With another lackluster quarter out of the way, the story remains much of the same at Cott Corporation (NYSE: COT), with North American volume troubles and resulting deleverage weighing on results as the company continues to navigate through a difficult environment and make its way to 2014.
Cott Corporation engages in the production and distribution of retailer brand beverages in North America and internationally. It offers carbonated soft drinks, flavored waters, energy-related drinks, juice, juice-based products, bottled water, and ready-to-drink teas. It primarily serves grocery, mass-merchandise, drugstore, wholesale, and convenience store chains.
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In 2014, comparables should ease, and raw material tailwinds should kick in at current spot rates, noting that the company will likely spend back some of the upside. However, the key question remains how long it will take for trends to stabilize.
"Today, the biggest risk to an otherwise compelling growth and margin opportunity in 2014 is aggressive competitive price points by the national branded competitors, who appear to be redeploying savings from likely unanticipated commodity cost weakness to relatively deep price promotions," Deutsche Bank analyst Bill Schmitz Jr. said in a client note.
There are significant challenges in the form of weakened category trends, stubbornly high commodity costs, irrational competitive behavior, suboptimal weather, or one of several other factors that have emerged to foil the company's progress in any given quarter over the last several.
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According to management, summer promotions on 2 liter products have persisted well into September, with one branded competitor still pricing its 2-liter portfolio at sub-$1/bottle. Both Coke and Pepsi issued pricing letters in late September, but retail pricing doesn't seem to be improving.
"Still, care! ful to note that plenty of potential risks loom and the company appears very cautious on the overall CSD landscape into 2014, we continue to believe the set-up looks relatively compelling," Schmitz said.
UK results accelerated this recent quarter, helped by Calypso and continued diversification away from the CSD category, with Cott exposed to a European consumption environment showing signs of life.
Moving down the P&L, and most importantly as we look out to next year, if the commodity environment continues to cooperate, the company should recognize a relatively significant margin tailwind in 2014.
On the flip side, hedge positions may limit some of this upside and potential volume deleverage if the competitive environment does not improve could also weigh on gross margin.
"Company has been clear that commodity upside from apple juice concentrate prices will be spent back to help return the category to growth, a sound decision for the long-term given the company's leverage to the category, while HFCS (High fructose corn syrup) should be a margin tailwind, all else equal," Schmitz noted.
With the set-up into 2014 looking compelling despite recent category softness and elevated promotional activity in the US, there is potential upside in Cott shares, with likely cash flow acceleration.
There is also potential for additional capital structure optimization (2018 notes) and plenty of accretive options for redeployment with stock currently trading at roughly 6x EBITDA and a greater than 13 percent free cash flow yield to the equity.
"Category deflating promotional activity cannot continue forever, with Coke and Pepsi's recent pricing letters to the trade potential steps in the right direction, noting ample free cash flow generation should continue to support Cott shares through this prolonged volume downturn," Schmitz added.
COT shares, which trade 14.8 times its forward earnings, were traded between $7.39 and $11.25 during the past 52-weeks.
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