Tate & Lyle (TATE)


Stockwatch: Sound prospects and a Brexit hedge

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Can Tate & Lyle (TATE) build on its recovery? After a downtrend from 883p in 2013 to 502p mid-2015, the chart (below) for this Mid-250 sugar and sweeteners giant is improving as its price tests 640p after prelims for the year to end-March 2016.

I drew attention last September at 540p, arguing that a yield of 5.2% covered 1.3 times by forecast earnings was helping establish a prop, and overall risk/reward favoured upside as a restructuring completed.

A strong upturn in demand for US high fructose corn syrup - representing some 40% of Tate's current profits - allowed scope to raise prices, which could sweeten the bottom line nicely. The directors had also bought stock keenly at 510p to 549p. So how does the investment rationale look in light of the latest results?

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Structural change complete to drive earnings growth

On a constant currency basis the numbers are sound if lacking sparkle as yet; Tate's managers emphasise the statutory figures which have turned out slightly better. Adjusted pre-tax profit rose 5% to £193 million, or 1% in constant currency, meeting expectations.

Sales edged up 1% to £2,355 million, but were 3% lower in constant currency, mainly affected by lower corn prices. The operating improvements helped adjusted earnings per share (EPS) rise 8% to 34.5p and the total dividend was unchanged at 28.0p, given modest cover.

Management emphasises both its specialty food ingredients and bulk ingredients divisions improving margins, also structural changes implemented to strengthen the businesses.

Within the group numbers, specialty ingredients enjoyed a 10% rise in operating profit (5% in constant currency) and bulk ingredients a 1% rise (3% lower in constant currency) as commodities price weakness offset good corn milling dynamics and manufacturing efficiency improvements. Improved supply chain performance also helped, and a complicated restructure of the Eaststarch business was resolved.

This leaves European operations mainly in specialty food ingredients from a facility in Slovakia, with reduced exposure to more regulated European commodity markets, and bulk ingredients focused on North America, where Tate enjoys strong market positions and efficient assets.

Resilient earnings are expected here, given 90% of the bulk sweetener and industrial starch operations serve this larger, more stable market.

Sucralose could benefit from anti-sugar campaign

In divisional revenue terms, "bulk" slipped 1% to £1,458 million or by 6% in constant currency, while "specialty" rose 4% to £897 million or by 2% in constant currency, with good international sales growth helped by capacity expansion and improved Sucralose performance now it is restructured and repositioned.

Attention has focused more on those customers able to value the benefits of this calorie-free sweetener, and its manufacturing costs have been reduced. While there have been claims of adverse reactions to Sucralose, medical opinion is overall positive - for example as a means to combat obesity, diabetes and tooth decay without serious harmful effects.

Tate & Lyle patented the substance in 1976 and since 1991 it has been approved in over 80 countries, so, although a few scare stories exist on the internet, there's been plenty of time for medical opinion to weigh it up. With obesity and diabetes on an epidemic scale in wealthy nations, and opinion shifting against sugar consumption, it ought to have good prospects as a substitute.

International profile offers hedge against sterling

The UK has represented only 2% of revenues, so, if voting does favour a "Brexit" result on 23 June, Tate is a potentially useful stock to buy should the market drop amid uncertainty, leaving investors wondering how to cope with a risk of medium-term sterling weakness.

With two-thirds of revenue derived from the US, the current prospect of another interest rate rise is likely to renew strength in the US dollar - and hence benefit translation of profits for a sterling-denominated group.

Management is confident of progressing towards its 2020 targets for 70% of profit to derive from specialty food ingredients and 30% of sales to derive from Asia Pacific and Latin America. Currently, Asia Pacific markets are strong, but Latin America has suffered weak consumer demand.

Regarding new products, the target is to achieve $200 million (£138 million) sales against £57 million in the latest year, up 34% in constant currency.

Dividend supported by cash flow profile

The cash flow statement is respectable, with cash generated from operations up 18% to £254 million and net cash from operations of £188 million. A total £252 million spent on investment and acquisitions was covered by £240 million joint venture disposals (Eaststarch) and £18 million sale of financial assets.

Dividend payments cost £130 million and the balance sheet cites year-end cash of £317 million, so despite only modest earnings cover of 1.3 times, the forecasts for a maintained 28p dividend look secure. The resulting prospective yield of 4.5% ought still to constitute support, so, if Tate's operational story can keep steadily improving, risk looks overall on the upside.

Net debt has fallen by £121 million to £434 million, helped by the cash injection from realigning Eaststarch, which should reduce a net £29 million interest charge last year, going forward.

Net assets per share work out at 221p with 38% of that constituting goodwill, so downside protection is more via the dividend.

Majority of brokers target upside, up to 27%

Following prelims the consensus remains 'neutral/buy', with price targets of 560p to 800p. Exane BNP Paribas have trimmed their target from 580p to 560p despite a 'neutral' stance and Citigroup raised theirs from 600p to 680p. So the brokers vary, but are overall supportive after digesting the results.

Tate should, therefore, continue to progress operationally and share price-wise, unless another bout of commodities deflation follows.

The chief risk for that happening looks like a Chinese debt bust, given the way its debt-to-GDP ratio has soared from 150% to 260% over a decade, so China's debt cycle needs watching.

Modest economic slowdown has already caused problems for commodity exporters in the last year; a Chinese hard landing would imply worse. Such fears on China have persisted - yet, to date, its authorities are managing through.

For more information see their website.

Tate & Lyle - financial summary Consensus estimates
year ended 31 Mar 2012 2013 2014 2015 2016 2017 2018
Turnover (£ million) 3,088 3,256 2,754 2,356 2,355    
IFRS3 pre-tax profit (£m) 379 301 277 51 126    
Normalised pre-tax profit (£m) 312 312 288 193   202 213
Operating margin (%) 11.0 10.5 9.2 7.1      
IFRS3 earnings/share (p) 64.6 53.8 52.1 6.5 25.9    
Normalised earnings/share (p) 50.5 56.1 54.4 36.8 37.2 36.4 38.4
Earnings per share growth (%) 15.8 11.2 -3.0 -32.3 1.1 -2.3 5.5
Price/earnings multiple (x)         17.0 17.4 16.5
Cash flow/share (p) 50.2 54.3 84.7 42.2      
Capex/share (p) 27.5 28.2 24.6 33.4      
Dividends per share (p) 24.0 25.2 26.6 28.0 28.0 28.0 28.0
Yield (%)         4.5 4.5 4.5
Covered by earnings (x) 2.1 2.3 2.1 1.3 1.3 1.3 1.3
Net tangible assets per share (p) 152 146 159 128      
Source: Company REFS

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.