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Turnaround upside and FX tailwind are reasons to like food producer

Surprisingly for a £3.72bn cap that generated the best part of £2.4bn sales in the year to March 2016, Tate & Lyle (TATE) is often misunderstood by commentators and investors.

In a nutshell, its innovative technology turns raw materials into high-quality ingredients that add taste, texture and nutrition to food and drink products.

No more sugar

The Tate & Lyle name is still heavily associated with sugar.

In fact the London-listed food producer sold its EU sugar refining operations to American Sugar Refining (ASR) in 2010 for £211m in order to focus the business, reduce volatility and improve earnings quality.

The disposal included Tate’s cane sugar refineries in London, the UK and Lisbon; the Lyle’s Golden Syrup factory in London; as well as the associated sugar and syrup brands.

Under the deal, the ‘Tate & Lyle Sugar’ name was licensed to ASR, ensuring the Tate & Lyle brand remains on supermarket shelves to this day. And not long thereafter, Tate also hived off its remaining businesses within the Sugars division, namely Molasses and Vietnamese sugar.

Present-day Tate & Lyle is a major supplier of ingredients to global food and beverage clients and selected industrial customers, operating from more than 25 large scale manufacturing plants around the world.

Today’s Tate

Tate & Lyle’s two divisions are the Speciality Food Ingredients (SFI) arm and a Bulk Ingredients unit. SFI, the long-term growth driver, consists of ingredients that use technology or IP and enable Tate to obtain premium prices and generate higher margins.

Products span texturants such as starch and gums, sweeteners, comprising nutritive sweeteners and a range of no-calorie sweeteners including ‘SPLENDA Sucralose’, and also wellness ingredients including speciality fibres and Tate’s salt-reduction offering.

Bulk Ingredients is the relatively commoditised division selling bulk sweeteners, industrial starches and fermentation products (primarily acidulants). Corn co-products from both divisions are primarily sold as animal feed for livestock, fish and pets.

Healthy moves

So rather than a sugar producer, Tate & Lyle in fact offers a play on drives to reduce sugar and salt in diets around the world. Consumers and governments are focused on healthier lifestyles, with the rising prevalence of diabetes and obesity in both developed and developing markets driving food and beverage companies to develop healthier alternatives.

Other drivers are the volatile and high sugar prices that have led to an increased focus by customers on cost reduction, while rapid urbanisation and rising levels of disposable income in developing markets are increasing the penetration of packaged and convenience foods in Asia and Latin America.


Tale of two industries

Investors should also understand that Tate & Lyle mainly operates in two industries: corn wet milling and high-intensity sweeteners. Corn wet milling is a major industry in the corn-growing parts of the world and Tate & Lyle has a network of corn wet milling plants in the US, where it processes around 2% of the annual corn crop, and in Europe.

Tate’s plants take shelled corn (maize), separate the kernels into their core components (starch, oil, protein and fibre), and process them to create a range of products including high fructose corn syrup, food starch, ethanol and animal feed.

Tate & Lyle is also the leading supplier by value in the global high-intensity sweeteners (HIS) market, where sucralose holds a 30% value share and its SPLENDA Sucralose product is the biggest brand. SPLENDA Sucralose is a high quality sweetener with a sugar-like taste and a sweetening power roughly 600 times that of sugar. Manufactured in Alabama, SPLENDA Sucralose can withstand high temperatures during processing and has a long shelf-life, though it has encountered downwards pricing pressure in competitive market conditions.

TASTEVA™ Stevia Sweetener_beverages

(Drinks with Tate's Stevia sweetener)

Sweet turnaround

We outlined the compelling turnaround at Tate & Lyle on 19 November 2015 at 605p. The share price has since appreciated 30% to 789.5p, helped by solid full-year results (26 May) showing margin expansion in both divisions, a strong first quarter update (21 Jul), as well as Tate’s status as a prized ‘dollar earner’ in the current weak sterling environment. Tate generates less than 2% of sales in the UK and most of its revenues are dollar based.

Tate & Lyle still has exposure to rising commodity costs, while weakness in large sweetener customers in the US and in the Chinese dairy market are negatives to weigh.

Our bullish thesis remains intact. Chief executive Javed Ahmed has stabilised the business following a poor 2014 and 2015, caused by supply chain disruptions, competitive pressure for sucralose and a lack of SFI capacity. Tate has completed necessary SFI capacity expansion and set out exciting and ambitious new targets to drive sustainable earnings growth and cash flow generation.

The right strategy

We believe Ahmed’s strategy to focus on the SFI arm is the right one. Lessening exposure to commoditised bulk ingredients, Ahmed plans to deliver 70% of group profit from the higher-margin SFI business (excluding any contribution from Sucralose) as well as 30% of SFI sales from Asia Pacific and Latin America by 2020.

He believes Tate can outperform the SFI market with the help of acquisitions while improving margins. In addition, management is targeting $200m worth of revenue from an innovative new product pipeline, spanning sweeteners, texturants and health and wellness products, by the aforementioned date.

How much money will it earn?

For the year to March 2017, Liberum Capital forecasts pre-tax profit of £230m (2016: £193m) for earnings of 41.2p and a 29.4p dividend, rising to £245m, 43.53p and 30.87p respectively by 2018. On these estimates, we concede a prospective price to earnings ratio of 19.2 times is rather full, though investors are also being paid an attractive 3.7% yield while they await further benefits from the turnaround to materalise. Though dividend cover looks somewhat skinny, net debt is coming down.

On balance, we believe it is worth taking a taste of Tate & Lyle ahead of next month’s (3 Nov) half-year results, with further earnings upgrades highly likely this year if current FX rates persist.

We’re staying positive on Tate & Lyle at 789.5p, being believers in the strategy and anticipating further currency-driven earnings upgrades.

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