DSM-Firmenich: Initiating Coverage With a Wide Economic Moat and a EUR 140 Fair Value Estimate

We are initiating coverage of DSM-Firmenich DSFIR with a EUR 140 per share fair value estimate and a wide economic moat rating. The company was formed following the merger between narrow-moat DSM and privately held Firmenich. It combines DSM’s capabilities in nutrition, health, and biosciences with Firmenich’s leading position in the flavor and fragrance (F&F) industry (as one of the top four players, along with wide-moats Givaudan, Symrise, and IFF). We believe the merger created a powerhouse in the consumer specialty ingredients market, enjoying switching costs and intangible assets across the majority of the segments.

Shares currently trade at a significant discount to fair value, of around 25%, primarily as a result of volatility in the last remaining commoditized segment of the business -- animal health and nutrition (ANH). Still, we believe the market is overly focused on the short-term headwinds faced by this segment to the detriment of the other high-quality businesses that account for the majority of group revenue and profit. With recently announced restructuring measures in ANH vitamins, we expect sentiment to gradually improve and the company’s performance to turn around, likely starting in 2024.

The group EBITDA margin is expected to be around 15% in 2023, materially below the historical run rate of both DSM and Firmenich as separate entities. This is primarily driven by cyclically low market prices for animal-feed-grade vitamins, which are wiping out profitability for certain vitamins, such as B6 and C. Restructuring measures that address DSM-Firmenich’s portfolio of assets, its services, and route-to-market in this segment are expected to deliver EUR 200 million per annum in savings by the end of 2024. This, together with planned cost synergies, and gradual normalization in market conditions should help margins recover to around 22% by 2027, in line with the company’s mid-term guidance and the average across other leading companies in the F&F industry.