EUR 850.00 For Business Accounts Only

Morningstar | Initiating Coverage of Kerry Group and Chr. Hansen With Wide Economic Moats; Kerry Is Our Top Pick

We initiate coverage of Kerry Group and Chr. Hansen, two leading food and beverage ingredient solutions providers, with wide economic moat ratings and fair value estimates of EUR 110 and DKK 600, respectively.

Although both companies operate in the $70 billion fragmented global food ingredient and flavor market, their business models and strategies differ significantly. Kerry's core competency lies in its ability to offer a wide range of food ingredient solutions and technologies with a substantial service component throughout the whole product development cycle of its clients. Chr. Hansen's strategy focuses on being the point of reference in the dynamic field of microbe solutions with core competencies the knowledge of bacterial strain properties, the result of years of R&D spending, widening the knowledge gap over ingredient generalists. Still, the common denominator between the two companies is the high added-value contribution to their clients' final product, which creates customer intimacy and supports our wide moat ratings.

Regarding valuation, Chr. Hansen shares look slightly overvalued trading in the 2-star territory, with our estimate implying a forward fiscal 2020 price/adjusted earnings ratio of 35.0 times and enterprise value/adjusted EBITDA ratio of 23.0 times. This is driven by robust fundamental market growth, pricing, and further market share gains as well as the introduction of next generation and innovative products to new and current customers/markets. Kerry, on the other hand, presents a compelling investment opportunity for the patient investor. Shares are trading at a 20% discount to our EUR 110 fair value estimate, which implies a forward fiscal 2020 price/adjusted earnings ratio of 25.0 times and enterprise value/adjusted EBITDA ratio of 16.0 times. We think current valuation levels offer an adequate margin of safety, with our worst-case scenario valuing shares at EUR 85, some 7% lower than the current market price.

Chr. Hansen's competitive advantages stem not from its cultures or composition of strains (which can be replicated). Instead, the firm’s edge lies in its ability to produce economically and at large scale high value-to-cost, innovative ingredients for a wide range of food manufacturers, nutraceutical, and pharmaceutical companies. Its high R&D budget coupled with an unprecedented level of market intelligence, acquired through decades of operating in the space, renders its wide moat virtually impenetrable. This should allow for consistent economic profit generation in the years to come.

On the contrary, Kerry’s generalist nature has contributed to its business model’s success. Clients buy a high added-value consulting service, under which Kerry also produces and sells the ingredients, cultivating partnership-like client relationships while enriching its regional and category insights library. This information further enhances its consulting offering, a virtuous cycle we believe is at the heart of the firm's considerable competitive advantages. Customers are looking for fast routes to market and at the same time traceability of its final products. Kerry can deliver on both fronts. The company has set up a carefully controlled supply chain over the years, while the full range of ingredients that it can offer in-house shortens the product development cycle significantly by simplifying the complex task of coordinating among various ingredient suppliers. With two thirds of its sales coming from local and regional food and beverage customers and almost one fifth sourced from the foodservice market, we think Kerry offers unique exposure in the most dynamic segments of the global food and beverage industry.

We expect the global food ingredient market to grow by close to 4%-5% CAGR over the following two decades, driven by increased penetration in the global food, beverage, and foodservice markets. The structural growth, in our opinion, will flow from: 1) higher penetration to clients of smaller size (national, local) looking to partner with a dedicated ingredient supplier as a result of consumer preference toward local, personalized, and artisan products and 2) a higher percentage of clients' budget spent on functional ingredients due to more demanding final consumers (both tasty and healthy food products). Given Kerry’s advantaged position in this fragmented market, we forecast a 2% outperformance, which reflects market share gains through both organic investments and bolt-on acquisitions.