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Higher Costs & Debt Levels to Hurt International Flavors

Zacks Equity Research

We issued an updated research report on International Flavors & Fragrances Inc. IFF on Feb 18. The company’s near-term results are likely to bear the brunt of input cost inflation and unfavorable foreign currency impact. Further, huge debt levels remain a concern.

Mixed Q4

International Flavors & Fragrances’ fourth-quarter adjusted earnings per share declined 19% on a year-over-year basis to $1.22 per share. However, net sales improved 43% year over year to $1.22 billion. The company lagged the Zacks Consensus Estimate on both the counts.

Higher Costs, Unfavorable Currency to Hurt 2019 Results

The company’s results will continue to bear the brunt of raw material cost inflation.  International Flavors anticipates mid-single digit inflation in its legacy business in 2019 as synthetic materials continue to rise, on account of several supply chain disruptions the company has been facing over the last 12 to 15 months. Further, natural ingredients costs like vanilla and citrus markets remained elevated near historical levels. Notably, over 2018 and 2019, raw material cost inflation in the scent division is expected to be around 20%.

Further, unfavorable currency is anticipated to be a headwind of approximately 3 percentage points on combined sales growth and 2 percentage points on combined adjusted earnings per share, excluding amortization.

For 2019, International Flavors provided sales guidance of $5.2-$5.3 billion, representing growth of 5% to 7% over 2018. Adjusted earnings per share are expected in the band of $4.90-$5.10, reflecting growth of 10% to 15% in 2019. Adjusted earnings per share, excluding amortization, are anticipated in the range of $6.30-$6.50. International Flavors reported adjusted earnings per share of $6.28 in 2018.

In the last five years (2014-2017), the company’s cost of sales has witnessed a compound annual growth rate (CAGR) of 7% while adjusted selling, general and administrative, and research and development expenses together have increased at a CAGR of 8%. We believe, if unchecked, higher costs and operating expenses are likely to prove detrimental to its margins and profitability.

High Debt Levels a Concern

A highly leveraged balance sheet can inflate International Flavors & Fragrances' financial obligations, and subsequently, hurt profitability. Following the debt raised to fund the Frutarom acquisition, the company’s current debt position is at $4.5 billion, up from $1.6 billion at 2017 end. The higher interest burden will have a negative impact of 55 cents per share on 2019 earnings per share.

Share Price Performance, Poor Valuation

In the last year, International Flavors' shares have fallen 7.3%, against the industry’s growth of 1.7%.

On a P/E (TTM) basis, the company's shares look overvalued compared with the industry with respective tallies of 21.6x and 19.3x in the last year.

The company currently carries a Zacks Rank #4 (Sell).

Some better-ranked stocks in the basic materials space are Ingevity Corporation NGVT, W.R. Grace & Co. GRA and Israel Chemicals Ltd. ICL. While Ingevity sports a Zacks Rank #1 (Strong Buy), W.R. Grace & Co. and Israel Chemicals carry a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank stocks here .

Ingevity has expected earnings growth rate of 17.7% for 2019. The company’s shares have gained 54% in the past year.

W.R. Grace has expected earnings growth rate of 10.4% for 2019. Its shares have gained 12% in a year’s time.

Israel Chemicals has expected earnings growth rate of 10.8% for 2019. Its shares have rallied 37% in a year’s time.

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