The desire for food to be better for us without tasting worse, and for it to cater to the growing number of recognised intolerances is giving rise to a burgeoning industry. Consumers increasingly want more 'natural' food, or need it to be free from gluten or lactose, or want enhanced nutrition from it, which means food producers are increasingly looking to specialist ingredients developers to help modify their existing products, and develop new ones.
In 2010, the speciality food and beverage ingredients market was worth $35bn (£27.5bn). Since then, major players such as Associated British Foods (ABF), Tate & Lyle (TATE) and Kerry (KYGA) have put even more emphasis on new and bespoke ingredients, while the likes of PureCircle (PURE) have continued to promote the use of sugar-alternative stevia. There are also companies such as Irish-domiciled Glanbia (GLB), whose diet-enhancing protein products target fitness enthusiasts.
According to analysts at Berenberg, the flavours and fragrance sector has, since 2011, delivered 4.9 per cent like-for-like sales growth on average - more than twice that of their end markets. The broker believes this outperformance is essentially driven by two main factors: successful new product launches that gain market share, and taking a greater 'share of wallet' within each new product launch. Another boon for these companies is that as well as catering for global multinationals, they also cater to a number of fast-growing, smaller regional competitors, including across emerging markets.
Interestingly, data produced by Berenberg shows that while the absolute number of product launches from the top 20 players across both food, beverage and home/personal care over the past decade has increased by roughly 50 per cent to 48,000, as a percentage of total new product launches globally, it has declined from 21 per cent to 13 per cent. This suggests there is a growing number of companies wanting to focus on developing products with specialist ingredients in them, which should support the trend for the long-term growth in this niche area of food production.
There's evidence to be found over at Tate & Lyle. Famous for its high-fructose corn syrup and sweetener brand Splenda, it wants its speciality food ingredients business to contribute 70 per cent of group profit by 2020 compared with the existing 60 per cent. Something it hopes will help it meet this target is a rare sugar it recently started manufacturing called allulose, which it has branded Dolcia Prima.
In the group's recent half-year results, the volume of new products within the speciality division rose by 28 per cent across three segments: sweeteners, texturants and health and wellness. Sales increased by 18 per cent to $51m (£40m) year on year.
AB Foods is also ensuring its North America bakery ingredients and yeast business focuses on faster-growing segments, including items such as tortillas and flatbreads. It's busy working on new products, including new organic bread ingredients and a range of natural ferments and flavours. There's also a new shelf-life extension product in the works, which should help reduce the amount of food waste in the supply chain.
AB also made a recent investment, both here and in the US, in its 'centres of excellence'. The UK site in Corby, Northamptonshire, was opened in November 2015 and means it can offer its customers what it calls "the latest innovations in bakery development". This echoes the baking hub it opened in January of last year in St Louis, Missouri, while a research and development centre in the Netherlands will be expanded next year.
The desire for 'reduced' or even 'no sugar' products is as strong in beverages as it is in food. One particular ingredient that's becoming well-known by consumers is stevia, a plant that is used as a sugar substitute in products as wide-ranging as Coca-Cola Life to recently launched UK ice cream brand Oppo.
PureCircle is a major provider of stevia-based ingredients to the food and beverage industry and stands to be a long-term beneficiary of the sugar substitute trend. The shares have struggled this year, but this was partly due to US border control wrongly quarantining a shipment based on false allegations that slave labour had been used to harvest the stevia. PureCircle provided verification of its sourcing and the shipments were duly released, but this may have knocked down market sentiment in the short term.
Analysts at Davy believe that, while stable raw material prices have helped margins expand in the sector as a whole, there is "cause to believe that margins can be maintained even if raw material costs were to rise". That's because the sector has become "tremendously dynamic" as demand for less chemically-enhanced foods, characterised by a 'clean' or additive-free label, continues to shape people's preferences. For manufacturers, be it 'big food' or disruptive smaller players, reliance on external food science expertise and new product development has also increased. This is largely provided by the speciality food ingredients subsector.
But this demand for speciality knowledge, and subsequently reformulation, has been largely positive for the sector stalwarts, too. As customers ask for new recipes for existing products and more sophisticated formulations incorporating special ingredients, companies have been able to leverage prices to compensate for these changes. This should give investors near-term confidence over margins, particularly in light of next year's potential inflationary pressures.
There's also potential for consolidation across the industry. Glanbia recently snapped up US company think Thin to enhance its performance nutrition division, its largest by cash profit. That division focuses on exercise and fitness-conscious consumers via its portfolio of largely protein-based products. Broker Davy reckons it could be looking for bolt-on deals given the current state of its balance sheet, while it believes there could be M&A activity in the second half for Kerry, too.
IC VIEW:
Consumers' constantly changing demands mean there will be a market for companies that can help food and drink producers meet those needs. And the fact there's a growing number of regional food and drink companies should mean the customer base remains well-served.
Favourites:
We're bullish about PureCircle given the clear demand for stevia in food and beverages and we also like Glanbia given recent acquisitions and its decision to focus on higher-margin ingredients. It's also got a healthy balance sheet which gives it added financial firepower to evaluate what we believe is a fragmented market. For those who don't want to invest in an all-out ingredients company, we also like Dairy Crest (DCG), which is starting to profit from new infant formula ingredients it has recently started selling.
Outsiders:
Right now, we're less enthusiastic about Tate & Lyle. We feel its goals for the specialist ingredients division appear quite bullish and we're unsure what the removal of sugar quotas in Europe next year - which also impacts high-fructose corn syrup - will mean for the company's existing sales. Analysts at Davy say the lack of "structural demand growth" in sucralose puts pressure on the rest of the ingredients division, too.
