Pricing as a result of inflationary pressures and low demand elasticity in key categories was the main driver of Unilever's strong top-line performance during the coronavirus pandemic. By the end of the forecast period, organic growth is anticipated to slow to less than 4% as the company turns its attention to volume growth and mix. Despite marketing products tailored to local markets and preferences, multinational consumer product companies still have to contend with small, local, and nimble rivals. Sufficient investment in marketing, trade, and R&D guarantees that products align with regional consumer preferences. However, the stock has underperformed in comparison to peers of similar size and stature due to declining investments in R&D, capital expenditure, and marketing, which have resulted in losses of market share and a weak organic growth rate.It is believed that moving from a matrix structure to a new organizational structure centered on business groups will improve execution, accountability, and agility. The management has made significant investments in active portfolio management, selling off low-growth underperformers and investing in important brands and categories through bolt-on acquisitions as well as organic growth. In emerging markets, where Unilever sources over 60% of its sales, population growth, urbanization, and economic expansion are secular drivers that support medium-term volume.
Unilever has surpassed Euronext Amsterdam and FTSE returns in the past decade.
Unilever is not held by any notable value investor at the time of writing this report.
Investment Upsides
Within the broad HPC and packaged food segment, Unilever's eight different categorieslaundry care, ice cream, haircare, bath and shower, deodorant, skincare, and dressingsaccount for 80% of its net sales. Over 60% of Unilever's revenue comes from grocery stores, with skincare and haircare receiving the least exposure.Due to the company's well-established position in the supply chain, which has been developed over decades of operation in these markets, the nutrition, ice cream, personal care, and homecare segments (roughly 75% of group sales) show indications of a broad economic moat. As might be expected, Unilever holds significant positions in most of the categories within those four segments, and its shelf space share generally corresponds to its market shares. As one of its strong intangible assets, Unilever's significant shelf space reflects the company's established position in the supply chain.The high cost of acquiring new customersmostly marketing and R&D expensesis another significant industry challenge. Due to its size and reach, Unilever is able to generate enough cash flow to support its brands and pay for the slotting fees required when launching new productsan intangible asset that new competitors cannot match. With the exception of high-end cosmetics companies, Unilever spent the most of its revenue in 202314 percenton advertising and promotion. For the bigger players, this amount of spending generates a positive feedback loop since, if done well, increased marketing and line extension expenditures can spur volume and category growth.
The market may be penetrated by new players, and startups may offer a retailer price leverage over major producers. Allocating shelf space on a localized, trial basis can help reduce the substantial risks of supply chain disruption associated with the smaller players. Due to cost advantages resulting from economies of scale, incumbents are in a good position to duplicate the competitive product and provide it to retailers at a lower price. This allows major players, like Unilever, time to adapt to the entry of a new brand. The most established vendors in the retailers' supply chains are shielded by the high barriers to entry created by this self-reinforcing combination of moat sources.Strong brand equity is better built in categories with a higher level of product differentiation. With characteristics of brand power in specific homecare, personal care, and beauty and well-being categories, Unilever has been successful in adjusting prices to reflect inflation trends. According to their framework, which compares the business unit's operating margin with a peer group of competitors or divisions of competitors, after adjusting for discretionary expenses and costs with high accounting-related subjectivity, Unilever demonstrates healthy cost advantages at the group level.
In the top half of the home and personal care coverage, Unilever, a well-known international ice cream company, has a high direct operating margin. More comprehensive research that takes into account factors like market share, relative size, and regional concentration, however, might yield stronger findings. Unilever has a 20% global market share, which is twice as large as its nearest rival, Nestle, despite having low margins (11% in 2023). The US ice cream division of Nestle, which was sold to Froneri in 2019, had an estimated EBITDA margin of 13%15% or an EBIT margin of slightly over 10%. Furthermore, the operating margin of Froneri, a joint venture between Nestle and PAI Partners, was only 10%, indicating lower profitability.Unilever's ability to sustain excess returns on invested capitalan average ROIC of 18% over the last five years and 20% over the last tensupports its wide moat rating. Over the next five years, this percentage is anticipated to rise to 17% thanks to Unilever's pricing and cost-cutting initiatives, which should lessen pressure in a highly competitive and inflationary environment.
Intrinsic Valuation
Unilever has surpassed Euronext Amsterdam and FTSE returns in the past decade.
The target share price for Unilever is $54.45. This suggests 2024 multiples of 20 times earnings and 13 times enterprise value/EBITDA, a free cash flow yield of 3.5%, a dividend yield of 3%, and a euro/dollar exchange rate of 1.03. Due to strong brand positioning and good demand elasticities, Unilever has been able to lead pricing while minimizing volume impact. It is anticipated that 2024 will be a normalization year, with volume increasing by about 3% and the pricing contribution to organic growth approaching the long-term average. It is anticipated that the midcycle assumptions for organic growth and its constituents of price, volume, and mix will somewhat revert.Another significant factor influencing valuation is the mid-term EBIT margin; Unilever's underlying EBIT margin peaked in fiscal 2019 at 19.1%. Nonetheless, the midcycle margin assumption is at 18.6% due to indications of a shifting perspective on investment levels and inflationary pressures. According to the company, Unilever and its shareholders would benefit more from a more balanced value-creation strategy.
Investment Downsides
Value-destructive acquisitions could be expensive in a competitive market due to Unilever's financial flexibility and strong balance sheet. Nonetheless, Unilever has restructured its portfolio, sold off low-growth companies, and purchased high-quality, high-growth brands. Economic downturns have not historically had a major impact on the consumption of packaged foods, although premium and discretionary food categories have seen modest drops during downturns. There is a translational currency risk because Unilever reports in euros. With more than 60% of group sales originating from emerging markets, the company is more exposed to these areas than some of its competitors. Unilever's material environmental, social, and governance issues are unaffected by its uncertainty rating. Nonetheless, single-use plastic is emphasized as a possible source of ESG risk. Despite the possibility of ESG risks for all packaged food companies, Unilever's response to these risks is more robust than average.
Portfolio Management
Over the last ten years, Unilever has continuously delivered respectable returns to shareholders, outperforming both the FTSE and Euronext Amsterdam. Since 2012, dividends have been the favored way to return capital, with a payout ratio of at least 60%. Although management has typically created value when repurchasing shares, share repurchases have not significantly increased shareholder returns. It is anticipated that Unilever will continue to pay out a high dividend and repurchase shares opportunistically, with tuck-in acquisitions probably continuing to be given priority.Even though Unilever is a very acquisitive company, it has sold assets to finance a large amount of its acquisitions. Since 2010, the company has spent about EUR 2 billion on acquisitions, which is less than 4% of its total free cash flow. Value has been added by Unilever's mergers and acquisitions, such as the $1 billion purchase of Dollar Shave Club and the $3.7 billion Alberto Culver deal. However, Unilever has lost a fiercely competitive and commoditized category that is unlikely to support growth in the medium term as a result of the disposal of the spreads and tea businesses.
