Stockwatch: Plenty of reasons to buy this share

Is Tate on the turn? In my last macro piece I suggested the London stockmarket is unlikely to slump because it offers plenty of stocks yielding 3-5% which is attractive when any interest rate rise will likely be minimal. Tate & Lyle is at the upper end, yielding 5.2% covered about 1.3 times by prospective earnings.

During the last few days the Mid-250 stock has bounced from a long-term low of 502p to about 540p, showing how a decent yield can act as a prop - yet there also appears a sense the overall risk/reward profile is improving.

A bullish indicator

After restructuring its European side, Tate's bulk ingredients operation (47% of last year's profit, 66% of turnover) will be a predominantly North American business operating in bulk sweeteners and industrial starches. These are large mature markets i.e. providers of strong cash flow in support of dividends and investment in new markets. (The table shows cash flow per share in excess of earnings per share, a healthy sign which enables strong dividends and capital spending.)

"Bulk commodities" sound boring if not downright risky in context of wider deflation, yet this may have conspired for the chart to shed nearly all its gains since 2011 - creating scope for an inflection point. This comes in the form of a strong upturn in US high fructose corn syrup (HFCS) pricing, which has shown itself as a barometer of related commodities, also that when the cycle turns it can do so quickly and dramatically. A respected analyst at the stockbroking firm Jefferies cites corn millers pitching for a 15-20% price hike despite input costs falling with deflation, as if the market is tightening amid firm demand. "It may not conclude quite this well, but it doesn't need to, to sweeten Tate's bottom line very nicely."

12% profit growth

He estimates HFCS accounts for about 40% of Tate's current profits, rising to 80% as the group's European operations are cut back; although he also points out the structure of some HFCS contracts limit upside potential, and that Tate's ethanol brewing is unprofitable. Yet his conclusions are for upgrades, in particular towards a 12% rate of underlying profit growth - "the true measure of momentum" despite earnings growth being limited by the restructuring and a higher tax charge. This would be good going in context of fewer choices of growth stocks in a deflationary world, also cyclicals on the upturn, while downside risk should be limited by the 5% yield - covered 1.3 times (and better so, in terms of the underlying trend).

For the long run I would be aware how any extent of focus on corn syrup invites risks of health scares - online you can find strings of reasons why it will kill you. Obviously refined carbohydrates have been under attack for decades, often by nutritionists hoping for best-sellers, and now Jamie Oliver is taking punches.

You can already see the effect in "sugar-free" squashes as drinks manufacturers scramble to adjust, and if public behaviour does turn more significantly against sugar then corn syrup is exposed. (It can be confusing, how there are bags of Tate & Lyle sugar on shelves, however this brand is owned by American Sugar Refining after it was bought for £211 million in 2010.)

So longer-term risks are involved, although tobacco stocks show that even when classed as a death warrant such manufacturers will simply be priced so as to exact a useful yield. People will continue to smoke, eat sugar, and bank dividends. The question more involves what limit to upside potential if any health slur sticks.

Aggressive director share buying

Their recent pattern indicates genuine belief in value and willingness to back it with cash, than tricky-to-interpret share option deals that expose directors only to upside. On 25 August the chairman added 10,000 shares at 510p taking his holding to 137,399 shares, after adding 4,393 shares at 548.85p on 31 July - a total £75,111 recently spent. Also on 31 July the chief executive spent £201,894 on 36,785 shares, taking his stake to 2,974,608 shares; and on 30 July a non-executive director spent £54,182 on 10,000 shares as an initial purchase at 541.82p. So despite the stock's upturn there has been material buying at higher prices.

Recent trading has improved overall

The buying comes in a context of a 29 July update revealing an in-line first quarter to June. Tate's specialty food ingredients side (53% of last year's profit, 34% of turnover) is doing better: Splenda Sucralose, a no-calorie sugar substitute (where high hopes have met reality of increasing competition, to hurt last year's results) has "performed solidly as we pursue volume only where we see value."

Volume across some other specialty ingredients was slightly down as actions continue against last year's supply chain disruption, but is expected to pick up in the second half (to end-March 2016) as additional capacity comes online. New products have also increased, which ought to bode well. The Jefferies analyst's points on the corn syrup market were reflected in "solid sweetener demand" in bulk ingredients, if not entertaining cyclical upside potential like he does. Continued low US ethanol margins are more than offsetting these gains.

Tate & Lyle therefore looks to remain a "good in parts" story for the time being and quite complex also. Yet the strong directors' buying coupled with a 5%-plus yield and a respected analyst touting cyclical upside in a chief product, imply risk turning to the upside. 60% of last year's revenue was US dollar-derived, so if pundits are correct to anticipate the dollar strengthening as the Federal Reserve moves to raise interest rates, the translation effect could enhance returns and help investors hedge against sterling - say if the UK recovery stalls and attention refocuses on UK debt. Tate's net debt was reported slightly down on £504 million at end-March, implying gearing of just over 50%.

For more information see: tateandlyle.com.