INGR - Ingredion: Higher Margins And Lower Growth

2023-03-13 14:56:20 ET

Summary

• Inflation could shift from a growth tailwind to a headwind, exacerbated by falling end-market demand.
• Like many peers, margins have been declining for the better part of a decade. Ingredion is trying to offset this by expanding product creation capabilities and optimizing their product portfolio.
• Ingredion’s current valuation is in line with historical norms but could decline if investor appetite for inflation hedges wanes.

Ingredion ( INGR ) had a solid 2022 on the back of extremely large price increases. Agricultural price inflation is likely to decline in 2023 though, which may eventually feed through into lower pricing for Ingredion. While Ingredion's growth appears set to slow, this could be offset to some extent by an improvement in margins. Even with increasing profits, Ingredion's stock could be pressured if investor appetite for inflation hedges leads to a multiple rerating.

Ingredion

Ingredion is a leading ingredients supplier to the food and beverage industry. They utilize raw materials like corn, tapioca, potatoes, plant-based stevia, grains, fruits, gums and vegetables to manufacture higher value ingredients. Ingredion’s products are derived primarily from the processing of corn and other starch-based materials. Ingredion products include:

• Starches - food-grade and industrial starches
• Sweeteners - glucose syrups, high maltose syrups, high fructose corn syrup, caramel color, dextrose, polyols, maltodextrins, and glucose and syrup solids
• Animal Feed Products
• Edible Corn Oil

Ingredion generally classify their products as Starch Products, Sweetener Products, and Co-products and others.

Starch Products

Starches are used in a range of processed foods to provide properties like adhesion, gelling, glazing, mouthfeel, stabilization and texture. There are also non-food starch applications (e.g. textiles, paper).

Sweetener Products

In addition to taste, sweeteners provide texture, body and viscosity; help to control freezing points; and act as binders.

Co-Products and Others

Refined corn oil is sold to packers of cooking oil and to manufacturers of products like margarine and mayonnaise. Corn gluten feed is sold as animal feed. Ingredion also offers fruit and vegetable products (purees and essences), pulse proteins and hydrocolloid systems.

Ingredion has broadened their portfolio over the past four years, through a combination of internal development and M&A. This appears to be a response to declining margins and a lack of growth. In particular, Ingredion have increased their exposure to potential growth areas, like alternative sweeteners and plant-based proteins.

Ingredion has a large number of manufacturing facilities that are distributed globally. Many of these facilities are relatively capital intensive, helping to provide a barrier to entry.

North America has 22 manufacturing facilities which produce a wide range of starches, sweeteners, gum acacia, peas, and fruit and vegetable concentrates.

South America has 7 manufacturing facilities that produce tapioca starches, high fructose and high maltose syrups and syrup solids, dextrins and maltodextrins, dextrose, specialty starches, caramel color and sorbitol.

Asia-Pacific manufactures corn-based products in South Korea, China and Thailand. Ingredion also manufacture tapioca and rice-based products in Thailand and plant-based stevia sweetener products in Malaysia and China.

EMEA has 6 manufacturing facilities that produce modified and specialty starches, glucose and dextrose in Pakistan, Germany and the United Kingdom.

Ingredion also utilizes a network of third-party manufacturers for the production of certain specialty starches. These manufacturers typically produce basic starches, which Ingredion completes the manufacturing of through their finishing channels.

Grind utilization on the production side is a potential tailwind for Ingredion going forward, if demand remains strong. Grind utilization is a large determinant of pricing and remains at elevated levels in the US . Part of this has been driven by strong demand for renewable feedstocks. The fixed asset investments required to expand capacity ensure that lead times to expand capacity are long.

Like a number of peers, Ingredion is trying to provide more value to customers by increasing their product creation capabilities. Ingredion have approximately 500 global food technology R&D scientists and 32 Ingredion Idea Labs. Ingredion's Food System offering helps customers commercialize new products faster by providing systems of ingredients that work in synergy.

Acquisitions

In April 2021, Ingredion acquired KaTech for their texture and stabilization solutions, which are utilized in the food and beverage industry. This acquisition was in support of Ingredion's Food Systems services.

Sugar Reduction

The global market for sugar and alternative sweeteners is worth over 100 billion USD , although growing slowing. In comparison, it is estimated that the market for alternative sweeteners is worth approximately 9 billion USD and the market for RebM approximately 2 billion USD.

This is a large opportunity, which Ingredion is capitalizing on through their acquisition of PureCircle in 2020. At the time, PureCircle was the leading producer of plant-based stevia sweeteners and flavors globally. Ingredion subsequently expanded the portfolio to include extracted, bio-fermented, and fermented Reb M, making Ingredion a market leader in high-intensity natural sweeteners. Ingredion's access to fermented RebM came through the acquisition of exclusive commercialization rights from Amyris ( AMRS ). As part of the deal, Ingredion also took a 31% ownership stake in a JV for the product.

Rebaudiosides are steviol glycosides found in the leaves of the stevia plant and are over 100 times sweeter than sugar. The use of steviol glycosides has been rising due to their combination of sweetness profile, cost and the fact they are naturally occurring. Steviol glycosides have zero sugars, zero carbohydrates and zero calories. Stevioside was the pioneering stevia-based sweetener as it is the most abundant steviol glycoside in stevia leaves, but it has a bitter aftertaste. Reb A is twice as sweet as stevioside, tastes better and is now the most widely used steviol glycoside. Stevioside ( 5–10% ) and rebaudioside A (2–5%) are the most abundant steviol glycosides, followed by various rebaudiosides (B, C, D, F, M). Reb M has a similar taste to sugar and unlike steviol glycoside and Reb A, it does not require masking agents, but it amounts to less than 0.1% of the leaf’s dry weight, making it impractical for commercial production through extraction.

PureCircle’s net sales are up by more than 60% on an annualized basis since 2020 and Ingredion continues to believe that there are large opportunities ahead for the sugar reduction business. For example, they are still in the process of gaining regulatory approval for some of their products. EU approval of Ingredion's Reb M product was received in the third quarter of 2022.

Plant-Based Proteins

Plant-based proteins offer a 10 billion USD market opportunity, which is growing more than 6% annually. This could potentially provide Ingredion with secular growth, driven by climate change concerns and evolving consumer tastes. For example, 50% of global consumers say they want to try plant-based versions of traditional cuisines.

While Ingredion's plant-based protein business is still small, the company believes it has a solid position. Ingredion believe there are opportunities in fortified bakery, alternative dairy, sports nutrition and beverages.

Ingredion's South Sioux City facility is an important part of their protein business. This facility is working on improving product quality attributes to broaden the appeal of Ingredion’s products and has been rapidly expanding output.

Ingredion also increased their ownership of Verdient Foods from 20% to 100% in November 2020 to support their plant-based protein business. Verdient is a Canadian producer of pulse-based protein concentrates and flours from peas, lentils and fava beans.

Pharmaceutical Ingredients

Ingredion plans on selectively expanding their pharma ingredient portfolio, which could improve margins and diversify their revenue streams. In support of this, Ingredion recently acquired two Indian companies (Amishi and Mannitab) in the high-value pharma ingredient space. Amishi manufactures chemically modified starch-based pharmaceutical excipients (non-API ingredients). These acquisitions enable tablet and capsule manufacturing. Ingredion anticipate double-digit net sales growth and above average gross margins for this business.

Starch-Based Texturizers

Starch-based texturizers are another focus area for Ingredion, as the company believes that this segment offers attractive returns with low execution risk.

In support of this business, Ingredion is investing in additional modified starch finishing capacity and are attempting to localize more production. Out of a planned 160 million USD of investments, one third of the capacity has been installed.

Ingredion recently ramped production at their Shandong facility in China, which increases their ability to produce specialty modified starches. This facility makes Ingredion the largest producer of modified starch in China and positions Ingredion to capitalize on potential growth there.

Financial Analysis

Two thirds of Ingredion’s revenue is generated outside of the US, and as a result of the strong USD, the company faced a 200 million USD foreign exchange headwind in the fourth quarter of 2022. Ingredion has been able to largely offset inflationary headwinds though pricing actions, which were responsible for much of Ingredion’s growth in 2022.

Ingredion expects double digit net sales growth in 2023, driven by both strong pricing and solid volumes.

Ingredion has a healthy sales mix across categories, with food generating the bulk of Ingredion’s revenue. PureCircle generated over 400 million USD net sales in 2022, achieving strong double-digit growth in the fourth quarter. The plant-based proteins business generated net sales of 36 million USD in 2022, up 118% from the prior year period. While this is a strong result, it fell short of management’s expectations, both in terms of top line growth and reduction in operating losses.

While Ingredion's recent growth has been strong, volume growth has been declining and could become a significant headwind in 2023. This could be exacerbated by lower inflation, which would undermine Ingredion's ability to drive further growth through higher prices.

Ingredion has faced significant cost pressure over the past 12 months, due to higher raw material prices, higher logistics costs and rising energy costs. Corn is Ingredion’s largest raw material input, the price of which was significantly impacted by the war in Ukraine and drought in Europe.

There have also been times where Ingredion has been forced to switch transportation from rail to trucks and from ocean freight to air freight in order to meet customer commitments, at significant expense.

A Union related work stoppage at Ingredion’s Cedar Rapids facility has also been a drag on performance. Ingredion ratified their agreement with the union in January 2023, which will reduce costs going forward.

Ingredion has been able to offset much of this through pricing actions and efficiency initiatives. For example, Ingredion delivered 1.3 billion USD of net sales growth in 2022 through a combination of inflation cost pass-through and customer and product mix management.

Ingredion continues to assess their supply chain and manufacturing operations in order to lower costs. This includes investments to:

• Enhance supply chain connectivity and visibility
• Drive digital transformation of the factory floor
• Unify the global procurement organization

In general, Ingredion believes that their pricing lags the cost of corn in inflationary environments, causing margin compression. With agricultural commodity prices now declining, this could be a margin tailwind in 2023.

Profits are only expected to grow high single digits to low double digits in 2023, indicating further potential margin compression.

Valuation

Ingredion’s current valuation appears to be in line with its historical average, but this needs to be weighed against the fact that sales volumes could remain under pressure and pricing is likely to decline substantially in the next 1-2 years. These factors could be offset by higher margins though.

There are growth opportunities offered by geographic expansion and evolving markets like plant-based proteins and alternative sweeteners, which could help to support modest growth going forward.

If investors decide that we are not in a long-term inflationary environment, the valuation of stocks like Ingredion that are viewed as an inflation hedge are likely to be pressured as well.

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