Cott Corporation, the world's largest private label soft drink maker, said this week that its exclusive supply agreement with US supermarket chain Wal-Mart Stores had been terminated "without cause". Michelle Russell looks at the impact.

The decade-old, exclusive supply agreement for carbonated soft drinks will come to an end in late January 2012, dealing another blow to the company and sending its share price spiralling by 29%.

The notice allows the retail giant to cut orders to Toronto-based Cott by a third this year and by as much as two thirds in the following two years.

While Dave Gibbons, the group's interim CEO, moved to calm analyst and investor concerns on Tuesday that it was losing its largest customer, this is certainly not good news for the company. Wal-Mart, after all, accounts for around 39% of revenue, and 46% of North America revenue.

Cott has been the sole supplier of Wal-Mart's private-label carbonated beverages, including clear sparkling, flavoured waters since 1998.

On a conference call following the announcement, Gibbons said that the financial impact of the decision was "unclear", saying it would need more time to understand the implications. However, the move comes at a time when the US soft drinks market is struggling.

The reason for the break is unclear, but price increases from Cott may have rankled the retailer, Damian Witkowski, analyst at New York-based Gabelli & Co., told the Financial Post.

"The market isn't going to try and figure out whether Wal-Mart is going to be there three years from now, it's just going to punish the stock and assume Wal-Mart isn't going to be there," he said.

Around 38% of the US$1.7bn Cott earned last year came from its deal with the Wal-Mart - that's some $628m.

"Losing exclusivity with Wal-Mart is a negative, period," said Stifel Nicolaus analyst Mark Swartzberg. "It increases the risk that you'll see major volume declines from this one customer."

Add to this the group's debt, plus other long-term liabilities of $430.6m, and you can see why Cott's fortunes continue to fall flat.

The firm's most recent results saw its net loss in the three months to the end of September leap to US$87.6m, compared to a loss of $5.8m in the corresponding period a year earlier. Sales slowed to $420.5m from $464.5m.

Yet despite this, BMO Capital Markets analyst David Hartley believes the decision may not have such a devastating impact on the company, which he said, was the only company that could satisfy the retailer's requirements for low-cost, private-label soft drinks.
"Cott is still going to be a good supplier for them unless some key assumptions change for Wal-Mart, meaning their interest in being in the category of private-label soft drinks and potentially other decisions around self-manufacturing and so on," Hartley told Reuters.

It doesn't seem likely that Wal-Mart would transition all of its Cott business to other suppliers. New York-based financial publisher Seeking Alpha believes it is more plausible that this action will result in some split of the business, a reduction in pricing, or both, with the most likely beneficiaries being DPS and FIZZ.

"This move by Wal-Mart enhances its 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," wrote John Appel.

Swartzberg, also of the opinion that Cott is unlikely to go out of business, says that its relationship with Wal-Mart will now be governed more squarely by "day-in, day-out economics."

"In its related call, Cott confirmed that it is seeing improving volume trends in North America as consumers trade down to private label," Swartzberg said. "Cott's margins expanded year-on-year in the 3Q as the effect of cost cuts became evident, and the input cost environment has become dramatically more favourable."

Looking back, Cott managed to transform itself from a small-cap company in the late 1980s to a thriving beverage giant - its stock gaining more than 9,000% from 1991-1993. It has struggled in recent years against rising costs and a shrinking market for carbonated soft drinks in North America, however.

While Gibbons maintains that he is "encouraged" by recent trends, and a pickup in US sales offers a pinch of optimism, Swartzberg predicts another decline in revenue in the current quarter.

He cautions that Cott's future will depend on its relationships "they have with key retailers and better management of their costs."