The slowdown in consumer spending across Europe and the United States for the vast majority of the working population is challenging traditional consumer staples companies as they seek to pivot further towards the more robust growth in emerging markets. Unilever (NYSE: UN, NYSE:UL) specifically has understood the growing difficulties in confronting the new economic realities after the company's top leadership highlighted the growing trend of cost-cutting amongst consumers in both developed and emerging markets. The diversified company which has four core areas of focus including personal care products, cleaning products, packaged consumer products, and food is facing the slowdown head-on, focusing on improving margins while sales growth remains lackluster.
Strong Earnings Not Enough to Justify Valuation
Unilever reported strong revenue growth of 2.80% in the first quarter of 2015 after coming off a weak 2014, growing at a mere 2.90% annualized. The company does expect similar factors to negatively impact the guidance going forward after releasing first quarter results earlier in the month, however, tailwinds from foreign exchange and higher prices are helping the company to meet revenue growth goals nearer to the top end of the projected 2-4% range. Although the financial side of the equation is not necessarily weak considering the company's strong balance sheet positioning and tendency to return cash to shareholders, the current price-to-earnings multiple is more a harbinger of the excesses brought on by record low interest rate policy than future expectations.
Unilever has been quick to temper analyst expectations, nevertheless, the company' shares do not reflect that sentiment. At the current P/E ratio of approximately 21.5 the company has a multiple that would typically be affiliated with a faster growing entity, perhaps a technology company, but not a consumer staple business. The strong dividend growth is a great feature for longer-term investors looking for robust income growth with Unilever shareholders enjoying a 2.86% dividend yield. Dividends have been growing steadily, hence the interest from European investors chasing after yields unavailable in traditionally safer government bonds.
Defensive Stocks Not Immune
Traditionally, consumer staples would serve as a more defensive sector when it came to offsetting any downturn in broader financial markets. They are considered non-cyclical meaning that no matter the economic cycle, they are typically boosted by the notion that the sector's goods are considered necessities and essentials. However, this has not prevented the sector from experiencing headwinds. Even though emerging markets have been a huge source of growth potential for the sector, the propensity for those gains to be erased by another global economic downturn is dramatic. Decelerating sales growth across emerging markets including China adds to Unilever's woes owing to the fact that the company has a very strong global presence. It needs to be reiterated that the deceleration in emerging markets is only one facet of the global economy that concerns top management considering the slowdown in developed markets.
Competitive Advantage
Relative to US peers like Proctor & Gamble (NYSE: PG), Unilever has been able to capitalize on its domiciling in Europe and costs denominated in Euros. The dramatic weakening of the Euro over the last few months as a confluence of monetary policies and risks to the Euro Area outlook has sent the Euro to multi-year lows against peers. This has made the company's exports substantially cheaper relative to US-based competitors. As such, foreign exchange has been a huge component in Unilever's recent success, but unfortunately is a factor that is largely transient and out of control of the company.
The European Central Bank's quantitative easing program, akin to comparable programs from the United States and Japan has had the knock-on effect of channeling money towards to stocks, as investors chase higher yields instead of those available in fixed-income markets. With many European sovereign bonds trading at negative yields, corporations could see their yields also go negative in the near-term. While this creates great borrowing conditions for the company, it also heightens of the risk of a sharp correction in equity valuations.
The Technical Take
Looking at a comparison of Unilever's performance relative to that of the broader Dutch AEX equity benchmark, Unilever has managed to outperform the index by a small margin, with the shares gaining 16.62% year-to-date. This strong performance however is not without downside risks amid the increasing evidence of a global downturn. As was highlighted above, the company is not immune from macroeconomic factors and has broad exposure to both developed and emerging economies, both of which are battling to find new avenues of growth. From a technical perspective the stock has been steadily trending higher, with upward momentum accelerating after the announcement of quantitative easing late last year. However, the prevailing uptrend is facing its first major test after Wednesday's spectacular losses which saw the company's European shares fall by 4.05%.
While the 50-day moving average crossed the 200-day moving average to the upside last November, typically considered a bullish sign, the recent break below the shorter moving average and prices sitting just marginally above the longer moving average are worrying for the outlook. The two major support levels of importance sit firmly at EUR 38.20 and EUR 36.17. Any break below the first level could be a sign of a major reversal lower with the second confirming the deeper correction in the valuation. If yesterday's move was the beginning of a sharper pullback, share prices could easily reach these levels within days. The medium-term target for the stock is EUR 34.05 considering the convergence of technical factors and fundamental risks to the outlook. However, should the hockey-stick economic rebound forecast by ECB actually occur, that would not prevent shares from retesting recent highs at EUR 42.75.
Conclusion
From the perspective of a value investor, strong dividends and robust growth are key determinants in compiling a portfolio. Long-term growth prospects are strong for Unilever considering its global, geographically diversified approach, making it a compelling option. However, near-term risks are keenly skewed to the downside as the combination of loose monetary policies and headwinds to revenue expansion remain. Although boosted temporarily by the fluctuations in exchange rates and improved pricing, the company closely tracks the local benchmark index while the consumer staples sector outlook remains pessimistic for 2015. The technicals also confirm the more bearish bias, meaning a deeper downward correction is justified in the short-to-medium term when taken into consideration with the underlying fundamentals.
