Speculation is rife regarding Tate & Lyle, one of the UK’s most established public companies, potentially facing a stock market buyout. Reports indicate that Advent International, a private equity firm, may be preparing a takeover bid for the 160-year-old food corporation. Given Tate’s volatile share price history over the past ten years, it seems likely that a buyer will soon emerge, which may lead shareholders to consider a straightforward exit strategy. However, does the interest in acquiring Tate signal that it is significantly undervalued in the current market?

Tate & Lyle, once synonymous with sugar, has undergone a significant transformation in the last decade. The company divested its sugar operations in 2011, although it continues to operate under the same brand name. The FTSE 250 firm also sold its starch division and a controlling stake in a commercial sweeteners business in the Americas to a private equity group for $1.3 billion in 2021, significantly reshaping its revenue sources.

Today, Tate has shifted its focus to specialized “ingredient solutions,” creating products aimed at manufacturers that enhance the health profile of beverages, snacks, and sauces without sacrificing taste or quality. In the previous financial year, Tate generated £1.4 billion out of a total £1.6 billion in annual revenue from these food and beverage solutions. The remainder of its revenue was derived from its sucralose division, which offers a high-potency, no-calorie sweetener, and a limited amount from its “primary products Europe” segment, which pertains to its corn wet milling operations.

This streamlined portfolio strategy aimed to bolster profit margins, but Tate’s recent $1.8 billion acquisition of CP Kelco, a pectin and gum supplier, has left investors feeling uncertain. The deal is anticipated to elevate total group revenue by approximately 30%, yet its cash component of $1.15 billion raises concerns about fiscal stability. The company’s net debt to adjusted cash profit ratio is projected to rise to 2.3, up from 0.5 at the end of March, although it remains within the target band of 1 to 2.5. The uneven financial performance of CP Kelco is a primary worry, with revenue growth slowing since 2021 and declining by 3% in 2023. Its adjusted cash profit margin has also decreased from 22.6% in 2021 to 17% this year, presenting a challenging scenario for beleaguered shareholders already navigating Tate’s significant restructuring efforts.

Nevertheless, an optimized CP Kelco might complement Tate’s updated strategy, as its spectrum of pectins, gums, and other natural ingredients aligns well with Tate’s new direction. Earlier this summer, there was a recommendation to buy Tate’s stock, highlighting the potential of CP Kelco to diversify Tate’s offerings. At that time, the stock had a modest price to earnings ratio of 10.8 and offered a favorable dividend yield of 3.2%. Since the rumors of a takeover surfaced, Tate’s shares have yielded a total return of 26%.

Tate’s improving profit margins and consistent growth make its stock appear attractive, currently valued above 760p, compared to 745p before acquisition talks surfaced. However, the company still trades at a lower price level compared to its larger ingredient sector competitors, showcasing a forward price to earnings multiple of 14, whereas larger players like the Dublin-listed Kerry Group and the Dutch firm DSM-Firmenich have multiples of 20.6 and 38.2, respectively. Given this context, Tate may struggle to command a premium compared to these industry giants. Current advice suggests holding onto shares, as they are unlikely to provide a premium equivalent to that of bigger competitors in the sector.

RWS Holdings Analysis

It is essential to recognize that excessive dividends can often signal a risky investment profile. For instance, RWS Holdings, an Aim-listed language services company, presents a forward yield of 9%, a possible red flag for investors.

Headquartered in Buckinghamshire, RWS specializes in translation services and operates four key divisions: language services, intellectual property services, regulated industries, and technology, which includes AI-powered solutions for content creation and automation.

RWS has faced challenges with sluggish sales growth, reporting a 4% drop in total sales to £350 million and a 16% decline in adjusted pre-tax profits to £45.6 million in their latest half-year results. Furthermore, cash flow has weakened considerably, with cash conversion plummeting to just 30% from 85% the previous year, attributed to low sales, targeted investments, and a temporary increase in debtor days, which indicates payment delays from clients.

The shares fell by as much as 16% recently, despite RWS indicating it had returned to growth in the second half of the fiscal year 2024 with a 2% revenue increase in constant currency. While adjusted pre-tax profits for the full year should range between £110.4 million and £114.4 million, this does not factor in foreign exchange impacts, which are expected to reduce profits by £3 million. Consequently, the broker Berenberg has lowered its earnings forecasts for next year by about 23%.

The company’s shares currently trade at an attractive forward price to earnings ratio of only 6, compared with an average of 18.9 over the last decade. Despite some signs of potential growth, investors should be cautious and may want to avoid RWS for the time being as it may still face a long path to recovery.

Advice: Avoid investment; the high yield comes with significant risk.