Will You Smell Profits With This Stock?

If you found your lunch today appetizing or your partner's perfume smelling good, you are the reason why companies like International Flavors & Fragrances maintain consistent revenues and profits.

May 5, 2014 at 4:07PM

Source: IFF

As global economic conditions remain uncertain, investors are always on the lookout for recession-resistant stocks with consistent profits; International Flavors & Fragrances (NYSE:IFF) is one such company that fits the bill. IFF creates flavors and fragrances which are used in a range of consumer products such as household goods, beauty care, and food & beverage products around the world. It has increased its revenue in every year of the past nine years, with the exclusion of 2009 when its top line declined by a mere 3% during the global financial crisis. With respect to profitability, IFF maintained high double-digit operating margins in the 13%-17% range over the same period.

How does IFF compare with other flavor suppliers such as McCormick (NYSE:MKC) and Ingredion (NYSE:INGR)? Do these companies also possess such recession-resistant characteristics?

Products with high benefit-to-cost ratios
Like IFF, both McCormick (a distributor of spices, seasoning mixes, and condiments) and Ingredion (a producer of starch and sweetener ingredients) sell critical inputs priced at fractions of the benefits they provide. An Alcott Group study indicated that two-thirds of people think that "flavor makes all the difference" for their food; McCormick went further to say that its products contribute to 90% of the flavor that its customers' food products offer. In the case of comfort foods like ice cream and soda, the high-fructose corn syrup that Ingredion supplies provides the sweetness that consumers crave. 

In addition to producing flavors for food products like Ingredion and McCormick do, IFF also develops fragrances for beauty-care products such as deodorants. For such products, the scent is the single factor that differentiates premium products from their mass-market counterparts.

Despite the importance of such fragrances, they don't cost much, with the liquid concentrate usually accounting for less than 5% of the total cost of a perfume. As a result, IFF has strong bargaining power with its customers because the suppliers of high benefit-to-cost inputs are less likely to be the targets of cost-cutting.

The results speak for themselves--all three companies have either maintained or expanded their gross margins in recent years. IFF and McCormick have historically maintained gross margins in the high 40's; Ingredion has increased its gross margins from 14.2% in 2009 to 17% in 2013. This is the strongest indicator of the pricing power that they enjoy because of the high benefit-to-cost nature of their products.

Emerging market exposure
A domestic focus exposes a company to the political and economic risks of the U.S. and also means that it misses out on the huge growth opportunities offered by emerging markets. IFF understands this very well and it is a geographically diversified company with close to half of its sales generated from emerging markets. IFF estimates that its businesses in the emerging markets are growing at least twice as fast as those in developed markets. It has been capitalizing on this growth and it has spent 4%-5% of its annual revenue on capital expenditures to build up its capacity and technology in these markets.

Similarly, McCormick and Ingredion also have strong international presences, with the U.S. accounting for less than 60% of their total sales.

Source: IFF

R&D edge
In addition to sharing unique product characteristics and geographical expansion strategies with Ingredion and McCormick, IFF also has its own edge in the area of R&D.

IFF invested about 8.8% of its 2013 sales into R&D to develop new products and technologies, which is a 500 basis-point increase from 8.3% in 2012. As a result, it introduced 27 new Flavors molecules in 2013, eight more than the number of molecules it launched in 2012. This isn't an one-off spurt in R&D spending; in fact, its R&D investments have increased by over 50% in the past four years.

IFF's commitment to R&D and innovation serves as an effective defense against new entrants. Firstly, because it is among the top four global companies in the flavors and fragrances industry with a 16% market share, IFF is able to spread fixed R&D costs over a larger revenue base.

Secondly, IFF boasts an intellectual property portfolio of over 250 patents granted in the U.S. New competitors that seek to replicate the unique flavors and fragrances created by IFF will have to either pay hefty royalty fees or face legal suits for infringement of intellectual property.

Foolish final thoughts
IFF is one of the rare stocks which combines the best of both worlds in terms of value and growth. On one hand, it meets a value investor's criteria of recession-resistant revenues and stable profit margins. On the other hand, it has set a long-term target of double-digit EPS growth.

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Mark Lin has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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