Tate & Lyle, a sweet contrarian buy

Since the sale of its sugar business in 2010, Tate has been focused on high-tech food ingredients and industrial goods, producing things such as corn syrup, ethanol, specialised starches, texturants and sweeteners. Its two divisions - bulk and speciality food - are highly profitable, but it’s the latter which offers the most exciting potential for growth and is benefiting from a great deal of investment.

Speciality food (SFI) accounts for 31 per cent of Tate's group sales, but higher margins mean it delivers 55 per cent of operating profit, so it's a vital business. It’s growing too, as industry trends are working in its favour: food producers - Tate's clients - are increasingly using products that address calorie and weight management, heart and digestive health, alongside additives that extend shelf-life and enhance texture and taste. Tate can cater to all of this through its range of sweeteners, both artificial and natural, heart-friendly fibres, starches and low-sodium salt. The innovation pipeline is replete with 35 products, with several to be introduced in the next 12 to 18 months.

Emerging markets are a particularly strong growth area, representing one-fifth of SFI sales. Last year Asia Pacific and Latin America produced double-digit volume growth. Acquisitions, though small, are promising too and give Tate a toe-hold in important geographic regions. For example, recently-acquired Chinese polydextrose fibre company Winway offers a springboard from which to expand across Asia. And Swedish oat fibre start-up, Biovelop, has isolated an oat-based fibre proven to reduce cholesterol and control blood-sugar levels. Having snapped it up, Tate plans to more than treble the size of the business. This is all part of a wider £100m investment into the SFI division, which will increase capacity, promote new products and lead to cost savings.

But all is not rosy in SFI. The division suffered a serious setback in February when a significant overhang of generic Chinese sucralose stock sent prices plummeting, just as Tate was renewing several multi-year contracts for its Splenda sucralose, which accounts about a fifth of the division's revenue. As a result, profits are expected to dip slightly this year. The good news, though, is that half of Splenda sales goes into food where formulation technology and application support is necessary - something which Tate excels at. It works with clients on formulations, product prototyping and testing, tailor-making blends to suit individual requirements, so customers remain loyal. That kind of expertise is what the Chinese generics lack. The division also has a good track record without sucralose. Excluding Splenda the division has achieved a compound average operating profit growth rate of 12 per cent since May 2010 compared with 7 per cent when the sucralose operation is included.

Further headwinds include currency risk and the volatile bulk ingredients division (BI), which is at the mercy of global sugar markets, corn harvests and the weather. That said, these are conditions under which this multi-billion pound business has been trading for years. Furthermore, as SFI blossoms, it will water down volatility in BI. Indeed, many have been calling for Tate to make a more significant acquisition to achieve just this. The balance sheet certainly could stand it: the net debt-to-cash profits ratio is just 0.8, with interest cover at 12 times. Should this materialise, it could lead to a re-rating, bringing the shares in line with others in the sector. Currently, the stock is trading on just 13 times consensus earnings forecasts for the next 12 months, which is a massive 33 per cent discount to the peer group average. And, should a catalyst take longer to develop than hoped, patient shareholders can still enjoy a 4 per cent yield.