Irish consumer defensive firm Kerry Group (OTCPK:KRYAY) (OTCPK:KRYAF) is a stock that usually trades at a premium price, and given its dominant position in the global ingredient and flavors sector, one could argue that it deserves to trade at a premium price. However, I do not believe that its current share price is warranted.
Kerry received a recent blow with its failed bid to acquire DuPont's (DD) nutrition and biosciences business, which was picked up by International Flavors & Fragrances Inc. (IFF) for $7.3 billion in December 2019. The deal, which Kerry apparently lost €17.6 million ($19.92 million) in preparing for, has not put the firm off pursuing its M&A strategy, according to Kerry CEO Edmond Scanlon:
There is an ambition and a capability within the organisation that if an acquisition regardless of scale hits a certain set of criteria - the number one being creating value for our shareholders - we would move forward.
For Kerry, moving forward has entailed the acquisition of clean-label food businesses and food protection businesses, and expansion into developing markets. Over the course of the past year, Kerry purchased Ariake USA, Ariake Japan's (OTCPK:AKEJF) North American business, which makes clean-label taste solutions in pork, poultry, and vegetables. Kerry also purchased Southeastern Mills' North American coating and seasoning business in the past year. Both businesses were purchased for $367 million. Developing market volume growth has increased by 10.3% in the Asia-Pacific region, the Middle East, and Africa collectively over the past financial year - a rate of growth three times greater than that of the overall food market in the same regions.
Ireland-based Kerry Group is the dominant player in taste and nutrition worldwide. Image provided by RTÉ.
All of this helps to cement Kerry's position as the dominant player globally in taste and nutrition, which makes up 82% of its 2019 revenue - the remaining 18% being made up by its consumer foods segment, which is primarily confined to the British Isles and contains branded packaged foods such as Charleville, Cheestrings, Dairygold, Denny, Fire & Smoke, Galtee, LowLow, Mattessons, Pure, Richmond's, Walls and Yollies. The profitability of this business model is evident from the revenue and net income figures that Kerry has reported over the past five years.
| Year | Revenue (€) | Revenue ($) | Net Income (€) | Net Income (€) |
| 2015 | 6.1 billion | 6.83 billion | 525.4 million | 588.63 million |
| 2016 | 6.13 billion | 6.87 billion | 533.1 million | 597.25 million |
| 2017 | 6.41 billion | 7.18 billion | 588.5 million | 659.32 million |
| 2018 | 6.61 billion | 7.41 billion | 540.5 million | 605.54 million |
| 2019 | 7.2 billion | 8.15 billion | 566.5 million | 634.67 million |
Figures collated from annual reports and financial history results available on Kerry Group's investor relations page.
This profitability has rewarded shareholders over the long haul as well, as Kerry has consecutively raised its dividend for thirty-three years, making it a European Dividend Aristocrat. That streak looks set to continue given the 22.54% payout ratio and reported free cash flow of €515 million ($582.79 million). The stability of the dividend is further underlined by the firm's strong financial position, which Scanlon has publicly affirmed will be maintained, stating that Kerry has:
... a long track record of financial discipline, which will not change...
The 11.53% operating margin (trailing twelve months) is evidence of this financial discipline, as long-term debt of €2.36 billion ($2.67 billion) is offset by a net worth of €4.56 billion ($5.16 billion), and total current liabilities of €2.01 billion ($2.27 billion) are offset by total current assets of €2.67 billion ($3.02 billion), cash-on-hand worth €554.9 million ($627.95 million), short-term investments worth €57.7 million ($65.3 million) and total accounts receivable of €1.07 billion ($1.21 billion). All told, it seems that Kerry's M&A strategy will be tempered by its fiscal discipline - this likely falls within the "certain set of criteria" that Scanlon alluded to regarding prospective acquisitions.
Analysts forecast revenues of €7.65 billion ($8.66 billion) for Kerry in 2020, and even the coronavirus epidemic does not seem to have hit this forecast, as Kerry - which have five plants in China - has stated that the company expects a 30% hit to Chinese revenue for Q1 2020. Despite the consistent trend of rising revenues being maintained, no business, no matter how excellent, should be bought at any price, and while Kerry Group rarely trades at a discount, that does not mean it should be bought at any valuation.
Currently, Kerry Group trades at a share price of €115.80 ($131.04) with a price-to-earnings ratio of 36.20 and a dividend yield of 0.63%. The current P/E is higher than the five-year average P/E of 27.60, and the current dividend yield is lower than the five-year average dividend yield of 0.68%. It seems, then, that Kerry Group is overvalued - but by how much?
To determine fair value, I will first divide the current P/E by the historical market average of 15 to get a valuation ratio of 2.41 (36.20 / 15 = 2.41) and divide the current share price by this valuation ratio to get a first estimate for fair value of $54.37 (131.04 / 2.41 = 54.37). Then I will divide the current P/E by the five-year average P/E to get a valuation ratio of 1.31 (36.20 / 27.60 = 1.31) and divide the current share price by this valuation ratio to get a second estimate for fair value of $100.03 (131.04 / 1.31 = 100.03).
Next, I will divide the five-year average dividend yield by the current dividend yield to get a valuation ratio of 1.08 (0.68 / 0.63 = 1.08) and divide the current share price by this valuation ratio to get a third estimate for fair value of $121.33 (131.04 / 1.08 = 121.33). Finally, I will average out these three estimates for fair value to get a final estimate for fair value of $91.91, or €81.22 (54.37 + 100.03 + 121.33 / 3 = 91.91). On the basis of this estimate, the stock is overvalued by 43%.
In summary, Kerry retains a globally dominant position in taste and nutrition, and will continue to be a profitable firm for its shareholders going forward. However, a 43% premium is too much to ask of a prospective shareholder, and it may be best to wait for a pullback before parking any money here.
