Treatt has had an outstanding year as the positive trends in its markets continue to play out. We believe the company is building a strong platform for the longer term and the performance continues to improve as the strategy progresses under the stewardship of Daemmon Reeve. Following the pre-close trading update, we upgrade our forecasts by c 10% at the EPS level to reflect the improved outlook. Our DCF-derived fair value increases to 240p (from 204p), which represents c 10% upside.
Treatt’s long-term strategy is to deliver consistent, sustainable growth in profit through developing value-added ingredient solutions, coupled with effective cost control. Key to this strategy is improved customer focus and closer relationships, with the ultimate goal of delivering greater profitability by concentrating on the more value-added segments. This latest period clearly demonstrates that this goal is being delivered. As a result of the trading update, we upgrade our full-year forecasts for 2016-18 to reflect the improved outlook. Our sales forecasts move up c 3%, while PBT and EPS increase by c 5%.
Growth in the ingredients space remains higher than average for the consumer sector as consumers demand cleaner labels and healthier products, but will not compromise on taste, and this requires specialist ingredients. Margins are also typically high at the value-added end. Treatt’s ingredient solutions are used both by food ingredients companies in their formulations, and by food and beverages companies directly. Treatt has placed particular emphasis on the beverages space and is becoming increasingly specialised in this space.
We value Treatt using a DCF model and we derive a fair value of 240p (previously 204p), an attractive c 10% upside to the current share price. This is supported by its relative valuation, with Treatt trading at 15.3x and 10.6x calendar P/E and EV/EBITDA multiples for 2016, representing a c 40% discount to its ingredients peer group on both metrics. Given our forecast for a mid-single-digit three-year CAGR EPS for 2016-18, we believe this level of discount is unwarranted.