One of the most common mistakes that is made by retail investors is not being able to calculate the fair value of an equity. In particular, many shareholders wrongly fall in love with their stocks and become fixated by the hype, while ignoring potential problems around the corner. The key is objectivity. Yes, maybe a company has been a great investment, but there will come a time to sell, particularly if it becomes overvalued.
Turkey of the Week: Tate & Lyle, (TATE, 664p) tipped as a BUY by The Times
Last week, The Times recommended buying the stock on the basis of its new, exciting products. Firstly its high-growth sucralose (Splenda), which is 600 times sweeter than sugar, but contains zero calories. Sales and profits are indeed powering ahead, with more capacity being brought on-stream to meet demand. However, there are threats on the horizon from new products (for example, NutraSweet’s Neotame), together with ongoing attacks against its patented technology.
Secondly, Tate is also co-developing an innovative corn substance (Bio-PDO) with DuPont, which could be used to replace oil-based textiles, such as polyester and Lycra. However, this is still at a very early stage and it’s premature to assign a meaningful valuation to the joint venture.
Clearly, both initiatives are encouraging, but it is crucial to put this potential upside in the context of the whole company. Let me explain.
As you’re probably aware, the majority of Tate’s operations still convert commodity sugars, corn and wheat into starches, sweeteners, ethanol and protein. These ingredients are incorporated into many products, including foods, drinks, pharmaceuticals, paper, detergents and animal feeds. Although there are obvious opportunities in biofuels with ethanol production, overall these activities are mature. Profit margins are being squeezed by higher energy costs, oversupply of sugar in Europe and constant pricing pressure. Furthermore, the business is being hit by the impact of the EU sugar reform, which is set to reduce selling prices by 36%.
In my view, The Times has fallen into the trap of applying a standard p/e multiple across the entire group, without adequately separating the two parts.
Even on a bullish sum-of-the-parts basis, I would value Splenda at 30 times 2006 p/e (or £1.4bn) at best, with the rest of the group on a blended 12 times multiple (or worth £2.2bn). Consequently, after adjusting for net debt of £0.9bn and a £0.2bn pension deficit, this generates a fair value for the shares of around 520p.
I believe the current share price of 670p is approximately 25%-30% overvalued from a fundamentals perspective. Frankly, although Tate has a good management team and offers defensive qualities, I believe it’s now worth taking profits.
Recommendation: The share price is ahead of itself. SELL at 664p.
Paul Hill’s personal portfolio has gone up by 483% over the last five years.
To find out more about his own specialist share-tipping service, ‘Precision Guided Investments’, click on the link below: