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Morningstar | Few Surprises in Ingredion's 2Q Earnings; We Maintain Our $131 FVE and View Shares as Undervalued

Ingredion reported second-quarter results with few surprises, as operating income fell 8% year on year to $193 million due to weakness in the North America segment, which generates around 60% of sales. The company had announced high-level earnings in mid-July and pointed to North America as the reason for the profit decline. With no changes to our long-term outlook and effectively no adjustments to our 2018 forecast, we maintain our $131 fair value estimate.

We view Ingredion as undervalued, as the stock currently trades at roughly 25% below our fair value estimate. We think the market is not giving Ingredion credit for its growing portion of specialty ingredients that command higher prices and higher profit margins. We expect specialty ingredients to generate the bulk of Ingredion's future earnings growth as specialty sales rise from 28% of companywide sales in 2017 to 33% in 2022. Additionally, the stock is trading at a multiple closer to those of its no-moat competitors even though we see strong evidence of a narrow economic moat.

In North America, operating income fell 17% to $150 million in the quarter as higher production and freight costs outweighed 1% volume growth. Higher costs were primarily due to higher input costs and lower capacity utilization rates from weak fructose demand in North America.

While this dynamic has created near-term headwinds, we view these as temporary as Ingredion has taken steps to mitigate each of these issues. To offset higher input costs, Ingredion will raise prices. However, depending on customer contract length, the price increases may not go into effect until a quarter or two later. To address the utilization issues, Ingredion announced a cost-saving program that will include the closure of one of the company's core ingredient manufacturing facilities. This should allow the company to run higher utilization rates, which should increase profitability as fixed costs are spread across higher volume.

For more information, please see our July 13 note, "Ingredion Shares Tumble as 2018 Guidance Is Cut Again; Our Long-Term Thesis and $131 FVE Unchanged."