Givaudan Stock: Exceptional Yet It Remains Priced Beyond Reach (OTCMKTS:GVDBF)

A little over a year ago, we started covering Givaudan (OTCPK:GVDBF)(OTCPK:GVDNY), highlighting its strong competitive moat and the attractive characteristics of its business model and industry. We gave it a ‘Hold’ rating given that we saw it as slightly overvalued. However, that didn’t stop the shares from outperforming the market, delivering a return of over 37% since then, compared to roughly 26% for the S&P 500 index (SPY).

The company recently reported 2023 results, which gives us an opportunity to update our analysis, and this time we will also compare the company to some of its peers.

Despite facing a challenging environment in 2023 that included de-stocking in some of its end markets, continued inflation, and high raw material costs, the company was able to deliver solid results for the year. We will be using Swiss Francs (CHF) with respect to the financial numbers, unless otherwise specified. Currently one Swiss Franc equals roughly $1.14 US dollars. In 2023, total sales were CHF 6.9 billion, a year-over-year decline of 2.8% as a result of the Swiss Franc strengthening against most currencies. On a like-for-like basis, growth was much healthier at 4.1%, and including acquisitions, growth in local currency would be 5%. Most of this growth came from pricing actions, which added 6.3%, while volumes declined 2.2%. The Fragrance & Beauty segment delivered particularly strong performance with sales growth of 7.6% on a like-for-like basis, while Taste & Well-being was significantly weaker with sales growth of only 1.1% on a like-for-like basis.

The strengthening of the Swiss Franc against most currencies in which they operate also had a negative effect on operating income, which increased only 0.3% in CHF, but was much stronger when measured in local currency, with a roughly 11% increase. Another bright spot was free cash flow, which was a record for the company, and represented slightly more than 13% of sales. Basic EPS came in at CHF 96.81 per share, compared to CHF 92.83 in the previous year.

The company also made significant progress with respect to its non-financial targets, particularly with respect to its use of renewable energy. The company has a goal of using 100% renewable electricity by 2025, and they were at 94% at the end of 2023.

Company Overview

The company has very strong positions in both Fragrance & Beauty as well as Taste & Well-being. It provides its customers compounds, ingredients and integrated solutions that define many of the end-product characteristics. The slide below shows a few examples of products that make use of the ingredients the company sells. It is important to note that Givaudan is a global company, with broad geographic diversification, having around 56% of its sales coming from mature markets, with the remaining 44% from high growth markets such as Latin America.

Attractive Industry

Givaudan operates in a very attractive industry, as we mentioned in our previous article. There are several reasons for this, including the fact that scent and taste have a significant influence on the perceived quality of the end products, while these ingredients represent only about 0.5-2.0% of the total costs. This means customers do not have significant incentives to be excessively aggressive in price negotiations, and most of them prefer to have a highly collaborative relationship where they work together to develop the best possible solutions that can help them differentiate their products in the marketplace.

There are also significant switching costs, as customers might not be able to perfectly replicate the characteristics of their products if they use a different supplier, and consumers might notice the difference. In other words, there can be a high impact for the customer if they seek a minor cost reduction by working with a competitor.

While Givaudan often collaborates with customers, they make clear that the IP and formulas are owned by Givaudan. The company likes to say that they compete on innovation, quality, and service, not on price.

Innovation and New Products

Givaudan reinvests around 7% of sales in research & development, and has 64 creation and research centers. This has resulted in a massive IP portfolio that includes roughly 5,000 active patents worldwide, and more than 20% of their sales are coming from innovations developed over the past 5 years. CEO Gilles Andrier mentioned a couple of recent promising innovations in the 2023 annual report, one in Fragrance & Beauty, the other in Taste & Well-being.

In Fragrance & Beauty, we launched PrimalHyal™ Hydra[+]. It is our new cationic hyaluronic acid (HA), crafted by white biotechnology that is expanding the boundaries of skin hydration. It is a unique cosmetic active that outperforms standard hyaluronic acid hydration benefits by at least a factor of two.

In Taste & Wellbeing, we are responding to consumers’ demand to optimise their wellbeing and their increasing awareness of the crucial role of gut health. We have a unique prebiotic fibre ingredient, Oatwell™, that makes use of the natural goodness of oats to support gut health. This ingredient delivers nutritious and delightful food experiences with scientifically proven benefits.

Some of the R&D efforts are directed towards making their products more sustainable, a good example being the PlanetCaps, which is a biodegradable fragrance delivery system.

Financials

As previously mentioned, growth in 2023 was strongly supported by pricing actions. Operating income was CHF 1,116 million compared to CHF 1,112 million in 2022, an increase of 0.4%, but 11.1% when measured in local currency. The operating margin saw a meaningful improvement, as it was 16.1% in 2023 compared to 15.6% in 2022.

Peer Comparison

Close peers include Danish company Novozymes (OTCPK:NVZMY), German company Symrise (OTCPK:SYIEY), and US based International Flavors & Fragrances (IFF). We believe Givaudan and Novozymes are the highest quality businesses, as they have considerably better profit margins and returns on equity compared to Symrise and IFF. In fact, IFF recently replaced its CEO, which is not surprising given the disappointing performance it has delivered.

Balance Sheet

Another area where Givaudan shines, is the strength of its balance sheet and elevated investment grade credit ratings. It has an A- rating from S&P (SPGI) and Baa1 from Moody’s (MCO). Its net debt-to-EBITDA was 2.9x at the end of the year, compared to 3.7x at June 2023 and 3.1x at December 2022. The company ended the year with net debt of CHF 4.3 billion, with a weighted average interest rate of only 1.7%.

Shareholder Returns

Givaudan is getting close to becoming a Dividend Aristocrat, even if recent increases have been rather modest. It recently announced a dividend of CHF 68.00 per share, which was a small increase of roughly 1.5% year-over-year.

Still, this is the twenty-third consecutive dividend increase following Givaudan’s listing at the Swiss stock exchange in 2000, bringing it close to the 25 years needed to be considered a Dividend Aristocrat. The yield is relatively modest, slightly under 2%, which is close to the recent 5-year historical average, but lower than the roughly 3% it used to offer earlier in the past decade.

Outlook and Financial Targets

Results for 2023 were within its sales growth targets of 4% to 5% on a like-for-like basis. It also exceeded its target of delivering a free cash flow margin above 12%, and made significant progress on many of its purpose-linked targets.

The company expects further input cost increases to be modest in 2024, but it is going to review its manufacturing footprint, particularly regarding Tate & Well-being which delivered somewhat disappointing performance in 2023.

Valuation

With Givaudan quality comes at a price, and we are therefore not surprised by the ‘F’ valuation grade given to the company by Seeking Alpha Quant. The company looks expensive on most valuation metrics, and it is difficult to justify a price/earnings ratio above 30x for a company growing revenue in the mid single digits. While we would not start a position or increase a position at current prices, we are maintaining a ‘Hold’ rating as the company is not too far from its historical average valuation multiples.

Compared to peers, we find Novozymes more attractive, even if it also trades at a premium valuation. Symrise is trading at an even lower forward price/earnings ratio, but we don’t think its competitive moat is as strong, given its lower profit margins and returns on equity. Finally, IFF could be an interesting opportunity for investors willing to take a risk that the new CEO can deliver a successful turnaround, but we see it as a significantly more speculative investment option.

Risks

The company, together with DSM-Firmenich, Symrise, and International Flavors & Fragrances, is being investigated for allegedly engaging in and coordinating anti-competitive behavior. Depending on the results of the investigation, the company could potentially suffer financial and reputational damages.

With respect to its financial strength, while the company does have a significant debt load, it has a very strong investment grade credit rating, and a very high interest coverage ratio. The financial strength of the company is also reflected in its Altman Z-score, which is comfortably above the 3.0 threshold needed to consider a company low-risk financially.

Conclusion

Earnings results for 2023 were relatively inline with expectations, with the biggest headwind being the increase in the value of the Swiss Franc. While the company delivered solid performance, and results were within its financial targets, we continue to believe shares are overvalued.

We can understand why investors pay a premium, as this remains a company with very strong competitive advantages, including impressive innovation capabilities and significant IP assets. After reviewing the most recent results we are maintaining our ‘Hold’ rating, but we would wait before starting a position, as shares are definitely not cheap.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.