International Flavors' Strategic Efforts A Boon, Risks Drag

We issued an updated research report on International Flavors & Fragrances Inc. (NYSE:IFF) on Mar 26. A vast customer base, gains from business expansion efforts and sound capital allocation strategies are key drivers for the company. On the flip side, risks related to international operations, high debts, rising costs and industry competition remain concerns.

The company, with a market capitalization of approximately $10.5 billion, currently carries a Zacks Rank #3 (Hold).

Below, we briefly discussed the company’s potential growth drivers and possible headwinds.

Factors Favoring International Flavors & Fragrances

Near- and Long-Term Growth Potential Solid: International Flavors serves a wide customer base — through its two business segments, Flavors and Fragrances — in the food and beverage industries. Its products, including flavor compounds, fine fragrances, consumer fragrances and fragrance ingredients, are primarily used by manufacturers of perfume and toiletry, soaps, detergents, fabric care, household cleaners and air fresheners. Such diversity in the application areas of its products is a boon. Also, international diversity, especially the company’s efforts for expansion in emerging nations, will be advantageous.

For 2018, International Flavors anticipates net sales growth to be 6-8% while predicting operating profit to grow 6.5-8.5%. Earnings per share growth are likely to be around 5.5-7.5%.

In 2016-2020 time period, the company anticipates local currency sales to expand 4-6%, operating profit to grow 7-9% and earnings per share to rise more than 10%. Sales from acquired assets are predicted to range within $500 million to $1 billion; capital spending to be 3-3.5% of sales and cash returned to shareholders to be 50-60% of net income.

Strategic Initiatives: Expansion of product portfolio — through the addition of new and innovative compounds — has been a priority for International Flavors over time. It has a dedicated research and development wing working in these aspects. Also, several other initiatives like Tastepoint — a new company to serve middle-market customers and Re-Imagine — programs that enable capture of unaddressed opportunities in the food and beverage industry will prove beneficial in the quarters ahead. Additionally, it is working on a multi-year productivity program. Through this program, it will be able to check on costs, make strategic investments and expand businesses globally. It intends to reduce the workforce by 5% globally. By the end of 2019, the company anticipates this productivity program to yield annualized savings of $40-$45 million.

Acquisitions and Shareholders Return: Buyouts has been International Flavors’ one of the preferred modes of business expansion. The acquisitions of David Michael & Company in October 2016, Fragrance Resources in January 2017 and PowderPure in April 2017 have proved beneficial since added to the company’s portfolio.

Also, rewarding shareholders with dividend payments and share buybacks have worked in favor of the company. In 2017, it paid cash dividends of $206.1 million to its shareholders while using $58.1 million for repurchasing treasury stocks. In August 2017, it announced an 8% increase in its quarterly dividend rate while in November, it announced a $300 million share buyback program.

Factors Working Against International Flavors & Fragrances

Share Price Performance, Poor Valuation & Earnings Estimates: In the last three months, International Flavors’ shares have declined 13.3%, worse than 7% decline recorded by the industry.



On a P/E (TTM) basis, the company’s shares look overvalued compared with the industry with respective tallies of 22.5x and 21.8x in the last three months. This makes us cautious about the stock. In addition, the stock’s Zacks Consensus Estimate has decreased 0.2% to $6.29 for 2018 and by 0.7% to $6.75 for 2019.

Rising Costs & Expenses, Huge Debts Raise Concerns: International Flavors is exposed to risks, emanating from the rise in costs and expenses. In the fourth quarter of 2017, its cost of sales grew 14% year over year while research and development expenses increased 19% and adjusted selling and administrative expenses expanded 6.4%. Margin profile was weak as adjusted gross margin slipped 110 bps year over year and adjusted operating margin fell 90 bps. Also, its long-term debt was approximately $1.6 billion while exiting the quarter. We believe, if unchecked, rising costs and expenses, and huge debt levels can be detrimental to its profitability in the quarters ahead.

Threat From International Expansion & Industry Competition: Expansion of business in international arenas has exposed International Flavors to risks arising from adverse movements in foreign currencies. Also, uncertainties in economic growth or reduction in consumer spending of the countries served can severely impact the company’s businesses.

Moreover, International Flavors faces stiff competition from the companies offering similar products and services or those producing different items for same uses. Some key players in the industry are CSW Industrials, Inc. (NASDAQ:CSWI) , DAQO New Energy Corp. (NYSE:DQ) and KMG Chemicals, Inc. (NYSE:KMG) . While both CSW Industrials and DAQO New Energy sport a Zacks Rank #1 (Strong Buy), KMG Chemicals carries a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks Rank #1 stocks here.

In the last 60 days, earnings estimates for each of these stocks improved for the current year and the next year. Also, average positive earnings surprise for the last four quarters was 9.55% for CSW Industrials, 34.57% for DAQO New Energy and 29.79% for KMG Chemicals.

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