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Transcript : Constellation Brands, Inc. Presents at Morgan Stanley Global Consumer & Retail Conference, Dec-06-2022 10:15 AM

06/12/2022 | 16:15

Presenter Speech
Dara Mohsenian (Analysts)

All right. Good morning, everyone. I'm Dara Mohsenian, Morgan Stanley's household products and beverage analyst. Before we begin, just a quick disclosure. Please see the Morgan Stanley research website at www.morganstanley.com for important research disclosures. And you can contact your Morgan Stanley representative if you have any questions.

So with that, I'm very pleased to welcome Constellation Brands and Garth Hankinson, Constellation's CFO to this fireside chat today. Constellation's got a great track record of growth over the last decade, driven by the beer business. And we're going to start today with some comments from Garth and then we'll go into Q&A from there. I'm going to turn things over to you. Thanks for being here.

Presenter Speech
Garth Hankinson (Executives)

Thank you. Thanks, Dara. Obviously, we're excited to be here today. Before we get started, we have some disclaimers here. I invite everyone to review our forward-looking statements and non-GAAP financial measures disclaimers, which can be found on Pages 2 through 4 of the deck that we posted to our website yesterday.

Reconciliations between the most directly comparable GAAP measure and any non-GAAP financial measures discussed today are included in the slides or are otherwise available on the company's website at cbrands.com.

And as a quick reminder, we just ended our fiscal third quarter, and we are in our quiet period. So today, I will not be sharing any results of operations or financial conditions for our Q3 fiscal year 2023.

Now as many of you are aware, we recently reached an important milestone for Constellation Brands. Last month, we transitioned to a single class of common stock and aligned the voting power and economic ownership of our shares. We want to thank our shareholders for their support of this important change and other governance enhancements combined with this transition.

We believe our company is in an even stronger position to execute against our strategic initiatives and pursue our capital allocation priorities as a result of this transition. So today, I'll be sharing in more detail how we intend to approach our capital allocation priorities moving forward. And why we are confident we will continue to build on the path of solid growth and value creation underpinned by those priorities.

With that, let's turn to Slide 5. About 3.5 years ago, our current leadership team began to come together following Bill Newlands appointment as CEO. From the outset, the team was committed to sustaining profitable growth and building shareholder value. And I am pleased to say that we have and continue to deliver against that commitment. Since the beginning of our 2019 fiscal year, we continue to extend our strong track record as a growth leader among large CPG companies.

We accomplished this with disciplined investments to support the growth of our core industry-leading brands and by thoughtfully expanding on that solid foundation with innovative products and emerging brands aligned with consumer trends. We firmly believe this approach is key to driving total shareholder returns above those of our competitors. So we are proud to be ahead of our competitors on delivering value for our shareholders. But we are not complacent, and we remain strongly committed to sustaining high levels of performance.

Moving to Slide 6. As I mentioned, we have a powerful collection of industry-leading brands that continue to deliver solid growth. Starting with our beer business. We are the #1 supplier in high-end beer and have delivered 51 consecutive quarters of volume growth. As you see, Modelo is now the #2 beer brand in the U.S. beer market and the #1 beer in the high-end beer market. Modelo is now the #1 or #2 beer in 11 states, which is more than double the number of states 3 years ago.

The brand has gained 3 share points since our fiscal 2019 and remained the #1 share gainer in the entire U.S. beer category in our last sixth consecutive fiscal quarters. Another exciting opportunity for the Modelo family is our Chelada brand, which is now the #1 RTD Chelada brand in the category. It has over 50% share of the segment and is driving 170% of the segment growth. So Chelada is no longer a niche business, it is a sizable platform, and we are excited as we expect to increase media investment by over 60%. And we continue to build on the opportunities within the Modelo family with a clear focus on maintaining the brand essence. So we are excited about the national launch of Modelo Oro next year, which has surpassed internal and external benchmarks in test markets.

Moving to the Corona family. Corona Extra has regained its momentum, delivering 6% depletion growth in the second quarter. We believe this return to mid-single-digit growth was not an accident, but a reflection of our disciplined efforts with this brand. We've continued to invest behind Corona, making it the official Cerveza of Major League Baseball and launching the La Vida Más Fina campaign, which has the highest scoring ads ever for the brand with 3 of the top 5 spots within the beer category this year, including the #1 spot.

We made these shifts in the brand thoughtfully and authentically. And consumers are responding as Corona Extra remains the #1 most loved beer brand with both the general market and Hispanic consumers. As with Modelo, we are also developing new products within the Corona family to meet the consumer where they're headed. We will be launching Corona nonalcoholic next March to align with the growing interest consumers have shown in the nonalcoholic space with 60% more consumers having tried NA beer this year alone.

Last but not certainly not least on the beer side, we are seeing a fantastic runway for Pacifico. The brand grew over 37% in the second quarter and was a top 10 share gainer in tracked channels, and the brand's national awareness increased by 4 points in the last year.

So we are increasing our investments in the brand through digital forward media for Gen Z audiences, which is a core demographic for this brand. That backdrop of strong core brands and thoughtful consumer-led innovation gives us confidence in our ability to continue to deliver against our medium-term net sales and operating margin targets. In fact, since fiscal 2019, despite the challenges faced by most businesses due to the pandemic, our beer business delivered net sales growth and average operating margin at the high end of our target ranges.

Turning to Slide 7. Our wine and spirits business has undergone a significant transformation over the last 4 years, shifting from a U.S. wholesaler focused, mainly on the mainstream segment, to becoming an omnichannel, global competitor, primarily focused on the higher-end segment. This journey includes building brands like Meiomi and the Prisoner Wine Company, which were only added to our portfolio a few years ago. These are now leading brands within the growing segments of the category.

It's also included the sale of around 30 lower-priced brands to Gallo and the more recent divestiture of a smaller set of brands to the Wine Group. But the business has retained scale as we remain the #2 supplier of wine in the U.S. market. As a result of these changes, approximately 60% of our portfolio mix on a net sales basis is above $15 per bottle, a dramatic shift of the roughly 25% in fiscal 2019.

But more importantly, in our second quarter, our largest premium and fine wine brands as well as our craft spirits brands, all delivered solid depletion growth rates. Furthermore, we are also driving growth in our wine and spirits business by shifting our geography and channel mix in line with consumer preferences.

So we are pleased that the net sales mix contribution of international and DTC channels has increased by 600 basis points since fiscal 2019. And that in our second quarter, our international and DTC channels each delivered double-digit net sales growth year-over-year. That said, we know there is more progress to be made towards the growth and margin targets that we aim to deliver in our wine and spirits business.

After adjusting the business reported fiscal 2022 net sales of approximately $2.1 billion and operating income of $470 million for the $44 million of net sales and the $26 million of operating income that the recently divested brands contributed, we anticipate net sales to be flat to down 2% and operating income to grow by 3% to 5% in our fiscal 2023. But ultimately, we continue to target top line organic growth of roughly 2% to 4% and operating margins of 28% to 29% over the medium term.

Moving to Slide 8. The solid performance of our beer and wine and spirits businesses has supported consistent strong cash flow generation over the last few years. However, since fiscal 2019, the uses of that cash evolved to better align with the shift of our capital allocation priorities to focus on maintaining our investment-grade credit rating, delivering cash returns to shareholders, advancing the brewery capacity expansion and construction processes in our beer business to support its continued strong growth; and lastly, executed on disciplined small M&A to fill gaps in our portfolio.

To that end, between fiscal 2020 and fiscal 2022, we used approximately 50% of our cash flow in debt repayment, approximately 26% in dividends and share repurchases, approximately 21% in capital expenditures and about 3% in mergers and acquisitions.

Turning to Slide 9. Our approach to capital allocation moving forward remains aligned with the priorities we introduced in fiscal 2020 to achieve a disciplined, balanced and thoughtful approach to support growth and value creation. First, we remain committed to our investment-grade rating and to growing the dividend in line with earnings as key elements of a disciplined financial foundation. Second, we will continue to balance supporting the growth of the business with organic investments and delivering additional returns to shareholders through share repurchases. And third, we will deploy excess cash to smaller acquisitions that fill portfolio gaps with a thoughtful and prudent approach. So let's step through each of those in more detail.

Moving to Slide 10. As I mentioned earlier, over the last few years, we have significantly reduced our debt obligations to support our investment-grade rating. Combined with the strong earnings growth delivered by our beer business, our net leverage ratio has been below the 3.5x we have been targeting.

To further reinforce our commitment to an even more solid investment-grade rating, we will now be targeting a ratio of approximately 3x. As a reminder, as of Q2 fiscal 2023, we were already operating in that 3x range. However, when factoring in the financing for the cash payment associated with our recent transition to a single-class stock structure, our net leverage would be 3.5x on a pro forma basis. So while we expect to retain our investment-grade rating, even when factoring that -- factoring in that financing, we're also confident in our ability to return and operate at 3x net leverage -- at a 3x net leverage target.

To that end, you'll see our maturity profile and that the $1 billion loan that accounted for the majority of that financing was structured to have no prepayment penalty, which gives us optionality on how we choose to manage our progress towards meeting our 3x target, particularly in the absence of any other debt coming due in our next fiscal year.

Turning to Slide 11. Another important element of our commitment to a disciplined financial foundation is targeting an approximately 30% dividend payout ratio. In line with that target, we returned approximately $1.7 billion to our shareholders in dividends over the last 3 fiscal years, which is over 4x the amount we spent on M&A. Importantly, our payout level has been consistent with the average for our competitor group. So while our dividend yield has been below our competitors, this has been a result of the relatively strong performance of our share price. Going forward, we intend to continue to target a payout ratio of approximately 30%, and we'll continue to evaluate our relative performance to offer an attractive dividend.

Moving to Slide 12. Given the strong growth of our beer business, we intend to continue to deploy capital to organic investments to support this momentum. As of the end of the second quarter, our brewery capacity in Mexico was approximately 41 million hectoliters, supporting an effective annualized supply of approximately 430 million cases. This included approximately 9 million hectoliters of capacity added between fiscal 2020 and fiscal 2022 as well as an incremental 2 million hectoliters unlocked from our brewery optimization and productivity initiatives. As we look ahead, we continue to expect adding another 25 million to 30 million hectoliters of capacity between fiscal 2023 and fiscal 2026. This will be supported by the $5 billion to $5.5 billion of investment over that same period.

We are deploying this capacity through a series of expansion waves, which is consistent with the modular approach we have consistently adopted to maintain capital expenditure discipline and flexibility. Importantly, all of these expansions continue to advance in line with our plans. And on that note, I am pleased to confirm that we have recently broken ground on our new site in Veracruz.

Turning to Slide 13. As a balance to our investments in organic growth, we have also returned cash to our shareholders through share repurchases. Over the last 3 fiscal years, our share repurchase ratio has significantly exceeded the average of our competitors. And over our last 6 quarters through Q2, we have completed approximately $2.8 billion worth of repurchases, which exceeds our combined fiscal 2022 and anticipated fiscal 2023 capital expenditures by approximately $400 million.

Looking ahead, we remain committed to executing share repurchases to at least cover dilution, but we also have approximately $1.2 billion of our repurchase capacity still in place and will remain opportunistic, particularly as we achieve incremental cash flow flexibility.

Moving to Slide 14. Judiciously deploying excess cash to M&A remains our last priority with a particular focus on small gap filling opportunities. Our recent acquisitions of My Favorite Neighbor and Lingua Franca as well as the purchase of the rest of Austin Cocktails from our venture portfolio, enhanced our wine and spirits business with supplemental offerings. All of these brands are delivering growth. And the cost of these acquisitions was largely covered by the divestiture of our ownership stake in another brand from our venture portfolio.

Again, we intend to remain disciplined in our pursuit of any M&A opportunities, and we'll continue to pursue transactions that we believe are consumer-led, deliver growth momentum, provide compelling returns, fill portfolio gaps and offer synergy benefits.

Lastly, turning to Slide 15. And I thank all of you for joining us and offer you a couple of recap takeaways. First, over the last 3 years, we have unquestionably delivered against our capital allocation priorities with clear determination. We consistently operated below our target leverage ratio. We're on track to exceed our $5 billion goal in cash returns to our shareholders by the end of this fiscal year, significantly increased the brewing capacity of our beer business through expansion and optimization projects, and we've conducted a handful of small M&A transactions to further enhance our wine and spirits business with supplemental higher-growth brands.

And second, as we look ahead, we continue to believe that the right framework to sustain profitable growth and build shareholder value is to: one, remain committed to a disciplined financial foundation with a solid investment grade rating and dividend growth in line with earnings; two, to balance organic investments to support growth and additional returns through share repurchases; and three, to thoughtfully and rigorously assess any deployment of excess cash to small acquisitions.

Thank you again, and I'll turn it over to Dara for Q&A.

Question
Dara Mohsenian (Analysts)

Thank you. That was great. So I wanted to start on capital allocation. I think you sort of answered a lot of my questions in the presentation. But maybe to put a finer point on a couple of points. Share repurchases, is it more sort of opportunistic from here around stock price and ROI? Is it more consistent based on cash flow leverage.

How do you think about that? And then on the M&A front, you clearly sounded like smaller, higher-growth acquisitions was a focus. So I'm assuming medium- to large-sized deals, unlikely not as much of a focus at this point, but maybe you can just give us a little more detail there.

Answer
Garth Hankinson (Executives)

Yes, Dara. So I would start by saying we're in a pretty enviable position given the growth of our brands, the top line and given the attractive margin profile that we have. We generate a good amount of cash. And so we're able to really execute against all of the initiatives that I just outlined. As it relates specifically to share repurchases, share repurchases will continue to be a meaningful part of our capital priorities moving forward.

Certainly, I think that you framed it as an either/or and I think it's probably more of an and. As we identify and our cash flow flexibility becomes clear, we'll have the ability to pull that lever if we want to. But in the near term, we also have the ability to be opportunistic as conditions present themselves. So it will be some and some on the share repurchase front.

Clearly, I think you articulated pretty well from an M&A perspective. I think that the recent past is a good reflection of the type of transactions that we're looking at, whether it's the transactions that we did this last year that we highlighted a couple of minutes ago, if I look back a little bit further, things like the Meiomis, The Prisoners is High Wests of the world. Those are the type of things that I think that you can expect as we look at M&A, keeping in mind that, that's the last of our list of capital allocation priorities.

Question
Dara Mohsenian (Analysts)

Great. That's helpful. And then shifting to beer business. You mentioned the great long-term track record over the last few years, and that's really continued year-to-date here. We've seen a little more volatility in the scanner data recently. Some of that is probably around Thanksgiving timing.

But just given it's created a little bit of concern, normally, we don't get as much into the short-term dynamics, but just any thoughts around some of the recent short-term volatility we've seen in scanner data and some of the underlying drivers behind that and your enthusiasm looking forward around the beer business in terms of the growth potential there.

Answer
Garth Hankinson (Executives)

Yes, Dara. So I think it's important to say that we remain on track to deliver our full year from both the depletion and from a shipment perspective. And if you look at the recent scanner data, we continue to take share in the total categories. We continue to take share in the high end. I think that what you've seen a little bit over the last couple of weeks, and this is something that we monitor very closely as we always do.

And certainly, given the context of the macroeconomic environment in which we're operating in, as we look at that, we think that some of what you're seeing in the most recent periods is largely driven by performance in California. Certainly, California, first this time last year is a really tough overlap where we're kind of growing in the mid-teens -- at the mid-teens range. But additionally, there's a very different weather situation last year in Southern California than this year. Last year, it was sort of 20 degrees warmer than this year and certainly beer consumption is driven in part by weather.

And so those are things that we've had to overcome this year. That being said, even in California, which -- and I point out California because that makes up about 23% of our overall business. But even in that market, with some of what you've seen, we continue to take share. Again, both in the broader category and in the high end, so outperforming the competitive set.

If we look more broadly across the rest of the country, we're doing really well in some of our nontraditional markets. In areas like Portland and Seattle, we're up over 30%. We're up similar amounts and -- or similar rates in places like Asheville and Richmond. We continue to perform well in New Orleans in South Dakota, Salt Lake City. So this gets back to the runway of growth for Modelo specifically and the rest of the portfolio, around some of the nontraditional markets and the distribution opportunities we have. So net-net, we're -- as I say, we're in good shape to deliver the full year.

Question
Dara Mohsenian (Analysts)

Okay. Great. That's helpful. And just given the consumer environment we're in, can you talk a little bit about macro impacts on your business. What you're seeing from a consumer standpoint? Obviously, with 100% premium portfolio. In theory, there could be some more pressure from the consumer spending weakness we're seeing in general. But obviously, your business has held up very well year-to-date.

So how do you think through some of those impacts? Should we expect to see a bit more channel shift to some of those larger format retailers that are in the scanner data I mentioned and less momentum in on-premise? How do you sort of think through macro impacts either in terms of less consumer trade down, channel mix shifts or whatever they may be in terms of the impact on your beer business and maybe you can touch on the wine business also.

Answer
Garth Hankinson (Executives)

Sure. So there's a lot there, so I'll try to get to it all if I missed anything, just bring me back to it. But in terms of the macro just -- obviously, this is something we pay a lot of attention to just given the macroeconomic backdrop. You've heard us talk about before. One of the key metrics that we look at is buy rate. And buy rate is the number of trips that the consumer makes to a retail outlet times the amount that they spend per trip.

For the most recent month that we have data, we're continuing to see very good performance. The consumer has been very resilient. Specifically, the high-end beer consumer as well as the Hispanic consumer continues to be holding up very, very nicely. That being said, again, this is something that we watch closely. I mean I think the good news for the category and the good news for us is as you think about some of the category dynamics more broadly is that beverage alcohol only makes up about 1.5% of our consumers' overall basket of goods. So it's not necessarily a big driver for their expenditures. So it's not necessarily a place that they're looking to cut.

For most consumers, somewhere in the neighborhood of 70%, they see beverage alcohol as a staple, not as a discretionary item. So it's on the list of things that they're looking to purchase when they go to a store, not necessarily an impulse buy.

Based on the work that we've done looking at past recessions, we also know that you pointed out that we have a higher end, more premium portfolio, whether that's in beer or Wine & Spirits. That premiumization trend that's been going on for a long period of time, you don't really see that abate. You might see a little bit of a slowdown in terms of the growth rate, but you're not necessarily seeing broad trade down and then once you -- the economic environment sort of normalize as you get back to write back on the same kind of growth trajectory.

So I think that those are all net positives for us. Certainly, as I say, this is something that we monitor regularly to the extent that we see any weakness. Obviously, we have levers to pull. One of those are things on a packaging or format perspective or from a pricing perspective. There are things that we can do to try to mitigate the impact if we see any areas of concern. Again, so far, we haven't seen those. The consumer remains resilient.

On the channel shift, when we look at IRI data, IRI data makes up about 50% of the overall category. So it's a good indicator, but it's not perfectly reflective of what's going on out there. And again, in IRI, we continue to perform very, very, very well.

In the on-premise, the on-premise is a channel that continues to bounce back from COVID. You know that our business pre-COVID, on-premise accounted for about 15%, 16% of our overall net sales. We ended this past fiscal year at about 11%. And at the end of Q2, we were back up to 12%. So we're still seeing some nice growth there.

But as you rightfully point out, given the macroeconomic backdrop, that is a channel that we pay particularly close attention to because that is where consumers sometimes will make changes to their spending habits, right? So that doesn't mean that there's necessarily a change in consumption, it's just is a change in where and how consumers consume.

And then we have additional non-track channels, which again have been growing nicely, but they face some of the similar macroeconomic conditions that the on-premise has. So again, we think that the consumer is pretty resilient, and we're confident in our ability to meet the year.

Question
Dara Mohsenian (Analysts)

Okay. Great. And think about your 2 largest brands on the beer side, Modelo and Corona. Can you talk a little bit about the growth opportunities for those brands going forward? And as you think about long-term growth, what the key drivers are there? Obviously, they've had tremendous strength in recent years. How sustainable are some of those underlying drivers? And maybe specifically, and I'll remind you if you forget this one, but Modelo Oro, just talk a little bit about your enthusiasm for that innovation coming up next fiscal year.

Answer
Garth Hankinson (Executives)

Sure. So -- and our growth drivers remain unchanged. I mean if you look at Modelo -- I'll start with Modelo, I mean, Modelo's going to continue to be the biggest driver of growth for us over the medium term. We continue to have a lot of opportunity for distribution growth whether that's basic distribution, which is just getting on the shelf for effective distribution, which is getting the allocation that you deserve given how quickly your product turns or our product turns and given the profit profile of it.

We think that retailers need to treat shelf spaces their most precious asset and give it to the brands that have the profile that deserves that shelf space. And certainly we've been successful with our Shopper-First Shelf initiatives to increase our product placement over the last several years. So distribution continues to a big opportunity for us.

Again, we're pretty well distributed across the coasts. But certainly, there's a lot of opportunity for us in the interior of the country. And as I indicated, as we do move across the country into some of those nontraditional or what haven't been traditional up to this point markets for us, we're seeing really good rates of growth. And our brand like Modelo, which is now the second largest brand in the category and the largest high-end brand, it still doesn't have the same distribution as Corona, let alone Bud Light. So a lot of opportunity there for distribution.

Continuing on with Modelo. Certainly, we have demographic tailwinds for us. The Hispanic consumer demographic is expected to grow at kind of a 3%, 3.5% compound annual growth rate, so that will double over the next 20 years or so. So that's another opportunity for us or another tailwind for us.

You mentioned Oro. Certainly, we've been a little bit more active with Corona as it relates to innovation and brand extension. We haven't been really up to this point with Modelo other than with Modelo Chelada, which, as you heard in my prepared remarks, this is a brand that's turned in to be a bit of a sneaky big brand with really good growth dynamics and a brand that we're going to further invest in next year.

And then we'll get to Oro right now because you mentioned it, but Oro we're really excited about Oro. We tested in 3 markets this past spring and summer. It exceeded our internal and external targets. And as a result, we're excited to launch that in March. It's -- personally, I'm really excited about it. It's a great liquid, and it really does capture an underlying consumer trend around wellness and better for you. So we'll build that in the right way. We'll make sure that we're building that in a sustainable way, but we think that there's -- that's a big opportunity for us.

And moving on to Corona. I mean, a similar set of drivers, right? There are still opportunities for that brand with distribution. It's returned to growth nicely. Again, not as fully distributed. It doesn't have the same number of points of distribution as something like Bud Light. So we think that there's still opportunity there.

We had some issues in the past couple of years with some spot outages as it related to availability of things like glass that led to some out of stocks with Premier. But Premier now is back fully in stock, and we're doing a little bit of a transition there from glass to aluminum cans because that's what the consumer is looking for, for that type of product.

So we think that, that can be a driver of growth, and we have some other initiatives within the Corona brand family that we're equally excited about. So all in all, same set of drivers that we've had. And again, that's why we have a lot of confidence and conviction in our near-term growth algorithm.

Question
Dara Mohsenian (Analysts)

Okay. Great. Maybe we can end on beer margins. Obviously, this year, with the cost pressures in the industry, you're not at that 39% to 40% long-term goal. As you think about returning to that over time, can you give us a little bit of sense of timing. And specifically, the back half of this year, you're obviously at a lower margin rate than the first half based on your implied guidance.

And some of that is the cost curves. I think you have some depreciation coming up early next fiscal year. So I'm sort of assuming next year, first half is lower than the second half. Is that fair based on the way the cost curves work, et cetera, but also just a sense for that 39% to 40%, how insight that is long term coming off this aberrational year this year to some extent with the cost pressures being so severe?

Answer
Garth Hankinson (Executives)

Yes. I mean, look, we continue to think that the right way to think about our beer margins is in that 39% to 40% over the medium term. As we've said previously, in any one given year, we're going to have more headwinds or tailwinds. Obviously, last year, we had more tailwinds. So we were over 40%. This year, we've had more headwinds. So we're going to be below 39% a bit. As we look forward to next year, and I guess, I have to give you one caveat there is just given the sort of bizarre fiscal year-end that we have, we're in the process right now of going through our annual planning process.

And so we'll have better line of sight around what margins look like in several months. And clearly, we'll provide guidance to when all that comes into focus, probably in line with our full year results. But that being said, next year -- as we're looking forward to next year, we are going to have some similar headwinds. Certainly, the inflationary environment is still with us. Obviously, some things have abated. Some of the commodities have abated off of their peak, things like aluminum, but they're certainly not back to where they were 24 months ago for sure. And so that's something that we'll still have to figure out exactly what the inflationary impact is next year.

I think as we've talked about before, our contracts for input costs are done on a calendar year basis and they're done on a staggered basis. So we're in the middle of negotiating some of those contracts right now. So again, we'll have more input. We'll have more clarity on that here in a few months.

Certainly, we're going to continue to have some -- as you noted, we're going to have some depreciation drags the ABA facility at Nava will come on fully online either at the end of this fiscal year, at the beginning of our next fiscal year. So that will be a bit of a headwind as well as a full year of depreciation for some of the expansion we've done at Obregon. So we'll have that drag.

And then again, as we lay around incremental capacity, you've got the fixed overhead absorption drag over the near term as you grow into that. So those are some of the drags. Obviously, some of the things we do to offset that is we'll continue to take pricing. We've been very disciplined around our 1% to 2% pricing algorithm and the flexibility that gives us.

Last year, we took more than 2%. This year, as we announced in our Q2 earnings, we're going to take 2% to 3%. So above that again. Next year we'll be in that 1% to 2%. I think we have to just see how the most recent pricing holds and what the impacts that has on us to the extent they have any before we know how aggressive we'll be in that 1% to 2% range to cover some of those inflationary pressures.

We're going to continue to work on our cost savings initiatives, as we always do in our footprint. And the team is really good about identifying ways to save dollars and take costs out. And I think that, that's reflective of the 2 million hectoliters of the capacity that we added just through optimizing the footprint. We'll continue to identify those type of initiatives.

So again, I'm being a little bit long-winded to say that it's a little bit too early for us to tell you exactly what next year is going to look like other than we know that we've got some headwinds that we're going to face. But we have a number of initiatives underway that we'll do our best to cover those.

Question
Dara Mohsenian (Analysts)

Great.

Answer
Garth Hankinson (Executives)

What you did -- and we're out of time, but you did ask the question, I guess, around the timing of I would say that I think that your assessment is pretty accurate around the fact that we'll have some more pressure in the first half of next year just given the way things like hedges get layered in and when those roll off. And so the first half of our current fiscal year is when we had the benefit of our most favorable hedges. And as we layered more in, obviously, we protected the P&L, but not at the same sort of favorability. So there likely will be an inverse of the impact next year than what you saw this year.

Question
Dara Mohsenian (Analysts)

Great. Well, that's very helpful. We really appreciate it. Thanks so much for coming.

Answer
Garth Hankinson (Executives)

Thanks. Thanks, Dara. Thanks, everyone.

Question
Dara Mohsenian (Analysts)

Great. Garth, thank you.

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