Treatt is a provider of ingredient solutions for flavorings, fragrances, and ingredients aimed at the wellness and beverage markets. In short Treatt helps manufacturers ensure their product tastes, smells and acts as intended.
This can be both lucrative and important as the flavor is often the key differentiator in many consumable products. By its own admission certain sectors that Treatt is focused on – such as beverages are currently in a period of new entrants eg craft beers and all of these want their distinctive flavor.
It is recommended that this commentary be read in conjunction with the half year results as I am not intending to lay out all the numbers, just what I see as the key points.
1) I am concerned that in the Highlights section management lay out 6 highlights of which 3 are non-GAAP "adjusted" numbers. I am very wary of "adjusted" numbers as the adjustments are often IMHO designed to reflect well on management rather than inform the reader.
Furthermore one of the "Highlights" is that revenue is decreasing. I fail to understand why this gets billed as a Highlight.
2) Revenue was down 1.2% YoY. (£40,893m from £41,408m). But Cost of Sales was down 3%. (£31,271m from £32,266m). Giving an improvement in margin of 5.2% (£9,622m from £9,142m). This gives support to management's claim that they are moving to a higher value added offering to their client base and this is resulting in a change in product mix.
3) There were worsening FX losses which the company says is due to the hedging strategy and will largely hedge out by year end. This of course can only be proven over time.
4) The non adjusted post tax profit went up by 7.7% (£2,229m from £2,070m). But this is only 5.45% operating margin after tax. Not terrible but not an indication of a real value added offering.
5) Share based payments went from £100m for the 6 months ended 31/03/15 to £225m for the 6 months ended 31/03/16 and increase of 125%. This seems to me to be excessive and expensive. Particularly so as there does not seem to be any reduction in salaries. I am very against share based payments in companies I hold as I see them as being much more expensive than disclosed. If the share was correctly valued I might as well sell my holding and have cash. It is only because the current share price, in my opinion, undervalues the futiure cashflows that I hold and this upside is being given, but not expensed in the share based payment. I get less, the new owners get more. On top of which given the actual profits delivered these awards seem high.
6) The exceptional items – which have for the last few years included a litigation issue, have now been extended to include restructuring costs. I will be watching this with caution as I do not usually see this as exceptional, particularly as the related revenue is not clearly categorized.
7) The litigation issue does not seem to be provided in the accounts. Nor does it seem to be going exclusively in Treatt’s favour. I expect a further provision to be required at some stage. This may be genuinely exceptional but I am sure it will be excluded from adjusted numbers.
8) Stock holding increased from £26,371m last year to £30,239m this year. An increase of 14.6% at a time when the Cost of Sales has fallen 3%. Treatt has imho never been terribly good at managing its stock levels and this suggests things are getting out of hand. The company has discussed a move and the need to build up supplies to cover this move. Also the figures on any one day should not be overestimated. But the stock level, which almost equates to six months sales is a further area of concern.
The reality is that Treatt has been a reasonable holding for me. It has steadily delivered and the SP has gone up. However it increasingly causes me concern and it is not a holding that I will be adding to without significant additional news.