Business Breakdowns
· Matt Reustle, Jeremie Fastnacht
[00:00:00] S0: You mentioned the operating leverage. Oftentimes that can work on the way up, but operating leverage on the way down can be painful. So my sense is that the organic growth historically has shown not much cyclicality, particularly to different macro environments, because since 2000 we've had actual recessions and down cycles. Have the margins shown more cyclicality than the revenue line? [00:00:00] S1: They're very good at maintaining margins. Something important for them is when you have inflation of raw materials, like 2011 or 2022, Givaudan has been pretty good, maybe best in class at negotiating – maybe thanks to their size, the value they bring – to pass the cost to the clients. Typically it's done in 12 months. The cash flows are very strong over time, even in difficult periods. You had an impact on cash flow, for example, in 2022 when you had the problem of supply chains and a spike in raw materials. So an impact on cash flow, but it's still very high cash generation during the recession. [00:00:00] S0: And I assume that the R&D is mostly shown on the income statement, so that's captured in the margins. It's not capitalized.
· Matt Reustle, Jeremie Fastnacht
[00:00:00] S0: And I assume that the R&D is mostly shown on the income statement, so that's captured in the margins. It's not capitalized. [00:00:00] S1: Yes. They do 7.5 billion Swiss francs. They have something like 4.2 cost of goods sold, mainly raw materials, which is the topic. The energy represents a small part of the input basket at 2 to 3%. You get a gross margin of 44%. R&D, it's – they put the highest R&D in the industry. They are at 8% of sales. Then they spend 13% on selling, marketing, distribution. A few admin expense and operating expense. And you still have a 18%, 19% operating margin. The cash generation is very strong. You have a cash flow margin at 18% of sales, so around 1.5 billion Swiss francs a year. The working capital is around 20% of sales and the G&A around 5%. You have CapEx, typically it's 300 million Swiss francs, just 3 or 4% of sales. It's split equally between maintenance, IT spending, and growth. And so you have free cash flow, it's above 1 billion. You have a target of 12% over the cycle. We like the very long term they have. They don't give yearly guidance. They have 5-year plan and for organic growth, and they talk about CAGR, and free cash flow margin must be above 12% of sales. So it's in line with net income, or half the time it's even above. [00:00:00] S0: You mentioned working capital's 20% of revenue. [00:00:00] S1: Yeah.
· Jeremie Fastnacht, Matt Reustle
[00:00:00] S1: Yeah. [00:00:00] S0: I can understand why. Fairly high number, but it's an interesting data point. On the cash generation, what do they do with the excess cash? Talk a little bit about their framework. I know they've historically had some acquisitions. It's a very long history, so it's hard to say. M&A is a huge piece of it, but how do you frame their capital allocation and using that excess cash, whether it's for shareholder returns or whatever it might be? [00:00:00] S1: The big acquisitions were actually a long time ago. Now they are doing more bolt-on acquisitions. So they are spending a few hundred million a year on bolt-on acquisitions. So they are going in trying to get adjacent growth opportunities, new technology, new raw material access, new clients. They are not doing a big transformative acquisition. They are spending half of the free cash flow on dividends. They have a good track record of increasing the dividend steadily, whatever the environment. Over the last few years, they paid down their debts and they are now at 2 to 3 times the EBITDA. The dividend is 2 times covered, so attractive. [00:00:00] S0: Taking it down into just general framework on valuation – not necessarily looking for a price target or anything, but how you would say the market tends to value this business, whether it's an earnings multiple, free cash flow multiple. Do you have any general sense of that framework used by the market and anything you would add to it?
· Matt Reustle, Jeremie Fastnacht
[00:00:00] S0: Taking it down into just general framework on valuation – not necessarily looking for a price target or anything, but how you would say the market tends to value this business, whether it's an earnings multiple, free cash flow multiple. Do you have any general sense of that framework used by the market and anything you would add to it? [00:00:00] S1: If you look at EV to free cash flow, Givaudan is trading most of the time at 30 times or even more, thanks to the quality. It was a premium compared to the global equity index. Even if you compare to defensive sectors like their end markets, like HPC or food products, they were above. But today you have quite an interesting situation, where despite strong quality and recurring growth, they are now trading something like 23 times free cash flow. So you have a 4.3 free cash flow yield, which is close to the two sectors. It's well below the global index now. What we like to do is to do a reverse DCF. You try to have an idea of what's implied in the market in terms of free cash flow growth. Currently, it's only around 3% implied growth of the free cash flow, so it's clearly below what I think the business is able to produce. So a lot of people look at the dividend yield on this company. Currently you have 3%. It did not happen for a decade. It's well covered by the free cash flow as we've seen, and it's also well above the global index if you look very simply.
· Jeremie Fastnacht, Matt Reustle
[00:00:00] S1: If you look at EV to free cash flow, Givaudan is trading most of the time at 30 times or even more, thanks to the quality. It was a premium compared to the global equity index. Even if you compare to defensive sectors like their end markets, like HPC or food products, they were above. But today you have quite an interesting situation, where despite strong quality and recurring growth, they are now trading something like 23 times free cash flow. So you have a 4.3 free cash flow yield, which is close to the two sectors. It's well below the global index now. What we like to do is to do a reverse DCF. You try to have an idea of what's implied in the market in terms of free cash flow growth. Currently, it's only around 3% implied growth of the free cash flow, so it's clearly below what I think the business is able to produce. So a lot of people look at the dividend yield on this company. Currently you have 3%. It did not happen for a decade. It's well covered by the free cash flow as we've seen, and it's also well above the global index if you look very simply. [00:00:00] S0: If you look very simply in terms of risks, I can imagine some of them – you will have competition over time, there could be particular EM market trends. But what would you point to as the key risks for this business?
· Jeremie Fastnacht
[00:00:00] S1: You now have a bit of change. You have a new management team following the retirement of Gilles Andrier, iconic CEO for two decades. And you also had Tom Hallam, the CFO for many years, who left a few years ago. They both did a great job. Investing for growth for the long term. Not doing M&A for the sake of doing M&A and getting bigger. Very transparent, long-term view. So there is a new CFO that came 2 years ago, but he has 15 years of experience in finance at Givaudan. Beginning of March, you have a new CEO. He has experience at Unilever, P&G, 2 decades at Danone with several management positions, but that's the main risk. My father taught me something when I was young. It's something from his mechanics course. The teacher used to say, you should never touch an engine that's running smoothly and perfectly. That's a problem for a lot of quality companies. There is new management, they don't understand it's a wonderful business already – and you have to invest to not be complacent – but don't change everything to change something. The ex-CEO, Gilles Andrier, he stays as chairman and, still owns lots of shares. So we hope that everything stays the same. Otherwise, a few years ago – in 2023 I think – there was an antitrust investigation against several players from the fragrance industry. Givaudan said they were collaborating and they've made no provision, so let's see if something comes out. You have some Chinese price competition, really on the more commoditized fragrance ingredients and parts. But it's only 6 or 7% of group sales I think, and very different, as we've seen earlier, from the rest of business – deeply tailored compounding with huge barriers to entry and competitive advantages. Of course maybe, more short term, I hope the effects of the Middle East war—the total region is maybe around 7 or 8% of group sales, but was a good growth driver over the last few years in fine fragrances. In general fine fragrances is more volatile than the other very stable end markets, and it's now 11% of group sales. Maybe finally, if you are more paranoid, a more remote risk would be AI chips implanted in your brain which could simulate taste and scent. You never know. But personally, I will never trade the experience of my favorite ice cream or drink with Givaudan flavors, for a chip in my brain.