It's an investment in oil, but not as we know it.
Treatt (LSE: TET) is one of those quirky companies that makes stockpicking so colourful.
It's one thing putting money into Royal Dutch Shell (LSE: RDSB), and telling your mates your company has struck black gold in Russia. It's rather more novel to listen to your girlfriend's friends talking about fragrances and wondering what it means for your investment in Bury St Edmonds-based Treatt.
Treatt trades in oil like Shell or BP (LSE: BP) -- except that Treatt supplies plant-derived 'essential oils' to perfume makers and other manufacturers. And Treatt's oils have certainly become more essential over the past decade, with sales increasing as the pendulum has swung back towards 'natural' products.
Oranges and lemons
Sales were up again last year, as Treatt revealed on Monday when it posted results for the 12 months to 30 September 2009.
The numbers made fairly pleasant reading for shareholders. Revenues across the group rose 13% to £56.3 million while operating profit increased by 9% to £3.9 million. Earnings per share were up 26% to 24.5p, and the dividend was increased by 7% to a twice-covered 12p per share.
Finally, positive cashflow of almost £7 million helped Treatt reduce debt from £15.8 million to £8.9 million at the year end -- a fall in the total gearing ratio from 73% to 39%.
Positive as these results are, they are flattered by beneficial currency moves, which often plays a role in determining Treatt's fortunes, since most of its business is done in dollars -- the exact consequences in any year being complicated by the hedging Treatt undertakes to mitigate the worst extremes.
There's little Treatt can do about the inherent instability of commodity prices, though, since that's its main business, and the price of its essential oils weakened throughout the year.
The price of orange oil -- a by-product of orange juice -- fell from $2/kg to less than $1/kg at the worst point, for example, while a lemon oil mini-price bubble that had boosted profits in 2008 moderated by half to $25/kg.
Sales have boomed but earnings haven't
Yet while those two oils are very significant ingredients in Treatt's revenue mix, they're only part of the company's diverse recipe for profits.
During 2009 Treatt traded materials in nearly 100 countries, including its Earthoil fair trade and organic vegetable oils. This range helps mitigate the effects of any particular commodity becoming less-than-essential in any year.
Indeed, while running Treatt may sound like a job for hippies -- and its £28.7million market cap qualifies Treatt for garage business status by the standards of the stock market -- this is a sophisticated, multi-site operation with operations in the U.S. and China as well as the UK.
For most of this decade it's been pretty successful, too. Treatt's share price steadily grew since 2000 to more than double by early 2007 to over 340p per share. Like most companies, the shares have endured a rockier time since then, dropping below 200p this time last year before bouncing back to 286p per share now.
Lacklustre earnings per share figures have sabotaged Treatt's progress. What's worrying about this profit stagnation is that it has come even as annual sales have remorselessly increased:
| Year | Sales (£m) | Pre-tax profits (£m) | Earnings per share | Dividend |
|---|
| 2005 | 32.5 | 3.4 | 23.3p | 9.5p |
| 2006 | 35.4 | 3.2 | 23.3p | 10.5p |
| 2007 | 38.1 | 2.8 | 20.0p | 10.8p |
| 2008 | 49.6 | 3.1 | 19.4p | 11.2p |
| 2009 | 56.3 | 3.5 | 24.5p | 12.0p |
Source: Digital Look
Growing turnover but static or falling earnings can be a warning sign -- Treatt's decent cashflow and this year's debt reduction reassures me that the business is actually producing cash, though.
Looking back through the past few years of accounts brings forward several different reasons for the standstill. There have been acquisitions and expenditure on new facilities. Extra staff has cost money but seemingly not yet boosted the bottom line, as well as currency and commodity price swings and a very inconsistent performance from the US division. After achieving record profits in 2008, the Florida operation stumbled into falling margins and sales, and "increased competitive pressures" in 2009.
Worse, there's no sign that 2010 will see earnings build on this year's advance. Chairman Edward Dawnay says of Treatt's imminent prospects:
"We are expecting 2010 to be a period of consolidation for the Group. With lower commodity prices compared to a year ago, and a weaker US Dollar, sales and margins may not be maintained for the coming year, although we do expect both Treatt USA and Earthoil to turn in stronger results. In addition, given the continuing economic uncertainty, Group order books are lower than a year ago as customers have delayed placing long term contracts due to falling prices and uncertain consumer demand, although this situation may now begin to reverse once again in the light of upward price pressures."
Not exactly rousing stuff, and the analysts agree, with earnings per share forecast to decline slightly in 2010.
Expensive Treatt, but worth waiting for
Despite all this, I think Treatt could make an attractive investment at the right price.
While I wouldn't have much faith in the claimed net asset value of 213p per share in a crisis, Treatt has seemingly developed into a meaningful niche player, and though earnings haven't grown much over the past few years, they have been resilient compared to many recently. The dividend payout has slowly advanced, too, and with debt and the associated financing charges reduced in 2009, the current 4.3% yield looks pretty secure.
While the difficulty in translating sales into profit for shareholders is disappointing, Treatt has potentially expanded to a scale whereby a focus on efficiency might get earnings and the share price moving again. One catalyst could be James Grace, the non-executive director who will replace long-standing chairman Dawnay in February.
At 282p, the shares trade on a trailing P/E of just over 11, rising to 14 for 2010. Hardly a screaming buy, though possibly attractive to income seekers.
Personally, I'll put Treatt on my watch list and look for signs either of the commodity boom running beyond industrial metals and gold, or of management making progress on getting earnings moving again.
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