2023-05-12 15:45:26 ET
Summary
- Q1 results were better than expected, and the Q2 guide shows sequential improvement in performance expectations.
- The Q2 guidance was, however, lower than consensus and this along with an increase in debt left the market wanting.
- The result has been a decline of over 13% in the share price since the results were published, which pushes the stock back down to near its 52-week low.
- More time is needed for the turnaround to take hold, and management appears focused on the things they can control.
- Maintain buy and $108.29 target along with a 4% dividend yield.
International Flavors & Fragrances ( IFF ) released results on the 8th of May 2023 , we'll run through them here as a follow-up to my first article on the company which was published on the 28th of March 2023 and see how things have progressed.
Let's dig in...
Results
These numbers were eagerly anticipated as they followed a miss in earnings for the full year 2022, which had caused a collapse in the share price. Consensus estimates were therefore factoring in another poor showing on the earnings front as soft end market demand and customer inventory destocking were expected to continue in the first quarter.
Q1 sales came in at $3b, with adjusted EBITDA at $503m. Turnover was flat year-on-year, but adj. EBITDA came in 19% lower than the prior year period. Quarter on quarter however the figures were quite nicely ahead of the most recent figures of $2.8bn and $441m posted in Q4 last year. From what I could see, the consensus figure for the adj. EBITDA number was $485m, so it was a pretty solid beat on that front. Margins held up well and actually rose to 16.6% from 15.5% and EPS ex amortization pushed up too from 83c to 87c.
Q4 2022 Consolidated Summary (Company results announcement) Q1 2023 Consolidated Summary (Company results announcement)
So, lapping the year, results were down quite substantially, but this was expected. From a quarter-on-quarter perspective, however, improvement has taken place which is promising.
The key thesis here was that lower volumes from customers, as they consumed built up inventories, would be the drag on results. On top of this, the company itself also had inventories it needed to get through too, which would also impact performance and costs because of suboptimal manufacturing processes. At the end of the day, this would 'pass through the system' and then the company would be able to continue to grow again as rising prices and inventory rebuilds for their recession-resilient product offering starts to positively impact results.
This was playing out well as the company reaffirmed its guidance on the 27th of March, which in turn sparked a nice rebound in the share price.
These results are providing some evidence that the thesis is playing out, but the market took the other side of the trade once again and the stock has fallen by over 13% since the numbers came out. This has put the stock right back down to the lower end of its 52-week trading range as a result.
Why the collapse?
The first reason was the second quarter guidance where the company suggested it would deliver adj. EBITDA of between $540m and $590m vs consensus expectations of $622m (roughly 9% below expectations at the midpoint).
The other thing I think that can be attributed to the fall was the lack of progress of the reduction of debt. The debt position actually worsened as gross debt rose from $10,987m to $11,309m. On top of this, the trailing 12-month adj EBITDA figure fell to $2,320m from $2,523m. The result was therefore a sharp rise in net debt to adj. EBITDA to 4.6x from 4.1x. This is now on the back of the company, guiding the figure to end up below the 3x mark by the end of 2024.
The reasons for this from what I can pick up are as follows, firstly capex of $175m was incurred in the quarter which was a chunky 5.8% of sales. Secondly, they paid the dividend, which totaled $206m. That alone was worth $381m. The increase in debt was $322m. Free cash flow was a negative $48m.
In my mind, the reason the stock has fallen by over 13% since the numbers were released is that the market perceives the financial position of the company and its balance sheet to be weaker than it was 3 months ago, despite operating performance showing signs of improvement.
Commentary
The deep value buy I put out on the stock was never a 3-month call. I think we need to see the whole of 2023 play out at least before we can make an assessment on whether buying the stock was a good idea or not.
This is my rationale. Cash flows and cash generation are expected to be under pressure as the destocking process alluded to above and in my first note plays out. This is likely to be skewed toward the first half and perhaps the early part of the third quarter of 2023, but it should fade progressively. What I'm expecting to see is both client and company destocking completed. This should then coincide with a pickup in orders which should ramp up growth, cash flows, and profits. On top of this optimal manufacturing, lower input costs and price increases should also combine to help boost margins which should give the profit and cash flow lines an added boost, setting the company up for a strong rebound in 2024.
The pickup in cash flows will also help speed up debt reduction and deleveraging. This could be further helped by some asset disposals, which haven't been ruled out.
I'm going to stick my neck out and say that with management keeping full year guidance intact that my thesis above has some merit to it. In order to meet this guidance, we'd need to see progressive improvement every quarter.
I'd go on to suggest that the quarter-on-quarter improvement and the forecast of a better quarter still for Q2 2023 are some 'proof' that this is in fact happening.
A dividend of 81c per share (ex-div 22 June) payable on 11 July might also illustrate management confidence in the outlook.
Conclusion
The company might finally be reaching the 'bottom' of this earnings cycle as is evidenced in the sequential improvement we've seen over the last 3 months and have been told to expect for the next 3 months. The company is controlling the things they can control at present by restructuring the business, focusing on working capital management and potential non-core asset sales. This sets them up to be leaner and meaner as the cycle turns, which could result in a solid investment return for shareholders. The current dividend yield of 4% remains attractive, and the company has a stellar dividend track record too with a growth streak now 20 years long.
Please see my last article and consider the risk write up there. I'd add to it here that the debt load is something that must be watched, and we need to see it start coming down.
All in all, it's tough out there but value certainly presents itself here for those investors that like value investments and solid dividend yields.
I maintain my value of $108.29 and retain the buy rating.
For further details see:
International Flavors & Fragrances: Still Perking Up My Senses