Why I’m avoiding PureCircle Limited shares after today’s 15% drop

Shares in food producer PureCircle (LSE: PURE) are among the biggest fallers today after declining by as much as 15%. This is due to a profit warning released by the business which shows that its sales for the first half of the year are set to be 14% lower than in the same period of the previous year. Despite this disappointing performance, there’s another reason why I’m avoiding the company for the long term.

A challenging period

PureCircle’s first-half performance was negatively impacted by the detainment of shipments by US Customs Border Protection (CBP). Since the US contributes around a third of the company’s sales, the impounding of shipments and inclusion of its name on the Withhold Release Order (WRO) means that it has inevitably posted a fall in sales. This has filtered down into profitability, with group gross margins also expected to be lower. As such, net profit is forecast to be lower compared to the first half of the prior year, although margins are expected to recover once the issue is resolved.

In terms of a resolution, PureCircle has worked extensively with the US CBP and has provided tracking documents and related data in response to their detailed requests. A decision from the CBP is now awaited.

Strong performance, but lacking appeal

In terms of the performance of the company in other markets, the first half of the year was impressive. It has achieved strong growth in Europe and Latin America, which represent over half of its sales. In the last six months there have been over 100 launches that contain PureCircle products, which provides an indication that demand for its products is increasing at a rapid rate.

Despite this, PureCircle is a stock I’m avoiding. Even after today’s share price fall, its valuation remains excessively high. Certainly, there’s growth potential within the business and further launches are likely over the long run. However, given its falling profitability and the risk posed by the US CBP issue, a price-to-earnings (P/E) ratio of around 32 is just too difficult to justify.

A better option?

In fact, even a relatively consistent and well diversified foods producer such as ABF (LSE: ABF) offers superior value to PureCircle. ABF has a P/E ratio of 22.6, which indicates that it has a wider margin of safety. Its business operates across the globe and is multi-faceted, with a retail operation providing significant diversification for its more traditional food production operations.

Furthermore, ABF is forecast to grow its earnings by 12% in the current year, while PureCircle is expected to make a net loss for the year of $2m. As a result, ABF seems to be a much better buy, while PureCircle is a company to avoid. Even if the US CBP issue is resolved swiftly, its high valuation means that it lacks sufficiently high potential rewards.

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Peter Stephens has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.