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Morningstar | Ingredion Poised to Increase Profits as Specialty Products Growth Will Drive Margin Expansion

Ingredion manufactures starches and sweeteners by wet milling and processing corn and other starch-based raw materials. The company steeps these raw materials in a water-based solution before separating the starches from co-products (animal feed and corn oil). The starches are then further processed into starch and sweetener ingredients used primarily by the food and beverage industries, in addition to the paper, corrugating, brewing, and personal care industries.The company classifies its products as either core or specialty ingredients, with core ingredients generating roughly 70% of companywide sales (as reported) and just below 50% of profits (based on our estimates). Core ingredients are typically commodity-grade, providing no pricing power for Ingredion. Ingredion sells roughly half of its core sales on a cost-plus basis. Specialty ingredients are value-added, requiring additional processing and, in many cases, proprietary formulations. They typically command twice the gross margins and enjoy twice the sales growth of core ingredients. Although we expect demand for Ingredion’s core ingredients to grow roughly in line with GDP in the regions where they are sold, specialty ingredients volumes should grow in the mid- to high single digits.Ingredion has a multinational footprint, reporting via four geographic segments: North America (60% of sales); South America (17%); Asia-Pacific (13%); and Europe, the Middle East, and Africa (10%). Raw materials account for roughly half of the company’s unit costs. Corn, which is purchased around the world at market prices, represents the company’s single largest expense. Accordingly, Ingredion actively hedges against corn price fluctuations in North America, which helps stabilize gross margins for the segment. Regardless, changes in corn prices can materially affect margins in its other segments. This is reflected by recent results, as a sharp rise in corn prices weighed on profitability from 2009 to 2012 before a subsequent decline drove margin expansion in the following years. We forecast that corn prices will settle at roughly $4.40 per bushel in a midcycle environment, which is over 15% higher than current prices.