If the wind is in the right direction on a breezy day in Karlshamn, a pretty town on the south coast of Sweden, the pungent smell from a vegetable oil processing facility situated in the harbour wafts over the municipality and surrounding countryside. But residents don’t mind. The factory has been there for decades and now forms part of the billion-pound vegetable oil and speciality ingredients giant AarhusKarlshamn (S:AAK), a major local employer. AAK is one of the world’s biggest producers of speciality vegetable fats for food and cosmetics manufacturers and has been delivering impressive double-digit profit growth over recent quarters. And with the wind set to remain in its sails, however smelly, we think there’s more upside to come as the company expands into fast-growing markets and capitalises on its higher-margin speciality ingredients products.
- Benefiting from high cocoa butter prices
- Good outlook on high margin infant nutrition
- Strong balance sheet
- Trend towards healthy living
- Scope for acquisitions in 2014
- Shares have already re-rated
- Emerging-market exposure
AAK's business is a lot more high-tech than just refining oil. In its fast-growing food ingredients division for instance, (which accounts for 63 per cent of profits and recently reported 11 per cent third quarter growth), the company creates unique oil blends which can substitute or complement dairy fat in foods like ice cream and cheese. Other varieties offer nutritional benefits, such as lower calories and added nutrients, like healthy omega-3 fatty acids and oils that are low in ‘bad’ trans- and saturated fats. This leaves AAK well-placed to benefit from the burgeoning consumer trend towards healthier eating, which is shaping the food industry and forcing producers (AAK’s clients) to offer more nutritious products to consumers.
But AAK's speciality fats/oils can also make life much easier, and cheaper, for food manufacturers, many of whom are feeling the impact of the global economic slowdown and looking to cut costs. For example, AAK makes fats formulated to deliver a longer shelf life, work better across a range of temperatures and are easier to blend. It’s a major supplier of speciality fats to the chocolate and confectionery industry, with its cocoa butter alternatives and fillings. These are as functional as they are tasty, offering properties such as better spreadability and moulding.
The chocolate and confectionery fats division, which accounted for 29 per cent of profits in 2012, has been a particular area of focus and is now gaining momentum. A third quarter trading update showed a 19 per cent rise in operating profit and this level of growth is set to continue over the next few quarters, partly thanks to the soaring cost of cocoa butter, which has forced many food producers to look for lower-cost alternatives offered by AAK.
| AARHUSKARLSHAMN (AAK) | ||||
|---|---|---|---|---|
| ORD PRICE: | SEK412 | MARKET VALUE: | SEK17bn | |
| TOUCH: | SEK412-413 | 12-MONTH HIGH: | SEK432 | LOW: SEK265 |
| DIVIDEND YIELD: | 1.8% | PE RATIO: | 19 | |
| NET ASSET VALUE: | SEK98* | NET DEBT: | 58% | |
| Year to 31 Dec | Turnover (SEKbn) | Pre-tax profit (SEKbn) | Earnings per share (SEK) | Dividend per share (SEK) |
|---|---|---|---|---|
| 2010 | 14.9 | 0.83 | 15.3 | 4.50 |
| 2011 | 16.8 | 0.82 | 14.7 | 4.75 |
| 2012 | 17.0 | 0.87 | 15.7 | 5.25 |
| 2013** | 16.5 | 1.02 | 17.8 | 5.90 |
| 2014** | 17.8 | 1.26 | 22.0 | 7.30 |
| % change | +8 | +24 | +24 | +24 |
*Includes intangible assets of SEK1.2bn or SEK30 a share Matched Bargain Trading, Beta: 0.636, £1=SEK10.67, **SEB Bank forecasts | ||||
The high-margin infant formula business is another growing market, particularly in emerging economies, and barriers to entry are high as developing fats for baby formula requires significant technological expertise. But what really gives AAK a competitive edge is customer service. It works closely with clients to develop tailor-made solutions that they can test and taste, as well as marketing advice and technical support, which means clients stay loyal.
The company has some exposure to emerging markets, but while recent currency weakness could provide a headwind it could also help AAK's acquisition ambitions in such regions. Management's expansion plans are especially focused on China and Brazil, and the strategy looks like a good one given the long-term demographic trends of rising urbanisation and wealth creation. The strong balance sheet puts AAK in a good position to make acquisitions and in July acquired Turkish-based oil and fat maker Unipro.
The stock has already re-rated and is priced roughly in line with the wider sector. But based on forecast of analysts at Berenberg Bank, the shares boast an attractive price-to-earnings growth ratio of 1.2. And the broker predicts that after more than doubling operating profit per kilo over the past five years, strong growth in speciality ingredients should drive a further 25 per cent increase by 2015. Given the trends powering recent growth, that looks highly plausible. So far this year trading has been strong, with volumes in the first nine months running 7 per cent ahead and operating profit forecast to end the year 17 per cent higher.
