International Flavors & Fragrances Inc (NYSE:IFF) is the second largest business in the flavors and fragrances industry. The company was founded 125 years ago and has been publicly traded for 50 years. International Flavors & Fragrances currently has a market cap of $9.6 billion.International Flavors & Fragrances is a member of the Dividend Achievers Index. The company has increased its dividend payments each year since 2002. The Dividend Achievers Index is comprised of businesses with 10 or more consecutive years of dividend payments. You can see the current list of all 238 members of the Dividend Achievers Index here.This article will look at International Flavors & Fragrances current events, competitive advantage, and future growth prospects. The company will be examined using The 8 Rules of Dividend Investing. The 8 Rules of Dividend Investing take a systematic approach to building a high quality dividend growth portfolio.

Business Overview

International Flavors & Fragrances operates in 2 segments. The flavors segment generated 47% of sales in fiscal 2014 for the company. The fragrances segment was responsible for 53% of sales.The flavors segment sells flavors for dairy products, beverages, savory foods, and sweet foods. The fragrances segment sells fragrances to a wide variety of consumer goods industries including home care and beauty care.International Flavors & Fragrances is a global business. The company generates 50% of sales from developed markets and 50% from emerging markets. The image below shows the company’s diversification:

IFF Diversification

Competitive Advantage

International Flavors & Fragrances has 50% market share in the flavors industry. The company also has 15% market share in fragrance ingredients and 35% market share in fragrance compounds. International Flavors & Fragrances is the second largest business in the flavors and fragrances industry, behind only Givaudan (GIVN).International Flavors & Fragrances decade streak of dividend increases, long corporate history, and large market share indicate a strong and durable competitive advantage.The company’s competitive advantage comes from the unique characteristics of the flavors and fragrances industry. The 4 largest businesses (Givaudan, International Flavors & Fragrances, Firmenich, and Symrise) have around 2/3 market share of the flavors and fragrances industry.   The oligopolistic industry indicates high barriers to entry that restrict competition and increase profits for the largest players.The fragrance and flavor industry has several barriers to entry. Relatively high regulatory burden in the industry helps reduce competition. To be successful in the food and fragrance industry, a company must work with the giant corporations of the food, beverage, and consumer products industries. As a result, customer relationships are very important in the flavor and fragrance industry.The biggest barrier to entry and source of International Flavor & Fragrances competitive advantage is research and development expenditures. The company has spent an average of 8.3% of revenues on research and development in each of the last 5 years. Based on current sales data, International Flavors & Fragrances spends about $250 million each year on research and development. Smaller firms simply cannot match the companies massive research and development budget.

Current Events & Growth Prospects

Research and development spending is International Flavors & Fragrances’ primary growth driver. Spending in this category helps the company develop new flavors, compounds, and fragrances that further drive sales.Over the last decade International Flavors & Fragrances has managed to grow earnings-per-share at 11.2% a year. The company’s above-average growth rate has come from international expansion and bolt-on acquisitions.Growth is not slowing for International Flavors & Fragrances. The company still has much room to further consolidate the flavors and fragrances industry by acquiring smaller businesses. The company will also grow the top line through further international growth.International Flavors & Fragrances initiated a share repurchase program in 2013 and has continued it through 2014 and the first half of 2015. The share repurchase plan more-than-offsets share dilution from management compensation. A shrinking share count means earnings-per-share increase.In the company’s most recent quarter adjusted earnings-per-share grew 13% on a constant currency basis, or 10% including the effects of currency fluctuations. Over the long run, the company is targeting 10% earnings-per-share growth. International Flavors & Fragrances has seen strong growth recently as it sheds or restructures contracts with its least profitable customers.

Recession Performance

International Flavors & Fragrances performed well over the Great Recession of 2007 to 2009. The company’s earnings-per-share through the Great Recession and subsequent recovery are shown below:

  • 2007 earnings-per-share of $2.70
  • 2008 earnings-per-share of $2.76
  • 2009 earnings-per-share of $2.69
  • 2010 earnings-per-share of $3.26

International Flavors & Fragrances earnings-per-share only dipped slightly in 2009 during the worst of the Great Recession. The company’s customers are primarily in the food and disposable consumer goods industries. These industries tend to do well during recessions as they sell relatively low-priced consumer goods that people find difficult to cut back on, even during recessions.

The 8 Rules of Dividend Investing

The sections below will compare International Flavors & Fragrances to other businesses with a long history of dividend increases using the 5 Buy Rules from The 8 Rules of Dividend Investing. Each rule has a short ‘why it matters’ section, explaining why the rule is relevant.

Rule 1: 25+ Years of Dividends Without A Reduction

International Flavors & Fragrances fails the first rule of dividend investing. The company reduced its dividend payments in 2000 and 2001. The company will still be compared to other businesses with 25+ years of dividend payments without a reduction to show where it would rank if it did pass the first rule of dividend investing.Why it matters: The Dividend Aristocrats (stocks with 25+ years of rising dividends) have outperformed the S&P 500 over the last 10 years by 2.88 percentage points per year.
Source: S&P 500 Dividend Aristocrats Factsheet

Rule 2: Dividend Yield

International Flavors & Fragrances currently has a dividend yield of 1.6%. The company has the 130th highest dividend yield out of 163 businesses with 25+ years of dividend payments without a reduction.Why it Matters: Stocks with higher dividend yields have historically outperformed stocks with lower dividend yields. The highest-yielding quintile of stocks outperformed the lowest-yielding quintile by 1.76 percentage points per year from 1928 to 2013.
Source: Dividends: A Review of Historical Returns

Rule 3: Payout Ratio

International Flavors and Fragrances has a low payout ratio of just 27%. The company’s low payout ratio gives management plenty of room to increase dividends faster than overall company growth over the next several years.   International Flavors and Fragrances has the 19th lowest payout ratio out of 163 businesses with 25+ years of dividend payments without a reductions.Why it Matters: High-yield, low-payout ratio stocks outperformed high-yield, high-payout ratio stocks by 8.2 percentage points per year from 1990 to 2006.
Source: High Yield, Low Payout by Barefoot, Patel, & Yao, page 3

Rule 4: Long-Term Growth Rate

International Flavors & Fragrances has grown its revenues-per-share at 6.3% a year over the last decade. The company has the 61st highest growth rate out of 163 businesses with 25+ years of dividend payments without a reduction.Why it Matters: Growing dividend stocks have outperformed stocks with unchanging dividends by 2.4 percentage points per year from 1972 to 2013.
Source: Rising Dividends Fund, Oppenheimer, page 4

Rule 5: Long-Term Volatility

International Flavors & Fragrances has a stock price standard deviation of 24.87%. The company’s stock price standard deviation is slightly lower than average, reflecting the high quality of the business. International Flavors & Fragrances has the 58th lowest stock price standard deviation out of 163 businesses with 25+ years of dividend payments without a reduction.Why it Matters: The S&P Low Volatility index outperformed the S&P 500 by 2 percentage points per year for the 20-year period ending September 30th, 2011.
Source: Low & Slow Could Win the Race

Final Thoughts

International Flavors & Fragrances is a high quality business with a strong competitive advantage. The business has a below-average dividend yield, and currently has a price-to-earnings ratio of 22.3. International Flavors & Fragrances appears slightly overvalued at current prices.The company will make an excellent addition to dividend growth portfolios if its price declines and the stock can be picked up at better prices.  The company would rank only around average at current prices using The 8 Rules of Dividend Investing if it passed rule 1.