How to invest in tastes and smells
Posted
Aug 21 2008, 12:06 PM
by
Anthony Mirhaydari
Rating:
Some of the best investments you can make during economic downturns are those that capitalize on basic human desires.
Consider International Flavors & Fragrances, maker of the tastes and smells we experience in a variety of foods and consumer products. A company that provides simple and inexpensive pleasures is well positioned to soothe the unprecedented pressure on the American consumer.
This is especially true because consumer goods and packaged foods need to appeal to the senses to justify premium pricing over private-label store brands. An example would be Tide's Water Lily and Jasmine laundry detergent.
The global market for scents and flavors stands at $12 billion, according to analysts. Annual industry growth of 4% is expected, with double-digit increases in developing markets. However, the four dominant players in the industry should continue to grow much faster, as the economies of scale that have driven recent merger and acquisition activity continue. The largest, with an 18% market share, is the European firm Givaudan, which is traded on the Swiss Exchange. Privately-held Firmenich comes in second, with a 13% share.
International Flavors & Fragrances or IFF is the third-largest, with an 11% stake. Last year it sold $2.3 billion in products ranging from unique strains of vanilla grown at a dedicated plantation in India to scents from flowers grown at a hydroponics lab in New Jersey.
Like a dealer in the arms of sensory bombardment, IFF maintains an inventory of tastes and smells it offers to the likes of Procter & Gamble, Avon, Kraft, and Hershey. Perfumers and flavorists located in IFF facilities across the globe work to develop an arsenal of 33,000 unique compounds that can be combined to meet ever changing consumer preferences.
IFF is unique in that it combines industry strength with a firm-level turnaround story. Much of this has to do with the mechanics of the flavors and fragrances industry. Product makers use an open bidding process in which a core list of up to four suppliers is asked to submit formulations to match specifications like "taco-flavored" or "summer night."
Success requires placement on the lists of the big manufacturers. According to Lehman Brothers analyst Lauren Lieberman, "high customer service levels, differentiated innovation capabilities, and global reach" are all imperative. In the 1990's, delayed deliveries and a "barren innovation pipeline" caused IFF to be removed from many supplier lists -- preventing it from bidding on a large number of new products.
Organizational reshuffling, along with a new management team and investments in research and development, saw the company return to bidding lists in 2002 and 2003. Now, IFF is in the midst of what Lauren call the "virtuous circle" of better service and products winning more sales, creating more financial flexibility for reinvestment, leading to more innovation and product wins.
JP Morgan analyst Jeffrey Zekauskas is worried that a combination of weaker spending on discretionary items like perfume and cosmetics, as well as a slowdown in new food product introductions, could weigh on the company's performance as we head into the holiday season. I beg to differ: Lower-cost gifts like perfume will likely replace more indulgent items like plasma HDTVs and jewelry. Meanwhile, the food manufacturers are looking to capitalize on the trade down from restaurants currently underway.
Shares continue to trough, so I'd wait for a move back into the mid-$40s on strong volume. Jeffrey is looking for earnings of $2.95 per share this year, moving 10% higher to $3.25 in 2009. With its five-year average price-to-earnings multiple of 16, shares should trade into the mid-$50s over the next 12 months.
(Disclosure: I don’t have a position in any of the companies mentioned)
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