Unilever: A “Safe” (?) Dividend Stock (analysis)

Introduction and summary:

This article is a very brief analysis of Unilever. The company has proven to be adaptable in many different economic climates and has been around for about 90 years, but its roots can be traced back to the 1880s. The current company is a result of the merger of Dutch Margarine Unie and the UK soapmaker Lever Brothers. Unilever has survived many crisis and expanded during every downturn. It’s truly global with sales in over 190 countries and over 50 brands generate one billion in sales each. 84% of the brands are either 1 or 2 in their markets. According to the annual report of 2019, about 2.5 billion people use their products every day, meaning they produce everyday necessities.

The ordinary share is listed on the London Stock Exchange and has the ticker code ULVR. In the US it trades as ADR with ticker codes UN and UL.

I’m long with a small position established some years ago.

The business:

Unilever has three segments

• Beauty & Personal Care: deodorants, hair care, skin care, skin cleansing.
• Foods & Refreshments: Ice cream, Dressings, tea etc.
• Home Care: Fabric solutions, home and hygiene.

Segment	Revenue in bn	Operating profit in bn
Beauty & Personal Care	21.9 (42%)	52%
Foods & Refreshments	19.3 (37%)	32%
Home Care	10.8 (21%)	16%

This is some of their most well-known brands:

• Axe
• Dove
• Lux
• Vaseline
• Knorr
• Lipton
• Cif
• Domestos
• Sunlight

60% of the revenue is derived in emerging markets, where growth is estimated to be higher than in developed markets in the coming decades:

Market	Revenue of total	Operating profit of the total profits	Revenue growth from 2018
Asia/AMET/RUB	47%	51%	5.5%
Americas	32%	31%	2.8%
Europe	21%	18%	-6%

 

Asia/AMET/RUB refers to Asia, Africa, Middle-East, Turkey, Russia, Belarus and Ukraine.

However, the 4Q of 2019 showed the lowest organic sales in a decade: 1.5%. Their guidance for 2020 indicates a growth rate of 3%, but that was of course before the coronavirus crisis. However, Unilever is probably one of the companies that will have their revenue the least impacted because of the virus.

Performance:

Unilever is one of those stocks that will not set the world on fire, but most likely will generate acceptable returns given you purchase shares at sensible multiples.

• The share price has returned 10% annually since 1990.
• Rolling 5 year CAGR is mostly hovering around 10%. The highest has been 20%, the lowest -3% in September 2004. In other words, the return has been pretty stable, as perhaps can be expected from such a huge consumer staple.
• Return on equity: 38% average over the last decade.
• Return on invested capital: 19.4% on average over the last ten years (including goodwill).
• Operating margin: 19.1% on average.
• CAGR EPS last decade: 3.5%.

Today the stock is trading around the 52 week low. Historically, whenever the stock has crossed the 52 week low plus 10% (if the low is 40 then the limit to buy is at 44) it has returned 13.8% annual returns the next three years. Not bad!

The dividend:

Many own Unilever because of the dividend. However, I believe this is the wrong approach because you can sell shares to generate “income”. The focus should be on total returns.

The dividend is paid quarterly and the payout ratio has been around 50-70%. The latest dividend is about 70% of the free cash flow. The dividend is paid in EUR, currently 1.64, which equals a yield of about 3.6%. There is no withholding tax on UK dividends.

Since the financial crisis, the dividend has grown at 12% per year, but I expect this to drop more in line with EPS growth.

The balance sheet:

As with most consumer staples they use debt, but not excessive, in my opinion. The most recent balance sheet says a debt ratio of about 1.9x EBITDA and debt is rated as A1 at Moody’s indicating low credit risk.

Moat:

Like most consumer brands Unilever faces the threat of competition from small entrants. Previously, such consumer brands like Procter & Gamble, Unilever and Kraft Heinz were almost considered infallible, but the fall of KraftHeinz has changed the landscape pretty much. Organic sales have fallen all over the board from 5% to a more modest 2-3%.

Morningstar writes Unilever has a wide moat, among the best on their rankings. Their moat consists of the following:

• Huge budget for advertising and promotion: 14% of revenues, thus an advantage over smaller and more adaptable competitors.
• Cost advantages: Unilever has the lowest costs per employee among the consumer stocks together with Estee Lauder and L’Oreal.
• Barriers to entry: because of its size it’s more convenient to use Unilever than many smaller suppliers.
• A huge portfolio of brands: goodwill and intangibles

Inside ownership and stewardship:

Unilever is very much an agent-managed company with insignificant inside ownership. That is of course a big minus and increases the risk of management being led astray by other motives than creating long-term results. Research indicates family-controlled or owner-managed companies perform better than agent-companies.

Despite being an agent-managed company, it’s hard to argue against the performance: it has of course been pretty good, indicating good stewardship.

The shareholder structure is a bit complex where one part is the owner from Amsterdam (UN) and another from the UK (UL). I assume this goes back to the foundation 90 years back, and it would certainly simplify it, but on the other hand, it makes them “immune” against a takeover bid.

Valuation:

EPS for 2019 was close to 2 GBP while free cash flow per share was the same. This means it’s trading at a TTM multiple of around 20 (trading at 39 as of writing). Forward PE is around 17-18 assuming most things return back to normal in late 2020. I believe Unilever is fairly priced.

Risk:

I believe the disruptions from the coronavirus to be moderate if anything at all.

Organic growth has dropped and the temptation for management to do M&A increases. This is of course nothing new for Unilever, but this is a very tricky field to maneuver. However, Unilever is used to acquisitions, even more so lately. Morningstar calculated their net outlays for M&A is only 1.6 billion EUR since 2010, indicating most of the acquisitions are financed by cash flow and/or divestments/disposals.

One other aspect in the future might be inflation. Inflation has been moderate for almost 40 years, and most people have forgotten the problems and destructive forces of inflation. However, governments all over the world are borrowing money that future generations need to repay. As far as I can understand from history, this has often led to increased inflation at a later stage. In the US, where the FED has used the Bazooka, they are literally issuing helicopter money to make people survive during the crisis. I believe the inflation rate will pick up at a later stage, just like it did after WW2. We will not have hyperinflation, but I guess in the 5-10% range. This means savings have a bigger chance of getting slowly decimated. However, Unilever is one of those stocks that can pass on the costs to the consumer pretty easily.

Conclusion:

Unilever’s scale, brands, emerging markets presence and innovation make this an interesting opportunity. Furthermore, the price has dropped over 20% over the last months and the multiple has contracted to fair levels. Historically, Unilever has offered good future returns whenever it has traded in the bottom range of the last 52 weeks.

Disclaimer: I’m long Unilever.

(This article was published 1st of April 2020.)

Disclosure: I am not a financial advisor. Please do your own due diligence and investment research or consult a financial professional. All articles are my opinion – they are not suggestions to buy or sell any securities.