International Flavors & Fragrances has been treading water for the past six months, recording a small loss of 4.2% while holding steady at $70.57. The stock also fell short of the S&P 500’s 11.5% gain during that period.
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Why Do We Think International Flavors & Fragrances Will Underperform?
We're sitting this one out for now. Here are three reasons you should be careful with IFF and a stock we'd rather own.
1. Revenue Spiraling Downwards
A company’s long-term sales performance is one signal of its overall quality. Any business can have short-term success, but a top-tier one grows for years. Over the last three years, International Flavors & Fragrances’s demand was weak and its revenue declined by 4.3% per year. This was below our standards and signals it’s a low quality business.
2. Operating Losses Sound the Alarms
Operating margin is an important measure of profitability as it shows the portion of revenue left after accounting for all core expenses – everything from the cost of goods sold to advertising and wages. It’s also useful for comparing profitability across companies with different levels of debt and tax rates because it excludes interest and taxes.
Although International Flavors & Fragrances was profitable this quarter from an operational perspective, it’s generally struggled over a longer time period. Its expensive cost structure has contributed to an average operating margin of negative 10% over the last two years. Unprofitable public companies are rare in the defensive consumer staples industry, so this performance certainly caught our eye.
3. Previous Growth Initiatives Have Lost Money
Growth gives us insight into a company’s long-term potential, but how capital-efficient was that growth? Enter ROIC, a metric showing how much operating profit a company generates relative to the money it has raised (debt and equity).
International Flavors & Fragrances’s five-year average ROIC was negative 4.2%, meaning management lost money while trying to expand the business. Its returns were among the worst in the consumer staples sector.
Final Judgment
We cheer for all companies serving everyday consumers, but in the case of International Flavors & Fragrances, we’ll be cheering from the sidelines. With its shares lagging the market recently, the stock trades at 16× forward P/E (or $70.57 per share). This valuation tells us it’s a bit of a market darling with a lot of good news priced in - we think other companies feature superior fundamentals at the moment. Let us point you toward one of Charlie Munger’s all-time favorite businesses.
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