International Flavors & Fragrances Inc. (NYSE: IFF). Analysts from the stock portal beststocks.com have a favorable view of the company’s innovative products and expect synergies and cross-selling opportunities from the Frutarom acquisition and the planned merger with DuPont’s Nutrition and Biosciences business. However, the pandemic has created challenges for IFF, including raw material shortages and higher operating and employee-related costs. The raw material shortages have forced the company to forgo the production of certain products, resulting in lower sales. IFF has also seen lower demand for some high-margin products, such as fine fragrances. We expect near-term challenges as the company works to complete the integration of Frutarom while planning the DuPont Nutrition merger and takes on additional debt incurred as part of that deal.
Recent Developments
The beta on IFF is 1.
On a currency neutral basis, adjusted EPS excluding amortization increased 1%. Gross margin declined 70 basis points to 41.4% due to higher raw material costs and declines in high margin businesses. Year-to-date free cash flow increased 30% to $223 million.
Management said that COVID-19 has affected the food service and fine fragrance businesses, which have declined 13% and 14%, respectively, over the prior year. Excluding these categories, management said sales grew 3% during the quarter on a currency-neutral basis. The pandemic has also affected the availability of raw materials and the company is recovering from a shortage in 2Q20 which forced IFF to forego the production of certain products, resulting in lower sales.
IFF has grown through acquisitions. In 4Q18, the company purchased Frutarom, a flavor and ingredients company. The company initially targeted $100 million in additional sales from the acquisition by 2024 but now estimates a pipeline of approximately $235 million. As part of the integration, IFF expects to close approximately 35 manufacturing sites by the end of 2024. It also expects $145 million in cost synergies over a three year period. In year 1, over $40 million of the $50 million target has been realized. The company expects another $50 million in synergies in year 2 and $45 million in year 3.
In 4Q19, IFF announced a merger with DuPont’s Nutrition and Biosciences business that is expected to take place in 1Q21. The deal values the combined company at $45.4 billion and includes a $7.3 billion cash payout from IFF when the deal closes. Management expects the merger to strengthen the company’s industry position, broaden its product offerings, and provide innovative integrated solutions for customers. The merger has received regulatory approval in all jurisdictions except the EU, where it is awaiting anti-trust approval. Management says that shareholder approval and financing has been received and that it remains on track to close the deal on February 1, 2024.
Management has withdrawn formal guidance amid the COVID-19 pandemic; however, it noted that the prior year included a 53rd week of sales, which represented 4 percentage points of currency neutral sales. We note that 85% of the company’s portfolio focuses on high-demand markets including food, beverage, and hygiene.
Earnings & Growth Analysis
Beginning in 1Q20, IFF changed its reporting structure from three segments to two. Nearly all of Frutarom, previously a standalone segment, has been incorporated into Taste, (60% of 3Q sales) and Scent, (40%). Recent business trends by segment are discussed below:
In the Taste segment, 3Q sales fell 2% on a reported basis to $765 million. Currency-neutral revenue declined 1%, reflecting challenges in food service sales. The segment profit margin was 13.3% reflecting cost synergies from acquisitions, offset by lower sales and high raw material costs.
In the Scent segment, 3Q reported sales increased 4% to $503 millon. Currency-neutral revenue also grew 4%. The result reflected double-digit increases in consumer fragrance and fragrance ingredients used in cosmetics offset by a decline in fine fragrances. Segment profit rose 15% to $101 million (up 20% on a currency neutral basis) due to higher volume and productivity benefits. The segment profit margin was 20.2%.
On the expense side, both gross margin and operating margin declined 70 basis points to 41.4% and 15.2%, respectively. Selling & administrative expenses increased 11%, representing 18.5% of net sales. Research and development expenses increased 6%, and were 7.1% of sales.
Turning to our estimates, we expect the rising cost and reduced availability of raw materials, additional disruptions from COVID-19 (especially in Europe), and the future merger with DuPont’s Nutrition and Biosciences business to impact profitability in the near-term.
Financial Strenght & Dividend
Long-term debt was $3.9 billion, consistent with 4Q19. The Debt to Capital ratio was 39%, consistent with the prior year. A $351 million note will come due at the end of 2024.
IFF pays a dividend.
Management & Risks
IFF Chairman and CEO Andreas Fibig has held the position since 2014. Prior to IFF, he held executive positions at Bayer and Pfizer. Rustom Jilla recently succeeded Richard O’Leary as CFO. Mr. O’Leary has become the company’s integration officer, with responsibility for the integration of the DuPont Nutrition and Biosciences merger.
Major risks for IFF include raw material cost inflation, changing consumer trends, and increased competition. The company purchases more than 10,000 different raw materials from all over the world, including oils, extracts and concentrates derived from fruits, vegetables, flowers, woods and animal products. While IFF requires high volumes of many different ingredients, it is usually able to source products from a range of countries and can look for alternatives when the price of a particular ingredient is high.
Another concern is exchange rate volatility, as IFF generates 75% of its sales from international markets.
IFF also faces integration risk related to its recent purchase of Frutarom.
Company Description
International Flavors & Fragrances Inc., based in New York, is a leading developer and manufacturer of commercial flavors and fragrances.
Valuation
We believe that this valuation more than adequately reflects the company’s current growth prospects, the modest benefits and high price of the Frutarom acquisition and uncertainty surrounding DuPont’s Nutrition and Biosciences merger. We may look to upgrade the stock if the company’s earnings outlook improves.
