International Flavors & Fragrances: More Asset Sales May Be Inevitable (NYSE:IFF)

Worldwide Flavors & Fragrances (NYSE:IFF) borrowed and overpaid for ill-timed acquisitions. The corporate is now utilizing asset gross sales to pay down debt and prop up its steadiness sheet. The inventory gives a very good dividend for earnings seekers, however dividend progress could also be restricted for the following few years. A reduced money circulate mannequin estimates the corporate could also be overvalued by 24%. Traders ought to revisit the inventory when it sells off to $90.

The corporate must develop organically

In Q3 2022, the corporate noticed its gross sales decline by 17% in its well being and biosciences unit (Exhibit 1). However, Nourish, Scent, and Pharma Options noticed gross sales improve. Pharma Options was one of the best performer, with gross sales surging 22% in comparison with the earlier 12 months on a GAAP foundation. This phase’s non-GAAP working EBITDA surged 73% in comparison with final 12 months. In Q2 2022, the corporate noticed good gross sales progress within the mid-to-high single digits throughout all its segments (Exhibit 2). However these statistics should not natural progress numbers.

Exhibit 1:

Exhibit 2:

The corporate had good gross margins, averaging 41.6% over the previous decade (Exhibit 3:). However inflation has taken its toll over the previous two years, with gross margins dropping under 40%. For the reason that quarter-ending March 2020, the corporate’s quarterly gross margins have averaged 36.4% (Exhibit 4), a distinction of 520 foundation factors in comparison with its common over the previous decade.

Exhibit 3:

Exhibit 4:

Working margins have nosedived from a mean of 17.2% over the previous decade to eight.6% for the quarter ending September 2022 (Exhibit 4). Even after huge value will increase to counter the consequences of inflation, the corporate’s non-GAAP working EBITDA declined in Q3 2022 in comparison with the identical quarter in 2021.

Debt is a priority, however the firm is concentrated on deleveraging

Worldwide Flavors and Fragrances has grown utilizing an acquisition-driven technique. As an illustration, the corporate paid $7.1 billion to acquire Frutarom in Could 2018. The corporate paid $106.25 per share for Frutarom, of which $71.19 was paid in money. About 67% of the $7.1 billion acquisition was paid in money. Because of this acquisition, the corporate’s long-term debt went from $1.6 billion to $4.5 billion. Frutarom was valued at 20.3x 2018 EBITDA on the time of the acquisition, on reflection, a really excessive premium.

In December 2019, the corporate merged with Dupont’s Nutrition and Biosciences unit in a transaction valued at $26.2 billion. This merger transaction was executed at an 18x EBITDA a number of. The corporate’s internet debt to EBITDA ratio elevated to 4.

In December 2022, the company sold its Savory Options Group at 14x EBITDA. Given the rise in rates of interest, it’s affordable to anticipate that valuation multiples have dropped because the acquisition of Frutarom. It was straightforward to pay a premium when rates of interest had been low, however the firm is now saddled with excessive debt and is promoting enterprise items to lift money and pay down its debt. The corporate raised $900 million through its sale of the Savory Options Group.

Each Frutarom and Dupont bought their property at or close to peak valuations. However, Worldwide Flavors and Fragrances sells property when valuations have reset decrease. The corporate has now formally acknowledged that it overpaid for its acquisitions by taking a goodwill write-off of $2.25 billion in Q3 2022 in its Well being & Biosciences unit.

On the finish of the September 2022 quarter, the corporate had $10.2 billion in internet debt (Exhibit 5). The proceeds from its Savory Options group’s sale ought to drop under $10 billion for the primary time because the finish of 2020.

Exhibit 5:

The corporate has a manageable quantity of debt coming due annually (Exhibit 6), assuming it could generate sufficient money circulate from operations. As an illustration, the corporate has $1.7 billion in debt coming due by 2025. However, the corporate is presently constrained by excessive stock prices which have lowered its working money flows. The corporate generated $1.4 billion in operational money circulate in 2021 and simply $500 million over the trailing twelve months.

Exhibit 6:

The corporate paid $805 million in dividends over the previous twelve months. The inventory yields 2.9% with a five-year common dividend payout ratio of fifty%. The yield is lower than the 2-year U.S. Treasury yield of 4.2%. The corporate has elevated its dividend by 4% on common over the previous 5 years, whereas the sector median is 6.6%. Given the present poor money circulate era capability of the enterprise, the corporate could should resort to additional asset gross sales to bolster its steadiness sheet and pay down debt whereas sustaining its dividends. The present state of the enterprise may additionally restrict dividend will increase.

Excessive stock reduces working money flows

The corporate’s carrying value of stock has elevated over the previous 12 months. The corporate now holds over $3 billion in stock and about 136 days’ price of gross sales. Worldwide Flavors & Fragrances has all the time carried a excessive stock in comparison with its gross sales, with a mean days’ price of gross sales of 130 and an ordinary deviation of 16.

Exhibit 7:

It is not going to come as a shock if the corporate appears to cut back its working capital necessities by decreasing its stock. Given the debt discount efforts the corporate has launched into, optimizing its working capital is more than likely a high precedence for the corporate in search of value financial savings.

The rise in stock value is the first purpose behind the decline in working money flows. Within the September 2022 quarter, the corporate reported $289 million in working money circulate. The optimistic contributor to this money circulate was the asset write-down (loss in goodwill) and restructuring prices of $2.2 billion and a acquire in internet working property of $208 million. The corporate had adverse working money flows in March and June of 2022 as a consequence of elevated inventories and decreased internet property.

Excessive-interest charges and debt have lowered the corporate’s valuation

The corporate is buying and selling at a ahead EV to EBITDA a number of of 15x, in comparison with its five-year common a number of of 16x. The corporate is presently buying and selling at $111.85, overvalued by 24%. However, the rate of interest improve has lowered the valuations of corporations with poor money circulate era and excessive debt. A reduced money circulate mannequin, with an optimistic progress estimate of 5%, a free money circulate margin of 10%, and a reduction fee of 9%, yields an fairness worth of $89.85 per share.

Exhibit 8:

The corporate could also be overvalued given its restricted progress potential, poor money circulate era, and excessive debt. The corporate took a large goodwill impairment cost of over $2 billion, suggesting that it not solely overpaid for its acquisition, however its valuation could have dropped as a consequence of a rise in rates of interest and softening of demand. The corporate just lately received simply 14x EBITDA when it bought considered one of its items. It gives a very good dividend, however dividend earnings seekers ought to put together for a couple of years of low progress in dividends. Traders trying to purchase ought to revisit the inventory when it drops to $90.