The agricultural market has been hit hard in recent years. A confluence of factors, ranging from oversupply in North America to crop-destroying floods and droughts in South America, has held back the growth of major companies in the industry. Ingredient (NYSE: INGR), which focuses on selling corn-based sweeteners and texturizing ingredients to food industries, has not been spared. From 2014 to 2016, the ingredients leader reported annual revenue of $ 5.67 billion, $ 5.62 billion and $ 5.7 billion.
The good news is that the stock has performed remarkably well over this period, easily beating the S&P 500 total returns. Why? Ingredion has started to walk the well-trodden path of other mature companies. That is, the company increased its EPS and cash flow by focusing on optimizing existing operations, rather than prioritizing revenue growth. Management expects this to continue this year, with a combination of growth investments. A look at the initiatives underway suggests the future of investors.
Image source: Getty Images.
The path to a cash cow
Investors looking for a stable business with reliable profits and cash generation may consider taking a look at Ingredion. It provides a range of valuable ingredients for many diverse industries. Customers reside in food, beverage, animal nutrition, papermaking, brewing and several other markets. The company classifies the products it sells into three categories:
|
type of product |
The description |
% of 2016 sales |
|---|---|---|
|
Starch ingredients |
Corn starches are found in most of the foods you eat due to their wide applications, from adhesion to fat replacement to texture. |
46% |
|
Sweeteners |
Most of the ingredients in this group are syrups that contain sugar, such as high fructose corn syrup, but several sugar-free sweeteners are also available. |
37% |
|
Co-products |
The by-products of corn processing are sold in animal feed markets and even to become salad dressings and cooking oil. |
17% |
Data source: SEC documents.
Yet while Ingredion has made itself valuable to various clients, it has struggled to increase its revenue in recent years. Thus, he doubled down on a popular strategy of “creating shareholder value”, as explained by almost all the companies that follow him. This includes containing unnecessary costs, investing in expanding margins rather than revenue growth, and initiating a share buyback program. The moves are aimed at increasing EPS and cash flow, even if revenue doesn’t increase much.
Investors can’t really be upset by the strategy. The results for 2016 have shown that it is working well.
|
Metric |
2016 |
2015 |
% Change |
|---|---|---|---|
|
Income |
$ 5.70 billion |
$ 5.62 billion |
1.5% |
|
Operating result |
$ 808 million |
$ 660 million |
22.4% |
|
Adjusted EPS |
$ 7.13 |
$ 5.88 |
21.2% |
|
Operating cash flow |
$ 771 million |
$ 686 million |
12.4% |
Data source: Ingrédion.
The strategy is expected to continue to make improvements over the coming year. Management forecasted adjusted EPS for full year 2017 in the range of $ 7.50 to $ 7.80 and cash flow from operations in the range of $ 800 million to $ 850 million, two clear improvements from levels reached in 2016. In addition, the number of shares has already been reduced by 1.1% since the end of last year, which will further increase EPS.
Of course, there is only a limited amount of fat that can be removed from operations, which has a limit to the efficiency they can achieve. There’s no way to know if the business is approaching that threshold, but it stands to reason the party will eventually end. What happens then?
Management’s strategy to exploit long-term growth opportunities is primarily focused on increasing the share of high-margin specialty ingredients that meet food industry trends, such as consumer demands for “Clean labels” and “natural” ingredients. Today, they’re grouped under the starch and sweetener product categories, but specialty ingredients would have accounted for 26% of total sales in 2016 if they had been reported separately. This is an increase from 24% in 2014.
Total return price INGR given by YCharts
The growth of specialty ingredients is important, especially as other starch and sweetener products are falling out of favor (hello stevia). Ingredion is currently expanding its portfolio through acquisitions, including that of TIC Gums in late December, although it may miss larger and longer-term opportunities presented by industrial biotechnology. Regardless, the last three acquisitions were specifically focused on specialty ingredients, again showing management’s priorities when using cash if necessary.
What’s next for Ingredion investors?
Ingredion’s mature business is emerging as a cash cow, which should lead to much higher dividend payouts or additional acquisitions, or perhaps a mix of the two. A growing war chest in the years to come could even allow it to quickly catch up with missed opportunities, such as in stevia ingredients or with innovative industrial biotechnology manufacturing platforms. It may take years to see a significant impact from increased sales of specialty ingredients that offset declines in other areas of the business, but the current strategy appears to put the company on a solid footing to long term.
This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are motley! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.
