A Rare Wide Moat in the Basic Materials Sector

Andrew Lane: International Flavors & Fragrances is one of the select few wide-moat companies we cover in the basic materials space and, at the time being, it's also trading at an attractive valuation. As its name implies, IFF develops bespoke flavor and fragrance solutions for a wide variety of customers, with its sweet spot being global CPG clients.

The company's wide moat is supported by both intangible assets and switching costs. Intangible assets stem from the R&D spending required for the development of highly engineered, proprietary formulations that can't be precisely replicated by peers. The evidence for switching costs is that, if a customer were to switch suppliers, it would risk losing the highly specific characteristics provided by IFF's products, potentially impairing its own brand equity. Perhaps the best way to think about the company's moat is that IFF's highly valuable intangible assets provide significant pricing power that allows for elevated returns on invested capital while switching costs help ensure the durability of economic profit generation.

Shares are currently trading at a 10% discount to fair value, which puts the stock in 4-star territory. To achieve our $137 per share fair value estimate, the company will only have to deliver roughly 100 basis points of adjusted EBITDA margin expansion over the next five years. Although price-implied expectations reflect concern about the ongoing slowdown for IFF's global CPG customer base, we believe the company's moat will help support healthy top-line growth and earnings growth in the years to come. With this high-quality operator now trading at only 18 times next year's earnings, we see attractive risk-adjusted return potential.