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Corporate Strategy

Can Cott put the pop back in its sales? Add to ...

Soft drink maker Cott Corp. is one of this year's top turnaround stories, with a cleaned-up balance sheet, a profitable bottom line and shares that have jumped 600 per cent. With the company's see-saw record, however, it's too soon to declare long-term success.

Cott bills itself as "the world's largest retailer brand soft drink company," which means it makes the no-name carbonated beverages sold in stores at lower prices than megabrands like Pepsi and Coke.

Simple enough. Cott, however, has a history of aspiring to be more - then screwing things up, burning its investors in the process. After a red-hot first year as a public company in the early 1990s, the stock collapsed amidst allegations about its accounting and a multimillion-dollar restructuring. More recently, an effort to push branded beverages, coupled with executive suite chaos, more losses and liquidity concerns, wiped out 97 per cent of the share value from 2005 to early 2009.

"Every time the company tries to be more than it is - a solid manufacturer for third parties - it gets itself into trouble," said David Hartley, an analyst at BMO Nesbitt Burns.

Mr. Hartley, however, has an "outperform" rating on the stock, and he's not alone in his enthusiasm. Rick Aristotle Munarriz, a contributor at the Motley Fool investing website, picked Cott as one of his "5 Stocks Under $10" for November. And Jake Lynch of TheStreet.com has been recommending the shares since August.

Many of the stock's fans point to macro trends like challenged consumers moving to cheaper alternatives, like store-brand pop. But Cott's turnaround in 2009 isn't a top-line story: Its revenue is down more than 5 per cent year to date (in part due to Cott's use of the declining U.S. dollar to present its results) and its volume of cases sold is down more than 4 per cent.

Instead, Cott is succeeding in the short term through cost-cutting and debt reduction. It's added nearly five percentage points to its gross margin - revenue minus the cost of goods sold - this year, going to 16.1 per cent in the first three quarters of 2009 from 11.4 per cent in the prior-year period. Cuts in selling, general and administrative expenses have added another couple of percentage points to operating margins.

The company has used nearly all its free cash flow this year to strengthen its balance sheet. An asset-backed line of credit that had $107-million outstanding at the beginning of the year was down to zero on Sept. 30.

A sale of new common shares helped with the refinancing of $269-million in notes that were scheduled to come due in 2011. (To postpone the maturity to 2017, the company issued $215-million in new notes paying 8.375 per cent, a bit higher than the 8 per cent of its previous debt.) "At this time last year, we had a significant long-term debt load and insufficient short-term liquidity," Cott chief executive officer Jerry Fowden told investors on the third-quarter earnings conference call late last month. "Now, just three quarters later, our total debt is significantly reduced and our short-term liquidity is more than sufficient."

Now, Mr. Fowden says, Cott will turn more attention to winning new business, both from existing and new customers. "Reducing costs is actually a route to top line opportunities because it improves our ability to compete and create value for our retailer partners," Mr. Fowden said in a written response to questions from The Globe and Mail.

Cott has a goal of adding 20 million new cases of business in the next 12 to 15 months; it's already secured nine million of that, Mr. Fowden said. (The company sold nearly 818 million cases in the first nine months of this year.) As Cott embarks on the next stage, however, questions remain. To boost cash flow, Cott has kept its capital expenditures well below its depreciation and amortization, raising the issue of whether its plants will be up to the task of new business.

Mr. Fowden says "our investments are sufficient to cover our maintenance needs as well as a few growth projects. Our manufacturing plant network is in great shape." BMO's Mr. Hartley believes the company is spending the proper amount to maintain its plants.

Cott remains highly dependent on commodity costs, particularly high-fructose corn syrup and aluminum, and sharp drops in the price of some of its raw materials this year have driven recent gross-margin improvements. The company has locked in costs on at least half the volume of those two major goods for 2010, meaning it's protected from most, but not all, potential price rebounds.

Most concerning, though, is the company's relationship to its No. 1 customer, Wal-Mart Stores Inc., which represented one-third of Cott's revenue in the first nine months of the year. In January, Wal-Mart gave notice that it's terminating its exclusive deal with Cott, resulting in a gradual decline in its obligations to use Cott over the next three years. (Wal-Mart did not respond to a request for comment.) What company will step up, however, to provide Wal-Mart with private-label pop? The bottlers of Coke and Pepsi? The makers of Dr. Pepper (who, Mr. Hartley says, already use outside bottling companies)? A hodgepodge of small independents?

"What Wal-Mart wants to do is make sure it's having an honest discussion with its suppliers," Mr. Hartley said. "Private-label soft drinks are still a desirable business. What are the other options [besides Cott] Very few, maybe none."

Cott's Mr. Fowden declines to comment on the Wal-Mart matter, but he's happy to address the issue of Cott's focus on its core business. "Our success as a private label producer will always depend on our ability to execute well on a few important priorities. … In the past, some of Cott's struggle with excellent operational implementation was in to trying to do too many things at once. Our current approach is the right one."

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