International Flavors Rides on Acquisitions, Costs Rise

We issued an updated research report on International Flavors & Fragrances Inc.IFF on Jan 21. The company will gain on cost cutting efforts, productivity initiatives, acquisitions and growth in global market for flavors and fragrances, particularly in emerging markets. Meanwhile, input cost inflation, disruptions in the supply chain owing to issues across International Flavors & Fragrances' ingredients suppliers and huge debt levels is likely to impact results in the near term.

Let's take a brief look at the company's potential growth drivers and possible headwinds.

Factors Favoring International Flavors & Fragrances

Acquisitions Aid Growth: Over time, the company has made meaningful acquisitions, which have helped expand offerings and in turn profitability. In October 2018, the company completed the acquisition of Frutarom, an Israeli company which develops, produces and markets flavors and fine ingredients. Together, International Flavors & Fragrances and Frutarom will create a global leader in natural taste, scent and nutrition with a broader customer base, more diversified product offerings and greater exposure to end markets. Frutarom is expected to be accretive to International Flavors & Fragrances' fourth-quarter 2018 top and bottom-line results.

The company provided sales guidance of $3.95-$4.05 billion and earnings per share guidance of $6.25-$6.45 for fiscal 2018. The company anticipates generating cost synergies of $145 million through raw material harmonization, footprint optimization and streamlining overhead expenses for third full year after the completion of the merger. International Flavors & Fragrances expects the acquisition to aid the top line by 5-7% and growth of more than 10% in adjusted EPS going forward.

Recently, International Flavors announced that its Frutarom Division has completed the previously announced buyout of 60% share capital of Mighty, a Thailand-based leading savory solutions company. Notably, Mighty produces, develops and markets reaction flavors, with an expertise in savory solutions. The company has a portfolio of marinades, seasoning blends, flavors and specialty functional raw materials for the food and beverage industry. The deal is in sync with Frutarom Division's growth strategy in Southeast Asia as well as pursuing attractive companies. Moreover, the company is committed to enhance its capabilities in savory solutions.

Emerging Markets to Fuel Demand: Theglobal marketfor flavors and fragrances continues to grow fueled by increasing demand for a variety of consumer products containing flavors and fragrances. The market which was around $24.8 billion in 2017 is projected to grow approximately 2-3% by 2021, primarily driven by anticipated growth in emerging markets. Growing economy in these countries bolsters demand for consumer products, and in turn the demand for flavors and fragrances used in them. Consequently, International Flavors & Fragrances is focused on gaining share in emerging markets with sales in these emerging markets accounting for around 48% of 2017 sales.

Over the past five years, the company's currency neutral sales growth rate in emerging markets has outpaced that of developed markets. Backed by the company's global presence, diversified business platform, broad product portfolio, global and regional customer base, it will be able to capitalize on the expansion in flavors and fragrances markets and deliver long-term growth.

Cost Saving Initiatives to Aid Results: In February 2017, the company entered into a multi-year productivity program designed to improve overall financial performance, provide flexibility to invest in growth opportunities and drive long-term value creation. This initiative will enable the company to check costs, make strategic investments and expand businesses globally. This initiative is anticipated to result in the reduction of approximately 370 members of its global workforce. By the end of 2019, the company anticipates this productivity program to yield annualized savings in the range of $40-$45 million.

Factors Working Against International Flavors & Fragrances

Share Price Performance, Poor Valuation: In the last year, International Flavors' shares have fallen 9.8%, compared with the industry 's decline of 7.4%.

On a P/E (TTM) basis, the company's shares look overvalued compared with the industry with respective tallies of 22.0x and 18.6x in the last year.

Rising Costs & Expenses to Dent Margins: Over time, the company has been grappling with the adverse impacts of rising costs and expenses. Further, the company's cost of sales increased 9% over the year-ago comparable period in the first nine months of 2018, owing to higher input costs. Adjusted selling, general and administrative along with research and development expenses grew 6% in the first nine months of 2018. In 2018, higher costs of raw materials across a range of categories (including turpentine, citrus and petro-derived products) will continue to impact margins. We believe, if unchecked, higher costs and operating expenses are likely to prove detrimental to its margins and profitability.

Supply Chain Challenges to Impact Results: In 2017, a fire at the manufacturing facility of BASF Group ("BASF"), one of the company's suppliers, compelled them to declare a force majeure and resulted in a disruption of the availability of certain ingredients used in some of the fragrance and flavor compounds. This BASF supply chain disruption issue impacted the margins of the Fragrances segment in the first three quarters of 2018, which is likely to persist in the remaining part of 2018 as well.

High Debt Level a Concern: The company's total debt/total equity was pegged at 108% at the end of third-quarter 2018, which is a concerning factor.

The company currently carries a Zacks Rank #3 (Hold).

A few better-ranked stocks in the basic materials space are Ingevity Corporation NGVT , Cameco Corporation CCJ and Israel Chemicals Ltd. ICL . All the three stocks sport a Zacks Rank #1 (Strong Buy). You can see the complete list of today's Zacks #1 Rank stocks here .

Ingevity has an expected earnings growth rate of 21.5% for 2019. The company's shares have gained 22% in the past year.

Cameco has an expected earnings growth rate of 20% for 2019. Its shares have rallied 23% in a year's time.

Israel Chemicals has an expected earnings growth rate of 5.4% for 2019. Its shares have rallied 33% in a year's time.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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