Morningstar | Weak Switching Costs and a Commodity Product Crucial to Barry Callebaut’s Lack of Moat; Shares Rich. See Updated Analyst Note from 27 Sep 2018
After taking a fresh look at Swiss-listed Barry Callebaut, a supplier of cocoa and ingredient chocolate, we reiterate our no-moat and stable moat trend ratings. We are slightly raising our valuation for the company to CHF 1,500 from CHF 1,480, which would equate to a fiscal 2019 price/earnings multiple of 23 times and an EV/adjusted EBITDA multiple of 13 times. Currently, the shares look overvalued.As an integrated manufacturer that sources a quarter of all cocoa beans produced worldwide and enjoys a 37% market share in the outsourced chocolate market, we believe Barry Callebaut is a valued partner for its clients (which include artisans, chocolatiers, pastry chefs, and bakers). However, we do not think the company’s size has translated into a durable competitive advantage.
Sales are volume-driven, with growth well above market, supported by increasing outsourcing from sizable multinational consumer packaged goods companies, development of its specialty business and high exposure to emerging markets, where Barry Callebaut generates one-third of its sales.
Our no-moat rating is based on the absence of the three primary sources of moats for ingredients companies: customer switching costs and intangible assets (proprietary technology) as well as a moatworthy cost edge. The critical difference between Barry Callebaut and other ingredients companies is that it does not supply customized ingredient formulations using proprietary technology; instead, it supplies undifferentiated cocoa and chocolate, which are readily available from a host of alternative suppliers. This implies that customer switching costs are nonexistent. Barry Callebaut's relatively commoditized position is evidenced by its low research and development spend (0.3% of sales versus more than 5% for other ingredient companies), its modest EBIT margin (7.2% in fiscal 2017), and ROIC (including goodwill) of 11.5%, significantly below the levels of other ingredients companies.
Barry Callebaut is a cocoa and chocolate company, engaged in serving the food industry, from food manufacturers to professional users of chocolate such as chocolatiers, pastry chefs or bakers and products for vending machines. Co. offers a range of chocolate and other cocoabased products with numerous recipes. Co. also provides a comprehensive range of services in the fields of product development, processing, training and marketing. Co. is fully vertically integrated along the entire value chain: from sourcing of raw materials to finished products on the shelf. Co.'s operations are organized in three business units: Cocoa, Food Manufacturers, Gourmet & Specialties Products.
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