GVDBF - Givaudan: Growth Is Not Without Its Downsides

2023-03-07 13:40:06 ET

Summary

• Givaudan has been expanding through a combination of organic growth, M&A and partnerships, with a recent focus on gaining exposure to products produced by biotech.
• While Givaudan has been able to maintain steady growth over a long period of time, this appears to be the result of expansion into less attractive areas.
• Management is targeting mid single-digit growth over the next few years, but growth could be undermined by declining margins.
• A combination of modest growth and deteriorating margins probably doesn't justify the current share price.

Givaudan (GVDBF) is a leading supplier of flavors, fragrances and cosmetic ingredients globally. The company has achieved relatively strong results in recent years, due in large part to their scale and expertise in product formulation. Givaudan is also trying to support future growth by increasing their exposure to biotech and markets like alternative proteins. Growth appears to be coming at the expense of profitability though, which should make investors weary about paying an excessive multiple for the stock.

Market

Givaudan segments their opportunity into three markets, each of which is large and growing modestly. Givaudan already has a strong position within the Flavor & Taste and Fragrance & Beauty markets, and are looking to expand their relatively small market share in the Functional & Nutrition market.

These markets have been consolidating in recent years, which could be supportive of industry margins going forward. Companies like DSM-Firmenich may also become a more serious contender in Givaudan's core markets.

Givaudan

Givaudan's history stretches back over 250 years , with the company's traditional strength being in fragrances. The company now has two primary businesses:

• Taste & Wellbeing
• Fragrance & Beauty

Givaudan is focused on providing consumers with clean label, organic and natural ingredients in addition to being a creative partner. As production technologies and consumer tastes evolve, Givaudan is also trying to maintain its market leadership by leveraging the capabilities of partners and start-ups.

56% of sales come from mature markets, which offer limited growth, but 44% of sales come from high growth markets. 55% of Givaudan's customers are local and regional and 45% are multinationals. This necessitates having a geographically distributed salesforce to reach the entire market.

Despite only contributing a relatively small proportion of total costs (0.5-2.0% in flavors and consumer fragrances to 4-6% in fine fragrance), scent and taste are important determinants of buyer behavior. As a result, it is an area that brands are willing to spend money on and offers potentially attractive economics.

Producing these types of products can be complex, as a large number of raw materials and sophisticated supply chains are involved. Givaudan utilizes over 12,400 raw materials and almost 3,000 raw material suppliers. In excess of 125,000 products are made to order and delivered to over 11,700 customers. There are also compliance and regulatory considerations which increase barriers to entry.

The fact that Givaudan works closely with customers to develop products is an important part of the company's competitive advantage. To win business, potential suppliers must be on a core supplier list, submit a brief, develop a solution and be selected by the customer. Givaudan works on more than 300,000 briefs per year, and winning a disproportionate share is the only way for Givaudan to maintain and grow revenue.

Givaudan is currently focused on expanding its product portfolio and extending its market reach, through a combination of internal development, partnerships and acquisitions. Alternative proteins and Health & Wellness are important parts of this growth strategy.

Recent product introductions include:

• Primelock - a vegan solution that locks in both flavor and fat in plant-based meat products, mimicking animal cells. This supposedly provides an enhanced food experience while reducing fat and calories.
• BioNootkatone - a product developed in partnership with Manus Bio. It is a product of fermentation that replaces traditional citrus extracts.
• PatchoulUp - an active for hair and scalp. It is produced through green fractionation of distilled patchouli leaves, after they have been used as a raw material in fragrance creation.
• PlanetCaps - a fragrance delivery system for fabric softeners, laundry sanitizers and scent boosters.
• AmbreXolide - a sustainable alternative to the musk Ambrettolide. It is a biodegradable and naturally derived molecule exclusively available to Givaudan customers.

Acquisitions

Givaudan has been an active acquirer in recent years, contributing to revenue growth and adding to the company's capabilities. These acquisitions are likely adding value as they are generally small and benefit from a well formed integration process. Givaudan is also sticking to acquisitions that can either leverage their formulation expertise and customer relationships or expand the reach of their products.

Myrissi

Givaudan recently acquired Myrissi for their AI, which is capable of translating fragrances into color patterns and images. This can be used to help predict the emotional response of an end consumer to a particular fragrance. The model was developed using database of more than 25,000 consumer tests . Givaudan will likely use this technology to help develop fragrances that match the marketing briefs of customers.

DDW

Givaudan acquired DDW to support the expansion of their Taste & Wellbeing business. DDW is a US based natural color company which will add to Givaudan's extensive portfolio of taste and sense solutions. DDW has 12 manufacturing facilities around the world and 315 associates. DDW's business would have represented approximately USD 140 million of incremental sales to Givaudan's results in 2020 on a pro-forma basis.

Customer Essence

Givaudan acquired Custom Essence to increase their access to local and regional customers and expand their natural perfumery capabilities. Custom Essence specializes in the formulation of natural fragrances and employs 70 people globally . Custom Essence's business would have represented approximately USD 40 million of incremental sales to Givaudan's results in 2020 on a pro-forma basis.

Alderys

Givaudan acquired Alderys to help build their competency in biotechnology. Alderys is a French biotechnology company with 30 employees that targets the production of compounds from renewable feedstocks for the chemical, cosmetic and nutrition sectors. Givaudan acquired 80% of the share capital of Alderys' shares in August 2020 for CHF 23 million. Alderys' business would have represented EUR 3 million of incremental revenues to Givaudan's results in 2019 on a pro-forma basis.

Cosmetics Business of Indena

Givaudan acquired the cosmetics business of Indena to support their active beauty business. Indena focuses on the production of active ingredients derived from plants, for use in the pharmaceutical, health food and personal care industries. Givaudan and Indena also signed a long term partnership agreement under which Indena will continue to manufacture ingredients for Givaudan, as well as providing innovation capabilities and other supporting services. Indena's cosmetic ingredients business would have represented approximately EUR 8 million of incremental sales to Givaudan's results in 2019 on a pro-forma basis.

Ungerer

Givaudan acquired the US based Flavor, Fragrance and Specialty Ingredients company Ungerer. This acquisition should strengthen Givaudan's specialty ingredient capabilities and increase exposure to fast growing local and regional customer segments.

Golden Frog

Givaudan acquired the Vietnamese flavor company Golden Frog to strengthen their position in natural ingredients. Golden Frog manufactures natural flavors, extracts and essential oils for the food and beverage industry. It offers a wide range of natural ingredients including herbs, spices, fruit and vegetable extracts and essential oils from Vietnam.

Cosmetics Business of AMSilk

AMSilk is a supplier of vegan silk biopolymers for cosmetics. These biopolymers can be used across categories like hair care and skin care with benefits including silk touch, anti-pollution and hair color protection.

Amyris Cosmetic Ingredients

Givaudan recently licensed the exclusive marketing rights for squalane and hemisqualane from Amyris ( AMRS ). The transaction has a total estimated value of 500 million USD , made up of a combination of an upfront payment, earnouts, and manufacturing revenue. Squalane and hemisqualane are skincare and haircare ingredients that will add to Givaudan's active beauty business.

Biotech

Givaudan has made efforts in recent years to ensure they benefit from biotechnology's increasing impact on specialty chemicals. In addition to their acquisition of Alderys, Givaudan has entered into agreements with LanzaTech ( LNZA ), Amyris and Manus Bio.

Givaudan and LanzaTech are collaborating on the development of fragrance ingredients using fermentation with waste carbon as a feedstock. LanzaTech converts emissions into ethanol and then subsequently converts ethanol into the building blocks necessary to make a wide range of consumer goods.

In addition to licensing molecules to Givaudan, Amyris is providing access to their innovation capabilities. Givaudan will also become the commercialization partner for Amyris' future beauty ingredients. While it is not known for sure, it seems likely that Givaudan's recently announced RetiLife product was developed by Amyris. RetiLife is produced using a fermentation process, and retinol had previously been announced as part of Amyris' product pipeline.

In addition to launching BioNootkatone together, Givaudan continues to work with Manus Bio to bring other ingredients to market utilizing biotechnology.

Financial Analysis

Givaudan achieved relatively strong revenue growth across categories and geographies in 2022, largely on the back of increasing prices. Price increases are expected to continue into 2023, but this may increasingly occur in combination with declining volumes.

Fine fragrance revenue growth was strong in 2022, driven by a rebound in prestige fragrances and travel retail channels. Demand for fragrance ingredients and premium actives in active beauty was also strong. Growth within Taste & Wellbeing was also strong, particularly in sweet goods , beverages, and snacks.

There did appear to be some weakness later in the year though, as customers began reducing excess inventory in North America , impacting both Taste & Wellbeing and the consumer products part of the Fragrance & Beauty division. Softening end consumer demand could cause this weakness to continue in 2023.

Raw materials, energy and logistics increased costs by an estimated 360 million CHF in 2022. Givaudan expects input costs to increase a further 5% in 2023 , adding to inflationary pressure on margins. Management is delivering on pricing actions which are expected to compensate for higher costs though.

Givaudan is also reviewing their manufacturing footprint to try and optimize costs and hope to reduce inventory levels as supply chain pressures ease. Freeing up working capital should help contribute to a return to a more normal level of free cash flow.

The decline in margins in 2022 appears to be part of a longer term trend though. Givaudan's gross profit margins have declined significantly over the past 15-20 years, although this has been offset somewhat by a lower burden from operating expenses. It is not clear whether this decline in margins has been driven more by Givaudan's product and geographic expansion, or increasing competition.

Valuation

Givaudan is targeting 4-5% average like for like sales growth between 2021 and 2025, and is also targeting average free cash flow greater than 12% of sales over the same period. Given these modest targets, Givaudan's stock looks relatively expensive, particularly if margins continue to decline. While Givaudan is a quality company, investors may be better served by waiting for a more attractive entry point, particularly given that consumer spending is likely to weaken in 2023/2024.

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