TEXT-S&P raises Cott Corp rating to 'B+' from 'B'
Overview -- We are raising our ratings on Mississauga, Ont.-based Cott Corp., including our long-term corporate credit rating to 'B+' from 'B'. -- We base the upgrade on Cott's better profitability and sustained improved credit metrics. -- The stable outlook is based on our belief that Cott's operating performance and credit protection measures will be in line with our expectations in the medium term. Rating Action On Sept. 26, 2012, Standard & Poor's Ratings Services raised its long-term corporate credit rating on Mississauga, Ont.-based Cott Corp. to 'B+' from 'B'. The outlook is stable. At the same time, we raised our debt rating on wholly owned U.S. subsidiary Cott Beverages Inc.'s senior unsecured notes to 'B+' from 'B'. The '4' recovery rating on the debt is unchanged, indicating our expectation of average (30%-50%) recovery in the event of default. The upgrade reflects what we view as Cott's improved business risk profile to "weak" from "vulnerable" stemming from increased profitability and completion of the majority of the Cliffstar Corp. integration. Despite a 2.2% revenue decline in the second quarter ended June 30, 2012, compared with the same period in 2011, Cott's reported adjusted EBITDA margin increased to 10.9% in this period from 10.3% for the second quarter 2011. Furthermore, the completion of the Cliffstar integration will allow management to focus on continuing to increase operating efficiencies and new product development--two key inputs to ongoing margin improvement. Rationale The ratings on Cott reflect Standard & Poor's view of the company's weak business risk profile and aggressive financial risk profile (as our criteria define the terms). We base our business risk assessment on the company's small size in a sector dominated by companies with substantially greater financial resources and market presence, customer concentration, and susceptibility to commodity cost swings. We believe these factors are partially offset by leading market positions in private label take-home carbonated soft drinks (CSDs) in the U.S., the U.K., and Canada, as well as shelf stable juices in the U.S. Cott's financial risk profile is based on the potential volatility of earnings and credit metrics due to competitive actions or changes in key commodity costs, partially offset by the company's adequate credit protection measures and positive free cash flow. Cott has largely completed the integration of Cliffstar, which it acquired in 2010 for US$569 million. The acquisition gave the company immediate entrance into the juice industry given Cliffstar's position as the leading North American private label manufacturer of shelf stable juices. In addition, the juice business contributed to a sizable increase in Cott's size, resulting in revenue rising 29% in 2011 to US$2.3 billion. A significant reduction in business with Cott's key customer, Wal-Mart Stores Inc. (AA/Stable/A-1+), could result in a material weakening of credit protection measures. In 2009, Cott announced that its exclusive supply agreement with Wal-Mart, regarding retailer brand CSDs in the U.S., was being phased out over a three-year period. With Wal-Mart accounting for 32% of the company's 2011 revenue, a significant loss in Wal-Mart volume could lead to a material drop in Cott's revenue and operating profit. In our base case scenario for 2013, Standard & Poor's forecasts: -- Organic revenue growth to be nominal given the maturity of both the CSD and shelf stable juice categories; -- EBITDA should continue to strengthen based on the company's focus on improving cost efficiencies; -- The company will continue to generate positive free cash flow next year; and -- A risk to our forecast is a material decline in Cott's business with Wal-Mart, which would negatively affect revenue, EBITDA, and credit metrics. Credit protection measures have remained good for the ratings and fairly stable in the past year, with adjusted debt to EBITDA of 3.3x, funds from operations to debt of 23%, and EBITDA interest coverage of 3.4x for the 12 months ended June 30, 2012. We expect adjusted debt to EBITDA will remain in the 3.0x-3.5x range in the medium term and that acquisitions will be financed in a manner consistent with the ratings. Liquidity We believe Cott will have adequate liquidity in the next 12 months, with sources exceeding uses by more than 1.2x. We expect that net sources would be positive, even with a 15% drop in EBITDA. We base our view on the following information and assumptions: -- The company's sources of liquidity include cash balances, positive free cash flow, and availability under the US$275 million asset-backed lending (ABL) facility due 2017. However, full access to Cott's revolver could be limited by borrowing base calculations. -- We believe Cott will generate sufficient cash flow in 2013 to support capital expenditures. The company has no major near-term maturities. -- We believe that the company will maintain at least a 15% EBITDA cushion on its financial covenant should it apply. The ABL facility contains a covenant requiring a minimum fixed-charge coverage ratio of 1.1x, which only applies if excess availability on the facility falls below US$30 million. -- Revenue and cash flow have some seasonality, with peak borrowings at the end of the second quarter until early in the third quarter. Nevertheless, we expect liquidity to remain adequate during this time given good availability on the ABL facility. -- We expect Cott to have sound relationships with its banks and a generally satisfactory standing in credit markets. Recovery analysis For the complete recovery analysis, see the recovery report on Cott Beverages Inc. to be published on RatingsDirect on the Global Credit Portal following the release of this report. Outlook The stable outlook is based on our belief that Cott's operating performance and credit protection measures will be in line with our expectations in the medium term, including adjusted debt to EBITDA in the 3x area. We could consider raising the ratings if Cott demonstrates continued strengthening of its market position to an extent that changes our view of the company's business risk profile, while at the same time improving its operating performance despite the potential for increased competitive activity, higher commodity prices, and a decline in its business with Wal-Mart, and maintaining leverage below 3x on a sustainable basis. Alternatively, we could lower the ratings if the company's operating performance falls below our expectations or if Cott's financial flexibility and credit ratios weaken, resulting in adjusted debt to EBITDA above 4x. Related Criteria And Research -- Methodology and Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- Criteria Guidelines For Recovery Ratings On Global Industrials Issuers' Speculative-Grade Debt, Aug. 10, 2009 -- Criteria Methodology: Business Risk/Financial Risk Matrix Expanded, May 27, 2009 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Ratings List Ratings Raised/Recovery Rating Unchanged To From Cott Corp. Corporate credit rating B+/Stable/-- B/Stable/-- Cott Beverages Inc. Senior unsecured debt B+ B Recovery rating 4 4 Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. Use the Ratings search box located in the left column.