luigi giordano
In August, I concluded that shares of International Flavors & Fragrances Inc. (NYSE:IFF) were leaving a bad smell with investors. This came after IFF has been struggling after it acquired a big chunk of the DuPont business, after which growth came to a standstill and costs were rising rapidly, putting continued pressure on margins.
The company resorted to divesting some assets in order to tackle leverage, but as the performance of the business has consistently missed targets, concerns were rising on the debt situation and the dividend policy. Debt continues to create a massive overhang, albeit that a recent divestment takes place at a compelling sales multiple, as more of such divestments pave the road for a non-dilutive deleverage roadmap.
A Multi-Year Overhang
Back in 2019, IFF announced a $20 billion acquisition of the Nutrition & Biosciences business of DuPont, as the deal tag actually exceeded the valuation of IFF itself at the time. The idea behind that megadeal, was to create an $11 billion business which was set to post EBITDA margins around 23% of sales, with synergies having the potential to bolster that percentage by some three points over time.
Given that investors were burned by a $7 billion deal for Frutarom a few years before, shares fell more than $10 overnight on the back of the announcement, as the deal was set to create quite a leverage overhang at 4 times EBITDA.
The deal for these assets finally closed in 2021, as some organic growth in the meantime made that sales were reported at $11.7 billion that year, albeit that EBITDA of $2.4 billion was coming in a touch light, with earnings reported at $5.63 per share.
The company guided for modest improvements in 2022, but investors were again disappointed. Whilst 2022 sales rose to $12.4 billion, EBITDA was stuck around $2.5 billion, as adjusted earnings per share fell by twenty-one cents to $5.42 per share, as the company was operating in an inflationary environment of course, as that applies to prices in general but certainly also the price of debt.
Trying to offset some of the debt situation, the company reached a deal to sell its Savory Solutions business in a $900 million deal late in 2022, as debt reduction was key with the 2023 guidance being underwhelming. Trying to address leverage further, the company sold the Flavor Specialty Ingredients business this year as well in a $220 million deal, resulting in $100 million in revenues leaving the door.
It Only Goes Downhill
After reporting a 6% fall in first quarter sales to $3.03 billion, the company saw adjusted earnings plunge from $1.69 per share to $0.87 per share, prompting the company to cut the full year guidance. The second quarter results were really soft, down 11% to $2.93 billion, as adjusted earnings fell from $0.99 to $0.34 per share.
With sales now seen at just $11.3-$11.6 billion, at the midpoint lowered by a billion, EBITDA was seen at just $1.85-$2.00 billion. This was outright worrying as net debt still hovered close to the $10 billion mark, with leverage ratios trending over 5 times. Moreover, a $3.24 per share dividend (for a yield around 5%) severely limits the potential to deleverage.
With shares trading in the mid-sixties in August, I believed that all credibility has been lost, as (leverage) concerns were very real and realistic, as potentially some outside pressure would be welcomed. If a turnaround were possible, potential was imminent as the original deal was set to deliver on earnings power of $6 per share. This could rather easily warrant a valuation above $100, certainly if growth returned and leverage became controllable.
Nonetheless, in the sixties I was not yet willing to alter a modest long position at levels around the $65 mark.
A Modest Recovery
Since August, shares of IFF have gradually recovered to levels around $72 per share at this moment in time. Part of this is driven by the divestment of the divestment of IFF´s cosmetic ingredients business unit to Clariant.
The activities are part of the scent division of IFF and generated about $100 million in annual revenues with about 200 workers. The $810 million cash component of the deal reveals that a steep sales multiple has been paid, as that gives investors comfort that IFF is managing debt reduction, but it is no longer selling activities on the cheap, or being forced to sell on the cheap.
To put this into perspective, the 255 million shares of IFF grant the business an $18.4 billion equity valuation at $72 per share, or about $28.4 billion if we factor in net debt. Based on the sales guidance of around $11.4 billion, IFF at large trades around 2.5 times sales. While it can easily be argued that the divested activities are more profitable, the deal makes a considerable dent in addressing leverage.
It was this sale and the reconfirmation of the annual dividend at $0.81 per share which drove some confidence among investors, driving a small recovery in the share price. Furthermore, reports about further divestments were swirling around, as such moves could really address leverage concerns, perhaps once and for all.
And Now?
The reality is that I still have no need to alter a modest long position here, although I am upbeat on the latest small divestment to Clariant, which together with potential upcoming divestments have the potential to bury leverage concerns.
Amidst all this, I am taking a wait-and-see approach, as a small silver lining (in the sense of a reasonable divestment) makes me a bit more upbeat about International Flavors & Fragrances Inc. However, the long-term challenges remain, making me cautious to get too upbeat, too soon.
