Sensient Technologies Smells And Tastes Great

By Will Ashworth | May 27, 2012 AAA
The next time you buy an energy drink from Monster (Nasdaq:MNST), shampoo from Procter & Gamble (NYSE:PG) or almost anything involving color, flavor or fragrance, Milwaukee's Sensient Technologies (NYSE:SXT) might have had something to do with the product's development. Starting out in 1882 as the Meadow Springs Distilling Company, it moved from the food business into the specialty chemical business in 2000, changing its name from Universal Foods to Sensient Technologies to reflect its new focus. Business has been good since the transformation. If you're looking for a small-cap stock to own, this is one to consider. Here's why.

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First Quarter Results

As far as its historical record goes, its first quarter numbers are better than they've ever been. Revenues grew 4.6% to $365.7 million while operating income grew 6.6% to $46.5 million, and earnings per share increased 9.4% to 58 cents. It was the 10th consecutive quarter meeting or exceeding analyst expectations. Sensient is on a roll. Things are so optimistic CEO Ken Manning raised its 2012 earnings per share guidance to between $2.50 and $2.59 per share, a two cents increase at the bottom end of the range.

Its business is divided into two segments: Flavors and Fragrances and Color. The color segment had the better results in the quarter with revenues up 4.5% to nearly $131.3 million, operating income increasing 14.2% to about $25.5 million and operating margins improving by 160 basis points to 19.4%. The color group continues to focus on digital links, pharmaceutical coatings and several other growth opportunities. More importantly, it expects to maintain the segment's operating margins throughout the year. If you look at operating margins for the entire company since 2002, you'll see that its best year came in 2002 at 15.6%. In the first quarter that year, the color segment achieved an operating margin of 23.5%, 410 basis points higher than in 2012. The operating margin for flavors and fragrances in the first quarter of 2002 was 14.1%, 50 basis points higher than today. While delivering record numbers on an absolute basis, it needs to keep nudging profitability upward. It's not an easy task, but I don't see why it can't be done over the next couple of years.

SEE: A Look At Corporate Profit Margins

Stable Shares

In the past decade, its shares have achieved an annualized total return of 5.87%, 184 basis points higher than the S&P 500. More importantly, in 2008, when the index lost 37% of its value, Sensient was off just 12.94%. Only once in the past decade has it lost more than 20% in a given year, and even then it was only down by 22.9%. It's a very stable stock with a dividend yield over the past decade that has averaged around 2.87%, meaning the capital appreciation accounted for a little more than 50% of its total returns. Its business model of providing the building blocks for some of the great consumer brands in America and elsewhere enables it to provide consistent, albeit boring returns. If you are an income investor you should be interested in this stock.

Balance Sheet

Its biggest direct competitor is New York-based International Flavors & Fragrances (NYSE:IFF), with revenues that are approximately double that of Sensient's with operating margins of 300 basis points higher. So why should you buy the smaller company? For starters, its enterprise value as a multiple of EBITDA is lower. Secondly, and more vital, is the fact its net debt to capital ratio is 24.2% compared to 39.9% for International Flavors & Fragrances. However, there's a caveat. IFF has done a lot of share repurchasing over the years, which has dramatically reduced its book value. If you add back treasury stock to both companies, the net debt to capital ratios is both around 24%. However, the $1.4 billion spent over the years buying back its stock should have gone to eliminating its debt. For this reason, I prefer Sensient's balance sheet.

SEE: A Breakdown Of Stock Buybacks

The Bottom Line

Both of these companies help make brands successful and they both generate consistent returns. For me, the decision comes down to allocation of capital. In my experience, share repurchases almost never achieve satisfactory results making Sensient the more sensible investment.

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

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