Long : IFF

International Flavors & Fragrances (IFF) is a significant supplier to the food and beverage, fragrance, home and personal care, health and wellness, and animal nutrition end markets. The company engages with customers throughout the supply chain by sourcing raw materials and collaborating on product designs, as well as through manufacturing and distribution. Its natural ingredients for flavors, fragrances, antioxidants, and nutrition are sourced from flowers, fruits, animal and marine products, and crops.

IFF will report Q4 '23 this week, and we are not terribly concerned about a negative surprise. In January, IFF reaffirmed their Q4 sales outlook and EBITDA at the mid to high end of its previously stated guidance range. IFF's new CEO and board member, Erik Fyrwald (former CEO of Syngenta) officially started in his role on February 6, and the feedback on Fyrwald has been positive; we view new CEO Fyrwald as a catalyst to improvement of operating performance and stock price at IFF. 

IFF generated $12.4 billion in sales with operating margins of 21% in their last fiscal year, with 85% of the company’s end markets in staples (food, health care, and personal care products), which helps generate resilient sources of revenue. Roughly 15% of its markets are more cyclical cosmetic actives, fine fragrances, and retail food services, and its market share in the global flavors and fragrances industry is 25%. International Flavors & Fragrances has 1,346 patents, and its sales are diverse enough that no single patent is material to results. Products that use the company’s ingredients are everywhere; management says that its ingredients are present in 50% of ice creams, 50% of nutrition bars, and 25% of bread consumed around the globe. Because of its low capital intensity, capital expenditures average about 4% of revenues, the company typically generates strong free cash flow. 

Investment Thesis

Large multinational consumer products companies are experiencing pressure from small and niche players more in touch with the latest consumer trends involving natural products. International Flavors & Fragrances is a significant player in alternative soy and pea proteins, helps create reduced sugar alternatives, and incorporates probiotics and enzymes, making it a valuable partner for these companies. Using more natural ingredients requires additional specialty ingredients that promote better taste, shelf life, or texture. Ideally, the company is a leading producer of these compounds. Most of its solutions in the Ingredients and Flavors categories are tailor-made and proprietary, allowing it to build a base of intellectual property with the compounds it develops.

Switching costs can be high for customers, fostering long-lasting relationships and enhancing the company’s competitive advantage. International Flavors & Fragrances is one of just a few core suppliers for many large clients. Smaller suppliers struggle to compete at scale, further enhancing the company’s competitive advantage. Large customers include PepsiCo, Unilever, Procter & Gamble, and Estée Lauder. The company’s top line is highly diversified, with sales in North America at just 28% of revenues, coupled with a strong presence in emerging markets. Emerging markets are a vital part of management’s growth strategy because these markets logically offer more potential expansion than mature developed markets provide. While this international exposure opens the company to more currency risk and economic sensitivity, the company continues to grow nicely.

International Flavors & Fragrances’ shares have underperformed the market, and have been hit, down nearly 50% from their summer 2021 highs. It is likely that the company has been significantly out of favor because its balance sheet contains more leverage than their historical norm. IFF completed a transformational deal in early 2021, merging with DuPont’s Nutrition & Biosciences segment. Ed Breen, executive chairman and CEO of DuPont, orchestrated the deal and served on the board of International Flavors & Fragrances until the 2023 shareholders meeting. To complete the transaction, the company increased its long-term debt by $7 billion, subsequently increasing its debt ratios to 5.4x net debt/EBITDA after the close of the transaction. Today, this ratio is closer to 4x, with further asset dispositions planned to reduce debt outstanding further.

The total addressable market for the Nutrition & Bioscience business is $40 billion, with key market drivers that include an aging global population and an increased consumer focus on health and wellness. Although similarities exist between Nutrition & Biosciences with International Flavors & Fragrances’ legacy business, the segments serve different markets. International Flavors & Fragrances historically served larger clients, but 59% of its 42,000 customers are small and mid-sized entities. The company is still in the early stages of a multiyear integration that management continues to expect will produce $250-$300 million in annual cost synergies, along with up to $400 million in revenue synergies from leveraging distribution and exposure to additional end markets and customers. Support for the deal was strong on Wall Street, with the split oversubscribed by DuPont shareholders, and the stock was initially a strong performer following the transaction—we assume this was a sign of enthusiasm for the transaction’s operational and strategic merits before a challenging macro backdrop caused the shares to reverse from their post-transaction highs.

While leverage was initially high after the transaction following the dividend paid to DuPont in 2021, recent actions have it trending in the right direction. Strong free cash flow generation will further support debt reduction. The company’s debt maturities exceed $1 billion annually from 2024 to 2027 but should be serviceable thanks to planned asset sales, free cash flow, and optional refinancing. Only 12% of the company’s $9.2 billion in long-term debt is variable-rate, and $5 billion of its long-term debt sits at maturities of 2030 and beyond. The company increased prices to fully recapture cost inflation, translating to better free cash flow performance in the coming year. In conjunction with solid organic growth and cost synergies contributing to increased operating margins, we expect the leverage ratio to fall to 3x by the end of 2026.

Valuation

International Flavors & Fragrances’ stock trades at approximately 15x EV/EBITDA multiple, but at less than 10x our 2025 estimate, which factors in potential earnings power and revenue and cost synergies. This figure is well below the company’s 21x historical average and the valuation of its peers, Givaudan and Symrise. Transactions within this market segment have traded widely but are still significantly higher than IFF’s current valuation. Givaudan bought Quest International BV in 2006 at 18x and Naturex SA in 2018 for 27x. The business is defensive since it caters to durable end markets and has engaged with clients over many years. Shares now offer investors an approximate 4% yield—one is getting paid to wait for improvements in the balance sheet and efficiency to improve. Using a combination of discounted cash flow analysis with 5% revenue growth and 22% operating margins, as well as multiples comparable to industry competitors, we estimate a long-term intrinsic value of around $150 per share. As debt paydown accrues to equity investors, cost synergies are realized, and the business continues to grow, we see an upside potential of roughly 80% over the next several years.

Risk to Investment

The company might not deleverage as quickly as expected, or depressed valuations could limit attractive opportunities to divest noncore assets. Unfavorable foreign exchange rates (stronger US dollar), international trade, or geopolitical challenges could go from bad to worse. Most of the Company’s revenues are generated outside the United States, particularly in emerging markets with higher volatility and unpredictability. However, this is sufficiently counteracted by the stability of the company’s end markets. Inflation might not be reined in as expected, with increases in raw material prices, transportation, and energy not fully offset by price increases. The Nutrition & Bioscience integration could grow problematic, preventing expected synergies from being unlocked. Price increases could affect the volumes produced or cause customers to choose competitors in some cases.