Margins increasingInvestment in new services
IC TIP:
Buy
at
1,180p
Bull factors
Structural shift in direction of more healthy meals and drinksImproving marginsManufacturing capability expansionFund supervisor pickAnalyst upgrades
Bear factors
ValuationExposure to uncooked materials costs
Founded in 1886 by important oil service provider Richard Treatt, Treatt (TET) specialises in natural extracts and substances for the beverage, flavour and perfume industries. Its merchandise are present in every part from speciality teas and chilly brew espresso, to alcoholic drinks and meat alternate options. The group is tapping into a world flavour and perfume market that is estimated to be price £27bn and is projected to develop by 5 per cent annually.With manufacturing websites within the UK and US, the group sells greater than 3,000 merchandise throughout 90 international locations, specializing in seven classes – citrus, tea, espresso, ‘fruit and greens’, ‘herbs, spice and florals’, ‘well being and wellness’, and ‘aroma and excessive impression chemical compounds.’The largest class is citrus. Treatt makes merchandise primarily based on the oils that come from fruits corresponding to oranges, lemons and limes. That means it is uncovered to cyclical uncooked materials costs which can be topic to the vagaries of the climate. For instance, whereas the orange oil value surpassed $12 (£9) per kilogram (kg) in 2017, it fell to as little as $4/kg final 12 months. It has since rebounded to round $7/kg, and chief govt Daemmon Reeve believes that costs at the moment are stabilising. “In the previous two years we’ve seen some weak spot in citrus uncooked materials costs, however they’ve now recovered to a extra typical degree,” he mentioned on the time of the group’s half-year leads to May.Treatt has labored exhausting to decouple the trajectory of its earnings from actions within the orange oil value. It’s accomplished this by shifting up the worth chain for citrus merchandise, whereas additionally rising its non-citrus companies. The proportion of income derived from citrus fell from 54 per cent in 2019 to 45 per cent within the six months to 31 March 2021.Moving away from commoditised, higher-volume citrus merchandise in direction of the manufacturing of extra subtle, ‘value-added’ substances has helped enhance margins. The working revenue margin has improved from 10.8 per cent in 2016 to 13.8 per cent in 2020, and the group is aiming to hit 15 per cent. It exceeded this ambition within the first half of its 2021 monetary 12 months, with the margin growing by 6.1 share factors to 17.4 per cent, translating to a 74 per cent rise in revenue to £10.6m. As the shift to worth added merchandise continues, analysts imagine that annual margins will preserve increasing.
Natural focus bears fruitMore than three-quarters of Treatt’s gross sales are generated by natural merchandise. Demand is benefiting from the continuing shift in direction of more healthy consuming, sustainability and so-called ‘clear labels’, which is the place fewer synthetic substances and fewer substances in whole are used. This long-term structural tailwind is being bolstered by regulation corresponding to sugar taxes.The group’s publicity to the wholesome residing pattern has attracted the eye of top-performing sustainability fund Liontrust UK Ethical (GB00B8HCSD36), the place it is a prime 10 holding.”Treatt’s positioning in direction of genuine flavour, style and perfume with natural ingredient and sugar discount expertise has proved astute,” says the fund’s co-manager Martyn Jones. “Our analysis highlights continued sturdy demand from customers wishing to eat more healthy and extra natural meals and drinks – significantly within the wake of the pandemic when many individuals are considering rigorously about well being and wellbeing.”‘Better for you’ merchandise can usually compromise on style, and it takes ability to maintain their flavours as true as potential to the unique model. For instance, Treatt’s merchandise allow corporations to cut back the sugar content material of their meals and drinks whereas sustaining their sweetness and mouthfeel. The group says that “demand from the health-conscious shopper reveals no signal of slowing down”, and certainly gross sales of its ‘more healthy residing’ merchandise – which span tea, well being and wellness, and fruit and greens – jumped by 57 per cent 12 months on 12 months within the six months to 31 March.This helped push total income up by 14 per cent within the first half of the 12 months to £61m. The bumper set of outcomes prompted analysts to nudge up their forecasts but once more.
Momentum has additionally been aided by the rising recognition of low-calorie alcoholic drinks, specifically ‘exhausting seltzers’. These are naturally fruit-flavoured glowing water drinks, usually with about 5 per cent alcohol and 100 energy a serving. This has been a explicit boon in Treatt’s largest market, the US, which accounted for 45 per cent of income within the first half. Hard seltzers are profitable market share from beer and wine within the US, the place the group is investing $1.5m in plant and equipment to make the most of development. They are additionally gaining traction within the UK and Europe. The world alcoholic seltzer market was estimated to be price $4.4bn in 2019 and is venture to develop by 16 per cent yearly between 2020 and 2027.“It’s largely pushed by customers wanting an alcoholic beverage, however more and more with a consciousness across the calorific content material,” says Reeve. “Unlike a beer, the natural extract has to do the entire heavy lifting by way of flavour, subsequently clients are ready to pay for high-quality, genuine, natural extracts.” Seeds of growthSome 46 per cent of Treatt’s income comes from promoting on to fast-moving shopper items (FMCG) corporations, most of which pertains to merchandise for drinks. Customers are typically very ‘sticky’, as as soon as Treatt’s flavours are included in a product, they have a tendency not to get replaced as a result of expense and threat of modifications. This makes it tough for brand spanking new opponents to get established.The group’s prime 10 purchasers have been with it for at the least a decade, and in some instances greater than 25 years. These long-term partnerships are underpinned by its deep data, in addition to product innovation. Treatt co-develops merchandise with its clients, creating bespoke ingredient options.The remaining 54 per cent of income is derived from gross sales to flavour and perfume homes, who’re each clients and opponents. This contains business leaders corresponding to International Flavors & Fragrances Inc (US:IFF) and Givaudan (US:GIVN). While Treatt is a a lot smaller enterprise, it enjoys aggressive benefits over its bigger friends. It specialises in natural extracts, whereas the large gamers deal with chemically processed substances. It additionally supplies the broadest vary of natural flavours for the beverage business, supported by its superior sourcing and manufacturing capabilities.Rather than develop their very own natural capabilities, the larger flavour and perfume corporations have a tendency to purchase from specialists in natural merchandise or purchase them outright. This may make Treatt a potential takeover goal, and analysts at Peel Hunt imagine that “if the market doesn’t worth the longer term appropriately, one of many main business gamers certainly will”.The dealer additionally believes that Treatt will be capable to seize market share from its opponents as its scale will increase, suggesting that bigger beverage corporations will select to take care of it on to develop customised options in lieu of the extra opaque “black field” method of flavour and perfume homes.Treatt initiated a £48m funding programme in 2017 to extend its manufacturing capability and capabilities. It spent $15m to develop its facility within the US, doubling the manufacturing capability for ‘more healthy residing’ merchandise. The new addition got here onstream final 12 months.It is additionally investing £41m in a new web site within the UK, which is anticipated to start manufacturing within the first half of 2022. With automated warehouses, upgraded laboratory tools and digitised manufacturing processes, elevated effectivity ought to assist enhance margins and in addition allow a step-up in scale of joint product developments with clients.As the group continues to spend money on its capabilities and deepens its relationships with its clients, Jones says he “stay[s] excited concerning the long-term compounding prospects for Treatt”.These tasks have pushed up the group’s capital employed – a measure of the historic funding within the enterprise – which has not too long ago weighed on the favored high quality metric ‘return on capital employed’ (ROCE). ROCE dropped from 25 per cent in 2016 to 16.9 per cent in 2020, however this ought to be short-term. Once the brand new services are totally operational, the group is aiming for ROCE to go again to a hearty 20 to 25 per cent. This expectation underlines simply how worthwhile the funding is for rising shareholder worth.The capital expenditure (capex) on the brand new UK facility has pushed Treatt from £400,000 of internet money at its September year-end to £5.1m of internet debt on the finish of March. This swing additionally displays a £5m enhance in stock, which the group says displays a regular inventory build-up forward of the height of the beverage season within the northern hemisphere. Treatt intentionally holds a important quantity of stock to take care of a dependable provide of its merchandise, and this could additionally assist offset sudden fluctuations in uncooked materials prices.The group tends to spend money on natural development reasonably than utilizing acquisitions to spice up earnings, and with £8m of capex nonetheless to spend on the UK facility, it is guiding that internet debt will enhance to between £6m and £8m by the tip of September. However, analysis home Edison forecasts that it’s going to transfer again to a internet money place from FY2022 and believes this may underpin a “important” enhance within the dividend. A zesty valuation There’s no getting round the truth that the valuation of Treatt’s shares is excessive. This means any disappointment could possibly be painful for shareholders. The shares presently commerce at 42 instances consensus 2022 earnings. That’s nicely forward of their five-year value/-earnings (PE) ratio of 27, however is on par with many of the group’s bigger friends. Treatt is costlier than a few of its bigger peersCompanyMarket Cap (£bn)Next 12 months (NTM) price-to-earnings (PE) ratioFollowing 12 months PE ratioNTM enterprise value-to-operating revenue ratioNTM return on capital employed (%)NTM free money move yield (%)NTM dividend yield (%)Treatt (TET)0.70442.238.832.017.01.50.7Givaudan (CH:GIVN)31.341.838.637.312.82.41.6International Flavors & Fragrances Inc. (US:IFF)26.723.721.032.84.03.62.1Symrise AG (DE:SY1)13.744.139.831.110.22.50.9Source: FactSet And that lofty valuation seems greater than justified if analysts are proper about Treatt’s long-term development potential. After normalising for citrus costs, Peel Hunt calculates that Treatt has seen a 7 per cent compound annual development price (CAGR) in gross sales over the previous 5 years, in contrast with 5 per cent for its larger rivals. The dealer believes that in a ‘blue sky’ state of affairs, the CAGR may rise to fifteen per cent over the following 5 years due to the funding in its services, new product growth and a decrease reliance on citrus. That would translate to an adjusted EPS of 68p in 2025, up from 21.1p in 2020, and on that foundation, the shares could possibly be thought of good worth proper now. The forecast improve momentum means that the ‘blue sky’ is price wanting in direction of. TREATT (TET) ORD PRICE:1,180pMARKET VALUE:£704m TOUCH:1,175-1,185p12-MONTH HIGH:1,225pLOW:489pFORWARD DIVIDEND YIELD:0.7percentFORWARD PE RATIO:40 NET ASSET VALUE:160pNET DEBT:5.4%* Year to 30 SepTurnover (£m)Pre-tax revenue (£m)**Earnings per share (p)**Dividend per share (p) 201811213.719.35.10 201911313.918.85.50 202010915.721.16.00 2021**12321.627.37.50 2022**13123.229.28.30 % change+7+7+7+11 *Includes lease liabilities of £0.7m**Peel Hunt forecasts, adjusted PTP and EPS figuresLast IC View: Buy, 506p, 12 May 2020
