Kerry Group: Expect A Big EPS Increase By 2026 (OTCMKTS:KRYAF)

Introduction

The Kerry Group (OTCPK:KRYAY) (OTCPK:KRYAF) is an Ireland-based company active in the food, beverage and pharmaceutical industries. Its core business is the “value add ingredients and solutions” where it helps its customers to develop the specific taste for its products. Think about making a burger taste better, or making a stevia-sweetened drink taste good without compromising on taste. One of the more recent challenges comes from the non-alcoholic beverage industry which wants its non-alcoholic products like beer taste exactly the same as the “normal” product. High-end applications and the shift toward healthier food (plant-based, non-alcoholic) should be a tailwind for Kerry as those companies could use Kerry’s products to improve their own product offerings.

Additionally, about 15% of its revenue is generated in the consumer foods segment (recently rebranded to Dairy Ireland) which includes Kerry’s own brands of butter and other dairy-related products.

Kerry’s primary listing is on the Dublin Stock Exchange where the stock is trading with KRZ as ticker symbol. The average daily volume in Ireland is almost 300,000 shares, making it the most liquid listing, followed by the London listing ( ticker symbol KYGA) with an average daily volume of approximately 120,000 shares. The London listing also uses the EUR to quote the shares.

The financial performance remained pretty strong in the first three quarters of 2022

The Kerry Group still has to publish its full-year results (the preliminary results will be published I about two weeks) so unfortunately we have to work with the H1 2022 financial statements and the Q3 trading update.

In the first semester of 2022, Kerry reported a total revenue of 4.06B EUR, an increase of just over 13% compared to the first half of 2021. The company also recorded about 69.5M EUR in non-trading items which weighed on the operating profit which fell to 298.1M EUR (instead of the 367.6M EUR on a normalized basis) but as this still was an increase compared to the 297.1M EUR recorded in the first half of 2021 we can generally say Kerry’s first half of the year was pretty good.

The total net finance expenses didn’t change that much, and despite recording a slightly higher tax bill, the net income still increased by approximately 0.6M EUR on a reported basis, resulting in an EPS of 1.28 EUR per share. Keep in mind this includes the net impact of 62M EUR from those “non-trading items.” That mainly was a non-recurring impact due to its restructuring activities as well as the decision to write down the value of the Russian assets. If Kerry Group wouldn’t have had to record that write-down, the EPS would have been 0.35 EUR higher, at 1.63 EUR per share.

And as Kerry’s sustaining capex is substantially lower than its depreciation expenses, the free cash flow performance usually exceeds the reported net income.

In the first half of the year, Kerry reported a net operating cash flow of 132.2M EUR but this includes about 278M EUR in working capital investments as well as 26M EUR in payments on the aforementioned non-trading items. We also see the company paid just 31.9M EUR in taxes although it owed 37.5M EUR based on its H1 2022 income statement. And finally, we need to deduct the 16M EUR in lease payments as well. When the dust has settled, the adjusted and normalized operating cash flow in the first half of 2022 was 424M EUR.

The total capex was just 61M EUR, resulting in an underlying free cash flow result of 363M EUR or 2.05 EUR per share. The FCFPS is higher than the EPS (and even the normalized EPS) due to the difference between depreciation and amortization expenses (150M EUR in H1) and the actual capex + lease payments (77M EUR).

The Q3 trading update basically confirmed Kerry is in a good shape and the management was able to narrow down its adjusted EPS growth guidance from 5-9% to 6-8%. As the adjusted EPS in FY 2021 was 3.80 EUR per share, a 6% increase (the lower end of the guidance) would result in an EPS of just over 4 EUR per share for this year.

The longer-term outlook is quite bright

Kerry for sure isn’t a dividend stock: the company only pays about 25% of its adjusted EPS as a dividend as it prefers to retain the cash on the balance sheet to pursue value-adding acquisitions. Additionally, the company sometimes sells a division like the recent announcement Kerry is divesting its Sweet Ingredients portfolio for 500M EUR which is a multiple of about 12.5 times the EBITDA of that division.

The company has a 2022-2026 plan, which calls for an average revenue increase of 4%-6% per year resulting in an EBITDA margin of in excess of 18% by 2026.

Assuming a revenue of 8.5B EUR in FY 2022 (to be confirmed when the company actually releases its financial statements) and an annual 4% revenue growth, the 2026 revenue would come in at 10B EUR, resulting in at least 1.8B EUR in EBITDA based on the margin guidance.

Assuming the depreciation and amortization expenses increase to 350M EUR per year from the current 300M EUR and assuming an increasing interest expense of 100M EUR (compared to the interest expenses of just over 70M EUR on an annual basis), the pre-tax income would be roughly 1.35B EUR. Assuming a 14% tax rate (the corporate tax rate in Ireland is just 12.5% but some of its subsidiaries will be subject to foreign tax regimes) the net income would be 1.16B EUR or 6.5 EUR per share.

Even if it slightly misses that mark, Kerry’s growth in the next four years should be pretty strong. The improvement in EBITDA margins will be the driver of the sharply increasing EPS as the EBITDA margins in the past few years have been around 12-15%. Boosting this to 18% will have a major impact on the bottom line.

Investment thesis

Kerry’s current share price of approximately 88 EUR still isn’t cheap as it implies the stock is currently trading at approximately 22 times the anticipated earnings for 2022. But given the longer-term outlook whereby Kerry plans to continue to increase its EBITDA and EPS, you are essentially paying for future growth and paying 13 times the anticipated earnings for a company with a resilient core business is not that far out of reach. As the stock has come down from its high of approximately 125 EUR per share in the summer of 2021 (which meant the stock was trading at 33 times the adjusted earnings), Kerry is becoming more attractive.

I currently have no position in Kerry Group but I will keep an eye out for the FY 2022 results while I’m also very interested in seeing an EPS guidance for 2023.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.