2024-01-16 14:09:11 ET
Summary
- IFF management is evaluating which business divisions to continue and which ones to divest.
- The company's financial performance has been unimpressive, with low profitability margins and stagnant operating income.
- The stock price is still down on a year-on-year basis, and the company's future business strategy is uncertain, making it difficult to determine a reliable fair value.
When a new CEO takes over the reins of a company, it is quite natural to expect some form of change in vision and direction. The next step in the process is evaluating the strategic choices and then announcement of an execution plan to achieve the goals and objectives upon which an investor assesses the future business prospects. An important element is to know which business divisions would continue and which ones would be shelved or divested. Accordingly, the International Flavors & Fragrances Inc. (IFF) management presented the following framework for the company divisions in February 2023 , which must have been determined after some homework.
However, the company has so far sold its winners " Cosmetic Ingredients ", " Flavor Specialty Ingredients (FSI) ", and " Savory Solutions ", and is now aiming to exit Pharma Solutions as well. If the management is selling its winners or core portfolio companies, then it is only logical to raise questions on the future growth prospects. We find it even more confusing that the strategy was discussed earlier in 2023 and within the same year, the actual decisions seem to have been taken a different direction.
Financial Performance
The company's financial performance has not been particularly impressive as the profitability margins are on the lower end of the range at least since 2013. The operating income and margins are of particular concern having stayed at the same level (~600m) for the last 10 years despite revenues having gone up by 4 times. That could be attributed to the depreciation and amortization charge which is manifested in the EBITDA growth, although the EBITDA margins have also declined considerably. The good part is the consistent dividend growth which should continue in the near future as well with further divestitures.
The net debt/EBITDA has gone up substantially but the company is still relatively stable from a leverage perspective, unless there is another large write down in goodwill/intangibles or operating loss in the near future. According to the Bloomberg report, the company is also exploring a potential sale of its pharma solutions business. The unit could fetch about $3.5 billion in sale and should help in further reduction of debt and a good payout in the coming quarters.
The deleveraging and asset optimization path should help de-diversify the business and enable a better focus. However there is some confusion regarding the units that will eventually be retained and the ones that will be divested.
Overall the management has been unable to show a positive impact on the shareholder value due to its inability to grow the bottom line, despite having loaded the company with debt (albeit manageable so far) and finance costs, ringing further alarm bells with goodwill write-offs. In addition, the key concern is the future business growth prospects from the units that are already marked by the company for either "result improvement or exit".
Valuation
The stock price has risen nicely from the recent 52W low at $62.11 but it is still down by 31% on YTD basis with a FWD PE (GAAP) at 170x as of January 14. The dividend yield is decent at 4% for a business with consistent dividend growth of 8.5% over the last 10 years and a consecutive dividend growth for 21 years.
On a relative basis the company still seems to be overvalued as evident above, but the main issue in arriving at a reliable fair value is the uncertainty associated with the future business strategy. Although the steps taken by the management could be considered as prudent, the conflict between the announced plan and actual decisions leaves one guessing in the dark in my view. The earnings recession, until reversed, also doesn't support the current valuation and one may consider applying a discount to the current price in order to mitigate against any potential capital losses should the financial performance be any worse in the near future. It would also help with a better visibility on the evolving business landscape and the eventual economic drivers that would continue to have an impact on the future growth.
Upside Risks
The company has very reasonable gross margins that averaged 40% over the last 10 years, and that is possible only for a company with leading market positioning. If the company can somehow turn this around and bring the margins back to mid-top range, the earnings growth would be substantial. There was an uptick in profitability margins during the last quarter (YoY as well QoQ basis) but it needs to be seen if it can be maintained.
Conclusion
The stock seems overvalued for all the changes currently taking place within the company, but once the picture is relatively clear and reliable, the business has good potential and one may consider accumulating it for the long-term. There is an obvious upside if the management is able to improve the business performance but it would be prudent to remain cautious at current price levels.
Disclaimer: The opinion in this document is for informational purposes only and should not be considered as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. I do not recommend that anyone act upon any investment information without first consulting an investment professional as to the suitability of such investments for his or her specific situation.
For further details see:
International Flavors & Fragrances: A Conflicted Outlook?