21 year old Kylie Jenner is the world’s youngest self-made billionaire. The company she started over three years ago, selling $29 lipstick kits, recorded $420m sales in its first 18 months. For context, Tom Ford Beauty was said to have taken a decade to achieve a comparable figure.
Similarly, Rihanna’s ‘Fenty Beauty’ line achieved €500m sales by the end of 2018, only 15 months after launch.
These are just two of many examples where small, niche brands have appeared, seemingly out of nowhere, threatening the positions of established brands. A sector that has benefited immensely from this ongoing competition is consumer ingredients.
The developments seen in marketing and distribution have meant that it is far easier to start a new brand today, than in the past. This applies across the consumer world – from diapers, to make up, to ice cream – the examples are endless. Consequently, large incumbents’ market share has come under threat in recent years.
In order to address this threat, many of these multinational food and HPC (Household & Personal Care) companies are placing an increasing emphasis on top-line growth, moving away from their recent focus on cost. They now talk more about innovation, spend more on R&D, and are launching more new products in an attempt to support their positioning and sales growth.
More innovation makes providers and consumers happy
This directly benefits the ingredients sector which is increasingly looped into the product development process, not only as the ingredients provider, but also for their market and technical expertise. Croda, a UK-based consumer chemicals company, has specifically drawn attention to the change seen in multinational companies’ innovation appetite. This was clearly reflected in the organic sales growth spike in their Personal Care segment in 2017, that also continued into 2018.
Aside from acting as the multinationals’ extended R&D arm, ingredients companies also benefit from the growth of smaller, local or regional brands by effectively being their end-to-end supply chain solution provider, helping with product development, manufacturing, compliance and more.
Barry Callebaut, a global leading chocolate supplier, is a good example. The company works with Hotel Chocolat, a largely UK-based brand, as their cocoa liquor supplier. At the same time, it also works with global giants such as Unilever and Nestle. Nestle’s Ruby Kit Kat was a collaboration between Nestle and Barry Callebaut, the inventor of ruby chocolate. Barry Callebaut’s chocolate innovation has also helped Unilever launch a vegan Magnum ice cream range.
Besides the size battle between the new entrants and the larger incumbents, the changes seen in distribution channels have provided another source of growth for ingredients companies. The more consumers value convenience, or deem their lives too busy to cook a meal, the more they are supporting the growth of ‘food-on-the-go’ companies like Starbucks and Leon.
The ingredients companies work closely with these food service providers on multiple fronts, ranging from menu innovation to flavouring ready-to-eat chicken slices for supermarkets. To keep customers interested, ongoing innovation and differentiation is crucial. Therefore, as experts on taste and nutrition, they will continue to have a role to play in this space.
More growth makes investors happy
These themes have helped ingredients companies deliver superior top-line growth versus multinational food & HPC companies in recent years, as seen in the organic sales growth chart below. This outperformance should continue as the number of smaller, ‘niche’ consumer players continues to rise, and at a faster pace than their larger peers, thus becoming a bigger part of the ingredient companies’ client base.
In addition to superior top-line growth, the sector has also demonstrated steady margin progression through the years. The ingredients companies have successfully mitigated the effects of raw material price volatility as they have been able to pass on price rises (albeit with a few months’ lag). The other reason for this defensibility is the limited pricing pressure the sector experiences, given that these performance-critical ingredients only account for a small percentage of total end products’ cost of goods sold.
Sorting the wheat from the chaff
The industry is extremely fragmented and each company’s direct exposure to these themes varies enormously. Some are more ‘pure play’ – uniquely positioned, specialised technical ingredients companies, such as Novozymes in the enzymes market. These tend to offer faster growth rates and, hence, command higher valuation multiples.
At the other end of the spectrum, there are players like chemicals giant BASF that are not purely exposed to the ingredients sector, or only in the more commoditised areas. These companies usually have lower and more volatile growth rates, hence shares are also cheaper.
Given the sector outperformance described above, we have seen a re-rating of multiples for the ingredients companies since early 2017, this is particularly evident for the ‘pure plays’. The valuation gap relative to the wider food & beverage sector has now widened significantly.
The sustainability of these valuation levels will, ultimately, depend on the companies’ ability to outgrow the Food and HPC multinationals. The evolving landscape continues to provide ongoing opportunities for growth, but with multinationals fighting back and investing more, both internally via their own R&D resources and externally via partnerships, the gains of the consumer ingredients companies may not be as easy and explicit as in the past. The risks and embedded expectations are clearly higher today than two years ago, cautioning us to be much more selective within the sector.
While the more diversified names currently retain a sizeable proportion of their sales in non-ingredients related areas, some are gradually shifting their positioning towards the higher-growth ingredients space. This growth potential is yet to be fully reflected in current valuation multiples. With these companies playing catch up, and trading on less demanding valuation levels, perhaps these names should be drawing more attention from investors.
The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance.