Summary
- IFF has been struggling since it announced the purchase of a substantial DuPont business in 2019.
- Growth has come to a complete standstill as leverage is high, and costs to service debt rise rapidly.
- Greater execution and discipline is required, certainly after the latest disappointment being the 2023 guidance.
- Divestments at modest multiples are not the (only) solution.
In the final days of 2022, I concluded that shares of International Flavors & Fragrances ( IFF ) were back to square one in this premium article.
This came after the company finally closed the large and complicated DuPont deal in 2021, creating a leverage overhang on the business, as lack of reported sales growth hurt the business, despite the sound long-term positioning.
Believing that the underperformance was taking too long, I concluded that outside involvement and discipline would be welcomed, badly needed to unleash the appeal.
The Base Case
Back in 2019, IFF stock announced the purchase of the Nutrition & Biosciences business of DuPont in what was a huge deal, with the value of the acquired activities exceeding the $20 billion valuation of IFF at the time. That deal was set to create a business which would post $11 billion in sales, 23% EBITDA margins (with synergies having the potential to increase this number to 26%) at the time.
Given a poor experience on the $7 billion deal for Frutarom years earlier and the size of the deal, investors were not too impressed with the transaction as shares fell from $134 to $120 on the back of the deal announcement in 2019. With earnings power trending around $6 per share and a net debt load of about $11 billion, this worked down to a leverage ratio in excess of 4 times EBITDA.
Ever since, shares have been trading in a rather wide $100-$150 price range as the company was working to address leverage as the fundamental performance came in a bit soft. The company sold the Microbial Control business in a $1.3 billion deal, as shares actually rose to $150 in the summer of 2021. This was driven by low interest rates and hopes from investors, but shares fell to $103 per share by December 2022.
Reasons for that were plentiful. An $11.7 billion sales number for 2021 (as reported early in 2022) was solid, yet EBITDA of $2.4 billion revealed lower margins, with earnings reported at $5.63 per share. The company guided for 2022 sales to rise to $12.5 billion, with EBITDA set to improve to $2.55 billion. This would still result in lower margins equal to 20.4% of sales, far below the 23% margins reported at the time of the deal announcement, as some synergies would by now be achieved as well.
After a reasonably solid first quarter, the company hiked the sales guidance to $12.8 billion, yet this was cut to $12.4-$12.5 billion again, despite inflationary pressures, although accompanied by a $2.55 billion EBITDA guidance. Net debt was cut to $10.3 billion by the third quarter, resulting in a 4 times leverage ratio, as 2022 was setting up to become pretty much a lost year.
In December, the company reached a deal to sell its Savory Solutions business in a $900 million deal, set to reduce net debt to $9.5 billion, resulting in a pro forma leverage ratio of 3.8 times as $65 million in EBITDA would leave the door as well. With $475 million in sales leaving the door, the resulting 2 times sales multiple looked cheap, with IFF itself still trading around 3 times sales. Consequently, I was not blown away by the price fetched for the divestment.
If the company can deliver on $6 in earnings per share, the resulting 16-17 times earnings multiple looks reasonable, as leverage is gradually coming under control, but more execution and discipline would be welcomed.
2023 - Tough
Shares rallied to the $115 mark in January as investors received another bombshell news report early in February. The news was not pretty as fourth quarter sales fell 6% on a reported basis to $2.84 billion, with adverse currency moves only explaining part of the picture. If we add back amortization charges, operating earnings came in at $280 million, down from $358 million in the year before. With GAAP losses posted at $0.10 per share, it was an adjusted earnings number of $0.83 per share, which looks very soft ($1.10 per share in the year before) as the fourth quarter typically is a softer quarter.
For the year, the company posted sales of $12.4 billion, EBITDA of $2.5 billion, and earnings of $5.42 per share, all a bit soft. Moreover, the company is not able to maintain the stabilization here, as 2023 sales are seen at just $12.5 billion. This marks just 1% growth on a reported basis, or 6% if we account for the Savory Solutions divestment.
That being said, 6% growth looks better than realistic might be in this inflationary environment, as underlying growth is likely not that impressive. More worrisome, EBITDA is seen at just $2.34 billion which together with a $10.4 billion net debt load (or $9.5 billion pro forma the Savory divestment) pushes up leverage to 4 times again, all in a much higher debt environment.
Addressing the leverage issue, the company announced its next divestment a week later. The company has reached a deal to sell its Flavor Specialty Ingredients business to private equity firm Exponent in a $220 million deal. This deal will cut net debt by about 2%, hardly making a dent, while some $100 million in revenues will leave the door, as the 2.2 times sales multiple comes in a bit cheap again.
And Now?
The truth is that I am negatively surprised by the (renewed) weakness in the business, with divestments needed to offset the relative leverage increase following the pressure on EBITDA. Hence, I am not surprised to see shares down to where they are as earnings power likely trend closer to $5 per share this year, with leverage still a concern.
Fortunately, activist involvement arrived as Third Point, the fund run by Dan Loeb, bought quite a large stake recently, as this might hopefully be the run-up for a more active involvement by Mr. Loeb.
Amidst all this, I am sticking to a modest long position here but the fundamental performance, or M&A actions, inspires a few reasons to alter/increase this position.
For further details see:
International Flavors & Fragrances: Do Not Like The Smell Of It