- As far as equities go in an increasingly inflationary environment, Ingredion is a pretty good pick.
- However, inflation in corn prices is stymieing their upside.
- Hedging policies will allow them to pass through costs safely with little friction, and the reopening will help them, but we are not seeing too much reason to add.
Reopening, especially in Latin markets, will be critical for Ingredion (NYSE:INGR) to achieve its recovery. We still believe in this recovery, but the Q1 2021 earnings call is beginning to help us notice that inflation is really going to impact equities. While Ingredion is positioned better than most thanks to its hedging policies, which gives it time to pass on costs without friction, we think that the upside has dwindled. While we are still going to hold Ingredion, we see these developments as a good reason to begin to get worried about equity markets and to take profits in other parts of the portfolio.
Co-Products and Gross Margin
As per our last articles on Ingredion, the co-product thesis continues to develop positively. Rising corn prices have been more than offset by the critical recovery in co-products from which Ingredion has been benefiting thanks to the rationalization in highly impacted markets like soy in the Sino-US trade war.
(Source: Ingredion 2021 Q1 Earnings Press)
Indeed, the consequent expansion in gross margin is clearly evident. While we are happy with the developments so far, we are also worried about other critical input markets. Corn prices are rising substantially, and this is limiting the ability of increased co-product values to entirely restore Ingredion's gross margins to previous levels.
Corn Prices - 5-Year Chart
Ingredion has managed to hedge these prices entirely as they settled agreements for coming corn at prices at substantially lower levels, towards the end of 2020. This is great news because it means that while capacity utilisation rates rise across the industry, promising avenues for price increases, Ingredion is not getting hurt by rising input costs. Indeed, their ability to pass on costs to customers should further improve as smaller customers, who had been underemphasised in the mix during the pandemic which struck smaller businesses harder, are beginning to catch up to larger and less affected peers.
Moreover, there are positives surely to come for Ingredion. With reopening in sight thanks to substantial vaccination programmes across the world, the critical brewery customers, especially in Latin America, should begin to recover as their restaurant and bar clients receive more reliable income. With Ingredion's substantial exposure to these markets, a recovery in volumes beyond the limited recoveries we so far have seen should eventually take hold.
(Source: Ingredion 2021 Q1 Earnings Press)
Note that the APAC sales are substantially overstated due to the consolidation of PureCircle's results, which account for about 20% of the growth in those figures.
While Ingredion can pass rising corn prices onto customers, we are concerned that while our original thesis expected much further growth in stock price to reach 2016-2017 levels when gross margins were preserved before the onset of the Sino-US trade war, such a thing no longer seems possible. Rising corn prices will eventually limit the ability for Ingredion to keep expanding its growth margins as it catches up to the rising co-product values and the hedges against corn resolve. We will continue to hold Ingredion, but we take the recent developments we've been seeing in commodities as major warning signs of inflation to come, and we will be substantially reconsidering asset allocation in other parts of the portfolio.
This article was written by
Formerly Bocconi's Valkyrie Trading Society, seeks to provide a consistent and honest voice through this blog and our Marketplace Service, the Value Lab, with a focus on high conviction and obscure developed market ideas.
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