GVDBF - Givaudan: No Signs Of Volume Recovery

2023-07-26 04:04:55 ET

Summary

• Givaudan's H123 results missed top-line expectations, which I believe is due to ongoing destocking trends.
• Despite the weak volume, Givaudan's EBITDA and net profit margins outperformed expectations.
• My hold rating on Givaudan remains unchanged due to the uncertain recovery from the current environment and the need for clear signs of volume improvement and economic recovery.

Summary

Givaudan SA ( GVDBF ) creates and sells perfumes, flavors, and fragrances made from both natural and synthetic materials. Readers may find my previous coverage via this link . My previous rating was a hold as I was wary of the combination of short-term uncertainty and high valuation. I am reiterating my hold rating as there are no signs of volume recovery in the near term and that the ongoing destocking trend might last longer than expected.

Financials/Valuation

Givaudan's 1H23 results were mixed, missing on the top line due to 2Q23 results that were below expectations. The like-for-like [LFL] increase in revenue for 2Q23 was 1.2%, which was lower than the consensus estimate of 3.2% growth. In spite of this, 1H23 EBITDA and net profit margins outperformed projections. I believe that the ongoing de-stocking efforts were the primary cause of the decline in revenue. The Taste & Well-Being segment saw the largest decline, down 2.6% year over year in 2Q23 as growth slowed across all regions except Europe. With stronger performance in Fine and improved results in Consumer, Fragrance & Beauty reported 5.9% growth. Regarding the weak volume, I believe this is not an isolated problem for Givaudan, rather, I see the entire industry facing such a problem, particularly in North America .

Based on my view of the business, Givaudan should be able to grow EPS by 8% over the coming decade. This is based on its historical growth rate of mid- to high-single-digit revenue growth, and my expectation for margin to expand over time due to its pricing power and scale. Note that Givaudan's net margin had a previous high of 15% at one point. A key assumption in my DCF model is the 8% discount rate. Given the stable nature of the business and the high barrier to entry, I think the business is relatively safe when compared to the market. Using my assumptions, I derived a target price of CHF 2833.

Comments

Using historical disclosure of total pricing growth and total LFL sales growth, we can back into the implied LFL volume growth. Pre-covid, volume tends to grow in the 2 to 4% range, and has hit a high of ~7% range during covid period. This figure has decelerated to -5% in the recent quarter and -~4% in 1H23. As the decline in volumes continues to be the primary challenge, my short-term concerns persist. I think retailers' destocking efforts are at the root of this problem, and they won't stop until those businesses regain faith in consumer demand and the economy. This is an issue that should resolve itself over time as retailers need to stock up on inventory eventually. More on the plus side, if the economy improves, this could pose an opportunity for volume to exceed expectations, thereby becoming the primary driver of organic growth through H2 and into FY24. As there are virtually no ways to ascertain the level of destocking so far, I think there is a possibility that retailers have destocked to levels below the base level of demand. As such, some retailers need to stock up on inventory to meet the base level of demand, which could provide a short-term boost in volume demand for Givaudan. That said, it was encouraging to see management's pricing and cost strategy bear fruit, resulting in EBITDA margins that were closer to their historical averages. As a result, while the top line may be weak due to the weak volume situation, the impact on EBITDA may be less severe.

The 2Q23 results weren't terrible as a whole, but I don't see anything promising coming up that would cause the stock price to rise. It was difficult to swallow Givaudan's 6% decline in revenue (to put this in perspective, revenue has only declined more than 6% once in the past decade, in 2011), even though I had anticipated negative volume growth in 2Q23 due to the ongoing destocking trend. However, I would be more wary about FY24, with my main concerns being the company's ability to recover from the current tough environment and regain market share, all while cutting costs and having little wiggle room in its balance sheet for organic or inorganic investment. Note that Givaudan's leverage ratio (net debt/EBITDA) has reached a high of >3x.

Risk & conclusion

What could cause further pain to the stock price is if the magnitude and duration of destocking are bigger and longer than expected. Firstly, this would mean Givaudan will not see any signs of recovery in the near or medium term. Secondly, consensus will push out their estimates, putting further pressure on the stock price.

In conclusion, my hold rating on Givaudan remains unchanged due to the absence of signs indicating a volume recovery in the near term and the prolonged destocking trend. The company's H123 results were mixed, with revenue missing expectations, largely affected by ongoing destocking efforts. The company's ability to recover from the current environment and regain market share while managing costs and leverage ratio adds to the caution. Until there are clear indications of volume improvement and economic recovery, I maintain a hold position on Givaudan's stock.

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