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Morningstar | Trimming Our Ingredion FVE to $128 on Continued Near-Term Headwinds; Long-Term Thesis Remains Intact

On Oct. 23, Ingredion issued a preliminary third-quarter earnings release in which management lowered its adjusted EPS guidance range for 2018 for the third time this year. Management cited foreign exchange headwinds in Argentina and Pakistan as well as an unexpected outage at its largest sweetener plant in North America as the primary reasons. Accordingly, we've reduced our near-term revenue and margin forecasts for the narrow-moat firm in 2018 and 2019 and lowered our fair value estimate to $128 per share from $131.

The market reacted negatively to the preliminary earnings, sending shares down nearly 8% at the time of writing to roughly $93 per share.

However, our long-term outlook is unchanged. At current share prices, we think the market continues to be overly pessimistic on Ingredion's long-term profitability. We continue to support management's plan to invest in growing the specialty business by converting existing assets previously used to manufacture lower-margin core ingredients. As a result, we continue to forecast that long-term operating margins will expand above 15% compared with the 11% margin Ingredion averaged over the last 10 years.

Ingredion typically purchases its corn inputs globally at prices set in U.S. dollars. When the U.S. dollar strengthens against other currencies, Ingredion's costs rise in its three segments outside of North America. Although the company can ultimately raise prices for its core sweetener and starch products to offset the cost increases, there is a lag of up to six months from the time costs rise until they are fully offset by higher prices. The recently devaluation of the Argentinean peso also created a temporary spike in costs that will not be fully offset until early 2019. Although we've lowered our revenue and operating income estimates for the South America segment's 2018 and 2019 results, our long-term outlook remains intact.

Ingredion's Pakistan business presented additional foreign exchange headwinds. The Pakistan operations purchase nearly all raw materials and sells nearly all products in Pakistan. This limits Ingredion's transactional risk, but subjects the company to translational risk. While we've slightly lowered our revenue growth estimates for 2018 and 2019 in the EMEA segment to account for a weaker Pakistani rupee versus the U.S. dollar, we remain confident that the segment's margins will remain above 20% throughout our five-year explicit forecast period.

In the North America segment, Ingredion's largest sweetener plant had a temporary outage that caused lower food-grade production. Management noted the company fixed the issue and the plant is back up and running. While this will affect the segment's results in the second half of 2018, we do not expect this issue to affect profits in 2019 and beyond.

In addition to the guidance reduction, Ingredion announced board authorization to repurchase an additional 8 million shares, which allows management to purchase a total of 10.1 million shares. At the current stock prices well below our $128 per share fair value estimate, share repurchases would prove value-accretive, reflecting favorable capital allocation.