Here's an Everyday Dividend Growth Stock for Your Portfolio

This stock raised its dividend by 20% in August and has a long runway for future dividend growth.
By Brian Bollinger ,

International Flavors & Fragrances (IFF) - Get Report  is a company you might not have heard of, but its 20% dividend increase in August should get your attention. We like getting consistent pay raises, especially from durable businesses that let us sleep well at night.

While International Flavors & Fragrances is technically a chemical company, almost all of its customers own leading consumer brands and use International Flavors & Fragrances's flavors and scents in their products that include packaged food, laundry detergent, shampoo, beverages, and more. International Flavors & Fragrances has been producing flavors and fragrances for more than 125 years and operates one of the most durable and predictable businesses a dividend investor can find.

For these reasons, we added International Flavors & Fragrances to our Long-term Dividend Growth Portfolio earlier this year. While the stock trades at a premium relative to the market today, we continue to believe the company is a solid long-term holding that will reward investors with double-digit dividend growth for years to come.

IFF

data by

YCharts

Competitive Advantages

International Flavors & Fragrances is very entrenched with its customers. Academic studies have shown that scent and flavor are two of the most important factors influencing consumers' purchases of packaged food or household products, so it's no surprise that International Flavors & Fragrances's compounds are really important to a company's brand. Importantly, International Flavors & Fragrances's products also represent a small proportion of a customer's total product cost, allowing International Flavors & Fragrances to enjoy strong pricing power.

Many of International Flavors & Fragrances's compound formulas are unique to the customers that use them. A company such as Procter & Gamble that has found a winning detergent scent with International Flavors & Fragrances doesn't want anyone else using that fragrant compound, leading to a sticky and long-lasting relationship with International Flavors & Fragrances.

The research and development process required to create certain scents and tastes is also very intensive. International Flavors & Fragrances routinely spends between 8% and 9% of its sales on research and development. The goal is to recreate a particular taste or scent by using computers to identifying hundreds of molecules from different foods. Next, a group of molecules is formed by International Flavors & Fragrances to recreate that taste while complying with regulations and a customer's budget. Many times these molecules have nothing to do with the initial food or product. Once the optimal molecule "recipe" has been created, International Flavors & Fragrances will create an artificial synthetic version and a natural version. The company works with thousands of different raw materials to help it with this process and regularly collaborates with biotechnology firms to develop low cost, natural ingredients.

According to the Wall Street Journal, food and beverage companies have increasingly outsourced produce development to companies such as International Flavors & Fragrances. Today, around 80% of all flavors are outsourced because they make up such a small portion of a product's cost. This requires International Flavors & Fragrances to conduct significant field research to gauge changing consumer preferences and help its customers maintain strong brands in the marketplace. To this point, International Flavors & Fragrances actually has more "creative centers" (31) than it does manufacturing facilities (29) to ensure its staff is on top of local consumer trends.

Finally, the industry's structure is also attractive because it has gradually been consolidating over the past few decades. Today, the top four companies (Givaudan, International Flavors & Fragrances, Firmenich, and Symrise) account for nearly 70% of the industry's sales. Each company is focused on profitable growth, and the sensitive nature of customer relationships and formula IP have limited the industry's pace of change. As regulations increase, consumer brands become increasingly international, and more research is required for natural products, further industry consolidation is likely.

All of these industry characteristics have helped International Flavors & Fragrances maintain returns on invested capital in excess of 10% over the past decade.

Key Risks

One of the biggest long-term risks to International Flavors & Fragrances's business is the increasing shift in consumer preferences away from artificial synthetics and towards natural products. International Flavors & Fragrances has produced natural products for many years but doesn't disclose what percent of its sales are tied to natural versus synthetic products today. However, the company says it has a higher win rate in naturals and is well positioned for the trend.

Another risk to consider is pricing pressure. Parts of International Flavors & Fragrances's portfolio have been subject to intense pricing competition in the past, causing the company to move out of certain areas. The diversity of International Flavors & Fragrances's product portfolio and geographic mix help mitigate this risk, and the company further benefits by being able to serve multinational customer with its global operations -- many smaller regional players cannot handle these accounts and lack the customer relationships.

International Flavors & Fragrances's business can also be impacted by swings in raw material prices (International Flavors & Fragrances uses over 10,000 raw materials) and foreign currency fluctuations (nearly 80% of sales are outside the U.S.). However, neither of these issues poses long-term risks to the company's health and profitability.

Dividend Analysis

Over the trailing 12 months, International Flavors & Fragrances's dividend payments have consumed 37% of its earnings, providing plenty of cushion and room to grow the dividend. The company has increased its dividend for 13 consecutive years, reaching the halfway point to joining the list of dividend aristocrats.

As seen below, International Flavors & Fragrances's dividend increased at a 9% annualized rate over the last decade but has seen its growth rate accelerate in each of the subsequent periods, capped off by a 20% dividend increase in August. The company's goal is to return 50%-to-60% of net income to shareholders, and its expectations for double-digit earnings growth through 2020 should fuel at least 8%-to-10% annual dividend increases going forward.

Source: Simply Safe Dividends

Valuation

International Flavors & Fragrances trades at 20.7-time next year's consensus earnings estimates and has a dividend yield of 1.9%. To justify its premium multiple, International Flavors & Fragrances needs to execute on its objective to grow earnings by 10% per year, excluding foreign currency movements. We believe the company can hit its goal because it basically calls for the business to do more of the same -- over the past five years, sales and GAAP earnings have compounded at annual rates of 5.8% and 15.5%, respectively.

With about 16% market share and half of sales coming from emerging markets, where consumer income is on the rise, International Flavors & Fragrances should have plenty of opportunities for profitable growth. Should foreign currency volatility or raw material costs create headwinds for International Flavors & Fragrances, we would view them as buying opportunities. The company doesn't appear to be a bargain today, but we have no reason to believe that International Flavors & Fragrances won't be a larger, stronger company by 2020. While the stock's earnings multiple is at a premium relative to the market, the stock's yield and earnings growth still suggest total return potential of about 10% per year.

International Flavors & Fragrances is a wonderful company trading at a fair price. While the company's dividend yield is too low for investors living off dividends in retirement, the dividend's growth prospects appear excellent for those seeking long-term dividend growth and capital appreciation.

This article is commentary by an independent contributor. At the time of publication, the author was long IFF.

Loading ...