Consumer goods firm Unilever (ULVR) first appeared on the site back in May. COVID aside, the investment case seemed fairly attractive. The stock traded for circa 4,122p per share at the time, equal to around 17x pre-COVID net profit. With stable and high quality earnings, not to mention the low interest rate environment, it looked a fair valuation. That piece concluded with a base case scenario pointing to high single-digit per annum returns. The stock has since rallied 8.5% in GBP terms, and the valuation still looks attractive in my view.
Like other stocks covered here, the investment case for Unilever ultimately rests on profit quality. That is largely underpinned by its huge and diversified portfolio of household brands. The firm states that 2.5b people use its products daily, a figure probably unmatched save for a tiny number of companies. Unilever owns over 400 brands in total, around a dozen of which bring in annual sales of over €1b. Well-known names owned by the firm include Axe, Dove, Hellmann’s and Cif.
Its size makes Unilever a key supplier to retailers. That, in turn, allows it to command all-important shelf space. This is a stable relationship, and one that is hard for upstarts to disrupt. The €7.2b annual marketing and brand investment budget helps maintain demand for its products, and is tough to compete against in its own right. Unilever is one of the top five advertisers globally. Cost advantages deriving from its huge scale and size also put competitors at a disadvantage.
The net result of the above is stable profit generation, and as mentioned above, that profit is typically high quality too. That results in significant economic value for shareholders. I have the firm’s 5-year average return on invested capital at circa 20%, including goodwill, with little variation year to year. That allows Unilever to spend large sums of cash on things like dividends, stock buybacks and acquisitions.
The first article briefly touched on the growth issues facing the firm. Broadly speaking, these boil down to two points. Firstly, Unilever is already a huge business to start with. It is hard to move the needle with respect to growth when you already sell €50b worth of goods each year all over the world. Secondly, a chunk of its products face increasingly price conscious consumers in developed markets (“DM”) in Europe and North America. That means stiff competition from discounters and store-owned brands. The net result is that both volume growth and price growth have come under pressure there. Indeed, DM underlying sales growth has been pretty static in recent years.
On the plus side, Unilever does a lot of business in emerging markets (“EM”). Its EM activity totalled just under 60% of sales last year. There, the outlook is generally a lot brighter. Demographics are more favourable for one, while there is also a significant emerging middle-class that can afford branded goods. Volume and price growth both registered in the low single-digit range last year, leading to mid-single-digit underlying sales growth. That has been the case over the past few years too, if not even a little better.
Recent results have obviously been heavily influenced by the pandemic. At €38.6b, sales over the first three quarters fell 1.8% versus the same period last year. That was largely driven by foreign currency changes, which shaved 4.5 percentage points off revenue in euro terms. Underlying currency neutral sales growth (“USG”) came in at 1.4% in the period, driven by 7.9% USG in North America. Analysts expect the firm to post underlying earnings per share (“EPS”) of circa €2.50 this year, increasing to €2.60 per share next year. The shares closed the day at 4,481p in London and €49.76 in Amsterdam.
The implied valuation still looks attractive in my view. That currently stands at just under 20x earnings based on FY20 profit estimates above. Taking more normalised FY21 estimates of €2.60 per share sees that drop to 19x earnings. Before COVID, management’s long-term targets had sales growth clocking in at 3% per annum at the low end. That is below recent historical performance. Operating leverage can push operating profit (“EBIT”) growth into the mid-single digit area.
After dividend payments, Unilever retains somewhere in the region of €2.25b each year. Its core business is inherently profitable, as set out in the Buy-And-Hold Case section above. That frees up a chunk of that retained profit for buybacks, acquisitions and debt reduction. At €22.7b, net debt is circa 2.2x EBIT and not much of a concern. In any case, that trio of additional shareholder return avenues can further support EPS growth.
On that basis, there seems little risk of downward pressure on the valuation. Average levels of profit growth (versus the market) and high levels of profitability support a premium valuation. The low interest rate environment also provides support, at least in the near term. The current annualised dividend stands at €1.64 per share, equal to a yield of circa 3.3%. Coupled with EPS growth in the 6% per year region, that touches on 10% annual returns under fairly reasonable assumptions.
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