Description

Overall: Kerry Group’s recently announced portfolio transformation should cause a substantial re-rating towards GIVN/ingredient peer multiples as investors will be forced to value KYGA as a pure play ingredients company vs. previously valuing it as an EU Food company which historically has traded at much lower multiples. In the meantime, we get paid to own a “reopening” stock (~30% of T&N biz is foodservice) that is fundamentally benefiting from reopening yet the stock is only up 3% YTD and where Street estimates are too low for 2021/2022. 3Q21e guidance beat/raise will be the catalyst for KYG to re-rate higher. Mgmt has recently purchased shares in the open market despite compensation mainly coming in the form of equity. Bull / Base / Bear of 194.94 (+58%) / 154.20 (+25%) / 110.89 (-10%) ex any M&A which could add an incremental ~15% to my TPs if levered up to 4x from 1x.

Kerry Group Company Description

·       Taste & Nutrition (93% of PF Sales, 96% of PF EBIT): #2 largest vertically integrated taste and nutrition player behind IFF/Dupont (was #1 until IFF/Dupont merged). KYG works with retail (ie NESN, KHC, etc) / foodservice (ie MCD, YUM, etc) customers on formulating new food/beverages to the global food, beverage and pharma industries (Ex/ work with Burger King to create clean label meatless burger to add to menu).

o   End Use: 69% Food (17% Meat, 11% Bakery/Confection, 10% Cereal, 13% Meals, 10% Dairy, 8% snacks), 26% Beverages, 5% Pharma

o   Channel: 73% retail, 27% foodservice (16% chains, 9% independent operators, 2% convenience)

o   Geo: 52% Americas (43% US, 9% Other), 27% EU (10% UK, 12% WE ex-UK, 5% EE), 21% APMEA (5% China, 6% SE Asia, 10% Other). Developing countries = 27% of sales.

o   MT Targets: Vol growth of +4-6%, +40bps margin expansion.

·       Consumer Foods (7% PF Sales, 4% PF EBIT): historically sold chilled/frozen food products in UK/Ireland but sold this biz in June 2021. The remainder of Consumer Foods is a legacy dairy biz that Kerry is in the process of selling.

Thesis

Overall: Kerry Group’s recently announced portfolio transformation should cause a substantial re-rating towards GIVN/ingredient peer multiples as investors will be forced to value KYGA as a pure play ingredients company vs. previously valuing it as an EU Food company which historically has traded at much lower multiples. In the meantime, we get paid to own a “reopening” stock (~30% of T&N biz is foodservice) that is fundamentally benefiting from reopening yet the stock is only up 3% YTD and where Street estimates are too low for 2021/2022. 3Q21e guidance beat/raise will be the catalyst for KYG to re-rate higher. Mgmt has recently purchased shares in the open market despite compensation mainly coming in the form of equity. Bull / Base / Bear of 194.94 (+58%) / 154.20 (+25%) / 110.89 (-10%) ex any M&A which could add an incremental ~15% to my TPs if levered up to 4x from 1x.

·       Superior biz model vs. GIVN (most expensive peer): Kerry's T&N portfolio make up is superior to most ingredients players including GIVN/others given: (1) higher foodservice exposure which is growing at ~7% vs. retail at ~4% ex c19, (2) higher exposure to plant based meats/alternatives, (3) higher exposure to clean label alternatives, (4) is a 1 stop shop/vertically integrated solutions provider vs. most peers which aren't.

·       Recent Portfolio Transformation will cause a substantial multiple re-rating towards GIVN (KYGA at 19x EV/EBITDA vs. GIVN at 27x):

o   Sold Consumer Foods on 6/17/21: this reduces KYGA's exposure to a lower growth/lower margin biz and allows Taste & Nutrition on a PF basis to be ~93% of sales (81% previously incl. Niacet) / ~96% of EBIT (88% previously). This will also enhance the growth in T&N as meat producers have been hesitant to use Kerry's T&N ingredients due to conflict of interest (Kerry sells meat products in Consumer Foods which is now being sold).

o   Purchased Niacet on 6/21/21: a global leader in food preservation (220m sales, 30% EBITDA margin). Deal is accretive to both volume growth (Niacet growing +MSD/+HSD vs. KYGA at +4%) and margins (Niacet EBITDA margins of 30% vs. KYGA at ~18%) adding ~40bps to KYGA's T&N margins.

o   Dairy next to be sold in 2H21? Would be accretive to growth/margins and welcomed by investors. We don't know how big this biz is but rumors are it's ~$1bn with ~$400m sitting in the Consumer Foods division implying ~$600m sitting in the T&N division. Dairy growth is ~flat/+LSD growth (vs. T&N +MSD growth) and only has margins of +MSD/+HSD (vs. T&N at 18%) and thus is dilutive to both growth/margins. Rumor is ~60% will be sold for 500-600m (11-12x ev/ebitda or 1-2x ev/sales) to the Co-Op. This deal fell through in early 2021 and the stock sold off. Recently there have been new rumors about KYG selling Dairy to another buyer (Saputo, Dairy Crest, etc) if Co-Op doesn't step up and buy the dairy assets. A strategic buyer could also buy the whole biz vs. only ~60% rumored in the media by Co-Op. Rumors are for a 2H21 sale.

o   Future M&A given ~1x PF leverage with scope to take it to 4x? Historically Kerry has been a serial acquirer as they have pivoted the portfolio from consumer foods/dairy to T&N over the last decade. Niacet will be one of Kerry's largest deals ever. The most notable transaction prior to Niacet was Cargill Flavor Systems for EUR 230m in 2011. Kerry will be buying Niacet for EUR 853m. Kerry will have a war chest of cash given only ~1x leverage. If take leverage to 4x, would have ~3.5bn of firepower. Priorities are Taste, Nutrition, Developing Markets, Foodservice. See appendix for 100 targets that Kerry could buy. If KYGA levered up to 4x leverage, it would add ~15% to my PT.

·       Margin Expansion Opportunity (independent of portfolio transformation): KYGA margins are materially below peers (KYG is estimated to have ~18% EBITDA margin ex Dairy/Consumer Foods vs. SY1 at 21% and GIVN at 23%). This provides KYGA a long runway to continue to expand margins towards peers over the next 5-10 years. In addition, Kerry has raised margins every year for over a decade in T&N ex c19 (9.5% in 2008 -> 15.0% in 2018).

·       Reopening Trade - ~30% of T&N exposed to foodservice which was materially impacted by c19. T&N volumes were -3.0% in 2020 vs. +4.0% in 2019. Kerry will benefit from foodservice outlets opening post vaccine.

·       Valuation - trades at a huge disc. to F&F peers. See valuation section.

·       Other Things:

o   Extremally stable biz: KYGA has grown vols in T&N 3-4% every year for a decade (ex c19) and grown margins every year (ex c19).

o   ESG/plant based meat play. KYGA is levered to plant based meat opportunity.

o   Numerous barriers to entry + structural tailwinds: #1 or #2 in all silos. On most core supplier lists, have LT contracts (3-5 years), fragmented space = more share gains from local players.

o    GICS Reclassification. KYGA is valued vs. NESN/ULVR/etc since it's classified as Consumer Staples GICS. Given the sale of consumer foods, GICS could move it to ingredients classification which would warrant a higher multiple.

o   Insiders Buying Shares & CEO heavily compensated w/ stock

Bear

·       Exit of dairy a potential near term overhang due to dilution (-5%) & Co-Op equity sale (12% stake)?

·       Slower Volumes in foodservice if slow c19 vaccine rollout

·       Increased competition from IFF/DuPont deal. One pushback is that while IFF/DuPont want to be "vertically integrated" like Kerry, they currently don't have the systems in place to do it on KYG's scale and thus will need to invest a lot of money to get there.

·       Value destructive M&A: KYG has been the target of 2 short reports both touching on this. KYG vehemently refutes this and has provided information to regulators about the M&A deals they have done.

·       Global minimum tax of 15%+ a negative for KYG (~13% tax rate now)

·       Margins: can be spun as both a bull & bear pt. KYG margins are materially below peers (KYG est 18% EBITDA margin ex Dairy vs. SY1 at 21% and GIVN at 23%). Bulls will say this is an opportunity as KYG can expand margins towards peers. Bears will say this is due to commoditized low margin product sales which warrants a lower multiple

·       R&D: budget is way smaller vs. peers and isn't focused on MT/LT projects. It's more focused on problems they are seeing right now vs. GIVN, etc which focus on LT problems.

·       Less EM exposure vs. peers

Valuation

Prior to c19, Kerry traded at a slight discount/closer to parity vs GIVN SW on P/E and EV/EBITDA. This all changed during c19 given Kerry’s outsized exposure to foodservice. Given (1) we are rebounding/recovering from c19 and (2) Kerry’s recent portfolio transformation actions, this should close the gap between Kerry & GIVN valuation over the next 1-2 years.

EV/EBITDA

KYG = blue, GIVN = green

Spread between 2y fwd EV/EBITDA for KYG divided by GIVN’s EV/EBITDA…close to multi year lows

Bull / Base / Bear of 194.94 (+58%) / 154.20 (+25%) / 110.89 (-10%) ex any M&A which could add an incremental ~15% to my TPs if levered up to 4x from 1x.

• Bull of 194.94 (+58%): Assumes my PF KYG ests and GIVN’s current EV/EBITDA multiple (27.2x).
• Base of 154.20 (+25%): Assumes my PF KYG ests and GIVN’s 2y avg EV/EBITDA multiple (22.9x).
• Bear of 110.89 (-10%): Assumes my PF KYG ests and GIVN’s 2y low EV/EBITDA multiple (17.8x).

Ingredients Industry

Flavors & Ingredients industry is ~$70bn and is estimated to grow 5-6% in value terms over the next 5 years. Artificial ingredients will grow ~0% vs. plant based ingredients which will grow 9-10%. Major trends:

1.       Health & wellness - has a number of pillars like:

a.       Taking unhealthy stuff out of food (ie cutting salt, sugar, fat)

b.       Adding ingredients we know that are good for us ie vitamins/proteins

c.       Replace/substitute certain ingredients ie reducing animal protein with plant based protein

d.       Shift towards more natural vs. artificial ingredients. Looking for organic.

e.       Clean Labelling - consumer wants to see as few ingredients as possible and want to be able to understand what the ingredients are (no ingredients you can’t pronounce)

2.       Shift in consumer spending patterns away from grocery/supermarkets to away from home/restaurants (largely undone due to c19). Foodservice/AFH was growing ~7% vs. Grocery Retail at ~4%.

Source: Exane BNP Paribas

Appendix

Kerry M&A Targets

Catalyst

3Q results for guidance upgrade

Sale of Dairy Assets

Announcement of another M&A deal

World continues to reopen from covid

GICS reclassification