Unilever: Grinding It Out

by The U.K. Income Investor

Unilever (ULVR) has been in the news a lot over the past few years. There was that audacious takeover attempt by Kraft Heinz, followed by a move to ditch its dual legal structure. The latter move would have seen Unilever abandon its UK headquarters in favour of Rotterdam, but it nixed the idea following a shareholder revolt. Now, of course, we have the COVID-19 public health situation.

This latest event is obviously completely out of its control, and on the plus side it will hold up better than most. Its 1Q20 trading update showed essentially static underlying sales growth, with the maker of Marmite, Dove and Domestos reporting total sales of €12.4B in the quarter. That was 0.2% higher than the equivalent period last year, though this includes a net positive impact from acquisitions & divestitures. Take that out of the equation, and revenue came in exactly flat compared to this point last year.

In terms of COVID-19 specifically, you’d probably expect a bit of mixed bag. On the one hand, the company’s Home Care segment should do quite well given the stockpiling. Sales growth here came in at 2.4% on an underlying basis. On the other hand, it has exposure to directly affected areas of pandemic. Food service and out-of-home ice cream seem the most obvious examples given the unfathomable number of restaurants and cafes that have had to close. Foods & Refreshment saw underlying sales fall by about 1.7%. Sales at the Beauty & Personal Care segment came in virtually flat.

Growth

Most investors here won’t be worrying too much about the pandemic. It is more likely they will have an eye on the longer-term growth situation. Much ink has been spilled on the secular headwind facing FMCG companies from store-owned and upstart brands. In terms of the numbers, Unilever’s reported top line has only grown by 1.4% per annum over the past five years. Profit margin expansion, plus the effect of stock buybacks, improves the situation in terms of per-share profit growth. I have EPS growth at circa 8.1% per annum on average over the past decade.

On the plus side, you could probably point to a few things. Firstly, the company retains in excess of €2B in annual profit (that’s after dividends) each year to help deal with these issues. That provides a handy buffer for its circa €7B annual marketing budget. Secondly, it has a prominent position in developing economies. The company generates 60% of its sales from emerging markets, as per last year’s annual report. Now, some of these economies have been battered in recent times – not to mention some really unfavourable foreign currency movements – though longer-term you’d hope for higher levels of growth.

Moreover, the valuation doesn’t appear to be totally out of whack here. I have the current share price as equal to just over 17x underlying annual earnings. Unless profit begins to drop, then that’s likely to provide some support in the current ultra-low interest rate environment. Indeed, I’m not sure this one has experienced the same degree of multiple expansion compared to some of its peers. I say that even after adjusting for the increase in leverage in recent years.

Outlook

The immediate outlook is obviously dominated by COVID-19. I’m not too bothered about that for two reasons. Firstly, Unilever should hold up better than most anyway given the nature of its business. Secondly, it has ample liquidity to ride out any short-term rough patch. As mentioned above, it is the long-term outlook that most people care about.

On that note, we start with a current dividend yield of circa 3.75%. Now, I’d like to be confident in forecasting at least mid-single-digit annual earnings-per-share growth on top of that. Fortunately, this doesn’t strike me as an aggressive target here. Indeed, the company’s own multi-year sales growth target currently stands at 5% per annum at the top-end. Underlying sales growth has clocked in at circa 3% per annum over the past three years, pretty much in line with the lower-end of its target range.

Even using the smaller number as our base, the shares can easily grind out high single-digit annual returns. If the growth picture improves, then we can bump that up a bit. It’s not the worst outlook in the world for such a stodgy name – doubly so in the current interest rate environment – but it wouldn’t surprise me to see a quiet period here in the short run.

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