Treatt — Rebasing expectations

Treatt (LSE: TET)

Currency in GBP

Last close As at 25/01/2023

GBP6.28

−2.00 (−0.32%)

Market capitalisation

GBP380m

Research: Consumer

Treatt — Rebasing expectations

Treatt’s unexpected trading statement of 15 August reduced FY22 pre-tax profit guidance to a range of £15.0–15.3m versus our previous forecast of £21.9m (pre-exceptional rather than normalised). The main drivers of the downgrade were lower sales in tea, driven by weak consumer confidence in the United States; over-hedging, which resulted in losses crystallising due to the devaluation of sterling against the US dollar; continued input cost inflation; and slower growth in China owing to ongoing COVID-19 restrictions. All categories excluding tea are showing strong momentum, and the company is taking active steps to limit its FX exposure and prevent over-hedging in future. Management remains confident in the long-term growth drivers for Treatt.

Sara Welford

Written by

Sara Welford

Director, Consumer

Consumer

Treatt

Rebasing expectations

Trading update

Food and beverages

7 September 2022

Price

577p

Market cap

£347m

Net debt (£m) at 31 March 2022

19.8

Shares in issue

60.1m

Free float

100%

Code

TET

Primary exchange

LSE

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

(28.1)

(36.2)

(44.5)

Rel (local)

(26.2)

(33.0)

(42.6)

52-week high/low

1315p

507p

Business description

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

Next events

FY22 trading update

October 2022

FY22 results

29 November 2022

Analysts

Sara Welford

+44 (0)20 3077 5700

Russell Pointon

+44 (0)20 3077 5700

Treatt is a research client of Edison Investment Research Limited

Treatt’s unexpected trading statement of 15 August reduced FY22 pre-tax profit guidance to a range of £15.0–15.3m versus our previous forecast of £21.9m (pre-exceptional rather than normalised). The main drivers of the downgrade were lower sales in tea, driven by weak consumer confidence in the United States; over-hedging, which resulted in losses crystallising due to the devaluation of sterling against the US dollar; continued input cost inflation; and slower growth in China owing to ongoing COVID-19 restrictions. All categories excluding tea are showing strong momentum, and the company is taking active steps to limit its FX exposure and prevent over-hedging in future. Management remains confident in the long-term growth drivers for Treatt.

Year end

Revenue (£m)

PBT*
(£m)

EPS*
(p)

DPS
(p)

P/E
(x)

Yield
(%)

09/20

109.0

15.8

21.3

6.0

27.1

1.0%

09/21

124.3

22.7

30.1

7.5

19.2

1.3%

09/22e

138.6

16.3

21.8

7.5

26.5

1.3%

09/23e

146.9

18.0

23.7

8.1

24.3

1.4%

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

Tea is a high-margin category

Tea flavours are highly specialised and the category as a whole is one of the higher margin contributors at Treatt. Given declining consumer confidence, one of Treatt’s beverage customers made the decision to reduce the scale of a new launch in the category, thus the launch was across fewer states in the United States, and with more subdued marketing support. This resulted in a loss in sales, and at extremely high margin, causing c £2.5m of the downgrade to profits.

Hedging to be tightened

Treatt’s FX exposure is both transactional and translational. Hedging for the translational exposure is fairly straightforward, but the transactional portion is complex, as the exposure is also partly offset by some natural hedges. FX should have been a net benefit during FY22 given the weakening of sterling versus the US dollar, but over-hedging caused a £2.5m loss. Management has already closed out Treatt’s over-hedged positions and plans are in place to use market experts to improve the way the hedges are managed, which should return hedging to a mere technicality utilised to smooth out any volatility, rather than having a material effect on profitability.

Valuation: Fair value of 630p

Treatt trades at 26.5x and 16.4x FY22 P/E and EV/EBITDA, broadly in line with its peers. We value Treatt on a DCF basis using a WACC of 7.7%, a terminal EBIT margin of 20.0% and terminal sales growth of 2.0%. Our fair value on our rebased forecasts is 630p (previously 737p).

Forecast changes

While our sales forecasts are only decreasing by c 3%, our profit forecasts are down c 30% due to the reasons detailed above. Management estimates a £2.5m downgrade to profits caused by the disappointment in the tea business, a further £2.5m loss due to FX downgrades, a c £1m impact from rising input costs and the inability to pass these on entirely to the customers, with the remainder of the downgrade (c £700,000) caused by the ongoing COVID-19 restrictions in China. We detail the changes to our estimates in Exhibit 1.

Our net debt estimate increases materially in FY22 and swings from forecast net cash to net debt for FY23 and FY24. This is driven by the downgrade in profit but also by an increase in our forecast of the working capital outflow, which in turn is caused by the current inflationary environment.

Exhibit 1: Change in key forecasts (FY22–24e)

FY22e

FY23e

FY24e

Forecast

Old

New

Diff

Old

New

Diff

Old

New

Diff

Revenue (£000)

142,975

138,623

(3%)

151,553

146,941

(3%)

160,647

155,757

(3%)

EBITDA (£000)

28,976

21,682

(25%)

30,960

23,990

(23%)

33,035

25,839

(22%)

Operating profit (£000)

21,974

15,483

(30%)

23,747

17,441

(27%)

25,654

19,110

(26%)

PBT (pre exceptional) Treatt (£000)

21,927

15,068

(31%)

23,723

16,437

(31%)

25,677

18,434

(28%)

PBT (normalised) Edison (£000)

23,978

16,331

(32%)

25,893

17,962

(31%)

27,982

20,104

(28%)

Basic EPS (pre exceptional) Treatt (p)

28.7

19.7

(31%)

30.6

21.2

(31%)

32.7

23.5

(28%)

Basic EPS (normalised) Edison (p)

32.1

21.8

(32%)

34.2

23.7

(31%)

36.5

26.2

(28%)

Net debt/(cash) (£000)

7,988.6

18,245.8

128%

(167.6)

16,647.8

nm

(11,015.2)

11,854.3

nm

Source: Edison Investment Research. Note: Edison normalised figures are pre-exceptional and also exclude share-based payments and amortisation of acquired intangibles.

Process changes

The reduction in profit guidance is clearly a disappointment for all stakeholders in the business, with the share price falling 34% (from 803p to 533p) on the day it was announced. That said, it does provide an opportunity for greater controls to be embedded into the business as it grows. The recent capital markets day on 30 May showcased Treatt’s new facility, which is significantly more automated than its old factory, and hence should allow for plenty of efficiencies, thus resulting in cost savings. As the company has undergone a period of strong growth, it has also had to build its cost base: among these have been new hires such as Wolfgang Tosch, the new global chief innovation officer, and a full team of experts for its new coffee business. While investment in the business is essential for future success, we believe management is likely to now shift its focus to delivering on the efficiencies and cost savings from its new facilities.

As discussed above, new controls and processes are being put in place to manage hedging. In addition, we expect a more robust budgeting process, which will differentiate more effectively between contracted sales and more discretionary launches. Furthermore, launches that are deemed higher risk, such as the one in the tea category that resulted in the downgrade, are to be managed more cautiously.

Treatt remains exposed to high-growth categories that are in the sweet spot of consumer preferences, such as sugar reduction. While weakening consumer confidence is obviously a concern for all FMCG businesses, the core of Treatt’s business is in less discretionary products, as highlighted at the height of the pandemic when demand did not decline.

Valuation

We show Treatt’s relative valuation versus its ingredients peer group in Exhibit 2 below. For 2022, based on Edison estimates, Treatt trades broadly in line with its peer group on both a P/E and EV/EBITDA basis, although we note that Kerry and Ingredion have a larger proportion of lower-margin products in their portfolios. If we exclude Kerry and Ingredion, Treatt is trading at a c 10% discount to its remaining peers on both P/E and EV/EBITDA, although we recognise Treatt is smaller than its peers.

Exhibit 2: Comparative valuation

Market cap
(m)

P/E (x)

EV/EBITDA (x)

Dividend yield (%)

2022e

2023e

2022e

2023e

2022e

2023e

Givaudan

CHF 28,333

31.5

28.1

21.8

20.5

2.2

2.3

IFF

$27,491

19.0

17.0

15.3

14.1

2.8

3.0

Symrise

CHF 14,377

32.0

29.0

17.9

16.9

1.1

1.2

Chr Hansen

DKK 56,710

32.9

28.7

19.8

17.9

2.0

2.2

Kerry

€ 17,615

22.8

20.6

16.5

15.2

1.0

1.1

Ingredion

$5,603

12.0

10.8

7.8

7.3

3.1

3.2

Peer group average

25.0

22.4

16.5

15.3

2.0

2.2

Treatt

£347

26.5

24.3

16.4

14.8

1.3

1.4

Premium/(discount) to peer group (%)

5.7%

8.8%

(0.5%)

(3.0%)

(36.3%)

(35.5%)

Source: Refinitiv, Edison Investment Research. Note: Prices as of 5 September 2022.

We also value Treatt on a DCF basis. Our longer-term assumptions remain unchanged: longer-term sales growth of 5.0% pa, falling to 2% growth in perpetuity; and a WACC of 7.7% (predicated on a beta of 0.8, a risk-free rate of 4.0%, an equity risk premium of 5.0% and a borrowing spread of 5.0%). This results in a fair value of 630p (previously 737p), as we have reduced our near-term forecasts as detailed above.

We illustrate a sensitivity analysis in Exhibit 3 below. The current share price is discounting medium-term sales growth of 3.3%, falling to 2.0% in perpetuity, with a WACC of 7.7%.

Exhibit 3: DCF sensitivity to terminal growth rate and medium-term sales growth (p/share)

Medium-term sales growth

2.0%

3.0%

4.0%

5.0%

6.0%

Terminal growth

0.5%

451

477

504

533

563

1.0%

474

501

530

560

592

1.5%

500

529

560

592

626

2.0%

531

562

595

630

667

2.5%

567

601

637

675

715

3.0%

611

648

688

729

773

Source: Edison Investment Research

Exhibit 4: Financial summary

£000s

2020

2021

2022e

2023e

2024e

2025e

Year end 30 September

IFRS

IFRS

IFRS

IFRS

IFRS

IFRS

PROFIT & LOSS

Revenue

 

 

109,016

124,326

138,623

146,941

155,757

163,545

Cost of Sales

(77,140)

(82,103)

(100,140)

(105,119)

(110,336)

(114,708)

Gross Profit

31,876

42,223

38,484

41,822

45,421

48,837

EBITDA

 

 

17,862

24,877

21,682

23,990

25,839

27,482

Operating profit (before amort. and excepts.)

 

16,053

23,172

16,571

16,746

18,966

20,781

Intangible Amortisation

(75)

(93)

(79)

(67)

(57)

(49)

Share based payments

(886)

(1,733)

(1,184)

(1,457)

(1,613)

(1,749)

Other

0

0

0

0

0

0

Operating Profit

15,092

21,346

15,483

17,441

19,110

20,393

Net Interest

(291)

(427)

(415)

(1,004)

(677)

(413)

Exceptionals

(1,060)

(1,302)

(3,000)

0

0

0

Profit Before Tax (norm)

 

 

15,762

22,745

16,331

17,962

20,104

21,777

Profit Before Tax (FRS 3)

 

 

13,741

19,617

12,068

16,437

18,434

19,980

Profit Before Tax (company)

 

 

14,801

20,919

15,068

16,437

18,434

19,980

Tax

(2,896)

(4,469)

(3,219)

(3,698)

(4,332)

(4,695)

Profit After Tax (norm)

12,762

18,090

13,112

14,264

15,772

17,082

Profit After Tax (FRS 3)

10,845

15,148

8,849

12,739

14,102

15,285

Discontinued operations

0

0

0

0

0

0

Average Number of Shares Outstanding (m)

59.8

60.1

60.1

60.1

60.1

60.1

EPS - normalised (p)

 

 

21.3

30.1

21.8

23.7

26.2

28.4

EPS - adjusted (p)

 

 

19.7

27.1

19.7

21.2

23.5

25.4

EPS - (IFRS) (p)

 

 

18.1

25.2

14.7

21.2

23.5

25.4

Dividend per share (p)

6.0

7.5

7.5

8.1

8.9

9.7

Gross Margin (%)

29.2

34.0

27.8

28.5

29.2

29.9

EBITDA Margin (%)

16.4

20.0

15.6

16.3

16.6

16.8

Operating Margin (before GW and except.) (%)

14.7

18.6

12.1

12.9

13.3

13.6

Operating Margin (%)

13.8

17.2

11.2

11.9

12.3

12.5

BALANCE SHEET

Fixed Assets

 

 

54,048

65,811

66,319

69,431

70,653

72,084

Intangible Assets

1,358

2,424

2,345

2,278

2,221

2,172

Tangible Assets

50,159

61,039

63,182

66,362

67,640

69,119

Investments

2,531

2,348

792

792

792

792

Current Assets

 

 

69,472

83,606

95,979

101,302

87,363

97,716

Stocks

36,050

47,263

58,222

61,715

65,107

68,035

Debtors

24,167

26,371

30,497

32,327

34,111

35,653

Cash

7,739

7,260

7,260

7,260

(11,854)

(5,972)

Other

1,516

2,712

0

0

0

0

Current Liabilities

 

 

(15,989)

(30,460)

(35,761)

(35,042)

(19,427)

(19,544)

Creditors

(12,640)

(17,620)

(18,614)

(18,961)

(19,284)

(19,401)

Short term borrowings

(3,203)

(12,697)

(17,004)

(15,939)

0

0

Provisions

(146)

(143)

(143)

(143)

(143)

(143)

Long Term Liabilities

 

 

(16,411)

(11,605)

(18,483)

(17,950)

(9,981)

(9,981)

Long term borrowings

(3,450)

(2,624)

(8,502)

(7,969)

0

0

Other long term liabilities

(12,961)

(8,981)

(9,981)

(9,981)

(9,981)

(9,981)

Net Assets

 

 

91,120

107,352

108,054

117,741

128,608

140,275

CASH FLOW

Operating Cash Flow

 

 

15,677

13,892

6,091

19,014

20,987

23,128

Net Interest

(191)

(270)

(415)

(1,004)

(677)

(413)

Tax

(2,191)

(4,874)

(3,219)

(3,698)

(4,332)

(4,695)

Capex

(23,909)

(13,195)

(7,079)

(8,204)

(6,336)

(6,771)

Acquisitions/disposals

(1,041)

(1,178)

0

0

0

0

Financing

(69)

(212)

0

0

0

0

Dividends

(3,378)

(3,704)

(4,509)

(4,509)

(4,848)

(5,367)

Net Cash Flow

(15,102)

(9,541)

(9,132)

1,598

4,794

5,883

Opening net debt/(cash)

 

 

(15,958)

(427)

9,114

18,246

16,648

11,854

HP finance leases initiated

0

0

0

0

0

0

Other

(429)

(0)

0

0

(0)

0

Closing net debt/(cash)

 

 

(427)

9,114

18,246

16,648

11,854

5,972

Source: Edison Investment Research, company data


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This report has been commissioned by Treatt and prepared and issued by Edison, in consideration of a fee payable by Treatt. Edison Investment Research standard fees are £60,000 pa for the production and broad dissemination of a detailed note (Outlook) following by regular (typically quarterly) update notes. Fees are paid upfront in cash without recourse. Edison may seek additional fees for the provision of roadshows and related IR services for the client but does not get remunerated for any investment banking services. We never take payment in stock, options or warrants for any of our services.

Accuracy of content: All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report and have not sought for this information to be independently verified. Opinions contained in this report represent those of the research department of Edison at the time of publication. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations.

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This report has been commissioned by Treatt and prepared and issued by Edison, in consideration of a fee payable by Treatt. Edison Investment Research standard fees are £60,000 pa for the production and broad dissemination of a detailed note (Outlook) following by regular (typically quarterly) update notes. Fees are paid upfront in cash without recourse. Edison may seek additional fees for the provision of roadshows and related IR services for the client but does not get remunerated for any investment banking services. We never take payment in stock, options or warrants for any of our services.

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Investment in securities mentioned: Edison has a restrictive policy relating to personal dealing and conflicts of interest. Edison Group does not conduct any investment business and, accordingly, does not itself hold any positions in the securities mentioned in this report. However, the respective directors, officers, employees and contractors of Edison may have a position in any or related securities mentioned in this report, subject to Edison's policies on personal dealing and conflicts of interest.

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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

1185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

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