Description

Tate & Lyle

Company & situation overview

Tate & Lyle is a leading European specialty food ingredients company, listed in the UK (included in FTSE 250), with diversified international exposure across the US, EU, and emerging markets. Its Food & Beverage Solutions (FBS) business is the primary business segment, producing sweeteners, texturisers, fibres, and stabilisers.

In Jul 2021, Tate announced a transformational deal with KPS Capital Partners to sell a controlling stake in its Primary Products business (PP) in North America for an EV of $1.7bn (~40% of EBIT at Old Tate, ~60% of revenue). Tate will retain a ~50% stake in the NewCo, with the deal expected to complete in Mar 2022. The Primary Products business is relatively commoditised (bulk sweeteners and industrial starches) and has been cyclical historically, lacking growth due to competition and market maturity. The sale perimeter includes three corn wet mills in US, three acidulant plans (US and Brazil), grain elevator and bulk transfer station networks in the US as well as small 50% equity stakes in JVs. To provide supply security to Tate, long-term 20-year agreements were struck with NewCo as part of the deal, given PP and FBS share a common asset base (agreed charges are a mix of unit pricing and cost past through).

TATE expects to receive ~£0.9bn of gross proceeds from the deal (EV of £1.2bn, 5.1x EBITDA for FY21), with ~£0.5bn set aside for a special dividend/share consolidation. Given TATE’s target of net leverage close to zero post completion, it will have flexibility for future growth investments (organic/inorganic). TATE also retains some upside from the remaining stake in NewCo, where KPS has the rights to initiate an IPO after 4 years.

New Tate consists of Food & Beverage solutions (~88% of NewTate revenue and ~74% of EBIT), which has grown earnings in 8 out of the past 10 years and delivered an average EBIT CAGR of 7% in the past five, as well as Surcalose (12% of revenue and 26% of EBIT in FY21). Surcalose is a high-intensity artificial sweetener, 600x sweeter than sugar with almost no calories, it offers sugar-like stability and versatility – Tate’s product is marketed under the Splenda brand. The primary growth driver of New Tate going forward is expected to be the Food & Beverage solutions business.

Thesis overview

We believe TATE is positioned as a misunderstood transformation story due to historical profit warnings and cyclicality within PP/Surcalose, which entrenched negative investor sentiment with the stock in the past. Given the transformational deal will reduce cyclicality and NewTate’s improving operational track record, we believe TATE presents an interesting opportunity for value-orientated investors.

‒      TATE’s FBS segment benefits from underlying market drivers - healthy eating and greater focus on non-meat products where texturants are key for creating a better feel/texture to the food. FBS has had a consistent operational track record, growing earnings in 8 out of the past 10 years. Compared to Dec 19 quarter, volume and revenue were 12% and 31% higher respectively. The segment has also proven to be able to pass on inflationary cost pressures through higher pricing, citing that customer contracts were renewed to offset inflation in recent earnings calls

‒      TATE will be revamped operationally, with the deal freeing up capital to invest in R&D supporting innovation across Sweeteners, Health & Wellness and Texturants (Tate aims to generate 20% of sales from new innovations by 2026 (vs 14% now). New products (e.g. mouthfeel and fortification) performance has been strong recently with 54% higher revenue (albeit from a small base). The business is targeting low/no leverage, providing flexibility to take advantage of inorganic/organic growth opportunities

‒      New Tate becomes a key strategic asset, as Primary Products was likely a dealbreaker for many strategic buyers due to its commoditised product and volatility

‒      Tate trades at ~37% discount to competitors based on FY23 P/E, creating an attractive takeover target. A 15-20% discount to key competitors implies 35%-45% upside. If TATE was to be acquired, multiples paid are likely to be higher given potential synergies and accretion with a strategic buyer, improving upside to 50%+

‒      Several near-term catalysts are apparent: more detail on special dividend / share consolidation of £500m for investors, earnings in June 2022 and potential further industry consolidation news & speculation

‒      Risks relate to input cost inflation with corn, ability to pass that on to customers and execution risk around new products, as well as JV operations. In an earnings announcement in Feb 2022 management indicated that they are “well covered” in terms of hedges for corn and energy. Tate has also built flexibility into some contracts to allow for renegotiation if they see further inflation. At a Barclays briefing in Mar 2022, management said they are fully hedged for corn costs in the US for the entire 2022 (US is ~50% of FBS revenue) but in Europe, given the illiquid corn futures markets, they’re only covered up until end of H122. There are no precise indications from management as to the potential headwind given recent price volatility. Estimates suggest up to ~15% of COGS at New TATE are likely tied to corn prices. We estimate that in a very negative scenario where TATE is unable to pass on higher European prices in H2 2022, operating margin could face a ~1% annualised headwind 

‒      In Nov 21 TATE announced that they experienced cost inflation of £26m related to energy, labour and consumables, transportation, and supply chain issues. Corn prices were hedged in North America but increasing corn prices had a £7m impact on the European Primary Products business (a part which stays with New Tate, ~£100m of revenue). In H121 TATE passed through £10m of price increases in FBS solutions. Management have indicated a strong focus on maintaining product margins. 

Business model

Ingredient companies transform basic raw materials from producers into necessary ingredients for end product manufacturers within various segments (Food & Bev, Personal Care, Pharma, Animal Health). Typically, ingredients are natural or synthetic depending on end-product requirements, some ingredients are relatively commoditised, whilst others are on the more specialty end. TATE’s main ingredient is corn, which it turns into its various products within its FBS and Primary Products divisions (as per Fig below). This process occurs through the hard assets which TATE owns such as corn wet mills and other production facilities for specialty starches, fiber and tapioca, as well as through some of the softer capabilities required such as the know-how within its innovation centre with scientific knowledge in bio-chemistry, materials, fermentation and nutrition. Customers: TATE operates under a B2B model, selling to food manufacturers, including start-ups within the space (e.g. NotCo, backed by Jeff Bezos in Latin America and Killer Creamery). Ingredient companies tend to have a broad range of customers – from large multinationals to fast growing startups and private label manufacturers. Revenue drivers are volumes sold and average price, in turn driven by pricing power through new products, customised solutions for customers or TATE charging a premium for its surcalose given it is the only US-based producer. Cost drivers: Raw materials, sourcing, operating facilities (e.g. energy cost), people, depreciation. R&D as a % of sales will increase from 3% to 4% with the aim to generate 20% of sales from new innovations by 2026 (vs 14% now, 8% in 2016). Corn and energy prices are the largest inputs, having increased materially year to date, with Russa/Ukraine conflict adding more pressure. GS estimate that corn accounted for ~48% of COGS for old TATE, likely significantly reduced at New Tate, more towards the 10-15% range. A key question is whether the company will be able to pass on costs increases successfully yet again, having done so in the past as was the case in its Q3 trading update where it showed high pricing power with 19% revenue growth in FBS. Cash generation:Ingredient companies tend to have a capital-intensive model due to fixed assets and positive net working capital. TATE has historically converted ~40%-50% of its EBITDA into FCF. 

Market

TATE plays within a specific sub-segment of the broader specialty ingredients market. The total relevant market for TATE is ~EUR 10bn and breaks down between starch texturants (EUR 5.2bn) and high intensity sweetener (EUR 4.8bn). The total texturants market is est. to be ~EUR 13bn and expected to grow at 3-4%. Starches (relevant for TATE) represent ~40% (EUR 5.2bn). TATE is also exposed to the sweetener market which is ~EUR 60bn (8% is high intensity sweeteners). The total sweetener market is expected to grow 1-2% but the sugar replacement market is forecast to grow faster at 3-4%, with large variations by tech. Growth drivers include healthier living trends amongst consumers who are more aware of food ingredients, demand low-sugar/fat/calorie and fewer artificial ingredients. Texturants are growing in importance with non-meat products and healthier alternatives as they are used to add a better feel/texture to the food. Key raw material used are corn (for starch texturants) and sugar (for surcalose). 

Competitors

Key competitors for TATE’s Food & Beverage Solutions business are Ingredion, Cargill and Roquette. Givaudan is also relevant and considered the “Rolls Royce of the industry”. Some ingredient companies like TATE play in specific market niches to build more sustainable advantages through focus and more customised products for customers, often limiting the level of head on competition to win new customers. The market tends to assign pricier multiples to ingredient companies which have higher margins and levels of customised solutions (vs. 25% for TATE for now). Some competitors are also potentially suitable acquirers such as Roquette, Bunge, DSM, Kerry. Margins tend to vary but are broadly in the 20%+ region for EBITDA and ~10% for net income. DSM at ~20% EBITDA margin and ~10% for net income, Kerry at 15% and 10% vs Givaudan at ~23% for EBITDA and ~13-14% for net income. TATE is slightly lower at 17%-18% EBITDA pf and ~10% for net income.

Management and incentives: Nick Hampton was appointed as CEO in 2018 (previously CFO 2014-18), conducing a strategy refresh and changing the trajectory of the business for the better in the last 2 years. New CFO Dawn Allen, ex Mars Global CFO & VP, 25+ career at Mars is starting from May, said to have played a key role in transformational projects at Mars. Incentive structures changed post deal to incorporate organic growth and ESG on top of ROCE and TSR. Previously performance share plans were measured by EPS, volume growth and ROCE only.

Corn price sensitivity

GS estimates suggest ~48% of old TATE COGS was corn. That would come down significantly following the separation, we think is likely to fall within the 10-15% range for New TATE. Management have hedged US corn prices for the entire 2022. We assume Europe accounts for ~35% of New Tate COGS (slightly more vs Europe revenue in FBS of ~30% to be conservative) and gross profit margin is ~37%. Overall, this would suggest that if corn prices increased 30% persistently into H2 2022 and TATE was unable to pass on any of the increase in Europe, the potential headwind to operating margin would be ~1%. A 40% corn price increase would mean ~1.3% reduction in operating margin, assuming no pass through. We believe TATE will be able to pass on a significant proportion of the corn price increase given (1) the industry-wide nature of the issue; (2) management have indicated that some of their contracts allow renegotiation; (3) track record of successfully passing on inflation in 2021.

Valuation

TATE trades around ~16.8x P/E FY23 and ~4% FCF yield based on consensus. Global ingredients peers trade at ~26.6x P/E, approximately a 37% discount. Based on our numbers, post the special dividend/share consolidation the P/E multiple drops to ~15.2x. Looking at SOTP, the deal valued NewCo “Primient” at EV of £1.2bn, 5.1x EBITDA (vs. total current TATE of £3.7m), leaving £2.6bn for remaining TATE, which would mean remaining TATE is trading at an implied ~9.2x EBITDA based on our numbers for ~£280m EBITDA in FY23. Some sell side analysts argue that a similar business at Ingredion trades at an implied multiple of 12x. With approximately 398m shares assumed post-consolidation (more clarity on this expected soon after deal completion end of Mar 2022), a price per share of ~1,000p or 40%-45%+ upside is possible (~15% discount to comps assumed vs 37% currently). If TATE were to be acquired, multiples paid are likely to be higher given potential synergies and accretion with a strategic buyer, improving upside to 50%+. Note, recently the comp set average P/E used to be ~30x towards the end of 2021 (e.g. GIVN traded at ~40x P/E).

Fig 1 – TATE financials

Fig 2 - Comp table based on consensus numbers

Risks

‒      Inflation: ability to pass on inflationary increases due to corn prices/energy given Russia/Ukraine conflict

o   In an earnings announcement on 11 Feb 2022 the CEO said they’re “well covered for corn and energy” and that they’ve built in flexibility into some contracts to revisit should they see further inflation. At sell side briefings towards the end of Mar 2022, CEO said TATE is well covered in the US in terms of corn costs for the entire 2022 (US is ~50% of FBS revenue) but in Europe, given illiquid corn futures markets, TATE is covered up until end of H122. Management have not given a precise number in terms of the potential headwind given price volatility

o   However, so far, TATE mgmt. has shown good ability to pass on cost inflation given industry-wide issue rather than company specific (price / mix accounted for 13% of 19% revenue growth in 3M to Dec 21)

o   More recent apparent progress in terms of Russia/Ukraine talks seems to have eased the increase in corn and energy prices

o   We estimate that in a very negative scenario where TATE is unable to pass on higher European prices in H2 2022, operating margin could face a ~1% annualised headwind

‒      Surcalose is in a weaker position vs FBS given it is an artificial sweetener and consumers trends are shifting, with studies linking surcalose to health issues. The business accounted for 12% of revenue and 26% of EBIT of New Tate in FY21

o   Further competition from Chinese producers, TATE is the only non-Chinese producer of surcalose (albeit that has allowed it to charge a premium given customer demand for diversifying supply chains)

‒      TATE discount to competitors does not reduce for a while given previous investor disappointment with the stock

Catalyst

‒      More detail regarding special dividend and associated share consolidation completion, increased transparency on post-deal pro-forma numbers. Clarity on post-deal accounting/numbers could be important as sell side analysts appear to have different methodologies for capturing the structural changes happening at TATE, leading to a wider range of views (e.g. JV accounting vs combined group view, amount of share consolidation post deal is not yet announced, special dividend etc.)

‒      Full year earnings on 9 Jun 2022

‒      Potential bid by an acquirer or a take private case