Description

IFF is the largest supplier of specialty ingredients into the food & beverage, home & personal care and health & wellness markets. At today’s price, IFF trades for 14x 2023 EBITDA (just guided) vs. peers at 17-20x. IFF is ~4x levered as a result of M&A activity in 2020/21 but today is focused on deleveraging. IFF has historically traded at a discount to peers due to mistakes of previous management leading to credibility issues (i.e. bad acquisition of Frutarom where IFF overpaid and did not properly diligence). IFF replaced both their CEO and CFO in the last two years and has been on a path to rebuilding credibility though has struggled with FX and raw material headwinds (each a ~$200M impact to EBITDA).

Unfortunately, IFF’s new management team just chunked on 4Q results – despite issuing guidance at their Dec. 7^th analyst day with a preliminary view for 2023 EBITDA of $2.5-$2.6B they formally issued 2023 EBITDA guidance of $2.34B two months later and the stock fell ~20%. The reason for the change in 2023 expectations is customer-level destocking which accelerated in mid-December (a few sub-segments saw volume down +20% in the month and the resulting 2023 impact is volume ~2% worse, or a ~$100M impact). On top of this, IFF made the decision to prioritize FCF generation over EBITDA generation and decided to bring production to ~95% of sell-out levels, which is leading to an additional ~$100M impact on negative cost absorption. This change in 2023 guidance effectively blew up the path that new management was on to rebuild investor confidence.

We think that the setup is interesting from here as we see the stock sufficiently de-risked at these levels and think that the $2.34B guide has substantial conservatism to avoid a 2^nd guide down (an Icahn representative just joined the board and another miss would put the new management team in a very difficult position). We see the following points as upside to the $2.34 guidance:

·         Management has guided to headcount reduction and other cost saving initiatives over a multi-year period that we think can be partially accelerated to offset the destocking impact. We assume that this is a ~$50M benefit to the $2.34B guide.

·         IFF has been running ~$200M behind on price / cost (from 2021 and was not able to catch up in 2022 due to additional inflation). IFF is working hard to maintain price increase but we are starting to see costs roll over (raw materials, energy, freight). We think that IFF can recapture ~half of this benefit in 2023; however, since management is working hard to maintain prices we think that this is a sensitive topic for discussion on earnings calls due to negotiating dynamics.

Taken together, this gets us to a more reasonable $2.5B for 2023E (which would be closer to $2.6B apples-to-applies w/ the investor day guidance however IFF subsequently made a small divestiture). However, we don’t think that the $2.5B is the right number to capitalize given the one-time inventory dynamics in 2023

·         The $100m negative impact of cost absorption is a one-time event that reverts when you start producing at existing demand levels

·         The $100m negative impact of customer destocking also cannot last forever. Sell-out at current guidance is in-line with past recessionary levels (flat to down LSD).

This gets us to a “normalized” 2023 EBITDA of $2.8B, which we think is the appropriate EBITDA to think about for valuation purposes. Taking out D&A/Interest/Other/Taxes gets us to EPS of ~$6.30. We think that the appropriate EPS multiple is ~20-25x based on historical trading of peers (against which IFF is now benchmarking organic growth at similar levels under new management). This gets us to ~50% upside for a diversified, moated asset with pricing power.

Catalyst

Beating guidance