Constellation Brands logo

In August 2018 I purchased two $190 January 2019 Call contracts on Constellation Brands (STZ) in the hopes participating in any upside it might experience by reason of its investment in Canopy Growth (WEED); I fully appreciated this was a speculative investment.

STZ's stock price rose following my purchase but in mid-October 2018, the share price reversed and it has been on a steady decline to the extent where my speculative position will result in a nominal ~$5,100 loss.

On January 9, 2019, STZ released Q3 2019 results and provided lower EPS guidance for the remainder of the current fiscal year; STZ's stock price plunged ~12.4%.

With STZ's valuation now far more favorable than when I initiated my option position, I take a look at whether STZ presents a buying opportunity.

Summary

  • Constellation Brands (STZ) issued Q3 2019 results and provided lower guidance. Mr. Market did not react positively and STZ’s share price dropped ~12.40% on January 9th.
  • In August 2018 when I purchased January 2019 2 Call $190 contracts I knew I was speculating. Those contracts are now of no value.
  • With STZ’s superior valuation following the January 9th stock price plunge I look at whether it is now a worthwhile investment.

Introduction

On August 28, 2018 I published a Constellation Brands’ (NYSE: STZ) related article in which I indicated I wished to be in a position to benefit from its investment in Canopy Growth (TSX: WEED) even though I was highly reluctant to acquire shares for various reasons, one of which is that STZ is far more speculative in nature than all my other holdings.

Long-term investors once knew STZ to be a ‘spirits’ business but in recent years, STZ has undergone a transformation and is now heavily pursing new growth opportunities. Further details on STZ’s diversification into the cannabis industry can be found in its Q2 FY2019 Investor Overview Presentation (link provided below).

STZ - Pursuing New Growth Opportunity

STZ - Cannabis Global Market Opportunity

Source: STZ – Q2 FY2019 Investor Overview Presentation

In my August 28th article I indicated:

‘There will be some shake out within this industry over the next several months / few years but I think STZ/CGC will end up being a formidable player. In my opinion, however, there are far too many uncertainties at this point in time for my liking and I would prefer to be cautious with any investment that is cannabis related. I do, however, I want the opportunity to participate in potential upside; I am of the opinion STZ will rise in value over the next few months.

Rather than purchase STZ shares outright thus requiring a significant cash outlay, I have decided to employ the use of options which allows me to gain exposure to STZ without having to lay out a significant amount of cash up front.

There is certainly a downside risk to the strategy I have employed but I have calculated my risk of potential loss in a scenario where STZ’s shares tumble below its 52-week low of ~$195.96; I am prepared to accept the downside risk.’

In that article I outlined the option transaction into which I had entered.

My STZ Call purchase was the first time I had purchased any option contract in at least the past 7 – 8 years; all previous option transactions had been from the position where I was the option seller. Several years ago I had, on the very rare occasion, purchased calls but only as part of a two sided option trade.

Since option contracts have a time value that erodes as we get closer to the contract’s expiry date, I have benefited from the passing of time with my previously written option contracts. In the case of my STZ options, however, the passing of time worked against me.

I had purchased 2 January 2019 $190 contracts @ $25.60 for a total outlay of $5,120 so for the first several weeks, the rise in STZ’s stock price worked in my favor.

If you look at STZ’s stock chart you will see that STZ’s stock price rose to ~$227 by mid-October meaning I could have closed out my position for at least a $2300 profit (($227 - $190)*200 shares) minus the $5,120 outlay (I am excluding commission and am not factoring in any time value benefit of the contract - there were 3 months remaining until expiry).

In hindsight, insider sales by the Chairman of the Board (Richard Sands): 148,773 shares sold on October 21st and the CEO (Robert Sands): 151,060 shares sold on October 21st should have been a warning sign. I have, however, seen a number of instances in which insiders have sold shares only to have the company’s share price rise in value.

What I have found is that insider purchases tend to be a vote of confidence in the company but insider sales can be for various reasons and not just because an insider thinks the company’s share price is going to drop in value (eg. estate planning, tax planning, or other purposes). In addition, the sale of this many shares still leaves the Sands with a significant number of STZ shares so I didn’t think they were ‘bailing’ on STZ.

In this case, however, STZ’s share price has fallen reasonably steadily subsequent to the October 21st share sales.

With just over a week to the expiry of the option contracts, the options are worth pennies and to close out my position would cost me more in transaction charges than I would salvage from my outstanding contracts.

I also very highly doubt that STZ’s stock price will surge above $190 prior to the January 18th expiry given that on January 9th STZ issued its Q3 results and provided lower earnings guidance for the year.

I am certain you can think of many lessons one can learn from my STZ speculative trade. Personally, this relatively inexpensive lesson has reinforced my opinion that I am the type of investor who should just stick to investing in higher quality companies at reasonable valuations for the long-term.

In the remainder of this article I look at STZ’s YTD revised guidance for FY2019, its current valuation, and whether the current valuation presents an opportunity to actually take a stake in the company…..for those with a higher risk tolerance level than me.

Please click here to read the complete version of this article.

Members of the FFJ community can access reports I generate on high quality companies which add long-term shareholder value. In an effort to help you determine whether my offering is of any value to you I am pleased to offer 30 days' free access to all sections of my site. No commitments. No obligations. That's 30 days from the time you register at absolutely no cost to you!

I hope you enjoyed this post and I wish you much success on your journey to financial freedom.

Thanks for reading!

Note: I sincerely appreciate the time you took to read this article. Please send any feedback, corrections, or questions to charles@financialfreedomisajourney.com

Disclaimer: I have no knowledge of your individual circumstances and am not providing individualized advice or recommendations. I encourage you not to make any investment decision without conducting your own research and due diligence. You should also consult your financial advisor about your specific situation.

Disclosure: I have purchased 2 STZ Call options expiring January 18, 2019.

I wrote this article myself and it expresses my own opinions. I am not receiving compensation for it and have no business relationship with any company whose stock is mentioned in this article.