11 top share gainer in tracked channels. Our beer brands continued to resonate strongly with the consumer, driving demand for our brands in the second quarter, which supported double-digit net sales and operating income growth in our beer business. This gives us confidence to shift our fiscal 2024 net sales and operating income guidance for the beer business to the higher end of our initial ranges. That is, 8%-9% and 6%-7% growth, respectively.

That said, it is important to remember that for our beer business, we indicated that only 45% of total volume for the fiscal year will be shipped in the second half, which aligns with the regular seasonality of beer demand in the U.S. and the timing of our brewery maintenance activities. Beyond fiscal 2024, we continue to see significant opportunities to maintain the growth momentum of our beer business, particularly due to the resilience of key secular trends in the consumer landscape, like ongoing consumer-led premiumization across beverage alcohol and the continued outsized growth of the Hispanic population in the U.S., as well as the relentless focus of our beer business on closing the distribution and awareness gaps that still exist across our brands, and on developing and scaling new and exciting products aligned with consumer-led trends....

We look forward to sharing more details on this compelling outlook at our upcoming Investor Day on November second. Moving on to wine and spirits. Our wine and spirits business continues to make headway on its vision to become a bold and innovative higher-end market leader. In the second quarter, our largest premium wine brands, Meiomi and Kim Crawford, outperformed their corresponding category segments in U.S. tracked channels. They both increased their respective share in the overall wine category. Our largest fine wine and craft spirits brands, The Prisoner Wine Company and our Mi Campo Tequila brand, also outperformed their corresponding luxury wine and higher-end spirits category segments. Notably, all of the individual brands just referenced also delivered solid depletion growth rates in the second quarter.

Our wine and spirits business also continues to advance the renovation of its mainstream brands to address the headwinds the corresponding category segments have faced over several recent quarters. While there is certainly more work to be done here, in U.S. tracked channels, the year-over-year dollar sales decline for Woodbridge improved relative to the first quarter, and SVEDKA's overall share remained relatively stable when compared to the first quarter. All of that said, our wine and spirits business continued to face lower demand, primarily for our mainstream brands, reflecting continued consumer-led premiumization trends noted in prior occasions, which in turn affected overall performance in the second quarter. Nevertheless, we are reiterating guidance for the full year and continue to expect fiscal 2024 organic net sales to remain relatively stable and operating income growth of 2%-4%.

As we shared when we provided our outlook for fiscal 2024, we see the year as a tale of two-halves for the wine and spirits business, with 55% of planned volumes being delivered in the second half and operating performance projected to accelerate over the rest of the year due to other key factors. We expect to benefit from the more proactive quarterly shipment and depletion rebalancing actions we have undertaken this year, versus our single downward shipment adjustment in Q4 of last year. We also anticipate an uplift in our direct-to-consumer channels and improved mix from incremental ASPIRA shipments in line with seasonality, as well as benefits from recent price increases. Ultimately, we also expect to see operating margins meaningfully accelerate due to the improved sales trends just described and the resulting positive operating leverage.

Before I conclude, it would be remiss not to highlight our consistent execution against our capital allocation priorities. We continue to make progress towards our reduced net leverage ratio of approximately 3x, with a 400 basis point reduction since the increase resulting from the financing of our Class B common stock reclassification last November. Importantly, our proactive management of the incremental debt from the reclassification now puts us on track to deliver lower interest expense than initially anticipated for fiscal 2024, and in turn, we now anticipate higher reported and comparable earnings per share, excluding Canopy, in the ranges of $9.60-$9.80 and $12-$12.20, respectively, for the full year.

In terms of cash returns to our shareholders, our dividend payout ratio for the second quarter remained aligned with our 30% target, and while we did not conduct any additional share repurchases in Q2, we have executed $35 million year to date, in line with our goal to at least offset dilution. Lastly, our brewery expansions are progressing as planned, including Veracruz, and we continue to develop and bring these online with the flexibility enabled by our modular approach. Before I conclude, I also want to again take an opportunity during our second quarter call to highlight the upcoming release of our annual ESG Impact Report in a few weeks. This report seeks to provide a comprehensive review of our strategy, initiatives, targets, and performance to address pressing environmental and societal needs that are important to our business, consumers, communities, employees, and broader stakeholders.

In particular, as noted in our last two calls, we have already surpassed our target of restoring 1.1 billion gal of withdrawals from local watersheds, and are looking forward to showcasing the initiatives in our beer business that drove most of this achievement, and to share more details on our new target in our upcoming ESG Impact Report. I invite all of you to spend some time reviewing this report when it is released, which will be available through our company website. In closing, I'd like to leave you with four main takeaways from this quarter. First, our beer business continues to outperform the industry, and the acceleration of its performance since the beginning of the year has given us confidence to shift our outlook for fiscal 2024 to the higher end of our initial net sales and operating income growth expectations.

And just as critical, we remain equally confident about the long-term runway for our higher-end brand portfolio. Number two, the benefits of our wine and spirits strategy continue to take hold. We expect the net sales growth and operating income growth of that business to ramp up through the remainder of fiscal 2024. And as we look to the coming years, we anticipate our wine and spirits business to further gain momentum and achieve stronger results. Number three, we are persistently delivering on our capital allocation priorities, maintaining discipline and balance to yield value and returns, and we remain committed to building on the consistent track record we've established with these priorities over the past few years. And finally, number four, we are excited to be sharing more of these important topics with you at our upcoming Investor Day in four weeks' time.

With that, I'd now like to turn the call over to Garth, who will review our financial results for Q2 in more detail. Garth?

Garth Hankinson (CFO)

Thank you, Bill, and good morning, everyone. Our second quarter results reflect the ongoing disciplined execution of our strategic initiatives and our relentless focus on continuing to deliver growth while enhancing our performance. As Bill noted, we achieved yet another strong quarter with double-digit net sales and operating income growth in our beer business, while our wine and spirits business delivered solid performance across its largest premium, fine wine, and craft spirits brands, which partially offset the category headwinds affecting our mainstream brands. We also continued to generate strong cash flow results and execute against our consistent and balanced capital allocation priorities. Now, let's review our Q2 fiscal 2024 results in more detail, where I will mainly focus on comparable basis financial results. To begin, our beer business increased net sales by 12%, representing an uplift of $253 million.

This was driven primarily by volume growth of 8.7%, as demand for our beer brands accelerated through the first half of the fiscal year. This growth also benefited from favorable pricing, which contributed $59 million of the overall net sales increase. As a reminder, we continue to expect pricing to account for 1%-2% of our net sales increase this fiscal year from the combination of the wraparound impacts from the significant pricing actions taken in Q3 of fiscal 2023, and targeted pricing actions we are taking in fiscal 2024. For the second quarter of fiscal 2024, beer shipment volume and depletions were generally in line with one another, and I'm pleased to report that our inventories are at healthy levels to support the ongoing growth of our brands.

Beer depletion growth for the quarter came in at 7.9%, reflecting a successful summer selling season, driven by ongoing consumer demand across our industry-leading beer portfolio, as evidenced by our share gain acceleration. Execution of our distribution and marketing strategies, including extending our category leadership across the key summer season, and continued positive results from our Shopper-First Shelf initiative. And lastly, the accelerated growth in share gains across our core and emerging markets. Before moving to on-premise performance, I'd like to take a moment to explain a notable recent development in off-premise channel observation. As many of you are aware, Circana tracked channel volume growth has historically been above depletion growth by a low single-digit variance.

However, more recently, that variance has expanded to the mid-single digit range as independent retailers, not captured by Circana data, have lagged in reversing the additional pricing they took beyond our October fiscal 2023 pricing actions. We believe this has led certain consumers to shift from these independent retailers to chain retailers, offering more competitive consumer pricing. While the shift in these variances has no impact on the overall demand of our brands, we continue to monitor channel performance and plan to provide further updates or insights needed to reconcile tracked channel data with our overall performance as warranted. As a reminder, Circana captures approximately 50% of our total beer volumes. Shifting back to the on-premise channel, depletions were essentially flat year-over-year and accounted for approximately 10.3% of our total beer volume.

Please note that while we did have some minor disruptions in our supply of kegs during the second quarter, this Q1 to Q2 step down largely reflects a normal seasonal pattern that we have seen in previous years. Importantly, while there is some disruption in the near term, we are currently producing and shipping kegs and fully expect to offset the impact of the disruptions as swiftly as possible. Looking forward to the second half of the year, as Bill noted, approximately 45% of our volumes will ship in the second half of the year as a result of it being our lower volume period. In addition, our Q3 shipment volumes are also normally more subdued due to routine maintenance activities. Lastly, from a pricing perspective, we will start to overlap the uplift we saw from significant incremental pricing actions taken in October of fiscal 2023.

Nonetheless, as we have previously stated, we fully expect our full-year shipments and depletions to be largely in line, both on an absolute and a year-over-year growth basis by fiscal year-end. In regards to selling days, they were flat year over year for the quarter. Please note, for the remainder of fiscal 2024, Q3 sell days will be flat year over year, and there will be one more selling day in Q4. Now let me review beer margins. For Q2, operating margin decreased by 60 basis points to 39.9%.... This decrease was driven mostly by the ongoing inflationary pressures in our COGS as we faced an overall cost increase of approximately 17%.

The largest drivers of these cost increases came from packaging and raw materials, incremental costs related to a voluntary product recall of select kegs for quality assurance, and higher depreciation that amounted to $12 million or a 24% increase. To mitigate the inflationary and depreciation pressures, we continued to work across the business on cost efficiency and operational productivity programs that yielded meaningful and sustainable benefits. Building on the $30 million of net savings delivered by these initiatives in the first quarter, we realized approximately $20 million in incremental net savings in the second quarter. In addition to our cost-saving initiatives, we incurred margin benefits from the following: a $4 million or 2% decrease in marketing expense, primarily driven by the divestiture of our craft beer business.

Marketing as a percent of sales came in at 7.1% for the quarter, and a $3 million or 3% decrease in SG&A expense, which was primarily the result of favorable foreign currency impacts. Regarding Q2, our marketing spend as a percent of net sales was outside of our previously stated algorithm of 9%-10%. As usual, part of this relatively lower percentage in Q2 is a reflection of the strong volume and therefore net sales performance of the business due to category seasonality. However, the impact of the reduction in marketing, due to the previously noted exit from craft beer, has further lowered that percentage.

For the full year, we now expect to be closer to the lower end of our stated range of 9%-10% of net sales due to the craft beer divestitures and our continued focus on ensuring our large marketing investments are prioritized to the highest return areas in our portfolio. As a result of the acceleration in the growth of beer business since the beginning of the year, we are shifting our expectations for fiscal 2024 to the higher end of our initial ranges, resulting in an 8%-9% expected increase in net sales growth and a 6%-7% expected increase in operating income growth. Now moving on to our wine and spirits business.

In line with the reshaping of our wine and spirits business to a higher-end portfolio of offerings, we continued to benefit from the solid performance of our largest premium wine, fine wine, and craft spirits brands. Meiomi, Kim Crawford, The Prisoner Wine Company, and Mi Campo, which, as Bill noted, outperformed the corresponding categories in tracked channels and delivered solid depletion growth. While we are pleased with the results with these leading higher-end brands, our overall wine and spirits organic net sales were down 11%, driven primarily by the category headwinds we continue to face from the performance of our volumetrically larger mainstream brands, Woodbridge and SVEDKA. Our plans to renovate Woodbridge and SVEDKA are underway, and our wine and spirits leadership team is looking forward to sharing updates on this progress at our upcoming Investor Day.

Shipments on an organic basis decreased by 15%, and depletions decreased by approximately 8%. As a reminder, approximately 55% of the wine and spirits sales are anticipated to occur in the second half of the year, where we also expect to see consumer-led premiumization mixed shift towards the higher end to continue, supporting what we believe will be a notable acceleration in the growth trajectory of the business for the remainder of the year. Wine and spirits operating income, excluding the gross profit, less marketing of the brands that are no longer part of the business following their divestiture, was down 12%, and operating margin decreased 10 basis points to 18.2%, also reflecting the same exclusion.

The margin decline was primarily driven by the volume declines of our mainstream brands and partially offset by lower material costs, primarily from sustainable packaging projects, supply chain savings, and lower marketing spend as we continue to focus on higher return areas of our portfolio. As we look forward, we continue to expect the wine and spirits business to significantly improve its net sales growth trajectory for the remainder of the fiscal year through a combination of increased contributions from our higher-end portfolio, as well as incremental pricing actions. We expect this acceleration in net sales growth, combined with our continued cost reductions and marketing efficiency initiatives, to also support our operating income growth targets. As a result, we remain confident in the outlook for wine and spirits for the year, and our guidance for that business for fiscal 2024 remains unchanged.

Now, let's proceed with the rest of the P&L. Corporate expense was approximately $67 million, an overall reduction of 19% when compared to the prior year, primarily driven by reduced spend in the second wave of our digital business acceleration program, lower headcount-related costs, and lower compensation and benefits post our reclassification transaction. Interest expense for the quarter was approximately $111 million, a 17% increase from the prior year, driven by higher weighted average interest rates on the portion of our debt with adjustable rates, which is approximately 5% of our debt obligations, and higher average borrowings due to the financing of the share reclassification.

However, we now expect interest expense for the full year to be approximately $460 million, roughly $40 million lower than our prior guidance, due to refinancing actions for some of our higher interest debt and faster than expected deleveraging throughout the year. We ended the quarter with a net leverage ratio of approximately 3.2x, excluding Canopy equity earnings, and expect to continue to make progress towards our 3x ratio target over the coming quarters. Our comparable effective tax rate, excluding Canopy equity and earnings for the quarter, was 17.8% versus 20.3% last year. For fiscal 2024, we continue to expect the comparable effective tax rate, excluding Canopy equity and earnings, to be approximately 19%. Moving to free cash flow, which we define as net cash provided by operating activities, less CapEx.

For the second quarter year-to-date of fiscal 2024, we generated free cash flow of $1 billion, a 15% decrease versus prior year, driven by a 34% increase in CapEx investments, attributable to the capacity expansions at our Nava and Obregon facilities and the construction of our new brewery located in Veracruz. As of Q2, we have fully commissioned our latest additional brewing capacity project at our Obregon facility and now have approximately 47 million hectoliters of capacity across our two breweries. Looking ahead, we remain on track to bring our AB facility online at Nava towards the end of this fiscal year, and the development of our additional expansion at Obregon and our third brewery site at Veracruz are advancing as planned.

We continue to expect fiscal 2024 free cash flow to be in the range of $1.2 billion-$1.3 billion, reflective of operating cash flow between $2.4 billion and $2.6 billion, and CapEx of $1.2 billion-$1.3 billion. Our comparable EPS for the quarter, excluding Canopy equity and earnings, was $3.80. As a result of the continued profitable and disciplined growth we have seen this year, we are raising fiscal 2024 reported EPS guidance to between $9.60 and $9.80, and comparable EPS guidance, excluding Canopy equity and earnings, to be between $12 and $12.20. Finally, our announced dividend of $0.89 a share will result in approximately $163 million returned to shareholders for the quarter.

In closing, I'd like to say that our entire team continues to execute and deliver against our strategic priorities. We demonstrated solid execution in the first half of fiscal 2024, and as we enter the back half of the year, we plan to remain disciplined as we seek to drive long-term profitable growth and enhance, enhance shareholder value. Our management team is excited to meet with many of you this coming November as we lay out our medium and long-term ambitions and vision for Constellation Brands at our Investor Day. With that, Bill and I are happy to take your questions.

Operator (participant)

Thank you. We will now be conducting a question-and-answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star key. As a reminder, we ask that you please limit yourself to one question. One moment, please, while we poll for your questions. Our first question comes from the line of Vivien Azer with Cowen and Company. Please proceed with your question.

Vivien Azer (Managing Director)

Hi. Thank you. Good morning.

Bill Newlands (CEO)

Hey, Viv.

Vivien Azer (Managing Director)

So, you know, obviously very strong first-half results in beer. I've been getting a lot of questions on, on why the positive revision to guidance wasn't a little bit more robust. And obviously, Bill, you laid out some of the factors to contemplate from a shipment perspective, as well as from, the lapping of pricing that Garth called out as well. But is there anything incremental that you can offer in terms of your outlook for the category in the back half that might have, informed a little bit more caution as well? Thanks.

Bill Newlands (CEO)

No, we remain very positive about the back half of the year. The critical things that are important relative to our back half is normal seasonality. We only do 45% in the back half. We do our maintenance in Q3, which always limits Q3 somewhat, and we're going against pricing from last year that won't largely be repeated, combined with the normal sales buildup ahead of pricing increases that occurred again in Q3 last year. Let's just keep in mind, when you look at the takeout data you see in tracked channels, our four-week numbers are very consistent with the 52-week numbers. This is an ongoing growth story that we have a lot of confidence in, which is why we raised our expectations for the year in beer.

We expect to have a very strong second half.

Operator (participant)

Thank you. Our next question comes from the line of Andrea Teixeira with JPMorgan. Please proceed with your question.

Andrea Teixeira (Managing Director)

Thank you. Good morning. I was hoping to see if you can comment a bit on the shelf resets and the category at large, how you're seeing consumers. I understand the keg situation and the off-premise and the on-premise consumption. Just hearing, obviously, the shifts in market share, and you were a beneficiary, and you have been doing a lot of work for a long, long time in the shelf resets. So if you can comment on that, how you're looking at as you go into the spring resets in the large boxes, as well as what's happening in the on-premise. Thank you.

Bill Newlands (CEO)

Certainly. We certainly expect to see a strong reset period. You know, there's some limited resets that occur here in the fall. Most of those occur in the spring. Our confidence around that drives primarily from the sheer velocities that we have within our key brands. Our portfolio is second to none in terms of delivering against velocities, and those have been consistent year-on-year, which gives us a lot of confidence in our ability to continue to see shelf set gains. You know, retailers are very smart about this, and they recognize where the growth and velocity is coming from, and that will work strongly to our advantage as those resets occur.

Operator (participant)

Thank you. Our next question comes from the line of Nik Modi with RBC Capital Markets. Please proceed with your question.

Nik Modi (Managing Director)

Yeah, thank you. Good morning, everyone. Bill-

Bill Newlands (CEO)

Hey, Nick.

Nik Modi (Managing Director)

I was hoping you can... Hey, how are you? I was hoping you can just comment on, you know, systems and supply chain and volume. And I ask this question because a lot of your growth is coming in areas that, you know, were not really driving your growth, let's call it five to 10 years ago. So getting the right volume in the right place at the right time, you know, requires some adjustment and probably some systems overhaul. So I just—I was wondering if, A, if that is a valid point to be making, and B, if it is, you know, what you're doing internally to make sure that you can actually have the most optimized supply chain?

Bill Newlands (CEO)

Certainly. A couple of things stand out, Nik, around this. As you know, a few years ago, we literally had no redundancy in the system. We now do, and that certainly provides much greater flexibility in terms of our operations footprint, to do a number of things. One is to make sure we're able to keep up with our increasing demand that we consistently see in our business. And in a scenario where something is accelerating at a greater pace than what we had anticipated, we can react to that. I think that's very strong. Secondly, as you know, we made some significant investments in our digital business efforts, and those are really paying dividends in terms of our supply chain capability as well.

That has significantly refined our ability to make sure we have the right supply chain capabilities all the way through the supply chain. So, I'd say both of those things have been critically important. In fact, and I know you'll be there, you'll get a chance to hear about this in some depth during our investor meeting on November 2nd. We think this is a critical factor that's been important to our continuing ability to maintain and meet the significant increase in demand that we've seen, and we'll go into that in a fair amount of detail on November 2nd.

Operator (participant)

Thank you. Our next question comes from the line of Dara Mohsenian with Morgan Stanley. Please proceed with your question.

Dara Mohsenian (Managing Director and Equity Research)

Hey, good morning, guys.

Bill Newlands (CEO)

Hey, Dara.

Dara Mohsenian (Managing Director and Equity Research)

So, just two quick clarity questions. The mid-single-digit gap versus Circana data that you saw in this quarter in terms of depletions, do you think that lingers? Might that close back towards a low single digit gap going forward? Just conceptually, how do you think about that? And in your answer to Andrea's question around shelf space, is there more opportunity this year than a typical year, just given ABI's business has obviously fallen off unexpectedly after the spring reset? So do you think about the shelf space opportunity as greater than typical, just given those dynamics, and there may be greater shifts, even if your business doesn't compete as much directly, you know, head-to-head versus them?

Bill Newlands (CEO)

Yeah, sure, Dara. On your first point, it, it... The question of whether or not the sort of mid-single digit continues, I think remains to be seen. Certainly, it, it, as Garth noted, at Barclays, and we said during our prepared remarks, it's more than it has usually been. Whether or not it reverts to the norm of what we usually see, which is sort of lower single digit, remains to be seen, and obviously, one that, that we watch carefully. Relative to the shelf sets, yes, we think this is gonna be a great opportunity for us for all the reasons I, I answered earlier, which is, you know, our velocities are second to none, and we fully expect that we're going to be able to expand our presence.

That also impacts some of our new product development. If you think about Oro, I mean, Oro is off to an excellent start, much in line with what our expectations were, and that also gives us a chance to expand our shelf presence because, you know, we expect that particular brand, using that example, is gonna get more shelf space. The last thing I would say, and I gotta call out Cheladas, because Cheladas has just been absolutely on fire. You know, our addition of additional sizes and variety pack in that particular category, again, gives us chance outside of the core beer set to also gain more shelf space.

We need to think about this very broadly, because we expect to gain both in what I would call the core beer shelf, as well as the ancillary beer shelf as well, with things like Chelada.

Operator (participant)

Thank you. Our next question comes from the line of Gerald Pascarelli with Wedbush Securities. Please proceed with your question.

Gerald Pascarelli (Equity Research Analyst)

Great, thanks very much. It's a macro-related question. Bill, one of the questions we get a lot is on student loan repayments. They're gonna resume this month after a three-year pause. So just how are you thinking about the impact from that, maybe the potential for down trading, just obviously given some of the premium price points on your beer products? Any color there would be great. Thank you.

Bill Newlands (CEO)

Yeah, I—you know, that is one of those things that I think remains to be seen. One of the important things that we see with our brands is the consumer loyalty that is attached to those brands. You know, taking Modelo as the example, we over-index with the Hispanic community, and the Hispanic community has tremendous brand loyalty to Modelo. You know, also with Corona. Corona is a much broader-based demographic, but you know, that we continue to say it's the most loved beer because it is. I think that's critically important. You know, people make choices all the time about where they're gonna spend their discretionary income, and you know, brand strength is critically important about how people make those judgments.

Specifically, your question, it remains to be seen, but we feel very confident in our ability to see our brands continue to gain traction simply because there's so much brand loyalty attached to them.

Operator (participant)

Thank you. Our next question comes from the line of Nadine Sarwat with Bernstein. Please proceed with your question.

Nadine Sarwat (Director and Equity Research Analyst)

Hi, two questions for me, please. Coming back to Modelo Oro, could you share some-- any updated data points that you have, especially when it comes to cannibalization, and how would you characterize that incremental consumer? And then just one final question on that voluntary keg product recall. Can you quantify the impact that this has had in the quarter, both on top line and on the margins? Thank you.

Bill Newlands (CEO)

Sure. As I noted earlier, we only had a couple of SKUs in Oro, but it's off to a really good start, and the cannibalization rates were less than we had anticipated, and frankly, less than they were in the three test markets that we had originally run. So we're very positive about that. One place where we're seeing disproportionate pickup on that particular sub-brand of Oro is in the Hispanic community. We've been very pleased by the takeaway in critical, large Hispanic markets, how Oro has done. And, you know, as we continue to build that out, you'll see additional SKUs coming next year, which we believe will help to continue to accelerate that brand's growth. And if the cannibalization rates stay where they have been, it's going to be better than we had initially anticipated.

Garth, do you wanna handle the second one?

Garth Hankinson (CFO)

Yeah, just on the keg recall, you know, the impact was entirely in the cost of goods as related to, you know, shipping and destruction of product, as well as the initial cost to produce the product. It’s, you know, it wasn't a material movement, it, you know, for us, for the quarter. There'll be a little bit more detail in the 10-Q on that, and you can find it there.

Operator (participant)

Thank you. Our next question comes from the line of Bryan Spillane with Bank of America. Please proceed with your question.

Bryan Spillane (Managing Director)

Thanks, operator. Good morning, everyone.

Bill Newlands (CEO)

Morning.

Bryan Spillane (Managing Director)

I guess, Bill, a little bit of perspective maybe on, and this may be a little bit of a follow-up from one of the earlier questions, but just, you know, we're getting a lot of questions about demand elasticity, you know, consumer tolerance of inflation. Can you just give us a little bit of perspective for both your beer business and also in wine and spirits, just, you know, what kind of economizing behavior might you be seeing? You know, again, is it like, you know, buying more in chain convenience versus independents, or choices people are making on packaging? Just, you know, as you're kind of looking forward, you know, just kind of where we are on economizing behavior and how you might, you know, have to adapt or adjust to that.

Bill Newlands (CEO)

Yeah. I think this points out to where our judicious approach to pricing has been spot on. We've said consistently... In fact, we got questioned about that on prior calls at times, about why we weren't taking more price. You know, our view has consistently been 1%-2% annually. We were a little more than that the last couple of years, but 1%-2% is the consistent way that we look at it, and we look at it market by market, SKU by SKU. The rationale for that is quite simple. It's much easier to keep your consumer than to have to go get them again if you have lost them. I think in this particular instance, as you point out, people are careful.

We're seeing more trips, but somewhat less purchasing per trip, than we used to see, which simply means people are being a little more careful about what they do, given the inflationary environment that exists. I think the important part for us is the fact that even though there are more trips, they are making more trips to purchase more of our brands, even if they might spend a little less on any particular trip.

... again, that speaks to what I just replied to on the prior question of, was, which is about our brand loyalty and about the consistent consumer dynamic that really works to our advantage over the long run. So again, I think the critical element to that is our judicious pricing approach over time is one that's gonna do us very well when you're in a consumer environment that people are a little bit more concerned or a little bit more nervous about the inflationary environment. And I think that's gonna work to our advantage as we go forward.

Operator (participant)

Thank you. Our next question comes from the line of Chris Carey, with Wells Fargo Securities. Please proceed with your questions.

Chris Carey (Senior Equity Analyst and Head of Consumer Staples Research)

Hi, everyone. Garth, can you just comment on how inflation is coming in relative to your expectations entering the year, puts and takes? I ask this in the context of your comments around marketing coming in at the low end of the historical range for the full year. I would just be curious on, you know, how you view gross margin delivery in the quarter relative to expectations, with any context on the back half of the year. Anyway, high level, just trying to get some context around how costs are running relative to what you were thinking going in, and maybe you could frame how this delivery is coming in, you know, again, relative to your going expectations. Thanks.

Garth Hankinson (CFO)

Yeah. Yeah. Thanks. Thanks, Chris. Like, look, you know, as a reminder, you know, we expect our beer operating margin for this fiscal year to be around 38%. You know, that remains unchanged. As it relates specifically to Q2, Q2 is historically, you know, traditionally our highest margin quarter, you know, given the volume associated with Q2. And so, you know, in the second half of the year, obviously, we're gonna continue to face inflationary pressures that we've had all year long. We are seeing some easing in inflation, as expected, as we've gone through the year. You know, unfortunately, while we've seen some improvement in inflation, we've also seen a strengthening peso kind of hold up.

So, any improvement that we had due to inflation has been really offset by the strength of the peso. Then again, in the second half of the year, because of the historically lower volume that we have in that half, there will be an impact, obviously, to fixed cost absorption as well as COGS and marketing. Additionally, incremental depreciation as we brought online, you know, partway through the year. Then, as Bill noted in his remarks, we scheduled maintenance that we traditionally do in the second half of the year, as well as the overlapping of the pricing benefits last year.

So, you know, all in, I mean, those are the sort of factors that will contribute to the 38% margin for the full year.

Operator (participant)

Thank you. Our next question comes from the line of Lauren Lieberman, with Barclays. Please proceed with your question. Lauren, are you self-muted?

Bill Newlands (CEO)

Hello, Lauren.

Operator (participant)

Lauren, unfortunately, we can't hear you. Are you muted? I will move on then, Lauren-

Garth Hankinson (CFO)

Daryl, come back to Lauren.

Operator (participant)

You got it. Okay, our next question comes from the line of Robert Ottenstein with Evercore. Please proceed with your question.

Robert Ottenstein (Senior Managing Director)

Great. Thank you very much. I was wondering if you could give us a little bit more detail on your productivity programs, you know, the specific buckets that you've addressed, that you're targeting. You know, is this something that is, you know, potentially a multiyear process of system optimization? Thank you.

Garth Hankinson (CFO)

Thanks, Robert. Yeah, I would say that our, you know, our, our cost savings and efficiency initiatives certainly are multiyear, year in nature. Obviously, we communicated earlier this year in Q1, we, we had taken $30 million out, and then this year, an incremental $20 million, or this quarter, I should say, an incremental $20 million. We're always looking at ways to sort of improve productivity, you know, create efficiencies in the business, whether that's through, you know, supply chain and procurement or, or operations.

You know, examples of that over time have been things like, you know, double stacking rail cars and the use of plastic pallets, optimizing the location of inventory, as Bill referenced in response to a question earlier, improved purchasing, in terms of raw materials, through better contract management and negotiations, as well as more effective and efficient use of our marketing spend. It's absolutely something that the organization is focused on, on a year-on-year basis. Certainly, we will share a lot more detail on our cost savings initiatives for both our beer and our wine and spirits businesses at our upcoming Investor Day.

Operator (participant)

Thank you. Our next question comes from the line of Filippo Falorni, with Citi. Please proceed with your question.

Filippo Falorni (Director and Equity Research)

Hey, good morning, everyone. Bill, you mentioned that the last four-week trends has been very strong and consistent with the last 52 weeks. Can you give a little bit, maybe more color on the performance of your business in September? And then at the industry level, one of your competitor, the Investor Day, mentioned that September for the industry is particularly sluggish, particularly the last couple of weeks, as you cycle the shipments ahead of the price increases in the last year or so. Maybe some color on the timing of shipments into September, into Q3 will be helpful. Thank you.

Bill Newlands (CEO)

Sure. When I look at the most recent Circana data for four weeks, our total beer business is up 13.7%, which is very consistent with what the 52 weeks, that's what I was alluding to in my prior comments around that. Certainly, as we also noted, we expected that we would see some element of tightness during the course of the beginning of this quarter that we are in, purely because we are lapping the October price increases that occurred last year and some of the pre-build that people do, that retailers do, ahead of any price increases that existed. All of that's consistent with what we've expected.

We expect, as we've said, the reason we raised our guidance expectation around beer is because we expect to have a very strong back half of the year, despite a couple of these headwinds that certainly exist.

Operator (participant)

Thank you. Our next question comes from the line of Andrew Strelzik with BMO Capital Markets. Please proceed with your question.

Andrew Strelzik (Equity Research Analyst)

Hey, good morning. Thanks for taking the question. My question is on capital allocation and in particular around buybacks. I think you noted no buybacks during the quarter, but being on track for your target to offset dilution a year to date. I guess my question, though, is what's the appetite for buybacks in excess of that, particularly given the momentum in the business, the strong cash flow generation? How are you thinking about that now versus where you were at the beginning part of the year and moving forward? Thanks.

Bill Newlands (CEO)

Yeah, so you know, capital allocation is obviously something that we're gonna discuss in greater detail at our upcoming Investor Day. But just broadly speaking, I would say for this fiscal year, as we noted when we entered this year, we were gonna at least buy back the dilution that occurred throughout the year. But this year, we were also prioritizing, you know, getting our leverage ratio back to our target of 3.0, versus where it was at an elevated state as a result of the reclassification. That said, we're always looking to be flexible and agile as conditions allow for. So something we continually look at.

Just as a reminder, we do have, you know, $800 million remaining under our current board authorization. In the event that we decide we want to be a bit more active, we have the ability to do so.

Operator (participant)

Thank you. Our next question comes from the line of Lauren Lieberman with Barclays. Please proceed with your question.

Lauren Lieberman (Managing Director)

Hi, can you hear me?

Bill Newlands (CEO)

We do.

Garth Hankinson (CFO)

Yes, part two.

Lauren Lieberman (Managing Director)

Okay, hooray! Okay, cool. Sorry about that. I don't know what happened. But just quickly, I was gonna ask about wine industry growth. And just, you know, against the backdrop of your comments on, you know, Woodbridge/SVEDKA, obviously not wine, and then the higher end brands performance. But just as you think about the path forward, not just second half, but, you know, into next year and so on, how do you think about wine industry growth, you know, wine versus beer versus spirits? I'm guessing we'll get into this a bit more at the Investor Day, but I was just curious if you could preview a bit your view on kind of that long-term growth in wine. Thanks.

Bill Newlands (CEO)

Yeah, certainly, Lauren. It's really the tale of two cities. The lower end piece of the business, what we refer to as mainstream, has been very challenged. It's down mid- to high-single digits, which obviously is somewhat challenging for us because we do have significant involvement with that category still, even though we have divested a number of brands that played in that category. That certainly is a very different answer than what I would say to you about the higher end portion of the business, where brands like Meiomi and Kim Crawford, and High West, and Booker, and things of that nature are all significantly outperforming our plans and expectations and gaining share. You're right, we'll talk about that at Investor Day.

The other thing I'd keep in mind, unlike beer, which is about 45% in the second half, it's directly the flip when it comes to wine. That's 55% in the second half. As we do, and a disproportionate amount of our business comes from ASPIRA, and which much more relates to vintage releases, those all tend to occur in the second half. Which again, weights our business toward the back half of the year versus the first half of the year. The other one I would just point out, which I think is important to recognize, we made the choice, as we said early this year, that we were going to balance our ships and depletes all year long, as opposed to doing it once in the fourth quarter, which is what we did last year.

That creates a bit of a challenge in the early part of our fiscal year, but gives us a significant improvement proposition in the back half of the year, as that won't occur as it did last year, creating a disproportionate shipment number in the fourth quarter last year, which won't be the case, and we will be going against a much better proposition this year. So, all in, I think the wine business certainly has seen some challenges, but much like we see in the higher end of the beer business, the higher end portion of the category is much stronger, and certainly our business in that sector is performing very nicely against category norms.

You're right, we will go into all of that in much more depth during our investor discussion on November 2nd.

Operator (participant)

Thank you. We have reached the end of our question and answer session. I would now like to turn the floor back over to Bill Newlands for any closing comments.

Bill Newlands (CEO)

Thank you, and thank you all again for joining our call today. We're very pleased with our performance in the first half of fiscal 2024. As anticipated, our beer business further accelerated during its seasonally strongest period of the year to deliver excellent results. In our wine and spirits portfolio, our higher end brands continued to outperform tracked channels, and we're looking forward to an acceleration in the growth of that business over the second half. All told, we remain confident in our outlook for the full year and have tightened the expectations for growth in our beer business at the higher end of the initial range, while increasing our overall EPS outlook as we drove interest expense lower through our proactive debt management.

In closing, I would like to encourage you to tune in for our upcoming Investor Day on November 2nd, where we will be sharing our latest perspectives on the medium-term outlook for our business. You will find further details on how to access this event through our investor relations website at ir.cbrands.com. Thank you again for joining us today, and we look forward to seeing most of you, if not all of you, November 2nd.

Operator (participant)

Thank you. This does conclude today's teleconference. We appreciate your participation. You may disconnect at this time. Enjoy the rest of your day. Bye-bye.