Treatt Initiation Of Coverage

In July 2012, Daemmon Reeve, then CEO of Treatt USA, was appointed group CEO. In May 2013, he presented his new strategy to shareholders, focused on value-added revenue growth and strict cost control. Both the acceleration in group performance in 2013 and his track record in turning around Treatt USA point to a positive future. In July 2013, the Bovill family sold their remaining stake to institutional investors, removing a c 30% overhang. We see upside to our double-digit earnings forecasts.

A credible medium-to-long-term strategy
Management’s new strategy is aimed at accelerating revenue growth by focusing on sales of its value-added products to larger multinational customers in key growth markets, such as beverages. In addition to the associated gross margin uplift this will generate, management is keen to instil a culture of keen cost control, which should further benefit the operating line. With an EBITA margin of 7.8% reported in the year to September 2012 versus peer group operating margins ranging from low double-digits to mid-teens, if executed well, there could be a significant opportunity for medium- to long-term value creation.

Early signs bode well
Although early days, a strong H1 performance (PBT +29%, EPS +40%) and early reassurances around 2014 and 2015 forecasts, in combination with Daemmon Reeve’s track record at Treatt USA, where profitability improved by 250% over his three-year tenure, all bode well. With c 20% of group sales exposed to orange oil, Treatt will inevitably suffer year-on-year fluctuations in revenue and cash flow despite management’s best efforts to hedge its position. However, in spite of the risk of short-term revenue volatility, we think that the medium- to long-term outlook for profitability has materially improved.

Valuation: Significant discount
Treatt trades at 13.1x FY14e and 12.0x FY15e calendarised P/E, a discount of over 20% to its listed peer group in the ingredients flavours and fragrance sector, and a 30% discount to its end-customers in the beverage industry. Given its global reach and strategy for growth in fast-growing areas of the beverage market, and with its renewed focus on strict cost control, we not only believe that its current discount is unwarranted, but also see potential for upside to our forecasts over the medium to long term. A key catalyst would be an upgrade announcement precipitated by major new contract wins with multinational customers.

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