International Flavors & Fragrances: Buy And Hold For The Long Term

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About: International Flavors & Fragrances Inc. (IFF)
by: Abrar Hassan Saadi
Summary

IFF is a globally renowned developer and manufacturer of ingredients with a substantial market share.

The firm has delivered excellent sales growth and maintained strong profitability over the years.

Recently announced a major stake at a European ingredients maker which will further substantiate its market position in the ice-cream and gelato ingredients market.

The dividend is steadily growing, FCF coverage is temporarily due to the large acquisition back in October.

My valuation indicates that the firm is undervalued, the stock could add value to income portfolios.

Investment Thesis

International Flavors & Fragrances Inc (IFF) is a leader in the world of flavor and fragrance development. In the last five years, the firm has delivered a 6.15% compound annual growth rate in sales with an average profit margin over 11%. During the period IFF has produced an average of 15%+ return on invested capital and a 9% return on assets while the dividend has followed a growth rate of 14.23%. On Wednesday IFF announced that the firm’s Frutarom division has completed the acquisition of a 70% stake in Leagel, a European family-owned ice-cream and gelato manufacturer with a geographic reach of 25 countries on Europe. The firm also retains an option for the residual 30% stake in Leagel to be exercised after three years. The purchase is aligned with IFF’s strategy to expand its ice-cream ingredients business while diversifying its geographic presence and leverage cross-selling business. Back in October IFF completed its $7.1 billion acquisition of Frutarom which has significantly strengthened IFF’s position in the health-based ingredients market, the firm is yet to extract full-scale benefit from the integration. For the full year of 2019, the firm is targeting $5.2-$5.3 billion in sales along with an adjusted EPS in between $4.90 to $5.10, reflecting growth rates of 5%-7% and 10%-15%, respectively. My valuation indicates that the intrinsic value of the stock is $140 a share, which implies that the stock is undervalued by $14 a share. Combining all the factors, IFF is a buy.

Source: Earnings Slide

“Leagel has 61 employees serving 1600 direct customers and distributors, with a geographic reach that includes 25 countries in Europe. The Company’s portfolio includes a wide spectrum of offerings, from individual artisanal ingredients to a full suite of products and equipment for the gelato and ice cream retailer.”- IFF Press Release

Excellent performance

In its latest fiscal year, IFF delivered roughly $4 billion in sales, a record 17% growth from the previous year. Both the taste and scent business delivered outstanding performance, revenue grew by 6% on both segments with a revenue contribution of 44% and 47%, respectively. The remaining portion was added by IFF’s Frutarom division- IFF’s $7.1 billion purchase completed on October the last year. Under the scent segment, the strongest performance was produced by fragrance ingredients and cosmetic active ingredients, growing by high-single-digit and double-digit, respectively. In its taste segment all the categories and regions delivered growth, Region-wise the performance was a global-achievement, mid-single digit growth in both EAME ( Europe, Africa, and the Middle East) and LA (Latin America), particularly driven by double-digit growth in Africa, Middle East, and Argentina. During the period (NOAM) North America delivered single-digit growth and made up 25% of total sales. Although all the categories delivered growth, dairy and beverage had a significant contribution.

Source: 10-K, chart by the author.

The following stats are calculated from the last five years of data. The performance was nothing short of stellar for a company operating in the basic industries.

Performance a glance

Revenue 5y cagr

Profit margin (average)

ROIC (average)

ROA (average)

Current debt to capital

6.14%

11.6%

15.5%

9.3%

42.8%

Source: Intrinio, calculation by the author.

The dividend has also been growing over the years, although dividend Coverage fluctuates during the years when there’s significant M&A activity undertaken by the firm, I don’t see any safety issues. For example, the large decline in FCF coverage the last year was due to its record $7.1 billion acquisition of Frutarom. If you exclude 2018 from the chart, the coverage averaged about 1.7x which shows substantial safety in its dividends. So I feel that the dividend is safer than many other firms with consistently lower or negative coverage ratios.

Source: Intrinio, chart by the author.

IFF will continue to consolidate the Frutarom taste business under its taste segment as it goes forward to capitalize on efficiencies and drive accelerated growth. The firm wants to leverage its Tastepoint’s strong blueprint to strengthen its exposure with small and mid-tier customers in every market around the world. The accretive growth strategy will also leverage the power of cross-selling options to enhance the top line. As the integration efforts move forward, the firm expects to extract significant cost synergy. In one year the firm expects $30 million to $35 million of expected savings from accelerating the rationalization and harmonization of its procurement spend.

Source: Earnings Slide

Discussion on debt

Following the acquisition of Frutarom, IFF’s outstanding debt was $4.4, reflecting roughly 75% of total equity. Although debt to equity historically fluctuated within a wide range for a past couple of years, debt to EBITDA was comparatively steady. But, after the purchase, debt to EBITDA has risen significantly, from the previous average of 1.8x to current 5.8x. However, this is a temporary effect on IFF’s slates as the firm expands its business both categorically and geographically.

Source: Intrinio, chart by the author.

Out of the total $7.58 billion in obligations, 33% will have to be paid within 2021. This year’s obligation is roughly 7.54% of the midpoint-guidance of $5.25 billion in revenue. If revenue increased by 5% during 2020-2021, the obligation will account for roughly 13% during the two years (in a simplistic case where no additional obligation comes up or debt extinguishment). For the portion on 2024 and thereafter, there should significant changes in the existing structure.

Payments Due

Total

Less than 1 Year

1-3 Years

3-5 Years

After 5 Years

(Dollars In Millions)

2019

2020 - 2021

2022 - 2023

2024 and thereafter

Borrowings

4,595

45

1,074

300

3,176

Interest on borrowings

2,273

144

268

226

1,635

Operating Leases

390

49

79

61

201

Pension funding obligations

70

23

47

Postretirement obligations

60

4

8

8

40

Purchase Commitments

136

126

10

U.S. tax reform toll-charge

53

5

9

13

26

Total

7,577

396

1,495

608

5,078

Source: 10-K

Valuation

My valuation model indicates that IFF is undervalued by roughly $14 a share. I have made several assumptions to value the stock which are shown below.

Source: Historical data from Intrinio, chart by the author.

The valuation output shows that the intrinsic value for each share of IFF is approximately $140, which shows that the stock is undervalued by $14 a share.

Summary output

Cumulative PV of FCFF

4,836

Present Value of Terminal Value

10,967

Indicated Value of Invested Capital

15,803

Mid-year Adjustment Factor

1.03

Intrinsic Value of Invested Capital

16,337

Add: Cash and Marketable Securities

649

Less: Debt and Lease Obligations

-4,584

Less: Book Value of Preferred Stock and Minority Interest

-92

Intrinsic Value of Equity

12,309

Diluted Shares Outstanding

88

Intrinsic Value per Share

140

Current Price per Share

125

Conclusion

IFF is a globally renowned ingredients manufacturer. The firm has delivered excellent performance over the years and strengthened its market position by acquiring lucrative businesses. The dividend is steadily growing and looks relatively safe too. I feel that IFF can economically achieve its guidance while maintaining its double-digit profit margin, My valuation model indicates that the firm is undervalued by $14 a share and could add value to long-term income portfolios.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in IFF over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.