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Cott’s soft drink business, Toronto bottling plant pictured, now account for just one fifth of the company’s sales.Fernando Morales/The Globe and Mail

Cott Corp.'s big makeover has yet to register with investors, who still view the company as a manufacturer of cheap fizzy drinks.

A transformational acquisition has greatly reduced the company's exposure to soft drinks, a segment of the market in perennial downfall. The new Cott is a company specializing in the much more lucrative business of providing water and coffee services to homes and offices.

The deal has done little to resurrect Cott's stock, which is still 40 per cent off its April 2013 high.

"With a lot less exposure to declining businesses, they'll hopefully get a re-rating," said Kamran Khan, a portfolio manager at Hesperian Capital Management, which owns shares of Cott.

The past year and a half has been unkind to Cott, which, as a discount producer, was particularly vulnerable to shifting consumer preferences. Soft drink consumption has been falling steadily for nearly a decade now, which has forced Big Soda to slash its prices.

The price war left little room for Cott to compete. Its discount generic and store-brand soft drinks share shelf space with Coca-Cola and Pepsi selling for as little as $3 for a 12-pack of cans.

Survival required strict cost control. In the meantime, the company's management committed to diversifying the company into growth segments.

That happened much quicker than expected with the $1.25-billion (U.S.) deal to acquire DSS Group Inc., which was announced in early November. The merger itself is huge relative to Cott's predeal market capitalization of about $560-million.

"Both companies are in the beverage business, but that's where the similarities end," CIBC World Markets analyst Perry Caicco said in a recent note.

DSS has a 30-per-cent share of the U.S. water-delivery market and is also one of the five biggest providers of office coffee services. It offers different products from Cott, through different distribution channels, Mr. Caicco said. He upgraded the stock to "sector outperformer" after the acquisition and raised his target price to $10. Of the eight other analysts covering the stock, just two rate Cott a "buy," the rest "hold," at an average price target of $7.89, representing a 17-per-cent premium over Friday's closing price of $6.72.

Cott expects its earnings to more than double by 2016 after accounting for synergies. Home and office delivery of water will make up the single largest component of its revenues. The private-label business – which includes items such as juices and sparkling beverages – will now account for less than half of sales, and soft drinks less than one fifth.

"It does certainly decrease the business risk of the company," Mr. Khan said. "But it also raises the financial risk."

The debt required to finance the deal will drive up the company's debt-to-EBITDA ratio to around 5.2 times, after adding in the "de facto debt" in the form of preferred shares, Mr. Caicco said. Cott's debt load has not been that high since 2001 and interest payments will be considerable. "Earnings per share will not be pretty for the next couple of years."

But the company's management has proven itself to be disciplined in cutting debt in the past, Mr. Khan said. The company said it plans to quickly deleverage, bringing that debt ratio down to the 3 to 3.5 range by fiscal 2018.

Sales and earnings growth over the short term will be modest, and the high debt level makes Cott vulnerable to any deterioration in market conditions, Mr. Khan said. Prospective investors should consider the stock as a longer-term play on Cott's transition to a new kind of beverage company, he said.

"This could be a big winner several years out if the strategy pays off."