DSM-Firmenich: Making Progress, Still Far From Delivering On Its Full Potential

seekingalpha09-14

DSM-Firmenich has shown promising advancements in achieving cost synergies, particularly through reducing duplicate roles, consolidating insurance policies, and renegotiating supplier agreements.The ...

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PixelbizzWe last wrote about specialty ingredients and perfumes company DSM-Firmenich (OTCQX:DSMFF)(OTCQX:DSFIY) in March of this year, when we noted that the forward valuation looked reasonable but that we were not yet seeing much in the form of synergies from the merger. After reviewing its first half of 2024 financial results, we are more optimistic about the cost synergies, but remain skeptical that the company will be able to deliver on the revenue synergies. One reason for the skepticism is that the bulk of the revenue synergies are expected by 2026 and the company has given fewer details, while cost synergies are expected to be mostly in place by the end of next year. The company has also been more specific as to exactly what is driving the cost synergies, and while it did have a slow start with only about €10 million achieved in 2024, the company is guiding for more than €175 million that will have been implemented by the end of 2025. DSM-Firmenich has also been good at sharing details as to where these synergies are coming from. It has named three main areas, general and administrative where it is planning to remove some duplicate roles, merging some insurance policies, leveraging its now larger scale to get better pricing, and renegotiating with suppliers where it particularly expects meaningful savings in logistics costs including warehouses, transportation, and air freight costs.   DSM-Firmenich Investor PresentationDSM-Firmenich's management is also expressing confidence regarding the revenue synergies, which involve things like new products developed through DSM and Firmenich scientists collaborating. Revenue synergies also include cross-selling, where DSM's and Firmenich's sellers will now try to promote products from the other company to their list of customers. The problem with revenue synergies is that it is more difficult to measure them, and some of the new product developments might have happened anyways. There is also potential for revenue de-synergies, where some customers might no longer want to work with the newly merged company. Perhaps because after the merger they now have an overlapping business area that makes them partial competitors. In any case, it is clear that there is less certainty about this type of synergy, as there have been fewer specifics shared with investors, and the targets are further into the future. The bulk of the revenue synergies are expected by the end of 2026.   DSM-Firmenich Investor PresentationFinancial Results Financial results for the first half of 2024 saw a drastic improvement compared to the same period a year earlier. The company delivered 7% organic growth, with volumes 9% higher, and prices contributing about -2%. Core adjusted earnings per share (EPS) of €1.55 were 55% higher year-over-year, despite performance from its vitamin business still negatively impacting results. Customer destocking appears to be fading away, which has helped the company to return to a more normal business environment.   DSM-Firmenich Investor PresentationAnimal Health & Nutrition Separation Despite the animal health and nutrition business being arguably of lower quality compared to the rest of the divisions, we are not sure that selling the business is the best alternative for shareholders. First, the company estimates it will incur approximately €100 million in separation and transaction costs. Second, if sold to private equity or another corporation, it will be difficult for the company to get a decent valuation, as it is well known that the company is a motivated and committed seller. Third, we think it is the easy way out for management to just sell an underperforming business instead of turning it around. It is true that they have already taken some measures to improve the profitability of the unit, but there is likely a lot more that could be done, including launching new innovative products in areas where competition is less centered around pricing, which could help drive margins higher. Levers for Higher Growth and Profitability While DSM-Firmenich has historically delivered organic growth in the 4% to 5% range, management believes that it will be able to reach 5% to 7% in the medium term thanks to revenue synergies and portfolio tuning/optimization. Portfolio tuning is likely a euphemism for selling low-growth businesses, which would naturally result in higher growth rates for the group. Still, if those businesses are sold below fair value, it could result in value destruction for shareholders, even if the business metrics look better. The other main lever management discusses relates to revenue synergies, where we do think some value can be created, but remain skeptical until we see more concrete evidence.   DSM-Firmenich Investor PresentationSimilarly, management expects significant improvements to its profit margins. Its adjusted EBITDA margin has historically been around 19% to 20%, with 2023 being below average due to destocking in the supply chain and significant weakness in its Vitamins business. The company believes it can reach margins between 22% and 23% in the medium term through synergies and portfolio tuning. Selling Animal Health and Nutrition would certainly help improve reported margins, but it could still be value destructive if sold at a low price.   DSM-Firmenich Investor PresentationFuture Outlook DSM-Firmenich increased its guidance for fiscal year 2024 to around €2 billion in adjusted EBITDA, an increase of about 5% compared to the previous outlook. Looking further ahead, the company expects to have separated or sold Animal Health & Nutrition, with the remaining three complementary business segments, all having attractive organic sales growth potential and elevated profit margins. While we find this vision for the company attractive, we hope management will be patient and not sell lower quality businesses below fair value just to improve reported business metrics.   DSM-Firmenich Investor PresentationValuation DSM-Firmenich is currently trading with an enterprise value of roughly €36 billion, which puts the forward EV/Adj. EBITDA multiple at ~18x, based on management's guidance of €2 billion in Adjusted EBITDA for fiscal year 2024. This is certainly not a low valuation, but it is not uncommon in the specialty ingredients industry, given its attractive characteristics. Data by YChartsDSM-Firmenich is currently trading with one of the lowest Price/Sales multiples compared to peers like Givaudan (OTCPK:GVDNY), Symrise (OTCPK:SYIEY), and Novonesis (NVZMY). Part of the reason is that DSM-Firmenich still has some lower quality businesses like Animal Health & Nutrition that are underperforming, particularly the vitamins segment. Still, if management does deliver on the synergy promises, we see potential for a re-rating. Data by YChartsRisks The biggest risk we see for investors is the elevated valuation, which seems to at least be partially factoring in some of the guided synergies by management. We are also concerned about the cost to separate the Animal Health & Nutrition business and that it might be sold below its intrinsic value. There is also the ongoing price-fixing investigation for alleged collusion by the company and some of its competitors. These risks are somewhat mitigated by the inherent defensiveness of many of its businesses, which sell ingredients often used in staple products that are less affected by recessions and economic weakness. Conclusion Financial results for the first half of 2024 showed significant improvement compared to the same period last year, and shows the company starting to deliver on some of the promises made related to the DSM and Firmenich merger. We remain more optimistic about cost synergies, and more skeptical that the revenue synergies will be achieved. At current prices, we believe shares to be a \"Hold\" at best, especially when considering the company's risks, including the potential sale of the Animal Health & Nutrition business at a disappointing valuation. On the other hand, should the company fully deliver on its cost and revenue synergies, a re-rating of the valuation multiples might be justified.  Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. 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