Givaudan: Sticky Player In A Niche Industry

Investment Thesis

It is quite exciting to find a niche market with several secular tailwinds and top players’ rational behavior. In my opinion, Flavors & Fragrances (F&F) is such a type of niche industry. Top 4 players consist of more than half of the market share with trends of continuing consolidation. In addition to that, the sector has substantial barriers to entry that keep protecting incumbents.

Leading player in the industry is Givaudan (OTCPK:GVDBF) (OTCPK:GVDNY), along with International Flavors & Fragrances (NYSE:IFF), Symrise (OTCPK:SYIEF), and Firmenich (private company). In my view, Givaudan is the best-managed company for long-term exposure based on its fundamentals and business model.

Heritage Over 250 Years

Givaudan is the world’s leading flavors and fragrances manufacturer with a legacy that stretches back over 250 years. Today, the Company has a leading market share and 73 production sites worldwide. It has two business divisions: Fragrances and Flavors. The Company also engages in research and development activities into perfumery raw materials, both synthetic and natural.

Industry Overview

F&F companies occupy a strong position in the value chain because their products make up only a small portion of the final product cost, but play a decisive role in the consumer’s purchasing decision. According to the Givaudan presentation, the share of F&F ingredients in customers’ COGS represents 4-6% in fine fragrances and 0.5-2% in flavors and consumer fragrances. On the other side, scent and taste largely determine the customer purchase decisions. Therefore, the F&F companies are in a sweet spot in the value chain, because they represent only a small portion of production costs, but a critical buying criteria.

Several megatrends support the organic growth of the industry. For instance, health & wellness, middle-class boom & urbanization, naturalness & sustainability, vegetarian/vegan/halal/kosher food, traceability, etc. In addition to that, the industry has a strong connection to population growth and disposable income, with little dependence on cyclical economic trends.

The total F&F market size is around USD26bn and is growing by an average of 4% per year in the long run. More than 500 companies are active worldwide, but the four largest producers have a market share of more than 50%. The F&F market is characterized worldwide by high barriers to entry (regulation, intellectual property, innovation, scale, global presence, preferred supplier lists, the complexity of supply chains, local taste preferences).

Recent Results & Outlook

Givaudan had a strong start to the year. In the first half of 2020, Givaudan recorded sales of CHF3.2bn, an increase of 4.0% on a like-for-like basis. The Fragrance division grew 4.5%, and the Flavors division grew 3.6% on a like-for-like basis. When we look deep into the top-line performance, we can see the relatively good performance of those parts of the portfolio which are not impacted by COVID-19. On the other side, Fine Fragrance, Fragrance Ingredients, and Active Beauty were down by 16.4% and 0.1% on a like-for-like basis respectively.

The Company had the right balance between mature and growth markets, with 58% of sales coming from mature and 42% of sales from growth markets. All regions were contributing to the growth on a like-for-like basis. The only market which was almost flat was India, given that the country has been heavily affected by the COVID-19 crisis.

EBITDA increased by 11.3% to CHF734m, while the underlying margin was remaining stable at 23.7%. At the bottom line, net income amounted to CHF413m or an 8.8% increase compared to the same period last year. Free cash flow was at the level of CHF178m or 5.5% of sales compared to 4.8% in 2019.

Balance sheet wise, the Company has a net debt (incl. pension obligations) of CHF5.2bn at the end of the first half of 2020. The weighted average effective interest rate for is 1.43%. The leverage range of 3.0-3.5x seems sustainable for a consumer goods company like Givaudan, given the free cash flow generation (CHF787m in 2019). But for future shareholders, the Company has already trod some of its flexibility.

Despite the higher debt than what it would be desirable, the maturity profile is quite favorable. Within the next 2-3 years, there is a need for refinancing of around CHF1.3bn.

The Company aims to outpace the market with 4-5% sales growth and free cash flow of 12-17% of sales, and both measured as an average over the five years. In 2016-2019, it grew sales by 5.1% and had a free cash flow margin of 12.5%.

Since 2014, the Company made 14 acquisitions, which contributed CHF1.5bn of annualized revenues. On the other side, the Company paid for M&A growth of CHF3.6bn. The strategy is to continue to grow through acquisitions by being opportunistic, disciplined, and diligent. Also, it is very assuring the Company is not going for size at all costs, rather opportunistic acquisitions. We can see from the list below that the Company strategically picks what best fits into its business model.

Valuation

Since the Company has delivered its outlook in H1 2020, I will keep it as a proxy for the next five years in my valuation model. It isn’t straightforward to model potential acquisitions, so I will not include them in my model.

For 2020, I used lower bound estimates for revenues and FCF, while for the rest of the projection period, I used mid-bound forecasts of 4.5% for top-line growth and 14.5% for FCF. For the terminal growth rate, I used 3%, which is consistent with world economic growth. I set a discount rate at 6%, but if someone uses 5% or 7%, the intrinsic value is CHF4,797 and CHF2,109, respectively.

Conclusion

Putting all the pieces together, we can conclude that Givaudan is in an attractive industry with a strong tailwind. But at the same time, we can see that these companies are trading at a higher price than my model indicate.

Therefore, it would be wise to wait for a better entry point because I don’t see a margin of safety at this valuation level. Putting all pieces into perspective, the Company would be on my list, but I would wait for a better entry point.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.