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Rising Demand Drive International Flavors, Higher Costs Ail

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On Jul 6, we issued an updated research report on International Flavors & Fragrances Inc. (IFF - Free Report) . While International Flavors & Fragrances is well poised to benefit from growing demand for flavors and fragrances, product innovation, acquired assets and expansion in emerging nations, higher costs along with huge debt levels remain headwinds.
 
Better-than-expected Q1
 
International Flavors reported better-than-expected results for the first quarter of 2018, delivering a positive earnings surprise of 7%. Adjusted earnings in the reported quarter improved 11% year over year to $1.69 per share.
 
Upbeat Outlook for 2018 and Beyond
 
For 2018, International Flavors anticipates gaining from its efforts to cut costs, make strategic investments and expand businesses globally. It anticipates achieving the upper-end of its previously-issued sales and operating income growth projections of 6-8% and 6.5-8.5%, respectively. On a currency-neutral basis, sales growth is predicted to be 3-5% and operating income growth is projected to be 5-7%. Earnings per share are anticipated to increase 5.5-7.5% or 4-6% on a constant-currency basis.
 
The Zacks Consensus Estimate for fiscal 2018 is currently pegged at $6.29, reflecting year-over-year growth of 6.8%.
 
In the 2016-2020 timeframe, the company anticipates local currency sales to grow 4-6% while predicts operating income and earnings per share to expand 7-9% and more than 10%, respectively. Results will benefit from business expansion in emerging markets and growth opportunities stemming from acquired assets. Capital spending will be 3-3.5% of net sales. Shareholders will be rewarded with returns amounting 50-60% of net income.
 
Strategic Initiatives a Boon
 
The company’s concerted efforts to innovate products by a dedicated research and development wing will be a catalyst. Notably, the company’s introduction of Veraspice — a fragrance ingredient; Re-Imagine — programs that enable the company to pursue unaddressed opportunities in the food and beverage industry as well as assist it in innovation initiatives; and Tastepoint — a new company formed to serve middle-market customers are worth mentioning here.
 
Further, the company has been working on its multi-year productivity program, anticipated to yield annualized savings of $40-$45 million by the end of 2019. These programs are predicted to help the company reduce its global workforce by 5%, reduce costs, make suitable investments and expand business globally.
 
Acquisitions to be Catalysts
 
Over time, the company has reinforced its product portfolio and leveraged business opportunities through the addition of assets. The buyouts of David Michael & Company in October 2016, Fragrance Resources in January 2017 and PowderPure in April 2017 are worth mentioning in this regard.
 
In May 2018, the company signed an agreement to combine its operations with Frutarom. While anticipated to be neutral to earnings per share in the initial year of the deal closure, this buyout is predicted to yield double-digits earnings accretion for the second year. Moreover, run-rate cost synergies of $145 million are predicted to be realized by the third year.
 
For 2016-2020 timeframe, the company anticipates acquisitions to generate approximately $500 million to $1 billion in revenues.
 
Higher Costs & Expenses to Dent Margins
 
International Flavors is dealing with adverse impacts of rising costs and operating expenses. Notably, the company’s cost of sales in the last five years (2013-2017) grew at 2.8% (CAGR) while its operating expenses (including adjusted selling, general and administrative as well as research and development expenses) went up 2.4%. The trend continued in the first quarter of 2018 as well, with costs and sales, and operating expenses increasing 13% and 7.6% from their respective tallies in the year-ago comparable quarter. Unwarranted rise in costs and expenses will prove detrimental to the company’s margins and profitability.
 
High Leverage a Concern
 
International Flavors is a highly leveraged company. In the last five years (2013-2017), the company’s long-term debt has soared 11.8% (CAGR) while grew roughly 2.7% sequentially to $1,676 million at the end of first-quarter 2018. Moreover, the company’s total debt/total equity has increased from 63.6% in 2013 to 96.6% in 2017. It was 94.2% at the end of first-quarter 2018. High-debt levels can inflate the company’s financial obligations and put pressure on margins.
 
 
In the last three months, International Flavors’ shares have declined 8%, against 2% growth recorded by the industry.
 
International Flavors currently carries a Zacks Rank #3 (Hold).
 
Stocks to Consider
 
Some better-ranked stocks in the sector include KMG Chemicals, Inc. (KMG - Free Report) , Domtar Corporation (UFS - Free Report) and Methanex Corporation (MEOH - Free Report) . All three stocks sport a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.
 
KMG Chemicals has expected long-term growth rate of 28.5%. Its shares have appreciated 26% over the past three months.
 
Domtar has expected long-term growth rate of 5%. Its shares have gained 11% over the three months.
 
Methanex Corporation has a long-term earnings growth rate of 15%. Its shares have appreciated 13% over the past three months.
 
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