Moskow, who has initiated coverage of Ingredion with an “outperform” rating, said the company’s shares are undervalued because of a “knee-jerk” investor reaction to its exposure to the high-fructose corn syrup market. Such a response is at odds with the reality of a relatively stable and profitable corn sweetener business and with the growth outlook for the specialty starch market. As an ingredient supplier, Ingredion has established a strong presence in products representing the fastest growing label claims – low glycemic, GMO free and gluten free, Moskow said.
“The reality is that the company’s specialty starch business (15% of sales) is well-positioned to help multinational customers reformulate and introduce new products that meet the growing demand for food with stronger nutritional profiles,” Moskow said. “Specialty starches are growing at a double-digit pace and enhancing the company’s margins, and they have high barriers to entry due to the capital investment and research and development required.”
With earnings per share growth prospects of 12% per year through fiscal year 2017 (fiscal year ending Dec. 31), Moskow has offered a price target for Ingredion shares of $80, versus a price of about $68 on April 16, the day the research report was issued.
The 52-page analysis includes discussions of both the specialty starch and the corn sweetener markets.
The specialty starch portfolio of Ingredion is targeted at food and beverage companies exploring ways to reformulate their products in ways that address rising concerns about obesity, nutritional content and label simplification.
“Ingredion’s strong R.&D. and technical capabilities, including a state-of-the-art facility in New Jersey, provide the company with a sustainable competitive advantage,” Moskow said. “Total starches comprised 41% of sales in 2013. Their uses in food are very broad and range from thickening and texturizing to product stability and emulsification. Starches are most commonly used as a thickener in products like yogurt and soups, but they have many more very specialized functions. As an example, cracker manufacturers use specialty starches to control the crunchiness of the product when they reformulate to remove gluten for health conscious consumers. Starches can also provide binding properties that allow manufactures to add vitamin-C to beverages without having it clump at the bottom of the bottle. Manufacturers of microwavable meals use starches to ensure stability of their products, as they are cooked, frozen, and then cooked again.”
He said food companies use Ingredion starches for fat and dairy replacement.
“The starches mimic the mouthfeel and texture of fatty ingredients without the actual fat,” Moskow said. “Customers also use certain Ingredion starches as a substitute for sweeteners to trick the mouth into thinking food is sweet while reducing calories. In addition, Ingredion supplies specialty grains products for food processors that are looking to increase the fiber content of their food products. Chicory root is considered a competitor in this area, but Ingredion has an emulate product in agave root that is more expensive but easier to digest.”
In Europe, Ingredion starches allow customers to navigate rules that require special labeling when starches are modified with enzymes. Ingredion’s Novation brand is produced with heat treatment rather than enzymatic or chemical modification, Moskow said.
As an investment proposition, Moskow said specialty products have higher margins (25% gross margins) than the Ingredion legacy products (16% margins). Because the products are customized, Ingredion will be able to establish customer relationship with a “high level of stickiness,” he said.
“Ingredion has more pricing power in the specialty products industry because it is a less competitive space than commodities without readily available substitutes,” Moskow said.
While upbeat on Ingredion’s outlook, Moskow is mindful of risks the company faces, beginning with the company’s exposure to the Mexico corn sweetener market, which has been subject to trade disagreements with the U.S. Similarly, Ingredion’s exposure to Argentina is worrisome because of economic challenges there. Domestically, the carbonated soft drink market looks vulnerable to accelerating declines given a shift toward organic/natural processed foods and beverages, Moskow said.
He had high praise for a management team he said includes “some of the longest tenured leaders in our coverage space.”
“CEO Ilene Gordon's arrival at the company in May 2009 was a positive catalyst for the organization,” he continued. “Gordon had a strong track record for success in prior roles at Alcan Packaging and Packaging Corporation of America and a bias toward action. She has an engineering background, selling experience, and excellent management skills. She arrived at the company during a critical time because the board had just voted down Bunge’s offer to buy the company, and business performance was getting hurt by the global financial crisis. Understandably, all of this caused a fair degree of distraction and uncertainty for the company’s employees, many of whom speculated that Ingredion would go up for sale again.
“Rather than radically shake up the organization when she arrived, she wisely chose to inspire the executives in the organization to achieve their full potential. Ingredion had talked for years about shifting the mix of its portfolio more toward value-added products but had not shown much progress. Gordon forced the issue by decisively acquiring National Starch quickly after she arrived. Since she joined the company, the stock is up 155% compared with 104% for the S&P 500.”