There is a reason the companies Ashburton Investments invests into as part of the Ashburton Global Leaders Equity Fund are renowned names, after all they offer exposure to key sectors such as information technology, healthcare, consumer staples, consumer discretionary and financials. The fund invests in no more than 25 hand-picked stocks including the likes of Microsoft, BlackRock, Home Depot and Novartis. But it is the lesser-known names and sectors which make for fascinating reading.
A key advantage for South Africans choosing to invest offshore is gaining access to attractive sectors which are not accessible on the Johannesburg Stock Exchange (JSE). One such sector is the US$75 billion global food ingredients and flavours market. Companies operating in this industry offer a wide variety of services such as formulating recipes, improving current product ingredients and taste, adding nutrition to products, developing products, localising food products, manufacturing products and fully integrated food solutions.
Globlal ingredients and flavours market 2019
Source: Kerry Group presentation 2019
Kerry Group's taste and nutrition division (Revenue%)
Source: Kerry Group presentation 2019
The ingredients sector has become increasingly more important to food producers and food service companies, this is driven by a need for constant innovation in order to keep up with rapidly-changing consumer preferences which, in turn, are shortening the lifecycle of food products. Nutrition, natural food ingredients, healthy convenience, plant-based, better-for-you, functional, local and ‘clean labels’ are key themes driving this sector.
‘Clean label’ is a term that refers to making food products that have fewer ingredients or more ingredients which are recognisable to the customer. Consumers want to know what goes into their food products and how much processing their food has undergone. In addition, lifestyle, wellness and nutrition have become increasingly more important for today’s consumers.
In a similar vein, ‘made for me’ products are becoming increasingly popular, from sugar-free, gluten-free and plant-based, to dairy-free, colourant-free and allergen-free.
Convenience is also extremely important as consumers demand the ability to access healthy food on the run. Plus, for global food companies seeking to enter new markets, it is critical to localise food offerings to suit local tastes and idiosyncrasies.
The technology, research and development involved in this sector come at a high cost, an industry-wide trend that has created a high barrier to entry as more and more food producers and food service companies outsource this function to specialists. In addition, the food ingredients sector is highly fragmented with a tremendous amount of consolidation potential.
Pick of the crop
Our preferred pick in this sector is Kerry Group which we own in the Global Leaders Equity Fund. The company was, until recently, the largest player in the food ingredients market with around 8% market share (see accompanying chart). However, in November 2019 two of Kerry Group’s competitors, namely International Flavours & Fragrance and DuPont’s nutrition business, merged to create a combined entity with an estimated market share of 16%. There is still, however, much scope for further consolidation in the sector, especially for Kerry Group which has a strong acquisition pipeline and balance sheet.
Kerry Group, which is headquartered in Ireland, operates in more than 30 countries worldwide and on six continents. It generates 28% of its revenue from developing markets, which represents the company’s fastest-growing area. Kerry Group’s end user market is well diversified as illustrated in the following chart, with three different service channels: food service, retail and manufacturing.
Kerry Group offers its clients assistance through all stages of product development from idea creation to development and testing, recipe fine tuning, scale up and manufacturing. The categories that have really been driving sales are meat, snacks and beverages. In addition, the company is seeing notable opportunities within the food service industry, which now accounts for around 27% of sales. Kerry Group’s client base is one third local, one third regional and one third global food companies and its top 12 clients comprise around 26% of sales volumes in its taste and nutrition business.
Due to the fragmented nature of the ingredients market, Kerry Group has been acquiring smaller players in both developed and developing markets. When making acquisitions the company has been focused on four strategic initiatives: taste, nutrition, developing markets and food service. When Kerry Group acquires these companies, it leverages the new technology across its portfolio in order to improve its offering to global clients. It also currently has the widest breadth of technologies across its peer group and is the market leader with respect to integrated solutions.
Kerry Group’s taste and nutrition division has reported strong organic volume growth over recent years which we expect to continue, supported by sales from acquiring small to medium-sized business. We also expect margin expansion through operating leverage, a further category shift towards its higher margin taste and nutrition offering and a better product mix due to the extensive use of sophisticated technologies. Combined with incremental growth from a strong acquisition pipeline, the Kerry Group offers investors good earnings growth in a structurally attractive sector.
Kerry Group vs MSCI All Country World Index
Source: Bloomberg (rebased)
Europe flavours, fragrances and ingredients competitive peers 12M forward price to earnings
Source: Bloomberg (equal weighted)
From a valuation perspective, in recent years there has been a significant re-rating of the European flavours, fragrances and ingredients sector (as indicated in the accompanying chart). The sector now trades at a premium to the food sector due to the expectation of superior organic growth and further consolidation opportunities.
We believe the re-rating better reflects the positive dynamics of the sector which, as explained above, are best accessed through Kerry Group.
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