Treatt — Update 11 October 2016

Consumer

Treatt

Treat(t)ing investors

Pre-close trading update

Food & beverages

11 October 2016

Price	219.50p
Market cap	£113m

Net debt (£m) at 31 March 2016		8.4

Shares in issue	51.7m
Free float	100%
Code	TET

Primary exchange	LSE
Secondary exchange	N/A

Share price performance

%	1m	3m	12m
Abs	18.0	29.5	33.8
Rel (local)	13.5	19.5	22.1

52-week high/low

219.5p

157.0p

Business description

Treatt provides innovative ingredient solutions from its manufacturing bases in Europe, North America and Africa, principally for the flavours and fragrance industries and multinational consumer goods companies with particular emphasis on the beverage sector.

Next events

FY16 results

29 November 2016

Analysts

Sara Welford	+44 (0) 20 3077 5700
Paul Hickman	+44 (0)20 3681 2501

consumer@edisongroup.com

Edison profile page

Treatt is a research client of Edison Investment Research Limited

Treatt has had an outstanding year as the positive trends in its markets continue to play out. We believe the company is building a strong platform for the longer term and the performance continues to improve as the strategy progresses under the stewardship of Daemmon Reeve. Following the pre-close trading update, we upgrade our forecasts by c 10% at the EPS level to reflect the improved outlook. Our DCF-derived fair value increases to 240p (from 204p), which represents c 10% upside.

Year end	Revenue (£m)	PBT* (£m)	EPS* (p)	DPS (p)	P/E (x)	Yield (%)
09/15	85.9	8.3	12.7	4.6	17.6	2.1
09/16e	88.1	9.4	14.0	4.8	15.7	2.2
09/17e	92.5	10.2	15.1	5.2	14.5	2.4
09/18e	96.2	10.4	15.5	5.3	14.2	2.5

Note: *PBT and EPS are normalised, excluding amortisation of acquired intangibles, exceptional items and share-based payments.

Impressive growth, strategy delivering

Treatt’s long-term strategy is to deliver consistent, sustainable growth in profit through developing value-added ingredient solutions, coupled with effective cost control. Key to this strategy is improved customer focus and closer relationships, with the ultimate goal of delivering greater profitability by concentrating on the more value-added segments. This latest period clearly demonstrates that this goal is being delivered. As a result of the trading update, we upgrade our full-year forecasts for 2016-18 to reflect the improved outlook. Our sales forecasts move up c 3%, while PBT and EPS increase by c 5%.

Ingredients space remains interesting

Growth in the ingredients space remains higher than average for the consumer sector as consumers demand cleaner labels and healthier products, but will not compromise on taste, and this requires specialist ingredients. Margins are also typically high at the value-added end. Treatt’s ingredient solutions are used both by food ingredients companies in their formulations, and by food and beverages companies directly. Treatt has placed particular emphasis on the beverages space and is becoming increasingly specialised in this space.

Valuation: Attractive ingredients play

We value Treatt using a DCF model and we derive a fair value of 240p (previously 204p), an attractive c 10% upside to the current share price. This is supported by its relative valuation, with Treatt trading at 15.3x and 10.6x calendar P/E and EV/EBITDA multiples for 2016, representing a c 40% discount to its ingredients peer group on both metrics. Given our forecast for a mid-single-digit three-year CAGR EPS for 2016-18, we believe this level of discount is unwarranted.

Forecast revisions

We detail our key changes to our P&L forecasts in Exhibit 1 below. Following the pre-close trading update, we have upgraded our medium-term sales forecasts by c 3% to reflect the improved outlook and expectations of a strong H216, which should provide a solid platform for future years. Our FY16 forecasts increase by only 2.5% as the FX hedging goes through the sales line thus any adverse impact from sterling devaluation affecting the hedging will go through the top line. Improved sales growth should lead to operating leverage. In addition, as discussed above, Treatt’s goal is to continue to concentrate on the more value-added segments and move away from the commodity trading business, hence we have raised our margin forecasts. We have increased our pre-tax profit and EPS forecasts by c 5%.

Exhibit 1: Old vs new key P&L forecasts

	EPS* (p)			PBT* (£000s)			Sales (£000s)
	Old	New	% chg	Old	New	% chg	Old	New	% chg
09/16e	12.1	12.5	3.3%	8,330	8,663	4.0%	85,934	88,082	2.5%
09/17e	13.0	13.5	4.1%	8,959	9,389	4.8%	89,371	92,486	3.5%
09/18e	13.2	13.8	4.5%	9,118	9,594	5.2%	92,946	96,186	3.5%

Source: Edison Investment Research. Note: *Stated on company normalised basis, which is pre-exceptional but after amortisation of acquired intangibles and share-based payments.

Valuation update

We illustrate Treatt’s valuation versus its ingredients peer group in Exhibit 2 below. Treatt trades at a significant discount to its peer group on all metrics. Some discount can be applied to reflect its small size and because some of its products are relatively ‘upstream’ in the ingredients spectrum, particularly the bulk ingredients that are sold to other ingredients companies. However, we believe a c 40% discount on EV/EBITDA and P/E is unwarranted.

Exhibit 2: Benchmark valuation

		P/E (x)		EV/EBITDA (x)		Dividend yield (%)
	Market cap (m)	2016e	2017e	2016e	2017e	2016e	2017e
Givaudan	CHF18,107	26.3	23.6	16.4	15.7	2.9%	3.2%
IFF	$10,938	24.6	22.7	16.1	14.9	1.7%	1.9%
Symrise	CHF 9,145	28.4	25.5	15.9	14.3	1.3%	1.5%
Frutarom	ILS11,705	24.0	20.2	16.5	13.9	0.6%	0.7%
Chr Hansen	DKK51,040	36.0	31.5	23.5	20.7	1.3%	1.5%
Kerry	€12,264	21.7	19.6	15.6	14.0	0.8%	0.9%
Ingredion	$9,580	19.5	18.0	10.6	9.7	1.4%	1.5%
Peer group average		25.8	23.0	16.4	14.8	1.4%	1.6%
Treatt	£112.1	15.3	14.3	10.6	9.8	2.3%	2.4%
Premium/(discount) to peer group (%)		-40.8%	-38.0%	-35.0%	-33.4%	57.0%	50.9%

Source: Bloomberg (prices as of 10 October 2016). Note: Treatt figures are calendarised to aid comparison.

Our DCF-derived fair value is now 240p (previously 204p) following the changes to our model detailed in our earnings section above (namely an increase in short- to medium-term sales forecast and margin assumptions). Our longer-term sales growth forecast remains at 3.5% pa, falling to 2% growth in perpetuity. Our DCF is calculated based on a WACC of 7.9% (encompassing a beta of 0.8, an equity risk premium of 5.0% and a borrowing spread of 5.0%) and a terminal growth rate of 2%.

Sensitivities

Despite 60% of turnover being exposed to the ‘defensive’ beverage sector, Treatt has a couple of key sensitivities, which it seeks to mitigate through the in-depth knowledge and skill base of its buying team and undertaking an active hedging policy where possible:

■

Commodity exposure: namely citrus oils, which make up c 30% of revenues.

■

Foreign exchange: translation risk on US dollar profits, which it manages through hedging.

Other points of interest

Relocation of UK business

As announced with the H115 results, Treatt has decided to fully relocate its UK head office and manufacturing plant in the Bury St Edmunds area. Discussions with landowners are at an advanced stage now, and we expect an update with the FY results in November. As a reminder, we currently forecast £20m total spend (the guidance is £15-20m), with the majority of the costs in FY17 and FY18.

Although there have been sharp movements in FY16, particularly with sterling devaluation following the EU referendum in the UK, Treatt has a number of hedging strategies in place, including using debt aligned with its business exposure. These mitigate the volatility and adverse movement in currency, particularly at the profit level. The underlying impact of the strengthening US dollar is expected to reduce profits by £0.5m in FY16, but the hedging policies should substantially reverse this figure in Q117.

Earthoil dispute

Treatt had been contesting a £2.3m claim against it related to deferred consideration on the earn-out from the acquisition of Earthoil in 2007-08. The company has now reached final settlement with the sellers, which concludes the dispute. Payment of £0.9m will be made to the sellers. In terms of accounting, £0.7m of this payment will be accounted for as an increase in goodwill, with the balance being treated as an exceptional item in the P&L. We have updated our forecasts accordingly.

Exhibit 3: Financial summary

	£000s	2013	2014	2015	2016e	2017e	2018e
Year end September		IFRS	IFRS	IFRS	IFRS	IFRS	IFRS
PROFIT & LOSS
Revenue		74,097	79,189	85,934	88,082	92,486	96,186
Cost of Sales		(56,510)	(61,218)	(66,955)	(68,365)	(71,413)	(74,173)
Gross Profit		17,587	17,971	18,979	19,718	21,074	22,013
EBITDA		8,360	9,068	10,307	11,488	12,557	13,233
Operating Profit (before amort., except and sbp.)		7,141	7,846	9,063	10,020	11,015	11,630
Intangible Amortisation		(181)	(172)	(175)	(160)	(160)	(160)
Share based payments		(22)	(46)	(198)	(600)	(671)	(686)
Other		0	0	0	0	0	0
Operating Profit		6,938	7,628	8,690	9,260	10,184	10,784
Net Interest		(651)	(724)	(740)	(596)	(795)	(1,190)
Exceptionals		(1,153)	(1,402)	(174)	(200)	0	0
Profit Before Tax (norm)		6,490	7,122	8,323	9,423	10,221	10,440
Profit Before Tax (FRS 3)		5,134	5,502	7,776	8,463	9,389	9,594
Profit Before Tax (company)		6,287	6,904	7,950	8,663	9,389	9,594
Tax		(1,655)	(1,553)	(1,786)	(2,209)	(2,394)	(2,446)
Profit After Tax (norm)		4,835	5,326	6,537	7,214	7,826	7,993
Profit After Tax (FRS 3)		3,479	3,949	5,990	6,254	6,995	7,148

Average Number of Shares Outstanding (m)		51.1	51.3	51.5	51.7	51.7	51.7
EPS - normalised (p)		9.5	10.4	12.7	14.0	15.1	15.5
EPS - normalised & fully diluted (p)		9.4	10.3	12.6	13.9	15.1	15.4
EPS - (IFRS) (p)		6.8	7.7	11.6	12.1	13.5	13.8
Dividend per share (p)		3.7	3.8	4.6	4.8	5.2	5.3

Gross Margin (%)		23.7	22.7	22.1	22.4	22.8	22.9
EBITDA Margin (%)		11.3	11.5	12.0	13.0	13.6	13.8
Operating Margin (before GW and except.) (%)		9.6	9.9	10.5	11.4	11.9	12.1

BALANCE SHEET
Fixed Assets		14,341	13,777	13,381	17,274	26,960	33,140
Intangible Assets		1,759	1,801	1,736	2,276	2,116	1,956
Tangible Assets		11,718	10,994	10,998	14,351	24,197	30,537
Investments		864	982	647	647	647	647
Current Assets		38,340	43,590	45,045	44,982	47,576	49,843
Stocks		23,669	28,020	25,799	27,306	29,041	30,587
Debtors		13,207	14,509	17,635	17,176	18,035	18,756
Cash		1,117	629	1,477	500	500	500
Other		347	432	134	0	0	0
Current Liabilities		(12,533)	(16,005)	(13,481)	(15,976)	(21,062)	(23,587)
Creditors		(11,962)	(12,729)	(12,675)	(12,948)	(13,596)	(14,139)
Short term borrowings		(522)	(2,356)	(567)	(3,028)	(7,467)	(9,448)
Provisions		(49)	(920)	(239)	0	0	0
Long Term Liabilities		(12,754)	(12,602)	(11,760)	(6,310)	(8,329)	(9,120)
Long term borrowings		(8,889)	(7,857)	(7,065)	(1,514)	(3,733)	(4,724)
Other long term liabilities		(3,865)	(4,745)	(4,695)	(4,796)	(4,596)	(4,396)
Net Assets		27,394	28,760	33,185	39,969	45,144	50,276

CASH FLOW
Operating Cash Flow		9,250	3,528	8,667	12,103	10,410	11,309
Net Interest		(714)	(724)	(740)	(596)	(795)	(1,190)
Tax		(649)	(1,552)	(1,469)	(2,209)	(2,394)	(2,446)
Capex		(1,433)	(538)	(924)	(4,821)	(11,387)	(7,943)
Acquisitions/disposals		(154)	(208)	(103)	0	0	0
Financing		(56)	105	147	0	0	0
Dividends		(1,585)	(1,899)	(1,978)	(2,363)	(2,492)	(2,701)
Net Cash Flow		4,659	(1,288)	3,600	2,113	(6,658)	(2,971)
Opening net debt/(cash)		12,949	8,294	9,584	6,155	4,042	10,700
HP finance leases initiated		0	0	0	0	0	0
Other		(4)	(2)	(171)	0	0	0
Closing net debt/(cash)		8,294	9,584	6,155	4,042	10,700	13,671

Source: Edison Investment Research, Treatt data

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Germany

London +44 (0)20 3077 5700

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United Kingdom

New York +1 646 653 7026

245 Park Avenue, 39th Floor

10167, New York

Sydney +61 (0)2 9258 1161

Level 25, Aurora Place

88 Phillip St, Sydney

NSW 2000, Australia

Wellington +64 (0)48 948 555

Level 15, 171 Featherston St

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New Zealand

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

245 Park Avenue, 39th Floor

10167, New York

Sydney +61 (0)2 9258 1161

Level 25, Aurora Place

88 Phillip St, Sydney

NSW 2000, Australia

Wellington +64 (0)48 948 555

Level 15, 171 Featherston St

Wellington 6011

New Zealand

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

245 Park Avenue, 39th Floor

10167, New York

Sydney +61 (0)2 9258 1161

Level 25, Aurora Place

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