Givaudan: The Magic Ingredients - [Business Breakdowns, EP.242]

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2:27This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. This is Matt Russell, and today we are covering the fragrance and flavor giant, Jivandong. My guest is Jeremy Fasnacht, fund manager at Banque de Luxembourg Investments. And we walk through this unseen empire in scent and flavor and how the work that Jivandong does touches so much of our everyday life, how it acts as influential marketing, and some of the interesting dynamics that go into this work, how the industry structure has evolved over time, and how Jeevandan has been able to capture 25 % market share over a 100 plus year history.

3:15So this is a fun one. Again, it's a large business that sits in an off the radar industry. Please enjoy this breakdown on Jeevandan. Jeremy, I'm excited. We finally get to break down Jeevandan together. Excuse my pronunciation in advance. But this is a business, you present it in a very interesting way as a potential breakdown candidate. The more I researched it, the more interested I got. So maybe you can start with the simple introduction, how you would paint the picture of Givandan to our listener base. Thanks for having me, Matt. First, I'd like to say that it's a special and quite secret, fascinating business.

3:55They are based in a city called Vernier by the League of Geneva. They have a currently market cap of 25 billion Swiss francs. A typical day for you or for lots of people. You wake up, you go to the bathroom, the floor is clean, smells lavender. You take a shower, you grab your favorite shampoo and gel that you use every day for years. And you brush your teeth with your favorite refreshing toothpaste. You put your organic deodorant while your partner maybe is putting this terribly attractive perfume. Magic skin cream. You put your shirt to go to work. It smells the fresh scent of your laundry detergent.

4:36Then you grab this healthy beverage. You eat plant-based yogurts that you take every morning on your way to work. Now you work a lot, so you're starving. You hesitate between this trendy veggie restaurant with delicious flavors or with your regular fast food. Finally, you fall for this yummy burger with an irresistible sauce and your favorite soda. And now the day is almost finished. You visit the supermarket and at the checkout, you can't resist the taste of this chocolate bar. All these products, tens of thousands of other products around the world, there is a high probability that Gervodon is involved.

5:13They are everywhere. They create the magic ingredients, the fragrances, the flavors that's influencing the sense of humans. These are the main reasons why people love certain products and keep repurchasing them for years. I am always amazed at the power of scent and taste. Anything around the five senses tends to be a good focus area. The studies show that this comes before advertising, usefulness of packaging and price. It's really the main reason, the flavor and fragrance, why people are crazy about some products. Givaudon produced this and these fragrances and flavors. And what's important is that it's a tiny fraction of the client's cost.

5:54Their employees are artists. They are scientists. They are experts in nature, chemistry, human emotions. Humans have hundreds of receptors in the body dedicated to smell and taste. And these are linked to our memory, to the brain, and to our emotions. So Givaudan's products, they have the critical role of creating, reinforcing the emotional bond between the brands that people love and the consumers. They are really the real innovators behind the tons of decades-long success, world-famous branded products that are sold by the largest usual suspects, multinationals that everybody knows. In HPC, you have, for example, P &G or Unilever, maybe Estee Lauder, L 'Oreal, Colgate, Rekit.

6:44In flavors, in food and beverage, you have PepsiCo, like Coke, Nestle, Starbucks, maybe Mondelez, Mars, Hershey, and lots of famous fast food chains. So the secret industry, as I said, these companies don't really want us to know that the big innovation is coming from Givaudan. Givaudan does even more business with tons of local and regional leaders and disruptive startups, small indie brands around the world who are growing actually much faster on average. In the end, hundreds of millions, if not billions of people are enjoying Girodon's creations every single day, but they don't know that. Don't know this coming from Girodon.

7:25That's crazy. The business provides a strong visibility and growth, strong cash flows and stable cash flow and nice return on capital. Because thanks to the structure, the value they provide in the end markets, the industry is like a staples like, but better. It seems that most investors don't really know the name, but they are still a very nice business, defensive recurring growth, attractive cash flows. The industry is more diversified and you benefit from lots of trends. It just seems better by construction. I'd be curious to know. It's such a fascinating market and industry and it makes sense to me.

8:02I just even think about, by me going onto a boardwalk and the odor of the funnel cake is its own attraction and stronger than any marketing that you could ever come up with in terms of packaging or visual aesthetics. Can you get into both the history of Givaudan, their exposure to this particular industry and how much they pioneered it or disrupted it over time? I'd be curious to know how their story fits into that. So Givaudan was founded a long time ago, 1895 in Zurich, by two brothers, Leon and Xavier Givaudan. And at the beginning, it was a perfume factory. There is a small story. A few years later, the local bakery complained because the factory, the fumes, make the bread smell like violet.

8:50So they were first to move and they went to Vernier. and they were really the pioneers to create synthetic perfume in large quantity because at the time it was only small boutiques craftsmen they really got into synthetic so it's funny because now it's exactly the opposite everybody's going into naturals but at the time it was revolutionary at the beginning it was a perfume then they moved with an acquisition another Swiss company in 1948 they bought their Solco to get into flavor and then in the 60s the famous company Roche, the pharma company. They wanted to diversify, so they acquired Givaudan, but also another company, Rour, a French company that is legendary in luxury perfumes and naturals.

9:35It was based in grass, the cradle of perfumery in Provence. Roche merged the two companies in the 90s, and then in 2000, Givaudan was spun off, listed on the Swiss exchange. They really became the dominant player by acquiring Nestle food ingredients in the early 2000 and then later Quest International. So big player in flavor and fragrances, which was part of Unilever. So this business were outsourcing this complex business. And now it's a bit funny, also the opposite, because some of companies are now like Unilever or P &G, they are trying to get back by investing in fragrance capabilities. With all that and other Bolton acquisitions, they are today the leader of this industry.

10:21Now they are equally split revenue between flavor and fragrances. It makes sense to me. Obviously, fragrance has an impact on taste. Anytime you restrict your ability to smell and you taste something, there's overlap. But in terms of how these teams operate, you mentioned they moved into flavor with an acquisition. Do those teams and divisions operate very separately? They operate separately. But on the other hand, you have lots of things that are common. If you want to succeed in the industry, you have to get big. You need scale, you need global and local operations. You need tons of R &D and IP.

11:00You need trade secrets, deep pockets. You need lots of relationship and trust from the clients. You have to navigate a complex regulatory environment, different in each country and region. You have to manage vast portfolio of thousands of raw materials and sophisticated global supply chains. This is the same for both business. The client issue what they call a brief to explain the product they want to create, describe the brand, the identity, the positioning, the image, the colors, maybe feelings they want to associate with the products. And they give a given price. So this is the same for both business.

11:38For example, hello, Givaudan. This is L 'Oréal. We want to create a new luxury creed perfume for women. We need a fragrance, something smooth and complex with pineapple, jasmine and bergamot. And we need it for 150 USD per kilo. Or, hello, I'm the founder of a startup, Mad Vita. I want to create the best premium organic tea. I need a delicious hibiscus flavor, which tastes fresh, natural, healthy. I want it for 5 USD per kilo. So it's a bit the same in both cases. What is special is that what you have is the core list. Most of the large and some meat, food and beverage and household personal care companies work with the core list systems.

12:23It's the list of their very few selected suppliers for several years, where you usually find the biggest FNF players like Givaudan. And they are guaranteed to be included in all the briefs, but then they are also in competition. So you have three or four companies maybe in the list. It's a very selective club. you have to pay thousands of dollars just to play. Buyers to entry in the industry, of course, are very high. Now, if you go back to the examples, the two creation examples, you have the perfumer, the ne, so it means a nose in French, or the flavorists from the FNF company who are the artists, but also scientists because it's very complex.

13:02The companies, they have thousands of employees, but the big companies have only a few thousands of these star flavorists and perfumers. They are generously paid. And you have evaluators that help them. You have chemists, you have food technologists that create a complete product. So the clients can really imagine what it would be. And it's very complex because even for a simple flavor, for example, apple, it must fit with the products, the specificities of the brief in terms of flavor. Which variety of apple is it? Is it flavor of a fresh, ripe apple? What form is it? What do you need? Liquid powder.

13:38You have to be careful with chemical stability. It must fit with the brand, with the regulation, tons of unique variation. Sometimes it must mask other ingredients. And you have to be careful because even if you change 1 % of a formula, it can change a lot of stuff, not only scent, but the texture or the stability. Certainly sounds like the chemistry is incredibly important on both sides of the business. You have deep integration. You have symbiotic relationship with the F &F companies and the clients. It's often a partnership. It's a cooperation process. So you have the product manager, the marketing guys of the client, and you have tons of iterations between both.

14:18Sometimes for a simple, small client, it can last a few weeks or a few months, but for a high-end perfume, it can last two to three years. The big players have trusted relationships, often built over decades. It's really secret. So they don't tell that a lot of innovation comes from this company. They provide the creation as we've seen, but they also advise supports in pre-creation. They can do internal testing for the clients. They can do market and trend analysis. They have a ton of data. They can do consumer panel testing. They can add on regulatory or marketing stuff. The company then will create a unique compound with a unique reference number for you for a unique client.

15:01It won't be used again with other clients. The IP on these products stay within the FNF company. You see that is very far from commodities. We heard from industry experts that sometimes an FNF company cannot replicate the flavor or fragrance of a peer despite having the formula. So it's really complex. That's why you see that these FNF companies, they spend 7 % or 8 % of sales in R &D, I mean invest. If you look at the HPC and the food and beverage, it's only 2 % to 3%. But it's also different by clients. For example, you have most of clients that don't have very big capabilities. But you have, for example, as I said, a P &G.

15:43They have some internal fragrance capabilities. Or maybe you have a Chanel. They have their own perfumer, so they will only buy the raw mat. The F &F companies, for all the creation, they are working for free. So that's why they keep their IP. They submit their creation, all the specificities, and then the clients, in the end, they will do testing with many end consumers. Then they will choose one of the submissions from the FNF and they will award the business to one of them, which will start the production and start making money. It's a bit like a royalty business where you have an upfront cost, but then you have optionality on the successful products, which might become a cash cow for many years.

16:26my assumption would be that once they win a proposal, so long as that product stays in service, let's assume they win an applesauce proposal for F &F, as long as that product stays on shelves and is selling, I assume that they continue to reap the benefits. You don't see any changes to the formula after that. That's another very critical point and nice point of the industry is that once you have, for example, a client like a very famous red soda or blue soda selling for decades with the same taste everywhere for decades in the world, selling billions, you have a special coffee from a Swiss company, you have a wonderful ice cream that you get in your sofa every night.

17:15Once you have a cash cow or billionaire products like this, the switching costs are enormous because if you change one person, you have no reward, no incentive to save a tiny fraction of your cost to change a formula. That's why you have cash cow business. And even if you look at a small client, Olipop or some smaller business with high growth, if you are relying on one or a few products that are small, but high growth, but for you, that's very important. Also, you have no incentive. You don't take the risk to change because it's too risky. Even before you talk about brand perception, you have safety, health failure.

17:55Why do you go to an untrusted supplier? That's why it's a very sticky business. And something which is also important is that in the flavor business, you have the cost of the flavor that the F &F company provides is just maybe 1 % of the client's cost. Even on the fragrance business, it's just 5 % of the client's cost. So you have no incentive to change. But on the other hand, you have the procurement team of the clients, which from what we heard from experts, they are constantly trying to get rebates on this. Sometimes you have contracts to maintain the price. Sometimes you don't have contract.

18:32But when you are in terms of big raw materials inflation, the F &F company has to negotiate to try to pass it to the clients. That's another negotiation between them. Can you just give me a sense of the size of the F &F market? You mentioned they're the market leader. How big is this? I can probably back out math based on what percentage of F &B versus fragrance it is. But just some context. I'd be curious to know the general size of the market, how much it's either growing over time. Any type of trends to the market size would be interesting as well. The segments where Giroland is active. So they are mostly in customized and tailored products, not basic commodities.

19:17So in flavor, if you take all the markets, it's roughly 30 billion Swiss francs. In fragrance, the market fragrance and beauty, it's around 25 billion Swiss francs. Again, all the clients we mentioned, plus local and regional and indie brands. The market share, it's a big difference between fragrance and flavors. In fragrance, there is the big four. So you have Givaudan, another Swiss company, which is called Firmenich, which was acquired by DSM a few years ago. And then you have US-based IFF. Then a bit smaller, you have the German Samurais. These are the big four players. And then it goes much lower in terms of sales.

19:58And you have, for example, two French companies. One is private. It's called Manet. The two companies are based in Provence. You have another great listed business. Founded is 1850. It's called Roberté. They have a very nice niche in raw materials. So these two are much smaller. And then you have a lot of small players, but the big four players, they control something like two thirds of the market in fragrance. And it's very stable. So it's very stable for decades. In flavors, it's more fragmented around the world. The bigger players, they have something like 10 % market share. The players are almost the same for decades.

20:36And what is interesting is that the competition in general is more like a golf contest than a Krav Maga fight, for example. The players are rational. Sometimes they even sell some specific ingredients to each other. They are not competing crazy on price. They are really competing on innovation. Sometimes it forces you not to become complacent. Sometimes in some kind of industries, a problem is when you have recurring growth, it's too easy and you stop innovating. So it's not the case in this industry. In terms of market growth, as you asked, the end markets are really mainly defensive, as we've seen, and high frequency, repeatable, small ticket transactions, so stable.

21:17From all the figures that we found, the industry is estimated to grow constantly at 4 % to 5 % per year. If you dig into the IPO prospectus of Givaudan in the year 2000, you check the figure that the markets were at the time, you calculate that the CAGR is really 5 % per year up to today. Typically, the FNF companies, they have a revenue churn. So the business you lose because the consumer's taste change or there is no product or there is competition. So it means you have 10 % that disappear roughly. So if you want to achieve 5 % growth, It means that you have to create 15 % new products, new creations.

21:57Every year. So it means, for example, Givaudan is selling tens of thousands of products. You have to win briefs and create thousands of new products each year. So really an innovation machine. The churn rate is much higher on a trendy perfume or small startups where a lot of them don't succeed. And the churn rate is higher than a billionaire ready to drink, for example, logically. If you look at the growth rate, this 4 or 5%, below the surface, there are very different things to know because you have EM countries that are growing on average four times faster than developed countries. So over the last decade, it was around 2 % for mature markets, roughly 8 % for the high-growth countries.

22:41The local and regional, they are growing on average three to four times faster. That's really driving the growth. Yes, I would imagine that population growth and general growth of consumption is a big piece of this. But what would you say are the underlying growth drivers of that broader number? You have tons of growth drivers in the industry in general. They benefit from population growth, more consumers. They benefit from urbanization, people who move in town and change the way they consume. You have the rising disposable income in EM. You have lots of trends like natural, sustainable, sourcing, better for you, the multiplication of indie brands.

23:20if you go in flavor the people want less sugar less fat less salt but don't want to sacrifice of course on the taste they love they want healthier food and beverage protein and dairy alternatives you have to improve the aspect you have to improve the taste you have to mask ingredients you have to improve the texture there is the trend of in the u.s natural colors to replace artificial dyes the market is expected to grow 10 in the next five years If you go on fragrance and beauty, people, it's a bit the same. People want less ingredients, better ingredients, but they want exactly the same effects and smell.

23:57You need to improve, for example, the scent to carbon ratio. You need to improve the scent to volume ratio. There is a trend with people who want more juice in the bottle, so more fragrance concentration. You have young generations, they are more interesting in fragrance. They are trying lots of products. There is the impact of social network and TikTok influencers. That's driving growth. You have encapsulation technology. So it's the way that the fragrance is released, which must stay longer. It must be more biodegradable. You have premiumization. You have people that are more savvy. They want more active in their skin cream.

24:36You have population aging. They have more purchasing power. They consume more beauty, maybe, and health products. So you have tons of drivers. And I think it was Mark Twain during the gold rush. It's a good time to be in the pick and shovel business. The big and most diversified FNF companies, they can benefit with all these trends without being too exposed on one specific segment. Relative to the other three in the big four, what would you say is differentiated about Givaldan's approach, if anything? They are the leader in fragrances globally. They have around 25 % global market share. in fine fragrances.

25:16They are very strong in prestige and eau de parfumerie. They have also increased their market share because over the last few years, they have really strong growth. Organically, they have doubled their business in fine fragrances since 2019. So very strong. They are also very strong global payer in consumer fragrances. So shampoo, soap, floor cleaner, laundry detergent. They have roughly a 20 % market share worldwide. They are really the leader on that part. they are smaller. They are also active in active beauty. They are smaller. They have low exposure to commoditized fragrance ingredients. It's a low single digit.

25:52They are the leader. They are the one which is closer with what we mentioned is Firmenich. And then you have IFF and Sunrise. On the other division, the taste and well-being, so the flavor, they're also the top player, but it's more fragmented. They have maybe 10, 15 % market share in the flavor market, So the most customized, not in the very basic businesses, low margin business. They are really a leader of innovation. They own tons of IP and they spend 3 billion Swiss franc over the last few years in R &D. It's 8 % of sales more than the competition. They own the 5 ,000 patents. They have 60 research and creation centers worldwide in Brazil, in Mexico, Eastern Europe, in South Africa.

26:38So they have local data on consumers. They have insight. They can anticipate where everything is going on in terms of consumer trends. They have a big team that is chasing and screening hundreds of startups. They are the pioneer to open a perfumers school in 1946. Most of the best perfumers went in the school. They have tons of PhDs. They have 200 noses. They have some stars. For example, Callis Baker, she created the iconic J 'adore the Dior, and she's now head of the performing school. They have also very nice, very interesting innovations. They have partnership with academic partners. They make crazy stuff in encapsulation, the way to release fragrance.