Treatt — Update 27 February 2017

Consumer

Treatt

Keep Treat(t)ing

Trading statement

Food & beverages

27 February 2017

Price	319.00p
Market cap	£166m

Net debt (£m) at 30 September 2016		1.7

Shares in issue	51.9m
Free float	100%
Code	TET

Primary exchange	LSE
Secondary exchange	N/A

Share price performance

%	1m	3m	12m
Abs	27.4	27.1	79.7
Rel (local)	25.4	19.8	47.2

52-week high/low

319.0p

163.5p

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

H117 results	9 May 2017
FY17 results	28 November 2017

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 yet again beaten expectations by delivering an exceptionally strong start to FY17 despite Q1 typically being a seasonally weak quarter. The success is across the board and has led to a surprise trading statement (23 February). We upgrade our forecasts to reflect the strong sales growth and also the margin improvement as Treatt moves further up the value chain. Our fair value increases to 350p (from 293p) as a result.

Year end	Revenue (£m)	PBT* (£m)	EPS* (p)	DPS (p)	P/E (x)	Yield (%)
09/16	88.0	9.6	14.3	4.4	22.3	1.4
09/17e	99.5	12.5	18.4	5.6	17.3	1.8
09/18e	107.4	13.7	20.1	6.1	15.8	1.9
09/19e	111.7	14.1	20.8	6.3	15.3	2.0

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

Strategy continues to deliver

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 goal has been delivered consistently over the past few years, with results often beating expectations. As a result of the trading update, we yet again upgrade our full-year forecasts for 2017-19 to reflect the improved outlook. Our sales forecasts move up c 10%, while PBT and EPS increase by c 20-30%, as Treatt’s move up the value chain should deliver a strong improvement in margins.

Ingredients remain an attractive space

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; this requires specialist ingredients. Margins are also typically high at the value-added end, as the ingredients deliver key attributes to the end products. 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 beverages and is becoming increasingly specialised in this space, with tea a specific area of growth.

Valuation: An attractive ingredients play

Our DCF-derived fair value is 350p (previously 293p), an attractive c 12% upside to the current share price. This is supported by its benchmark valuation, with Treatt trading at 16.7x CY17e P/E and 11.8x CY17e EV/EBITDA. This represents a c 30% and c 23% discount, respectively, to its ingredients peer group. Given our outlook for the business and its strong track record, we believe this level of discount is unwarranted.

Business update

Treatt has witnessed strength across the board. All key product categories have been performing well in H117, with citrus and sugar reduction solutions being particularly successful. The group has also seen strong growth in the personal care space (the Earthoil division). Order books are in very good shape for the rest of FY17 but also looking out to FY18.

Revenue growth has been particularly strong as it is currently estimated to be up over 20% during H117. This comes as a result of both new business wins and growth with existing customers, which is very encouraging. Margins continue to improve as the company moves up the value chain and delivers more enhanced solutions to its customers.

Higher raw material costs and a bulging order book have had an impact on working capital, and hence net debt is now expected to be £10-12m at the end of H117 (vs £8.4m at H116). As a reminder, Treatt typically has a seasonal cash outflow in H1 that then reverses in H2, hence FY17 net debt is still expected to fall significantly vs H117. We forecast net debt of £2.0m at end FY17.

Forecast revisions

We detail our key changes to P&L forecasts in Exhibit 1 below. We have upgraded our FY17 forecasts to reflect the extremely positive start to the year, and we have also increased our forecasts for future years as Treatt is accelerating its move up the value chain, and order books for the remainder of FY17 and for FY18 are materially up. Improved sales growth should lead to operating leverage, and the move towards value-added products should also be beneficial to margins. We have increased our pre-tax profit and EPS forecasts by c 20-30%.

Exhibit 1: P&L forecast changes

	EPS (p)*			PBT (£000s)*			Sales (£000s)
	Old	New	% chg	Old	New	% chg	Old	New	% chg
2017e	13.7	16.5	21.2%	9,509	11,525	21.2%	92,442	99,485	7.6%
2018e	14.1	18.1	28.7%	9,812	12,629	28.7%	96,140	107,444	11.8%
2019e	14.4	18.8	30.7%	9,998	13,063	30.7%	99,985	111,742	11.8%

Source: Edison Investment Research. Note: *EPS and PBT are stated on a company normalised basis, which is pre-exceptional but after amortisation of acquired intangibles and share-based payments (IFRS).

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 30% discount on P/E and c 23% discount on EV/EBITDA is unwarranted.

Exhibit 2: Benchmark valuation

	Market cap (m)	P/E (x)		EV/EBITDA (x)		Dividend yield (%)
	Market cap (m)	2017e	2018e	2017e	2018e	2017e	2018e
Givaudan	CHF16,814	23.6	22.0	15.7	14.7	3.2%	3.5%
IFF	$9,740	21.0	19.4	14.3	13.1	2.1%	2.3%
Symrise	CHF8,048	25.9	23.4	14.6	13.2	1.5%	1.6%
Frutarom	ILS12,153	26.8	21.6	17.2	14.7	0.5%	0.6%
Chr Hansen	DKK55,338	33.7	30.0	21.8	19.7	1.5%	2.0%
Kerry	€12,780	20.9	18.9	14.9	13.4	0.8%	0.9%
Ingredion	$8,659	15.9	14.9	8.9	8.3	1.7%	1.8%
Peer group average		24.0	21.5	15.4	13.9	1.6%	1.8%
Treatt	£161.9	16.7	15.5	11.8	10.7	1.8%	2.0%
Premium/(discount) to peer group (%)		(30.3%	(27.9%)	(23.2%)	(22.6%)	11.2%	7.9%

Source: Bloomberg. Note: Prices at 23 February 2017. Treatt figures are calendarised to aid comparison.

Our DCF-derived fair value is now 350p (previously 293p) 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 7.5% (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

Treatt has outgrown its current UK manufacturing facilities in Bury St Edmunds and had been exploring options for some time. In May 2015 the company announced its intention to fully relocate the UK business to another site near the existing one. On 22 December 2016, Treatt announced it had conditionally exchanged contracts on a 10 acre plot of land. The purchase is conditional upon the vendor obtaining outline planning permission, so the exact timing is unknown, but is likely to be later during CY17. The new facility will be purpose-built, with upgraded machinery and the latest technology. Construction is expected to begin in 2018, with the site up and running by late 2019.

Although there have been sharp movements in FX, 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 reduced profits by £0.5m in FY16, and the hedging policies should substantially reverse this figure in H117.

Exhibit 3: Financial summary

	£000s	2014	2015	2016	2017e	2018e	2019e
Year end 30 September		IFRS	IFRS	IFRS	IFRS	IFRS	IFRS
PROFIT & LOSS
Revenue		79,189	85,934	88,040	99,485	107,444	111,742
Cost of Sales		(61,218)	(66,955)	(67,639)	(75,338)	(81,042)	(84,061)
Gross Profit		17,971	18,979	20,401	24,147	26,402	27,681
EBITDA		9,068	10,307	11,604	14,692	16,297	17,273
Operating Profit (before amort., except and sbp.)		7,846	9,063	10,257	13,034	14,506	15,410
Intangible Amortisation		(172)	(175)	(142)	(160)	(160)	(160)
Share based payments		(46)	(198)	(566)	(790)	(866)	(896)
Other		0	0	0	0	0	0
Operating Profit		7,628	8,690	9,549	12,084	13,480	14,355
Net Interest		(724)	(740)	(703)	(559)	(851)	(1,291)
Exceptionals		(1,402)	(174)	(553)	0	0	0
Profit Before Tax (norm)		7,122	8,323	9,554	12,475	13,655	14,119
Profit Before Tax (FRS 3)		5,502	7,776	8,293	11,525	12,629	13,063
Profit Before Tax (company)		6,904	7,950	8,846	11,525	12,629	13,063
Tax		(1,553)	(1,786)	(2,144)	(2,939)	(3,220)	(3,331)
Profit After Tax (norm)		5,326	6,537	7,410	9,536	10,434	10,788
Profit After Tax (FRS 3)		3,949	5,990	6,149	8,586	9,408	9,732

Average Number of Shares Outstanding (m)		51.3	51.5	51.9	51.9	51.9	51.9
EPS - normalised (p)		10.4	12.7	14.3	18.4	20.1	20.8
EPS - normalised & fully diluted (p)		10.3	12.6	14.1	18.1	19.8	20.5
EPS - (IFRS) (p)		7.7	11.6	11.8	16.5	18.1	18.8
Dividend per share (p)		3.8	4.0	4.4	5.6	6.1	6.3

Gross Margin (%)		22.7	22.1	23.2	24.3	24.6	24.8
EBITDA Margin (%)		11.5	12.0	13.2	14.8	15.2	15.5
Operating Margin (before GW and except.) (%)		9.9	10.5	11.7	13.1	13.5	13.8

BALANCE SHEET
Fixed Assets		13,777	13,381	16,161	22,335	39,996	43,150
Intangible Assets		1,801	1,736	3,364	3,204	3,044	2,884
Tangible Assets		10,994	10,998	11,361	17,695	35,516	38,830
Investments		982	647	1,436	1,436	1,436	1,436
Current Assets		43,590	45,045	54,435	51,081	53,515	54,407
Stocks		28,020	25,799	29,990	30,904	32,302	32,477
Debtors		14,509	17,635	17,853	19,676	20,713	21,430
Cash		629	1,477	6,588	500	500	500
Other		432	134	4	0	0	0
Current Liabilities		(16,005)	(13,481)	(16,388)	(17,660)	(26,706)	(24,799)
Creditors		(12,729)	(12,675)	(15,834)	(16,383)	(17,693)	(18,401)
Short term borrowings		(2,356)	(567)	(487)	(1,277)	(9,012)	(6,398)
Provisions		(920)	(239)	(67)	0	0	0
Long Term Liabilities		(12,602)	(11,760)	(17,021)	(9,951)	(13,618)	(12,111)
Long term borrowings		(7,857)	(7,065)	(7,755)	(639)	(4,506)	(3,199)
Other long term liabilities		(4,745)	(4,695)	(9,266)	(9,312)	(9,112)	(8,912)
Net Assets		28,760	33,185	37,187	45,805	53,188	60,647

CASH FLOW
Operating Cash Flow		3,528	8,667	10,804	13,986	14,973	16,889
Net Interest		(724)	(740)	(703)	(559)	(851)	(1,291)
Tax		(1,552)	(1,469)	(2,022)	(2,939)	(3,220)	(3,331)
Capex		(538)	(924)	(679)	(7,992)	(19,612)	(5,176)
Acquisitions/disposals		(208)	(103)	(861)	0	0	0
Financing		105	147	280	0	0	0
Dividends		(1,899)	(1,978)	(2,095)	(2,257)	(2,892)	(3,169)
Net Cash Flow		(1,288)	3,600	4,724	238	(11,603)	3,921
Opening net debt/(cash)		8,294	9,584	6,155	1,654	1,416	13,019
HP finance leases initiated		0	0	0	0	0	0
Other		(2)	(171)	(223)	(0)	0	0
Closing net debt/(cash)		9,584	6,155	1,654	1,416	13,019	9,097

Source: Edison Investment Research, Treatt data

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NSW 2000, Australia

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 8249 8342

Level 12, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

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 8249 8342

Level 12, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

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 8249 8342

Level 12, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

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