How Will Losing Wal-Mart Exclusivity Impact Cott Corp?

Cott Corporation (COT) announced that Wal-Mart (WMT) has decided to terminate its existing 10-year old exclusive supply agreement for carbonated soft drinks. This action gives Wal-Mart the option to transition to other suppliers over time: up to one third of its requirements can be moved this year and up to two thirds can be moved next year.

While the ultimate outcome is unclear and discussions between Cott and Wal-Mart are reported to be ongoing, this is certainly not good news for Cott. Wal-Mart represents 35%-40% of Cott’s sales. If Wal-Mart were to move its business to other suppliers, Cott could have difficulty servicing its debt.

This risk was highlighted in my previous articles on Cott. The last article, entitled “Mysterious Silence from Cott Corporation,” argued that Cott’s silence was an indication that something was up. It raised the potential that the company had received an acquisition offer, but also focused on the risks associated with Wal-Mart, saying, “Wal-Mart’s reduction of Cott’s shelf space last year may have been the first step toward reducing its exposure to Cott. The next logical step would be to split the business, or maybe even go all the way and switch suppliers….”

It does not seem likely that Wal-Mart would transition all of its Cott business to other suppliers. It is more plausible that this action will result in some split of the business, a reduction in pricing, or both. (The most likely beneficiaries are DPS and FIZZ.) This move by Wal-Mart enhances Wal-Mart’s bargaining leverage by introducing greater competition among suppliers. It would not be in Wal-Mart’s best interest for Cott to go out of business.

This situation is complicated by Cott’s high leverage. Debt plus other long-term liabilities totaled $430.6 million as of September 27, 2008, which was approximately 4.6x LTM adjusted EBITDA, and over 7x adjusted EBITDA less normalized capital expenditures. Sales to Wal-Mart were 35.8% of Cott’s total sales for the nine months ended September 27th. This implies that Wal-Mart represents approximately $600 million of Cott’s annual sales. Products not covered by the exclusive supply agreement comprise some of this amount. The annual sales covered by the agreement might be approximately $500 million. If Cott were to lose 25% of this business, the impact on EBITDA would be $25 million, assuming a contribution margin of 20% (just a “swag”). This would be nearly 50% of adjusted EBITDA less normalized capital expenditures.

I have previously estimated the fair value of the company’s stock to be in the range of $1.00 to $1.50 per share, based on EBITDA multiples and discounted cash flow analysis. Until we have better visibility into the status of Cott’s relationship with Wal-Mart, it will be difficult to develop a revised cash flow forecast and fair value estimate. As a placeholder, I have cut my previous range in half to $0.50 to $0.75 per share.

Disclosure: The author has no positions in Cott Corp. stock as of this writing.

Comments

[Alice1:]

Choosing to place your products in and with Wal Mart is a double edged sword. Your product reaches millions of people. However, Wal Mart will badger your personal profit prices down to the point that you have problems paying employees, buying your own supplies, etc. so that Wal Mart can make themselves look like heros by helping the public "save money~live better" and offering your product at the lowest prices yet make themselves billions in profits. If you cannot meet their demands it is meaningless to them as they have thousands upon thousands of others wanting to have their products on their shelves. On that same note, should they decide to drop your product you're in trouble as well. Simply because you get in with this corporation doesn't mean you'll get to STAY there. Never put all of your eggs in the Wal Mart basket because when it drops you've got yourself one very ugly mess. That you might have to close your doors and tell all of your employees that they are out of a job is not Wal Mart's problem. They simply wash their hands of you and move on to the next vendor.

Jan 29 06:05 AM

[ebndr:]

In the conference call an analyst asked if WMT will want a mix of flavors on their shelves for the same drink and the company did not answer that clearly but that is a point to think of before concluding that WMT will switch immediately.

Also, it is possible that under current US economic condition the volume that is getting off of WMT system can be sold at higher prices to other clients and be more profitable. (see WMT policies regarding suppliers in Alice1 comment).

Its hard to see though where can they do 500M USD business elsewhere w/ higher prices.

its not good news for COT but implications remain to be seen, hopefully, if management is any good, they can turn this into their advantage.

Jan 30 10:54 AM

[Go4soda:]

If Wal-Mart is anxious to replace its North American bottler with a Chinese-based supplier, then it is playing with fire. A lot of consumers already boycott Wal-Mart because of its appetite for cheap Chinese products. With this news, there are jokes already circulating about Wal-Mart Melamine Soda. How low does the price have to go to satisfy the WMT monster?! They're selling 2-L bottles now for 67 cents! Is that a huge hardship for the American consumer? I remember Chrysler used to brag about how it was squeezing suppliers to provide its alternators and air conditioners cheaper than anybody else. Well guess what happened: suppliers cut corners. Their cars performed poorly in J.D. Power Dependability surveys and sales tanked. Chrysler is in death watch mode today. A lesson for Wal-Mart about abusing suppliers?

Jan 31 03:23 PM

[stackrock:]

Having tasted numerous clones of Dr. Pepper, I'll state for the record that no one makes a better clone than Cott. Indeed, I consider the Cott product to be better than the original. Were I to find the Coke and the Cott product on the shelf at the same price, I would buy the Cott nine times out of 10. (What is the worst mirror soda? Dr. Shasta. Nasty stuff! Interestingly enough, their former product, Doc Shasta, was one of the best. History appears poised to repeat itself.)

If WMT switches suppliers, there may be no price point at which I would buy the new soda. So, while I appreciate that Wal-Mart wishes to offer its customers low prices, they must understand that you can't slap a label on dishwater and expect repeat customers.

Jul 08 05:12 AM