Ingredion Incorporated (INGR) Earnings Call Transcript & Summary

All right. Great. Well, thank you, everybody, and good afternoon. My name is Adam Samuelson. I'm the agro business and packaging analyst here at Goldman. Happy to continue our Goldman Sachs Staples Forum with Ingredion, one of the largest producers of corn-based and specialty ingredients in the United States and around the world. We have their CFO, Jim Gray, here today, Jim, welcome.

Adam. How are you?

We're going to jump into Q&A and fireside chat in one second. But I want to remind the audience that there is a box in your webcast window to type in questions. We love getting them in from the audience, please do send them in. They'll come to me, and we'll be getting to those through our discussion. So any questions from the global audience, please do send it in.

But first, Jim, maybe let's just start, let's level set. Maybe talk about the current market environment on the demand side. It's been, obviously, now starting to lap pantry stocking with COVID last year, which had some positives and negatives in different parts of your business. Can we kind of maybe take a tour around the world and think about volumes in different regions and different product categories?

Yes, sure, happy to. As you mentioned, the lapping some of the pantry stocking but also lapping some of the food service decline in -- due to restrictions, whether or not consumers around the world were hitting their local pubs or their favorite food joints and having a soda. As I look at the year and the lap into Q1 and even April activity, if you start with the U.S., you've largely seen foodservice traffic come back, and I would actually say it's lapping 2019 levels and even higher here in the last couple of months. It's a combination of stimulus checks, a lot more confidence with people being vaccinated, and I think just business is opening up in general. So that'll benefit us in what I would call a kind of our syrups and our sweetener business. That was the business that probably had the biggest volume impact from last year's foodservice channel, kind of, pullback. And so that's -- we'll benefit from that, and that volume is benefiting us as we look into Q2 and the rest of the year. I would characterize it -- there're really 2 markets, right? So you have a developed market like the United States, which has a pretty high penetration of vaccinations, and it's moving along, and then you have other countries, some of which are in our portfolio, and we have significant businesses there, where the vaccination rates are not as high. And so if you look at Mexico or Brazil or Pakistan, what you have is still a return to consumer mobility. Some of it driven by a necessity to work and just being able to bring an income into the family, some of it driven by just being too cooped up over -- particularly in the southern hemisphere over summer. And you saw the activity just -- people just had to get out and enjoy the weather and move around. What that's done is that even though pandemic case rates are somewhat high in some of these countries, the demand for our ingredients into our customers is not nearly as down as much as we may have experienced in March, April, May of last year, probably maybe 10% to 20% of the impact of that decline that we experienced last year. So you really have either people getting used to the pandemic, finding a way to manage through, or by necessity of either school or work returning to some of the consumer mobility patterns that we witnessed, say, in 2019. So that'll be a tail that, I think, that'll help the business throughout 2021 in some of these emerging countries and these developing economies, and we'll see that kind of probably fully play out by the end of the year or maybe into 2022.

Okay. That's really helpful. And maybe just to clarify something you mentioned earlier, just on the sweeteners and the syrup side. Is that specifically to the beverage and food-grade high fructose in the U.S. where you're seeing those volumes back at 2019 levels?

Yes, yes, that's primarily the HF. Yes. And then I'd also say like, so in Mexico we have a brewing adjunct, in Brazil, we do a brewing adjunct, right, which is into beverages. And yet, I've seen some of those still recovering a bit, but pretty close, much more kind of low single digits, mid-single digits type of volume and just continuing to kind of climb back.

All right. That's really helpful. And then maybe anything notable in the differentiation between some of your specialty products and some of your more base kind of commodity products, or are they all kind of rising tide lifts all boats?

No. I think as we noted our -- as we finished 2020, our specialty, particularly our texturants, actually did quite well. We had probably one kind of backup in May, where there was a bit of a kind of a grocery or take a home kind of readjustment to pantry stocking and SKU simplification and trying to make sure that the right kind of main pack and main variety of one of our customers' products was really on shelf just because everything was so constrained, right? Grocery labor was constrained. Packaging availability was constrained into the CPG companies. But as you came out of that and some of the restocking occurred and was evident on Walmart and Costco and grocery store shelves, the ingredients demand for some of our texturants and our specialty food starches really did quite well, right? And you saw things like ready-to-eat meals really did well in, I think, the second half of 2020. And so our lap into 2021 is sort of similar to what we would kind of continue to see. So I don't see like extraordinary bounce back in specialty ingredients, because 2020 was actually pretty good from a volume perspective overall.

Okay. All right. That's really helpful. So maybe kind of from the demand side on the near term, let's talk about some of the cost dynamics. And the inflation has been a hot button topic across the market and across staples and ingredient sectors through first quarter earnings. For you, there's a couple of key buckets. Let's start with corn, which is going to be the biggest one, and maybe level set for where we are in terms of our corn procurement for the year. And the co-product side of that, how that is a positive or negative as we watch corn prices over the balance of the year.

Yes. I think it's really helpful to understand, if I started in the fall of 2020 in our contracting season, corn was trading just below $4 a bushel. And then really kind of mid-December, it just started heading up, at least with regard to a U.S. kind of CBOT market. And we've seen the -- depending upon kind of which future you choose to look at, it's touched definitely into the $6 range and kind of pushing -- some of the futures hit -- have broken $7. They've come back a bit recently, but nonetheless, you're talking at least a $2 change upward in the cost of corn. And then, as you asked and mentioned, there's a couple of co-products, 3 co-products that we sell that offset that cost of that corn, and those co-products have also increased in value. I wouldn't say that they've offset the total increase in the gross cost of corn, but they've offset a nice chunk of it. So net-net, I think we're still probably looking at maybe $1.50-ish kind of a bushel increase in the cost of corn between where we started the year and now. Now that said, we have a hedging policy within the U.S. and Canada that we follow. And so largely, at this stage of the year, we're covered on all of our gross corn costs or gross corn needs as we finish the year. So what's really just dependent is does the corn cost stay elevated and do the co-product values kind of remain elevated at this level. I would say we anticipate a little bit of softness in those co-product values in what we're thinking about the back half of the year.

Okay. And maybe just closing the loop on corn. First, more recently, been very dry in Brazil, which is an important region for you. Anything to note in terms of corn availability that you're looking at with some of the -- seems like the crop expectations there are getting smaller as it doesn't rain. And so anything to note there?

We're not seeing anything necessarily in availability, mostly because the -- just the absolute size of the corn crop is so big relative to our production needs. But obviously, we're wrestling with the higher cost of the corn domestically. And what you've seen in our Q1 results in Brazil is that some of the contracting method and how we've managed the co-products has been a benefit in terms of stronger price mix, particularly, Brazil is really the one that has driven kind of the South American performance in Q1. And so in some ways, that -- unlike or maybe in contrast to the United States kind of form of contracting, within Brazil and also partially within Colombia, the pass-through of the corn is -- can be a benefit. We've also worked a lot on our pricing down there, and so that's also been a driver. But I'd say that there is a little bit of a tailwind in terms of just where the cost of the corn is.

Okay. All right. That's really helpful. And then how about noncorn items, which for you mean freight, labor, chemicals. Just help us think energy, just think about how some of those other items, which have also been inflationary, how those are impacting the business? What you're seeing.

Yes. Well, I think that freight is one of the biggest components of our cost. A couple of years ago, in our reporting, we moved freight into cost of sales. And as such, freight for us is really an issue between products moving from Asia Pac to North America and Europe and back to China. And then within the U.S. or within Canada/Mexico, rail and trucking are probably our bigger components of our cost. The way that we approach contracting with customers is both a price for a product of our finished good and a price for the freight. And so really kind of going into this year, we already had an idea of what dry van or what freight rates to the customer might be, and we set those expectations early. So we'll see really kind of how the second half plays out. I mean, obviously, there's quite a bit of supply chain constraint happening right now, but you see it loosening up. I think with ocean freight, more containers are being made available, which will help kind of movement of product, imports unloading and moving around. And dry van or trucking is usually a model that actually, as rates go up, you get more drivers coming in and then you get more availability and then rates soften. So we're just kind of watching freight. I think with regard to some of the other key inputs, Adam, that are probably not as clearly passed through to customers, that kind of hit our manufacturing costs, energy is -- the energy complex around the world, we largely hedge natural gas. And so -- and natural gas rates have been somewhat favorable. As we look -- I mean we had a little kind of up and now in Q1 given the cold weather. But largely, that's been -- something that's been quite predictable. And so we're really then just watching some of our less expensive inputs, both whether it's plastic supply, plastic and plastic wrap, pallets and/or our chems, and those seem to be relatively in control right now.

Okay. All right. That's really helpful. So if you want to maybe close the loop on the cost side, and it's a question that we've got from a lot of investors, is thinking about -- it's early, but how do we think about the implications for '22? It sounds, as you just described, the demand side, especially in North America, seems better, which is encouraging. The cost side is still -- it's a -- but if we think about where corn is today or probably going to be in the second half of 2021 relative to when contracting happened last year, it's substantially higher. How do we think about that balance and kind of the pricing bogey that you have to wrap your head around?

Yes. Well, I think first, an answer globally, is U.S. dollar-based corn prices have escalated in non-U.S./Canada markets. That pricing is getting translated into a domestic corn cost, and our teams are working to pass through that change in that cost. Just as if we had FX exposure in Brazil or someplace else in the world, we're working to do that. And sometimes, we have a lag on that. But generally, we've been pretty tight on that pricing. So really, the question that I think is is really around the U.S./Canada portion of our business that's part of North America. And just to reflect and maybe remind some of the folks tuned in here, within that U.S./Canada business, a little bit more than half of our business really passes through that change in the cost of corn, and it's usually to our largest, kind of more sophisticated customers have those types of contracts. And so they're actually witnessing cost increases today, unless they've placed a lot of hedges earlier in the year, which some have. But they are seeing that higher cost of corn passing through right now kind of as we reprice monthly. So it's really the other half of the customer base that's in U.S./Canada that probably gets some attention from us. And it's really a lot of medium and smaller customers, thousands. And so for them, they're enjoying a very beneficial contract timing this year. And so as we go into the fall contracting, I firmly believe that the cost of the -- the cost increase of the corn, however it may net out by the time we get to September, October, will be something that's reflected in pricing. As necessary. The corn is just too much of a variable cost for all the suppliers in the industry. So yes.

Okay. All right. That's really helpful. So maybe now, let's take a step back and think of it longer term. And clearly, the growth algorithm for the company has been very much predicated on specialty ingredients. Maybe first, can we just remind how -- remind investors how you actually define specialty ingredients? What is in that bucket? What's not?

Yes, sure. Internally, we use -- we defined, I think, 8 criteria, 2 are kind of similar, in how we look at a specialty. But it -- first of all, the ingredient has to have functionality, which then is also reflected in the value for the customer. It has to be in a growth segment or where there's takeaway from the customer that's growing. And then we also look at what's the kind of the implied gross margin from the product or products that are in that segment. And are those usually kind of 2x what we're seeing in maybe our more commodity-like syrups business. And then we also look at -- is there patent protection, is there a differentiation that we can achieve around that particular ingredient. So those are the criteria, but really, they help establish a good competitive moat, and they're highly valued by the customer, as reflected in usually the price point.

So can we just dig into a few of those. So on the margin differential, is that percent gross margin or is that gross margin per pound or per bushel? Just because sometimes, the increase in specialty mix is not always clear in the consolidated financials, and so that's what I'm trying to make sure people get.

Yes, yes. It's really 2 factors, right? So one, the higher percent gross margin is usually reflected in a specialty ingredient. But then also what accelerates that profit impact to our bottom line is that the average price per ton for specialty ingredients is, right now, I would argue that it's probably 4x to 5x the average price per ton for more of our core ingredient -- syrup, right? So you get both a dollar value as well as a profit per ton benefit from focusing on growing specialty.

Okay. And then the point on the IP protection and unique formulation, how much of that -- I mean help us think about kind of some of the intellectual property that defines that competitive moat and the pricing power.

Yes. Absolutely. I mean there's a lot of intangible value, I think, if you focus on the specialty business. One that's very evident is, well, what's your IP portfolio, how much of it is actually protected ingredients or protected process. And I'd probably say that that's like probably like 6% to 7% of our net sales, total net sales [ in there ], and so kind of a higher proportion of our specialty that we still have patent life left and/or kind of exclusive kind of rights to the technology and the manufacturing. But beyond that, I would say that it's -- there's a confluence of 2 or 3 things that have to happen in order to be able to take a plant-based material and make it a fairly unique, highly functional ingredient. And it's really 3. So one, you got to be able to formulate into the recipe for the customer, right? And so that's food scientists, and that's technologists. Two, you have to be able to convert that plant-based material in a high-yield way and a consistent way that's food quality and meets regulatory across the globe. And three, you have to identify the plant-based material that's coming in if it has requirements like non-GMO or it's going to be from a certain region of the country or it's a certain varietal, so the type of yellow pea or the type of corn that starts the process. We have plant-based research around the type of species that we're actually cultivating and growing. So those 3 things, if you bring those together in your value chain, you can actually create a nice arbitrage between the cost of the plant and the cost of the raw material versus this 24/7, 365 ingredient, that consumer packaged goods really want and need, that fits into their supply chain.

Okay. And so let's think about some of the specific applications that Ingredion is particularly focused on between texturants, specialty sweeteners and plant protein, which I think would reasonably encompass most of it. Maybe in each, kind of talk about the key growth drivers as you see it, maybe where you're most excited and where the points of differentiation are clearest?

Sure. Texturant is one where it's probably a little vague in the description, right? So to the extent I think about a flower and then I go to kind of a purer form of that flower called a starch or a functional starch, and what it does is, starches are basically hydrocolloids. And so they allow flavors and they allow other oils and things to kind of cling to that starch molecule. And then how that starch molecule separates from its other starch molecules, depending upon temperature and depending upon kind of composition, that forms what you and I think of as the composition of something that we eat. So you can think like Jell-o pudding. You put it in a bowl, it's this dry powder. You add milk, and all of a sudden it's creamy and it has this certain density to it. And it has a certain mouthfeel when we're consuming that product, right? So that texture is very much part of taste. And so what our team has done on texturants is, whether it's with a starch, like a potato starch or a tapioca starch or a rice starch, or it's a natural gum like gum arabica, we really have thought about what's the customers need in terms of what's the recipe, how does the final food product supposed to look, how is it going to be manufactured and how is it going to be prepped by the consumer prior to eating it. So that experience with the consumer offers that texture that I think is really valuable. So it's high functionality. It's also lower cost in the recipe. So whether you're replacing an oil or maybe replacing a milk fat or you're replacing an animal protein, the starch with its functionality has a much lower cost in recipe for the customer. And so that's why we see, I think, continued growth around the world as we think about our texturant portfolio, and particularly as you go into developing and emerging countries, like China, we see just a wide open path for modified starches that are plant [Audio Gap] in your [indiscernible] process. So we've actually been quite knowledgeable of how to separate out a protein from a carbohydrate for a long time. And then when you get into plant-based, what we really liked was the demand within the U.S., particularly with younger generations, really being concerned about both sustainability and the impact actually affecting their initial food choices. So it's generating a lot of trial. And with that trial becomes some affinity towards different brands, and therefore you get a decent repeat. And so you're seeing that get a lot of traction, and so I think that's a megatrend. I think that's going to be generational with both millennials and kind of Gen Z. And so we've made some significant investments into plant-based protein here in North America, and it's just really progressing nicely, I think, on our 2 facilities, generating really big customer lists and a lot of sampling, a lot of testing, a lot of trialing going on right now. And as we've said, we really see that as a nice revenue build for end of this year, but really into 2022, 2023.

Okay. So maybe if we wrap that together, and I guess what I've candidly struggled with is trying to see the net impact of those investments in that growth in the aggregate portfolio relative to the base. And help us think -- I mean you have -- every year at CAGNY you've had this multiyear plan that you've laid out and basically presumes the base business is kind of flat in the multiyear build, and then the specialty is what drives the growth. And that hasn't really been the lived experience in the last few years, and I'm trying to understand why and what -- where the confidence would come that we should -- that's going to be that way going forward.

Yes. Well, I think on specialty, first, maybe I'll answer in 2 parts, I'm trying to be concise. I think with specialty, as we've invested in these new capacities, there is a bit of an operating income hit while these facilities are getting up to speed, right? And so some of that is we're enduring here, right, in 2020 and 2021. And we'll start to see that curve and that revenue acceleration, which is nothing but the pure contribution margin towards covering those fixed costs. And so that's true for plant-based protein. And obviously, in PureCircle, we've talked about the turnaround there and are making really nice progress with that as sales grow and just more contribution margin covering the fixed costs. So that's one, so that's in our kind of starting point right now. And so as that turns, you see quite a bit of incremental, both revenue and profit growth, impacts to the algorithm, so to speak. But then your second point is, hey, how do you think about the business being stable on the core? And -- part of the headwinds, candidly, that we had in the second half of '18 and '19 had been -- we've gone from a really kind of favorable corn market in North America or the U.S. to something that was a bit more challenging with U.S.-China trade and kind of a separation of some of the co-product values offsetting the gross cost of the core. Now we're in a more favorable co-product market with a lot of demand for soybeans that's really kind of been increasing the values of the corn gluten meal and the corn oil. So those are nice offsets. But I think more importantly, right, because that's -- Adam, we always can talk about the U.S. market because it's visible to us, right? But out of our core, that's only 35% of our net sales. So 65% of our net sales is really coming from other countries where we have growing populace, and I like to say growing stomachs. So that -- you just -- we sell ingredients into food and beverage that's consumed. And so I really like our market share positions, and positioned well in geographies that for our core ingredients, I do think it's pretty reasonable to assume that we're going to get 0.5% to 1.5% growth in that demand in those markets. It's very in line with population growth.

Yes. Okay, okay. So maybe then thinking about kind of what you do with that. So switching to capital allocation. How do we think about where you're deploying your capital going forward? And I guess one thing I've been struck by with Ingredion has been -- you've mostly been pursuing fairly bite-sized or small enough tuck-in acquisitions. The leverage has never been -- has always been pretty managed, kind of 2x and below. But also the specialty percentage of the portfolio has been just creeping up 100 to 200 basis points a year. Is -- do you have appetite to do something bigger to remix that faster? What would it take? And put another way, do you think you have enough capability in-house to effectively compete with the portfolio that you have?

Yes. Well, definitely, I think that we -- maybe I'll answer your latter question first, right? I mean if I look at our positions and our businesses, whether it's in Europe or it's in Asia Pac or here within the U.S. and then growing specialties franchises in Mexico and South America. In terms of just the sheer number of food technologists and research, I absolutely think that we're very competitive. I personally think we're the global leader in food texturants. When we think about the M&A landscape and where we want to be able to accelerate along our specialty platforms, I think there's 2 things that are opportunities for us and then one that kind of constrains us, right? So the first opportunity is that we have a really extensive network as either a distributor partner, maybe a co-collaborator. And we usually develop our target list from folks who know us and realize that, hey, Ingredion is both a source of cash but also a way of just continuing the franchise of the business that may be an owner/operator or a family-begun, and they want to see its success. And so I can point to Western Polymer and KaTech and even to some extent PureCircle, were all relationships that we had within the industry that time came along and it was time for an event, and we were there well positioned. The second piece is that, well, with that, there's some adjacencies to what you're acquiring. So there's always going to be some synergy value, right, whether it's top line or cost synergy. And so the thing that holds us back is always going to be the multiple and what's the premium that's required on a target. And necessarily, when we work through the opportunity, is it something that's positive for the Ingredion shareholder relative to where we're trading? And so look, market multiples have been pretty high, what I would say, kind of 2018, 2019. I think 2020 had a bit of a respite, a brief pause. We closed 2 acquisitions in 2020. We closed PureCircle July 1 in 2020. So I thought we were fairly opportunistic, and yet you still see multiples a bit elevated. So we're always going to be prudent around the multiple. But -- and kind of your capstone is we'll look at any size, Adam. I mean we really consider like what can make sense in terms of, I think, accelerating the profile, both from a relative market position, from a strategic position, and then also just maybe from a growth perspective, that everyone in your community would look at us and say, "You know what, this seems like a really well-positioned company that has longevity and has growth opportunities in front of it." That'll ground us in how we think about M&A.

No, that's really helpful. And the point on the multiple actually kind of gets to the next question, and it's actually a perfect segue. Just thinking about the value merit of having those specialty pieces tied to that more core business, thinking especially in North America, but Brazil and certainly in South America, too, I -- probably would be a similar concept. One of your -- there's been press reports of one of your competitors thinking about trying to separate those in some capacity. Help us think about the fit. Is that actually something that you think is feasible? Or what's the value of putting the 2 together or keeping the 2 together?

Yes. Well, I mean the value of keeping the 2 together is where you have customer overlap and then where you have in your cost structure, producing at one wet mill and having a product that's kind of interstage, and then does it get moved to a different facility for finishing or for packaging or something like that. So there's no kind of clean separation of these plants do that and these plants do only this, right? So you're always going to have this kind of cross flows of products that exist within kind of any kind of wet milling network in my view. I would -- I don't really comment on competitors in terms of their M&A. I would just say that that competitor trades in the U.K. and may have a different shareholder roster, and that may make sense relative to the type of shareholders that they have, and so let's see how it plays out. But -- yes.

Okay. And so I guess, absent something there, just maybe kind of we can close on this, just as we think about excess cash from here, I mean bolt-on M&A still seems like something you're pursuing. But how do we think about kind of the appetite for share repurchase against that?

Yes. I mean, obviously, if Jim Zallie and the leadership team here are finding organic capital growth opportunities and those are helping us target ROICs that are, we think, year 2, year 3, kind of above 10%, those are very attractive to our shareholders from a kind of a long-term value creation. So we pursue those first, and we think secondarily about the dividend. And we think the dividend is a nice return, given some of the kind of the core portion of our portfolio. And then to the extent that we can deploy cash towards tuck-in M&A or just any M&A that we think is going to accelerate and strengthen the strategic position of the portfolio, that's where we're at, and we'll be doing that at return rates that are above our WACC. So then I think if that didn't exhaust all the cash available and/or the kind of the balance sheet capacity that we have, we can think about repurchase. We did some repurchase in Q1, and so we'll watch that, and if it's opportunistic and we think that that's a right time to be acquiring shares back that's going to lead to a higher return for remaining shareholders, then we'll do that.

Okay. All right. Great. Well, I think we're bumping up right against our scheduled time. So maybe we can -- we'll leave it there. Jim, I want to thank you for taking the time. I want to thank everybody on the webcast for dialing in, and I hope everybody has a great day.

Okay. Great. Thanks, Adam. Appreciate it.

Thank you.