Investing.com -- Barclays downgraded Barry Callebaut (SIX: BARN ) to “equal weight” from “overweight," in a note dated Tuesday, stating that the investment case has ’melted away’ due to a series of operational and strategic setbacks, including a first-half earnings miss, persistent cocoa price pressures, and a delay in cost-saving initiatives.

The brokerage said its previous optimism, based on expected cocoa price normalisation, increased outsourcing momentum, and confidence in management’s delivery of cost savings, has not materialised.

Barclays had anticipated that cocoa prices would begin to normalise after peaking in April 2024, but while prices have slightly moderated, they remain at historically high levels.

This has sharply impacted Barry Callebaut’s free cash flow and balance sheet, with net debt to EBITDA rising to 6.5x at the half-year mark.

Even after adjusting for readily marketable inventories, leverage still stands at 3.1x, well above comfortable levels and constraining operational flexibility.

The brokerage also pointed to a reversal in outsourcing trends, which had been expected to accelerate under the EU’s Deforestation Regulation.

Instead, the regulation has been delayed, and in some cases, customers have moved toward insourcing.

Barry Callebaut attributed its weak performance in Western Europe in the first half to this shift, further undermining one of the core pillars of the prior investment thesis.

Most notably, the company announced a 12-month delay to its “Next Level” cost savings programme.

Barclays now doubts whether the company has the financial and operational flexibility to fully execute the plan.

Analysts have scaled back their expectations for net cost savings across FY26 and FY27 to CHF115 million, well below the company’s CHF190 million target.

The first-half results raised broader questions about visibility and execution. EBIT missed consensus by 7%, while net income of CHF63 million fell 66% short of the expected CHF184 million, despite being reported just six weeks after the Q1 trading update.

Barclays cut its FY25 EBIT estimate by 9.8% and adjusted EPS forecast by 38%, citing higher finance charges, a rising tax burden, and muted pricing power.

The delay in cost savings and low opex/capex outlays to date have also led to significant downward revisions to FY26 and FY27 EBIT and EPS estimates, around 25% for earnings in both years.

In a bear-case scenario where cocoa prices remain elevated at GBP8000 per tonne in FY26 (versus the base case of GBP5500), net debt to EBITDA would stay high at 5.6x.

Barclays estimates this would add CHF89 million to net interest costs and, factoring in a potential credit rating downgrade and an assumed 50 basis point increase in financing costs, could lead to an 18% downside in FY26 EPS.

S&P and Moody’s currently rate Barry Callebaut at the lowest rung of investment-grade, and both have linked their outlooks to lower leverage and delivery of planned savings.

In this environment, Barclays does not rule out an equity raise, though such a move would be more dilutive now following a 37% share price decline year-to-date.

Structural risks are also mounting. The brokerage warns that growing trade tensions, particularly in North America, could threaten the company’s global production model.

Barry Callebaut operates 60 factories worldwide, with several serving cross-border clients. In a scenario where the U.S. imposes tariffs on imports from Canada or Mexico, Barclays estimates a potential 8% EBIT impact from stranded production capacity.

A more protectionist global environment could also lead customers to insource manufacturing, undermining Barry Callebaut’s outsourcing-based model.

The stock’s steep underperformance has not been matched by a full valuation reset. On Barclays’ revised estimates, the company trades at 11x and 10x PE for FY26 and FY27, respectively, well below its 10-year average of 21x.

But given the scale of EPS downgrades, the de-rating appears justified. Even in the bear case, a forward PE of 13.5x may not fully compensate for the growing operational and financial risks.