Description

At today’s price we are paying ~11x normalized earnings power for a stable, defensive business with a clean balance sheet run by capable, shareholder friendly management with a good track record of reinvestment. 

Ingredion is a producer of starches and sweeteners made from raw ingredients such as corn, potatoes, tapioca, grains, fruits, and vegetables.  The company sells 1,000+ ingredient solutions to 18,000+ customers in 120 countries. 

Corn is the raw ingredient used for ~70% of revenue.  Ingredion buys corn and upgrades it into starches and sweeteners at its numerous wet milling operations.  This is a capital-intensive business with high barriers to entry.  In the U.S., there are only four major players (Cargill, ADM, Tate & Lyle, and Ingredion) and there has not been a new wet mill built since the early ‘90s.  This consolidated market structure has allowed for rational competitive dynamics and consistently attractive returns on capital for Ingredion. 

Over time, Ingredion has thoughtfully expanded its portfolio of ingredients into other categories, including potato, rice, and tapioca starches, fruit and vegetable ingredients, hydrocolloids (i.e. guar gum), specialty sweeteners, and plant-based proteins.   

This investment has enabled INGR to increase its specialty mix over time.  The company now attributes 30% of revenue and ~50% of EBIT to specialty ingredients.  This is important to the investment case because specialty ingredient companies are regularly valued at 16-20x EBITDA.  

Specialty ingredient businesses are coveted because they tend to have attractive financial characteristics (pricing power, high margins, long-term contracts).  This is because specialty ingredients are generally a small portion of the total cost of the product (3-5% of COGS) but are critical to the taste, texture, and performance.  Switching suppliers is generally not worth the risk. 

If we do a SOTP and use 14x on INGR’s specialty EBITDA, it implies a value for the bulk ingredients business at only 1.6x EBITDA.  That’s cheap!

I think one of the reasons for this valuation disconnect is that INGR is associated with high fructose corn syrup, which has been a secular loser.  This concern is overblown.  INGR broke out its HFCS exposure (I believe for the first time) at the recent 2020 CAGNY presentation.  The presentation indicated that HFCS is currently 12% of sales and has been declining 5% per year.  This decline has been offset by the growth in INGR’s other sweeteners (glucose syrups, high maltose syrup, dextrose, polyols, maltodextrin, and stevia), which make up 24% of sales and have been growing 2% per year.

Ingredion has a great balance sheet (1.7x net debt-to-ebitda) and has historically been very shareholder friendly.  The company has a 3.2% dividend yield and has reduced its share count by a 2.5% CAGR since 2014.  Moreover, management has consistently found ways to reinvest in the business above the company’s cost of capital.  

As a positive signpost, INGR is one of the few companies going on offense right now.  The company recently announced the opportunistic acquisition of 75% of a troubled (but promising) vertically integrated stevia producer.  This acquisition fits in nicely with management’s strategic objective to grow INGR’s specialty sweetener portfolio.  INGR has the right to buy the remaining stake in a few years.  I like the deal.

In terms of the near-term results, due to the lockdown, the company suspended its guidance for the year.  Full-year earnings are now likely to come in 5-15% below prior expectations.  The biggest headwind is in Mexico, where INGR is a key supplier to the brewing industry.  Breweries are temporarily closed per government order.  Ingredion has also seen softness in its bulk sweetener volumes (e.g. syrup for fountain soda), its food service business (e.g. French fries), and its industrial starches (<10% of revenue).   This has been mostly offset by strength in the grocery channel.

The lockdown impact should reverse once countries inevitably open back up.  Ingredion’s product portfolio should be quite resilient in a more typical recession. 

It is notable that a director with a background in the food ingredients business (DuPont, Royal DSM) bought stock in the open market a few days ago.

To conclude, I think this is a low-risk way to achieve a 10-12% annual TSR without needing any multiple expansion.

Catalyst

cash flow