One of the sectors we have followed for many years is fragrances and flavors. These are companies that sell essences to perfume, edible, cosmetic, beverage and pharmaceutical producers.
An attractive feature of the industry is high margins once a brand and its distribution channels are established. The companies we look at today are global and will be around for years to come. Of course, there are those that are in the “mata donkey” – either they hit the nail on the head, and can have their value multiplied quickly, or they will end up being absorbed by the larger ones (which is not necessarily a bad thing). We are aware of merger and acquisition activities as they can impact almost all companies in the sector.
The diversity of distribution channels in this sector makes businesses whose final products are similar, different both in their operation and in the distribution of capital use within each company. This could eventually allow two giants to coexist in the same market.
At the “nascent” of the sector are basically four companies: Givaudan, Firmenich, IFF and Symrise. They have a characteristic in common that we consider the “Holy Grail”. They are critical elements of the value chain (they produce perfume and flavor concentrates), even though they represent a small portion of the cost of the chain as a whole. Due to this characteristic, these companies have pricing power and the demand for their products is more inelastic than average. These are businesses that we fit into the “clock pin” category.
Of these four, Firmenich is the only privately held company and this year announced a merger with Dutch chemical producer DSM.
Givaudan, Switzerland, has a market capitalization of 27.2 billion Swiss francs with annual revenue of approximately 6.7 billion. Founded in 1895 and long based in Switzerland, the company has had a long relationship with Nestlé. In 2002, Givaudan bought the flavors and fragrances division of the conglomerate, which now holds a 10% stake in the company. Nestlé only sold its share in 2013, for more than 1.2 billion Swiss francs.
Since 2014, Givaudan has made more than 20 acquisitions and ended 2021 with a leverage of 3x net debt/EBITDA. It pursues a model of frequent acquisitions in specific market niches.
The American IFF, on the other hand, is still undergoing a process of integration and digestion of an important merger with the Nutrition and Biosciences arm of DuPont, announced in December 2019 and concluded in 2021. Today, with a market capitalization of US$ 24.5 billion, its annual revenue is around US$ 11.7 billion.
This transaction took place while IFF was still digesting the purchase of the Israeli company Frutarom, which it acquired in 2018 for 7.1 billion dollars, which was marked by a series of legal problems due to “hidden liabilities” in the company, mainly arising from corruption problems.
The IFF appointed a new CEO in January of this year, Frank Clyburn. The executive comes from Merck, where he headed the area of medicines and vaccines and was even quoted to become CEO of the German multinational in 2021. Clyburn already held a seat on the DuPont board, so the choice seems to make sense.
The new CEO will have important challenges ahead. The first will be to deal with the wave of activism that has hit the company for years without letting it distract you from the needs of the business. In February of this year, the IFF reached an agreement with activist investor Carl Icahn and appointed one of his nominees to the board. The company has also been the target of activism by Sachem Head Capital Management LP, whose founder, Scott Ferguson, had an option to join the board until late last year but did not exercise.
A Brazilian entity related to the 3G group also has a stake in the company, although it is not known which. It is worth mentioning that it has not engaged in any activism since it set up a position.
The CEO’s second challenge will be to manage the company’s high leverage, which currently hovers around 6x net debt/EBITDA. Against a backdrop of rising interest rates, supply chain disruption, cost inflation and uncertainty about the health of world economies, this level of indebtedness poses considerable risk.
The third company to be mentioned is the German Symrise, founded in 2003 from a merger between the pharmaceutical subsidiary Bayer and also the German Dragoco. It has a market cap of 13.6 billion and annual revenue of 3.8 billion euros. Today, the company has the third largest market share, behind IFF and Givaudan and ahead of Firmenich. Like the other players, Symrise has also been very active in the field of M&A.
The company has performed especially well in the pet food segment, and has been investing to maintain this trajectory. According to the executives, half of the company’s capex is being directed to this market.
The solid competitive positions of these companies and the characteristics that make the models resilient and profitable are widely known and recognized by the market, which makes their shares trade at high multiples.
One of the most important differences between these companies is the M&A model they chose to pursue and the consequences of that choice. While IFF opted for large and complexly integrated acquisitions, Symrise and Givaudan made a greater number of small acquisitions in order to complement and expand their portfolio without straining their balance sheet or internal organization. This is reflected in the price.
While IFF trades at 25.6x P/E, Givaudan hits 34.5x and Symrise 33.1x. The IFF has its lowest multiple – albeit no bargain – justified by the higher risk profile the stock presents. The hope of long-term investors is that the market downturn will reduce the multiples of these companies to allow entry points with a good margin of safety and good prospects for returns in the next 5 years.