Following a good start to 2011, the wheels came off for specialty chemical producer International Flavors & Fragrances Inc. (NYSE:IFF) a few months ago. Higher input costs, overstock and a slowdown in demand triggered a share price and inventory correction that could last for several quarters as IFF's customers remain cautious about consumer spending.

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In Your Home
If you have products in your home right now that contain compounds created by IFF, and the odds are that you do, it's your spending habits that IFF customers are worried about. The New York City-based producer of tastes for the food industry and scents for the personal care and beauty industry controls roughly a sixth of the market.

IFF is touted as a consumer staple (i.e. a defensive investment). This reputation derives from the company's role as a supplier for many consumer staple companies. Principal customers include The Procter & Gamble Company (NYSE:PG), Unilever plc (NYSE:UL), Colgate-Palmolive Company (NYSE:CL), PepsiCo, Inc. (NYSE:PEP) and The Estee Lauder Companies Inc. (NYSE:EL). But, the company's dreadful recent performance is reflecting a decline in volume sales, caused by price sensitivity to higher costs that more deeply impact cyclical stocks. There's not much that's stable about it these days. (For related reading, see Guard Your Portfolio With Defensive Stocks.)

A Foul Wind
IFF operates in two different segments. You can probably guess the two: flavors and fragrances. Each segment accounts for about one-half of the company's revenues. The flavors segment produces and sells flavoring to food and beverage companies. Revenues in the flavors segment performed well last quarter, increasing 13% compared with the same period last year to $341 million.

The bulk of it's problems are in fragrances. The fragrance segment sells fragrance compounds for perfumes, colognes, toiletries, personal care, household products and beauty care. Fragrance revenues were flat last quarter and have really soured over the past couple of years, hurt by price-driven volume declines and tough comparables. Higher input costs have really hurt; it's raw material prices jumped 13% last quarter.

Meanwhile, the landscape is getting extremely price competitive. If customer demand is elastic, IFF faces an uphill battle. With input costs holding at elevated levels, the company must try to first pass on price increases to customers. In the event that doesn't work, and new offers of alternative reformulated product fail, the company could be forced to simply exit. Since it lacks locked in customer relationships, the company must constantly bid for new contracts. Aggressive price action by privately held European competitors Givaudan, Firmenich and Symrise is really pressuring its volumes.

Total revenues rose 6% to $714 million. But the company's shares sold off steeply after the November earnings report as the slowdown in fragrances forced it to revise down its full year earnings forecast.

The Bottom Line
The near-term outlook has changed for IFF. However, if it can get through this difficult period, there is fresh air on the horizon. High barriers to entry limit the game to the few major players, of which the company is one. Also, project wins are still relatively strong for the company, and emerging economies will drive new growth opportunities. Those are extremely important revenue catalysts. More importantly, investors have reason to support the stock, thanks to the 2.3% yield that the company is committed to growing. These positive factors, however significant, do not outweigh the headwinds working against it. Until IFF can demonstrate the ability to pass higher costs onto customers or better control pricing, investors should not hold their nose and buy ... even at these depressed levels. (For related reading, see The 4 Basic Elements Of Stock Value.)

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At the time of writing, Matt Cavallaro did not own shares in any of the companies mentioned in this article.

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