A Dab of Background
After a series of acquisitions in the 1920s, the eventual merger of Lever Brothers and Margarine Unie on New Year's Day 1930 gave birth to a two-headed giant with a dual identity. We know it as Unilever. The dual identity persists and seems to have become aggravated so that Sunlight Soap and Blue Band are duking it out for supremacy. Who will win? Soapsuds or Marge?
Unilever (Fortune 500 #140; FTSE 100 #19) is "the operating arm of Netherlands-based Unilever N.V. and UK-based Unilever PLC." Unilever N.A. and Unilever PLC are two corporate entities that function as if a single corporation.
In the United States equity in the British PLC is traded in American Depositary Receipts (NYSE:UL) and in the Dutch N.V. it is traded in New York registry shares (NYSE:UN). The two stocks follow in each other's footsteps (or worm-line, as it were) almost perfectly so for all practical purposes it is one and the same stock. From the second week of July the two diverged with UL trading higher by pennies but the two still track almost perfectly. The divergence is probably because UN is subject to a Dutch withholding tax but UL is not and the mutual tracking is because of Unilever's Equivalence Agreement which "implies, in rounded terms, a ratio of 1 NV New York registry share to 1 PLC ADR." This agreement actually translates into a dual equivalence considering that there is a material linkage between a share of N.V. and a share of PLC which carries through to shares, depositary receipts, and ADRs on the Amsterdam, London, and New York stock exchanges.
(Anyone who is confused or put-off at having to decide between two scrips for one and the same company can check out Choosing Which Unilever Share Class Is Right For You. The article discusses tax withholding implications, opportunity cost of tax withheld, tax-deferred IRA comparisons, and price differentials, while it -- quite correctly -- does not identify currency conversions between EUR, GBP, and USD as a factor.)
Unilever has 14 'Billion-Euro Brands.' Interestingly, these are perfectly split between food and personal care / cleaners (Knorr, Hellmann's, Flora/Becel, Rama, Heartbrand (ice-cream family), Lipton, and Magnum, versus Dove, Rexona/Sure, Lux, Axe/Lynx, Sunsilk, DiG (Persil/Omo family), and Surf). In terms of its largest revenue generators the old marge-and-soap company is perfectly balanced between its two main sectors.
In fact, Unilever also operates in a lesser-known third sector. Unilever Food Solutions, which has country-specific websites, enables restaurants and caterers to offer A Moveable Feast or two. The company's food and food services divisions not only boost one another's top-lines but also 'feed off' one another -- that is fairly transparent from Unilever Food Solutions' country-wise websites. (Which brings to mind a corporate buzzword: 'synergies.')
A Buffet of Brands
Recently Unilever has been in the news as to divestments of well-known brands and products. Proctor & Gamble (NYSE:PG) is the only other large multinational with a similar mix of businesses and product lines. As it happens, P&G is also trimming quite a number of brands from its portfolio.
For almost a century these two companies have had overlapping product ranges which has resulted in them being seen as direct competitors. This viewpoint, however, presents an incomplete picture. While the two companies certainly compete in product lines they are essentially different. P&G is very much a top-down corporation with a strong center in Cincinnati while Unilever has been more of a 'glocal' company, to use a newfangled term that actually makes sense, and is becoming increasingly more so.
P&G's portfolio strategy is described as a "consistent tweaking of its portfolio in an effort to regularly boost profits and consistently deliver a return to shareholders." This year the boardroom "has turned to its highest revenue-generating products for the most growth potential," to wit its 40 best-selling brands. It has been disposing off, among others, Max Factor, Noxzema, Duracell, Innova, and pet care lines, while at the same time acquiring Natura Pet Products. Thus, P&G is not considering the sector or industry but is making decisions on a brand-by-brand basis, asking, "What have you done for me lately?" Low-growth and low-profit brands are being put in the shop window whereas high-margin brands that generate most of P&G's profits are being even more aggressively promoted.
Unilever seems to have taken a sharply different tack to its divestment strategy. The company has been looking to trim its low-margin food sector since 2011 to the extent that it actually considered divesting a billion-euro brand and a reservoir of goodwill, America's top-selling mayonnaise, Hellmann's. Earlier this year Unilever sold Ragu and Bertolli, vacating the pasta sauce business in North America. At the same time, Unilever is making even further inroads in the high-end beauty segment of the personal care sector- would you believe that the world's largest producer of ice-cream and the world's biggest consumer of palm oil is also the world's number 2 manufacturer of cosmetics?
While P&G is engaging in tactical re-focusing, it appears that Unilever has embarked upon a strategic reorientation. This reorientation is away from Food and towards Personal Care. Is Unilever bidding A Farewell to Food?
Next Course, Please
In the week of 01-12-2014 due to low growth prospects and declining profits Unilever split its Flora/Becel and other spreads brands into a separate unit as the first step to an eventual spin-off or sale, tipping the balance of its billion-euro brands towards Personal Care and Cleaners. It's Marge For Whom the Bell Tolls at Unilever. That food brands divestment is well and truly on. Or is it? That very same week, the company also announced it had purchased Talenti, artisanal makers of all-natural gelato and sorbetto. This acquisition announces Unilever's presence in natural and organic foods.
While margarine and spreads sales have flat-lined, gelato promises to deliver year-on-year sales growth and better-than-average profit margins (for the food industry) so the respective divestment and acquisition are good business. Furthermore, Unilever is a leader in ice-cream and, at the present time, consumer tastes are turning away from full fat and also trending towards artisanal and organic foods. The Talenti purchase not only fits Unilever like a glove but also plugs one possible gap and fills a growing demand. So, first, divesting (really) losing product lines is a good move.
However, what could be the implications of Unilever's -- increasingly trigger-happy -- product divestitures?
Making divestment decisions solely on the basis of margins would be a short-sighted idea for any company that owns several brands in a single sub-sector. Just as there is such a thing as a market leader, as a loss leader, so too is there such a thing as a 'Reputation Leader', as a 'Trust Leader. If a niche brand like Marmite is divested, that is one thing. But consider Knorr. Knorr, a Unilever brand since 2000, is a Reputation Leader and a Trust Leader (strongly implied by its positioning at Unilever Food Solutions). It is the point of the wedge that, because of its word-of-mouth and popularity, gets Unilever through the (pantry) door. And once through that door, the trust that it engenders holds the door open for other Unilever brands to follow it. Therefore, even if Knorr's profits slide into the red, Unilever would still not press the eject button on Knorr (or, more pertinently, Hellmann's). Or would it?
For an investor it could be a cause of concern that the company that dumped not only passe´ Ragu but also high-end Bertolli and time-tested Skippy just may discard Knorr if growth bottoms out and sales go flat. Routinely following the latest consumer fad and discarding time-honored all-weather staples like peanut butter may put Unilever's foods division in a tizzy when things come full circle and its back to the basics. As the poet said, man cannot live on bread alone -- he also needs peanut butter. There is such a thing as 'Core Brands.' If Unilever unloads Knorr or another core brand without any comparable replacement on board, the investor should consider staying away from or unloading UL/UN.
Balancing the Diet
Second, Unilever is eyeing the home care and personal care industry as it trims its exposure to certain food segments and their lower profitability and lower growth. CSIMonitor's Consumer Non-Cyclicals Sector shows that Personal & Home Care Products' margins dwarf those of Food Processing. As Clinton & Carville would say, "It's the margin, stupid."
However, Fidelity's data show that as an investment, Food Products is a steady and sure bet while the sharply growing and higher-margin Personal Care sector has a negative RoE and a lower dividend yield. That said, it is likely that the latter industry's numbers are skewed due to the ongoing influx of L'Oreal and Revlon wannabes into an industry that may experience a shakeout and consolidation.
It is relevant to mention that the third consumer goods global giant seems to have taken note of such facts and figures. Switzerland's Nestle (OTCPK:NSRGY) -- that coffee and cocoa company -- has all but announced that it is entering the personal care segment by opening skin care centers and launching a 'skin health' initiative for seniors. It already owns a range of creams, lotions, and other skin care products after its recent Galderma acquisition. These developments will bring it into greater competition with Unilever as well as P&G. (Nestle's board's strategic nous bears watching: the company has come from nowhere to steal a march on both Unilever and P&G by smartly combining the high margins and high profitability of personal care with the rapid growth of the in-favor health care industry.)
The correct interpretation of the several announcements and news items about Unilever's food portfolio is that, third, the company is striving (key word, 'striving') to strategically rebalance its food portfolio in and of itself. The existence of the company's Food Solutions division also serves to suggest that Unilever's divestment of its food sector brands would (or should) be a careful, coldly-calculated undertaking.
A food-centric figure of speech aptly describes the strategy: Unilever wants to have its cake and eat it too.
By way of a strategic rebalancing of its portfolio and its portfolio components, Unilever stands to make (key phrase, 'stands to make') gains to its operating margin -- and also its profit margin -- that would be measured, not in basis points, but, in whole percentages.
Thus, if the cards are played to win the game and not just the hand, Unilever's overall strategic re-orientation should have no downside and treble upside.
Brochettes for BRICs
Unilever has a very long history of being, one might put it, a confederation of (a variety of) highly localized companies and subsidiaries. Furthermore, unlike P&G, a relative newcomer into the developing world, Unilever's companies and its decades-old products are beneficiaries of a decades-long accumulation of trust, reputation, and goodwill in many parts of Asia, Africa and even South America.
Unilever, at least to some extent, was glocal by corporate culture long before anyone had dreamt up the word -- or even the catchphrase 'corporate culture.' They do not need to 'parachute in' anyone; they've had 'feet on the ground' for more than half-a-century in some regions which is a significant advantage over top-down P&G.
Trefis explains why Unilever's low-pricing model for personal care products will fuel growth and also do better than P&G in the BRICs and emerging markets by winning upwardly-mobile though price-conscious shoppers. Further to which it is also more committed to the BRICs one and all than is P&G. In fact, Unilever was already poised to edge out P&G because while "P&G derives a majority 62% of its overall sales from developed markets," Unilever's majority share of 55% comes from emerging markets and BRICs. In developed countries Unilever is improving its competitive position versus P&G through ongoing strategic portfolio rebalancing, though it may well be a case of two steps forward and one backward.
A 2012 Economist article explains why Unilever is winning (and will win) the battle with P&G for hearts and minds in the Third World. Essentially, its glocal -- even grassroots -- operations and lower-price structures give it the advantage. Unlike P&G, Unilever has subsidiaries and interests that include developmental and outreach programs that are highly specific to various lower-income communities, garnering goodwill for the company. Name-recognition and loyalty also result from the company directly sourcing its raw materials from Third World countries, ranging from palm oil from Java and Borneo to tea from the Slopes of Kilimanjaro.
Heck, Unilever, quite good at P.R., has made sure that its goodwill is not limited either to developing countries or lower socio-economic classes -- First World chefs are beneficiaries of the company's freebies too.
On the other hand, Unilever has recently behaved like a playground bully. Instead of competing on product quality it has tried to litigate a young upstart or two out of existence. A change.org petition asks Unilever to "Stop Bullying Sustainable Food Companies." With 75,000 signatories within a month and mainstream media exposure, it is not easy to ignore this petition. Buying out the small competition, which Unilever has a proud history of, is fair game and picking a fight with someone your own size is not at all shameful. Unilever did just that with P&G in the mid-1990s' 'Detergent Wars' (coming out on the losing end). However, trying to squash the competition like a bug is quite another and brings disrepute to Unilever. The company with a history of good P.R. and who, somewhat ironically, proclaims 'Dirt is Good' is 'dirtying' its name . . . and losing its mojo. The threat to Unilever is not from without; it may be from within.
Though P&G won the 'Detergent Wars,' a peer comparison of valuations between UL/UN and PG (surprisingly?) favor the former, though not by much.
By valuation ratios, PG is superior to UL/UN on P/B ratio and also D/E. PG's D/E ratio is twice as good as UL/UN's, 0.3 to 0.6. However, where the P/B ratio is concerned, though PG's is clearly superior one should factor in that PG carries a very large proportion of intangible assets on its B/S; proportional to total assets, PG's intangible assets are about 33% more than UL/UN proportionate intangible assets. Furthermore, American stalwart P&G is the proud owner of its own PP&E in the United States whereas faster-evolving Unilever manufactures near-globally using -- besides its own PP&E -- more advantageous leasing arrangements. These facts go some way to explaining the essential differences not only in the two companies' respective balance sheets that underlie their P/B ratios.
On the rawest measure of company performance, P/S, UL/UN is more than 33% superior to PG. On the key P/E valuation, UL's 18.8 and UN's 18.1 are more attractive than PG's 25.5 multiple. As for dividend yield, UL/UN are clearly superior here too.
The stock is discounted compared to competitor PG because while strong fund and institutional buying support underpins Cincinnati-based PG -- it is a favorite of American funds and institutions -- fund and institutional ownership of either UL (British PLC) or UN (Dutch N.A.) by American funds and institutions is not only comparatively sparse, even proportional to the relative market caps and shares outstanding it is a fraction of that for PG. This highly uneven support from American funds and institutions is part of the reason that UL/UN is a better value than PG dollar for dollar for the individual/retail investor.
Squeezing the Juice
Unilever suffered an earnings 'meltdown' this past quarter -- which the company attributed to its ice-cream division! The problem was "underlying sales growth" of 'only' "2.1 per cent in its third quarter to €12.2bn, compared with the same period last year." (Dear, dear!) "This was 43 per cent below average expectations of 3.7 per cent growth and 30 per cent below even the lowest forecast of 3 per cent." The spreads division had long been under scrutiny and these numbers likely contributed to Polman & Crew pulling the plug on Flora/Becel.
One bad quarter is no reason for investors to panic, however. Unilever's impressive margin stats are quite obvious and self-explanatory but a possibly under-the-radar YoY trend is worth noting. The company's revenue increased from $38,305 m to $38,844 m, causing EBITDA to rise from $6,111 m to $6.762 m. Or did it? Actually, the revenue line-item got two assists. Note that CoGS decreased YoY from $22,020 m to $21,915 (-0.477%) as did Administrative Expenses from $10,175 to $10,168 (-0.069%). Tiny numbers but this is what squeezes out the additional penny in profits and keeps a proactive lid on expenses. Also, this movement is in the opposite direction from (increasing) revenue. Quite a feat for an already-efficient large-cap multinational to become a little more efficient. (Note: If Unilever's financials on some other site look radically different, check the currency used.)
In a (quite excellent) 2013 Ernst & Young comparative report on Unilever, P&G, and other Household & Personal Care companies, it is explained that "Unilever's focus on continuous improvement generated savings of €1.5b in 2011. Unilever achieved its savings by dramatically reducing overheads and implementing a wide-ranging set of initiatives across all areas of the supply chain." Evidently it is this ongoing 'continuous improvement' that brought about those small decreases in costs and expenses.
This conclusion is supported by, or at least is correlated to, Unilever's key statistics. One sees quite a few generally impressive numbers but what stands out is a five-year YoY increase in EPS, a similar (though not same) trend in dividends, and a surprisingly high FCF/share.
Though the company had negative change in cash for two consecutive years, YoY it posted a big improvement from -$435 m to -$103 m (+76%), going into positive territory in the most-recent quarter at $621 m (which may have removed a dampener on its stock price as it lifted off after those figures were released) though it is unlikely to maintain such a figure after dividend payouts (and the usual acquisitions).
The only (and big) knock on UL/UN would appear to be that it is a little too highly-leveraged for comfort. Its long term D/E ratio MRQ Annualized is 55.65% and total D/E ratio MRQ Annualized is a whopping 96.72%. Discomfort about these ratios is justified when one sees that the respective ratios for P&G are only 28.67% and 50.14%, and for Nestle are only 18.59% and 39.74%. This is the one number to keep an eye on. The investor may also keep an ear open as to what London or Rotterdam may have to say about deleveraging tactics. (However, Unilever does not provide any earnings guidance.)
On the Salty Seas
Talking about London and Rotterdam, as Unilever's 'Captain of Industry' navigates troubled waters, it would do well to gain insights into his helmsmanship by reading HBR's 2012 interview. Paul Polman (Paulus Gerardus J. Polman on filings) makes it abundantly clear that UL/UN are 'supposed to be' long-term buy-and-hold investments. Here's a fascinating sentence from this far-ranging interview: "And if you work with local communities on soil management, you create livelihoods for people who then buy your products." This is close to the Henry Ford Philosophy of operating a business and doing the right thing by the community. (Let's create a market for our Model T's!)
The idea that "if you satisfy the basic conditions of price and quality and then provide more on top, you will be in a significantly better position" (emphasis added) seems to imply that it's not all about the shareholders or the insiders; a welcome outlook. Elsewhere in the interview Unilever's captain seems to offer a refreshing albeit implied indictment of the rabid capitalistic WTO-driven EU and seems to harken back to the Middle Way capitalism-socialism-nationalism-communitarianism of the GATT-era E.E.C.
Captain Polman appears to be as single-minded in his purpose as that fabled Old Man on the Sea and that bodes well for his ship's voyage -- and the portfolios of its shareholders.
Whether or not Polman & Crew own stock is hard to tell as there do not seem to be any filings for insider trading in UL/UN for a two-year period. Either the company is clean to the point of being prudish and does not allow insiders to trade stock or else Form 4s and other data are not available at the usual suspects including the SEC. It is possible that Unilever's insider trading occurs only in shares on the bourses where this Anglo-Dutch company is incorporated, London and Amsterdam, and not in ADRs. On which note, UL/UN shareholders are safer than most from being left holding the bag by insider trading; the company's code is worth emulating.
Simmer, Simmer ... Sizzle?
Merely 30 days back UL/UN's technicals -- MACD, MFI, and stochastics -- had indicated a bullish outlook (and the stock rose). What a difference a month makes. After several days in a whipsaw phase with numerous false signals, UL/UN failed three support levels on 12th December and several technical indicators signal a sell. The bears are in full cry. If you hold the stock and want to make a couple of bucks by selling and re-taking your position then that is a possibility. However, the real opportunity is to enter it or increase your position at a bargain price that is edging closer to the 52-week low of $37.63/$36.57 but should not cross it. It's not a bad idea to get in on quite a fundamentally-sound company whose stock trades at a discount to the competition, whose price has recently been buffeted somewhat, and whose sector has fallen out of favor (i.e. Consumer Goods as a whole).
In an overheated stock market UL/UN is one of the few bargain buys. It is a blue chip stock, the company is a global behemoth, the stock is nearing a 12-month low, it is undervalued compared to its peers, at present price multiples in its sector, it trades at a small but distinct discount, and it pays a sweet dividend. It is a Value-Income double play with the likely bonus of a touch of Growth. When the present bubble starts losing 'gas' (which has seemed to have started) and the froth dissipates from patent chasers, eBay imitators, and other exotica, some portion of the proceeds generated from sales will return to stores of value. UL/UN will be two such choices.
At a price of $40, UL (British PLC) and UN (Dutch N.A.) 2013 yield is 3.625%. Its YTD yield (previous four quarters) is 3.778% At the current price it is a buy-and-hold stock for the retirement income-stream and near-certain capital gains -- though an investor must stay vigilant for the red flags mentioned above. And it gets better as Unilever has an established history of quarterly payouts so if you're not close to retirement you can opt for their reinvestment plan (if and when available in the U.S.A.) and have your cushion inflate itself.
So, in sum, Unilever is not really bidding a farewell to food. It is only going through a mid-life crisis as it goes on a new diet and tries to decide on its one true love. It was perhaps inevitable that the company that was founded on the popularity of Sunlight Soap would return to its first love: as someone once wrote, "The Soap Also Rises."
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.