INTERNATIONAL FLAVORS & FRAGRANCES INC. $63 (New York symbol IFF; Conservative Growth Portfolio, Consumer sector; Shares outstanding: 80.3 million; Market cap: $5.1 billion; Price-to-sales ratio: 2.0; Dividend yield: 1.7%; TSINetwork Rating: Above Average; www.iff.com) makes over 34,000 unique compounds that improve the taste of foods and the smell of a wide variety of consumer products. It has 31 plants in 14 countries. Major clients include Procter & Gamble, Nestle, Kraft, Unilever and General Mills.

In 2010, the company’s Fragrances business accounted for 54% of its sales, and 49% of its earnings. These products are found in such items soaps, detergents and air fresheners.

The remaining 46% of IFF’s sales and 51% of its earnings came from its Flavors division. These products are used in soft drinks, candies, baked goods and alcoholic drinks.

The company’s sales rose 14.0%, from $2.1 billion in 2006 to $2.4 billion in 2008. The negative impact of foreign-exchange rates pushed down sales by 2.6%, to $2.3 billion, in 2009 (IFF gets 75% of its sales from outside North America). In 2010, sales rose 12.8% to $2.6 billion, due to new clients and stronger sales in Asia and Latin America.

Earnings rose 10.7%, from $213.8 million in 2006 to $236.6 million in 2007. Earnings per share rose 15.4%, from $2.34 to $2.70, on fewer shares outstanding. However, earnings fell to $2.69 a share (or $214.3 million) in 2009.

In response to the lower sales and earnings, IFF restructured its European fragrance business. This included closing a plant in Ireland, for which IFF will pay $34 million in severance and other costs. However, the plan should eventually lower its annual costs by $17 million to $20 million.

These moves are starting to pay off. Savings from the restructuring helped push up IFF’s earnings by 25.3% in 2010, to $3.37 a share (or $263.6 million).

New products continue to spur growth

A big part of IFF’s success is due to its ability to create profitable new products. IFF works closely with its customers to keep up with changing consumer preferences. These close relationships make it harder for customers to switch to other suppliers. As well, IFF’s long history of successful new products makes it easier for it to attract new customers.

In 2010, IFF spent $218.8 million (or 8.3% of its sales) on research. That’s up 18.4% from $184.8 million (or 7.9% of sales) in 2009.

IFF’s strong balance sheet will let it maintain its high research spending. At the end of 2010, it held cash of $131.3 million, or $1.64 a share. Its total debt was $921.6 million, or just 18% of its market cap. That’s down 8.9%, from $1.01 billion at the end of 2009.

The company’s improving balance sheet is also helping it expand overseas. IFF recently announced that it would spend $100 million over the next three years to build new plants in China and Singapore. These plants will complement its existing facilities, and help it increase its sales in Asia.

Ready for higher costs

The company makes its products from over 10,000 raw materials, mainly oils and extracts from fruits, vegetables and animal products.

The costs of these ingredients are rising. That could hurt IFF’s profit margins. However, it limits its risk by keeping enough materials on hand in case droughts, floods or other unusual weather conditions cut supplies of certain crops, and push up prices.

The company is also facing increased regulation from the U.S. Food and Drug Administration and similar bodies in other countries. That’s partly because consumers are becoming more concerned about the health effects of food ingredients, particularly from genetically modified crops. These new rules are making it more expensive to develop compounds, and adding to the time it takes to win regulatory approval.

Even so, IFF’s long-term outlook is improving. Developed markets, such as North America and Europe, accounted for 56% of its sales in 2010.

However, sales in emerging markets are growing fast. That’s because more people in these countries can afford packaged foods and scented consumer goods. That should spur more demand for IFF’s products.

The stock fell to $25 in March 2009, but recently reached a new-all time high of $64. Even so, it still trades at 16.4 times its projected 2011 earnings of $3.84 a share. That’s a reasonable p/e ratio in light of its high research spending and international growth prospects.

Dividends linked to earnings growth

This dividend-paying stock also has a long history of annual increases. The current rate of $1.08 a share yields 1.7%. IFF now plans to pay out about 30% to 35% of its earnings as dividends. That implies that its 2011 dividend could rise to $1.18 a share, which would give the stock a yield of 1.9%.

We’re adding International Flavors & Fragrances to our Conservative Growth Portfolio. It’s a buy.