Mopping up after Cott’s spill
Analysts try to decipher profit warning
To hear Cott Corp. president and CEO John Sheppard tell it, the rise of the privatebottler has been nothing short of a “retailer brand revolution.” You can almost picture thirsty consumers casting off the yokes of the oligarchic soft drinks brands Coke and Pepsi. Guzzlers unite!
Well, like many revolutions, this one is running out of steam. The question now is can Cott change with the times?
Last week, Cott blindsided shareholders when it said earnings for 2005 would be “substantially below previously announced guidance.” Astonished investors, who thought the company’s recent woes were behind it, promptly knocked the stock to $ 20 Toronto and below US$18 in New York, its lowest level in four years.
The last year has been one of misstep after misstep for the bottler, which produces beverages under retailer monikers like Sam’s Club Cola at Wal-Mart and the President’s Choice ginger ale at Loblaw’s.
First it was an inability to produce enough pop to meet demand. Then it was a spike in plastic costs and a failure by the company to raise prices fast enough to maintain its margins. Then consumer tastes shifted to water away from the sugary soft drinks that fill Cott’s coffers. Two hurricanes later and Cott has scrapped its earnings guidance for the rest of 2005 altogether, the latest in a string of lowered forecasts.
Under Mr. Sheppard’s reign Cott has gone from one of the Street’s favourite growth stories to a company with a reputation for failing to deliver. One analyst, Peter Holden of Veritas Investment Research, has even run the numbers to value Cott as an income trust — the surest sign some believe the bottler’s era of hyper growth is a thing of the past. (For what it’s worth, Mr. Holden pegs Cott’s value as a trust at US$ 28.15, assuming a 10.7% yield.)
It’s not all Mr. Sheppard’s fault, though. If anything, the blame lies heavily with the company’s previous CEO, and now chairman, Frank Weise, who Mr. Sheppard replaced last year. Mr. Weise won over analysts with solid profit growth, but those earnings came at the expense of reinvestment in its plants and operations. While rivals Coke and Pepsi have responded to the rise of cheap, private-label pop with expanded product lines and better marketing, Cott fell behind.
Mr. Sheppard has said the company is racing to introduce new products like its Red Rave and Red Rain energy drinks, as well as sparkling flavoured water, but for now those are still small segments compared to Cott’s traditional pop business.
Meanwhile, a shortage of production capacity in 2004 forced the company to turn to outside bottlers to meet increased demand, which drove up costs. Cott has taken steps to solve its capacity issues by building a new plant in Texas, while adding several production lines in heavy growth regions around the U.S. northeast.
Then last month Cott acquired Macaw (Holdings) Ltd., a United Kingdom bottler, for US$135-million. While the company said the deal increased its capacity in the British beverage market, it also put Cott on a shakier financial footing. Standard & Poor’s, the debt-rating agency, lowered its outlook for Cott’s credit rating to negative from stable.
There’s another challenge facing Cott, though it is impossible to capture it in numbers. Several former insiders say morale among the company’s employees is low. There have been complaints within the middle management ranks that members of the board of directors are disconnected from the problems facing the company. “No one from the board ever visits the plants and sees things for themselves,” said one former manager who left the company in the past few months.
While Cott announced the high-profile departure of Raymond Silcock, its former chief financial officer, in April, former insiders say there have been several departures of key employees. A company spokesperson was not available for comment.
One end to the problems could come in a takeover, as analyst Cynthia Rose-Martel of Jennings Capital suggested after the latest earnings warning. Unfortunately, the warning had caught Mrs. Rose-Martel off guard, as she had upgraded her recommendation on Cott to “buy” from “sell” just days before the announcement.
David Newman, an analyst with National Bank Financial, proved more prescient. Just days ahead of the company announcement, he reiterated his “ underperform” rating, citing slowing soft drink sales. “The only question is the pace of decline,” he wrote.
Earlier this month Mr. Holden, the analyst at Veritas, said that based on declining gross margins and slowing growth, the share price, then US$24.14, could fall to US$20.22, which he called “ its intrinsic value.”
To reach that estimate, he assumed that gross margins per case would stay at 19% with volume growth at 3%.
In his report, Mr. Holden said increases in material and labour costs led to a decline in gross margins per case to 19.4% in 2004, from 21.8% in 2002. Based on his research, every 100 basis point in gross margin loss trims about US$2.30 off the stock. If gross margins per case drop as low as, say, 16%, the intrinsic value of Cott’s shares could fall to about US$13.
In an interview this week, Mr. Holden said he was comfortable with the current price, but said he will wait until the company announces its third-quarter results at the end of October before revisiting his outlook for Cott.
“ What they said was earnings would be ‘ substantially’ below guidance,” he said. “But what exactly does substantially mean?”