Thirst for water takes fizz out of Cott profit

North Americans are chugging back bottled water, and the trend is hammering the world's largest pop makers, including Canada's Cott Corp.

"The water category, I think, has surprised everybody. It is continuing to grow . . . I don't see that slowing down in the near future," Cott chief executive officer John Sheppard said during a conference call to discuss the company's latest quarterly earnings.

Moments earlier, Cott unveiled second-quarter profit that was weaker than a year earlier and lowered its outlook for the remainder of this year.

Sales for 2005 are now expected to rise between 6 and 8 per cent, slower than the company's previous target of 8 to 10 per cent. Share profit will be between $1.06 (U.S.) and $1.11, down from earlier estimates of $1.14 to $1.18, the company said.

Toronto-based Cott is the world's largest maker of private label soft drinks, supplying retailing giants such as Wal-Mart Stores Inc. and Loblaw Cos. Ltd. with their in-store brands of pop.

While Cott also has a small bottled water operation, "the reality is it's very tough to make money on water," Mr. Sheppard later said in an interview, referring to razor-thin margins.

And as bottled water sales have exploded in recent quarters, industry experts say the popularity of fizzy beverages has gone flat.

"Non-carbonated beverages are absolutely where the volume growth increases are going to come and PepsiCo, especially in North America, has the strongest brands," Matthew Reilly, an industry analyst with Morningstar Group Inc. in Chicago, told Bloomberg News.

Cott isn't alone in its struggle.

Last week, PepsiCo Inc. said total volume growth in North America declined by half a per cent as a result of sluggish sales of carbonated drinks -- reflecting consumers' shift from drinking soda in favour of bottled water and other drinks seen as healthier. Volume growth of Pepsi's non-carbonated drinks like Aquafina, Propel and Gatorade mostly offset the decline in carbonated soda. (Pepsi is the market leader in non-carbonated drinks).

Today, behemoth Coca-Cola Co. will report its latest quarterly earnings, with expectations for a 2-per-cent decline in profit. While Coke is the biggest player in soft drinks and diet soft drinks, its non-carbonated drinks, such as Dasani and Nestea iced tea, trail Pepsi's.

Citing industry data from consumer research firm ACNielsen, Mr. Sheppard said that in the United States, by far Cott's largest market, total carbonated beverage sales at grocery stores have declined 2.4 per cent over the past year as bottled water sales have soared 25 per cent.

In Canada, Cott's No. 2 market, pop sales are down 2 per cent while bottled water sales are up 23 per cent.

According to Mr. Sheppard, there are four key drivers behind bottled water's recent success: prices to consumers have come down significantly; the products have become available in a greater number of locations (such as fast-food restaurants); there has been a flurry of new suppliers into the bottled water market; and, perhaps most influential, anti-obesity groups have trumpeted the merits of consuming water instead of sugary pop.

"All this talk about the North American obesity epidemic has been a huge detriment to any of these high-fructose, corn-syrup-sweetened, carbonated soft drinks that make up the bulk of these companies' portfolios," observed Rob Tulloch, who follows the Canadian beverage industry for Chicago market research firm Euromonitor International.

He said that Canadians, in particular, have been heavy consumers of bottled water ever since the 2000 Walkerton, Ont., water safety crisis. What's more, he doesn't see it abating any time soon.

"I absolutely think its part of a longer-term trend," he said, adding that while Cott is being hurt by the phenomenon, rivals Coca-Cola and Pepsi can benefit through their recognizable brands and higher margins.

For the second quarter, Cott posted a profit of $25-million or 35 cents a share, down from $29.4-million or 41 cents during the same period of 2004.

Analysts were anticipating profit of around 34 cents share. However, when a one-time gain from the settlement of a lawsuit is taken into account, profit was about 30 cents a share, according to Legg Mason analyst Mark Swartzberg.

Sales for the quarter rose to $492.7-million from $463.7-million a year earlier.

Profit for the first six months was $33.3-million, weaker than its year-earlier $44.8-million. Sales, however, rose to $888.2-million from $834.6-million.

Looking forward, Mr. Sheppard added that Cott plans to put more emphasis on its line of diet soft drinks and "new age" flavoured sparkling water beverages to make up for the bottled water hit. Cott also sees strength coming from its packaging changes, such as new sizes of bottles.

Shares of Cott fell $1.48 (Canadian) or 5.1 per cent to $27.50 yesterday on the Toronto Stock Exchange, at the bottom end of their 52-week range of $26 to $43.14.

The beverage shift

Pop makers are watching sales fizzle as consumers grab bottles of water and non-carbonated beverages instead of the sugary sweet soda.

SOFT DRINKS

Carbonated drinks like cola are experiencing sluggish sales after enjoying decades of strong growth.

Sales by volume

BILLIONS OF LITRES SOLD IN CANADA

2003: 3.72

2004: 3.71

2005: 3.64 (estimate)

Sales by revenue

$BILLION

2003: 6.47

2004: 6.47

2005: 6.37

BOTTLED WATER

Consumers are choosing bottled water chiefly because of concerns about the obesity epidemic.

Sales by volume

BILLIONS OF LITRES SOLD IN CANADA

2003: 1.05

2004: 1.17

2005: 1.30 (estimate)

Sales by revenue

$BILLION

2003: 1.1

2004: 1.2

2005: 1.4

SOURCE: EUROMONITOR INTERNATIONAL