Stockwatch: Turnaround with 23% upside

Is Tate & Lyle's turnaround intact? Weak commodity prices and supply chain issues triggered a fall in Tate & Lyle shares from 883p in 2013 to 502p in the summer of 2015. Then came a strong recovery to 810p, only for the shares to plunge back to 666p late last year.

Yet this recent drop looks to have affirmed a support level in the medium-term chart context, and the latest third-quarter trading update cites performance modestly ahead of expectations on a constant currency basis.

Tate derived 74% of revenue from the US last year, with only 1% generated in the UK, 12% from Europe and 13% from the rest of world. Thus, the prelims should see a weaker sterling benefit when eventually declared in May.

I initially drew attention at 540p in September 2015 on grounds that Tate's risk/reward profile was improving. A 5.2% yield covered about 1.3 times by earnings offered support, and Tate's bulk ingredients side (62% of revenue, 36% of profit in the last financial year) was benefiting from a strong upturn in US high fructose corn syrup (HFCS) pricing. The HFCS business had become much more important after Tate had either cut back or exited from various European operations.

Value support

Also in support of value, the directors were buying shares aggressively between 510p-549p. I followed this up last June at 630p, when prelims to end-March showed adjusted pre-tax profit up 5%, albeit only 1% in constant currency - still meeting expectations, however. Sales edged up 1%, but were 3% lower in constant currency.

Director buying affirms cash flow strength and should provide technical support

Not exactly great if reflecting commodity price weakness despite an improved performance from the Sucralose sweeteners business - now restructured and repositioned. However, operational cash flow was up 18% helping cut debt and the dividend looked plenty secure.

The early November interims showed much better progress with normalised pre-tax profit up 37% on revenue up 13%, also normalised diluted earnings per share up 34%, with bulk and speciality food ingredients both performing strongly.

I calculate 40.5% of the profit improvement derived from currency translation, although pre-tax profit at constant currency was guided higher for the full year based on this strong first half and the second half proceeding in line with expectations. Net debt was down 3.7% to £418 million for gearing of 37.4%. The subsequent 17.5% drop in share price was frankly incongruous.

Profit ahead

Specialty food ingredients are in line with expectations and bulk ingredients are ahead. "North American sweetener volume remains robust; 2017 bulk sweetener pricing is expected to deliver modest margin gains; commodities' performance is somewhat ahead of our expectations."

Like-for-like Sucralose profit is also ahead, helped by efficiencies albeit overall sales are flat: North America and Asia Pacific have trended lower, while Latin America, Europe, the Middle East and Africa advanced.

Initially, the stock jumped from 720p over 735p then traded down by 9am Thursday, settling at about 710p. It had, however, risen from 670p at the start of February. In response to the update, Credit Suisse has raised its EPS forecast by 4% amid stronger commodity prices where ethanol was previously expected to make a loss but should now breakeven; also respecting margin gains in US sweeteners; and Sucralose seeing the benefits of consolidating two production sites despite weaker pricing.

The analyst hasn't increased a target share price of 750p because improvements relate to bulk ingredients i.e. the lower-valued more cyclical aspect of the group. Meanwhile, Liberum Capital and Berenberg maintain their targets of 770p and 810p, likewise Jefferies which is the most bullish with an 870p target i.e. 22.5% upside before yield considerations.

Sugar issues

When people think of Tate & Lyle it's still the brand appearing extensively on packets of refined sugar on grocery shelves - the addictive evil supposedly worse for health than saturated fat. But Tate's EU sugar refining operations and retail brand name were acquired by American Sugar Holdings (ASR Group) in 2010, one of the world's largest integrated sugar businesses.

The story isn't squeaky clean, but it favours continued upside

Certainly, HFCS is in the firing line, this corn starch-based sugar being common in sweetened drinks and processed food as it's sweeter and cheaper to produce than regular sugar. Part of the case against it is glucose and fructose being chemically separated in manufacturing, such that when HFCS hits the human liver it responds with excess fat production; at least according to critics.

However, studies have not deemed any special adverse effect of HFCS: all sugars and excess calories can contribute to fatty liver disease. It's mainly a public relations issue: McDonalds decided last August to replace all HFCS in their buns with sugar as part of cutting out preservatives and artificial additives. Other companies such as Pepsi and Heinz have partially replaced it with regular sugar. The upshot implies a risk of steady substitution if no major dent in usage.

Director buying

In January, Tate started a share buyback programme and as yet owns 2.8 million of 465 million issued. That it commenced on Friday 13th may come across as a company unlucky for truly attractive investment options, and there is a cynical view such "returns of cash" can help directors achieve EPS targets, hence bonuses, than deliver a genuine cash return to shareholders.

At least it affirms strength of cash flow and should provide some technical support going forward.

So, the story around Tate isn't squeaky clean or strong growth. Nevertheless, it favours continued upside with the operations in broadly sound health and numbers benefiting from translation into sterling, while sentiment is cautious.

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.