Cott Corporation (Cott) is a (i) leading supplier of home and office delivery water and coffee (HOD); and (ii) private label beverage manufacturer. Cott’s management team and Board have successfully executed a masterful transition to reduce exposure to their legacy (“Traditional”) business, which is no growth and suffers from excessive customer concentration risk. Cott now generates the majority of its EBITDA and FCF from their higher margin, high FCF generating HOD business which has a solid growth outlook and leading market share in North America and Europe.
The good news is that the investment case highlighted well by AtlanticD (February 17, 2016) remains strong and there are a number of levers to unlock value that are not well understood.
Firstly, there is a powerful free cash flow growth story. Last year Cott generated around $1.08/share of FCF, which I expect to grow to $1.92/share in 2019. At 12x FCF in 2019 that’s 68% upside to today’s share price. The FCF growth story is relatively low risk, as the biggest drivers include: (i) rollover of Eden and S&D acquisitions into the numbers due to only part-year contribution in 2016; (ii) cost synergies from Eden and S&D deals; (iii) interest savings from high cost debt re-financings and future de-levering; (iv) cost savings from DS Services; and (v) cash generation from highly FCF accretive tuck-in acquisitions in HOD.
Second, I expect Cott to continue to reduce exposure to its Traditional business over the next two years. This is likely to occur via a sale of the Traditional business in two or three pieces – UK; North America hot fill; North America cold fill. Given the lowly rating the market ascribes to these assets (c. 6x EBITDA), I expect that a sale of these assets at around 9x EBITDA would create around $3 per share of value (21% upside), and enable the business to rapidly de-lever to around 2.7x ND/EBITDA. While the Traditional business is mature low growth (flat volume), Cott has a clear market leading position in the USA with approximately 60% market share. There are numerous potential buyers for these assets including the likes of Refresco, Lassonde, National Beverage, Dr Pepper and private equity. The Cott team is savvy, and I would expect them to lock in a sale of these assets opportunistically.
Third, de-levering and very low multiple bolt-on deals in HOD. Cott has a track record of buying small HOD businesses at around 3x EBITDA and integrating them rapidly. These transactions are de-levering, which in combination with strong FCF generation will help Cott to rapidly de-lever to around 3.7x ND/EBITDA by 2019 (versus over 5x on 2016 numbers). These helps open the universe of buyers of the stock to more cautious investors who cannot stomach the current leverage.
Fourth, over the next two years and following the likely sale of Cott’s traditional business, we see the potential for Cott to execute a transformational acquisition of Nestlé’s HOD business in North America. That business is viewed as non-core by Nestle and is likely to be sold, in my view. Nestle has a similar market share to Cott in HOD of 30% (so the top two share around 60% of the market, with only small players outside of Cott and Nestle). My antitrust work suggests that the deal is do-able, given the way the “market” is defined (it includes regular bottled water, not just HOD).
The following slide shows the breakdown of adjusted EBITDA, and how it has shifted from 100% Traditional Cott (ordinary business) to now 65% HOD (good business). I expect that to shift to 100% HOD over time via the disposal of Traditional. The other important point displayed on the slide below is that the structurally challenged parts of the Traditional business (Carbonated Soft Drinks and Juices) have shrunk from 58% of EBITDA in 2014 to just 19% last year.
The following slide shows the healthy trends evident in Cott’s HOD market:
And Cott’s market leadership:
Please see below snap-shots of the financials, valuation ratios, FCF bridge, sum of parts valuation, impact of sale of Traditional and a comps sheet.
Financials and Valuation Ratio Summary
Free Cash Flow Bridge 2016-2019
SOTP Summary 2018-2019
Valuation Impact of Selling Traditional Business
De-levering Impact from Sale of Traditional Business
I do not hold a position with the issuer such as employment, directorship, or consultancy. I and/or others I advise do not hold a material investment in the issuer's securities.
Growth in FCF/share
Bolt-on acquisitions in HOD Water at low multiples
Likely sale of Traditional private label business in Europe and North America
Potential transformational acquisition of Nestlé’s HOD business in North America