What's The Best Consumer Goods Company?

| About: The Procter (PG)
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Summary

The market was disappointed by Unilever’s earnings.

We compare Unilever with Procter and Gamble and Nestlé.

The three companies have similar fundamentals but different strategies.

Recently the market was disappointed by Unilever's (NYSE:UL) earnings. On the 26th of January, the stock plummeted by around 5% to $40.7 per share. Therefore, we decided to see whether Unilever offers good value at these prices and, in doing so, we will compare Unilever with other two giants like Procter and Gamble (NYSE:PG) and Nestlé (OTCPK:NSRGY).

More or less, all three companies supply food, home and personal care products. Most of their brands are well known. Unilever is home to Persil, Dove, Knorr, Domestos, Hellmann's, Lipton, Wall's, PG Tips, Ben & Jerry's, Marmite, Magnum and Lynx.

Nestlé produces its famous chocolates, Kit & Kat, Nesquik, Nescafe, various water brands such as San Pellegrino, Perrier, Vittel and Nestea. It also owns ice creams such as Movenpick and pet products (Purina, Felix, Friskies). In addition, the company controls a minority stake in L'Oreal.

P&G owns many wonderful brands such as Ambi Pur, Ariel, Braun, Febreze, Gillette, Head and Shoulders, Olay, Oral-B, Pampers, Pantene Pro-V, Tampax, Tide, Vicks.

The image below captures the brands of these three large companies (and others). Of the three, we like the fact that P&G is not very exposed to unhealthy and sugary snacks. That said, Nestlé commercializes pets' products, a segment where we expect growth.

It is obvious that these three companies own the best consumer brands around the world. Their sales are resilient and their market power unquestioned. But are these companies a good investment? And if so, which one is the best investment?

Fundamentals

First, let's start with some basic valuation metrics. In terms of P/E, all three companies are expensive. The main problem is that they are considered a safe haven with decent yields. This characteristic is extremely valuable in a low yield environment. Unilever (left) is the cheapest in terms of P/E (20.8). Nestlé (right) is the most expensive based on a P/E ratio.

(Source: Simply Wall st; ; From left to right: Unilever, P&G, Nestlé)

If we take into account potential growth, Unilever (left in the above graphic) actually becomes the most expensive with a PEG of 2.5, while P&G (middle) is the cheapest with just 0.7. Looking at a simple valuation such as the price to book, Unilever is again the most expensive of the three, while Nestlé (left) is the cheapest.

(Source: Simply Wall st; ; From left to right: Nestlé, Unilever, P&G)

In recent years, due to (mostly) currency headwinds, the three companies have struggled. From 2011 to 2016, the net income of the three companies has "grown" as follows:

  • Nestlé: income stagnated at CHF 9.5B.
  • Unilever: income declined from $5.9B to $5.6B, a 5% decline
  • P&G: income declined from $11.8B to $10.5B, a decline of 12%. However, P&G is restructuring and selling parts of the business, so this comparison is not exactly accurate.

Over the next few years, earnings and revenues are expected to grow for each of the three companies. Nestlé (left) earnings are expected to grow 41%, compared with 31% for Unilever (middle) and 29% for P&G (right). This leads to a 2017 P/E multiple of 20.6 for Nestlé, 19.6 for Unilever and 18.4 for P&G (source: 4-traders).

Using another performance metrics such as EV/2017 EBITDA, we obtain the following multiples: 14 for P&G, 12.5 for Unilever and 13.3 for Nestlé (source: 4-traders). Despite minor differences, the three companies are similarly valued.

(Source: Simply Wall st; ; From left to right: Nestlé, Unilever, P&G)

In terms of profitability, the three companies offer good margins. ROE is very strong for Unilever (middle, 34.3%), and decent for Nestlé and P&G (around 15/16%). ROA and ROC are similar for the three companies. ROA hovers around 7-8%, and ROC around 20%. Unilever dominates all performance categories.

(Source: Simply Wall st; ; From left to right: Nestlé, Unilever, P&G)

However, Unilever seems to achieve better performance metrics thanks to higher leverage (debt to equity). Unilever (middle) has a debt of $16B, in line with its equity of $15B. This compares with Nestlé (left) that has equity of CHF 58B and debt of CHF 26B, while P&G (right) has equity of $53B and debt of $29B. Yet, if we use another metric to calculate the level of debt (net debt/EBITDA), Unilever looks better. Unilever has net debt 1.16X EBITDA, compared with 1.26X for P&G and 0.78X for Nestlé. All three have sustainable levels of debt (source: 4-traders).

(Source: Simply Wall st; ; From left to right: Nestlé, Unilever, P&G)

Dividends and buybacks

Finally, the three companies are well-known for their robust dividends. The highest 2017 yield is offered by Unilever (3.42%), followed by Nestlé (3.32%) and P&G (3.12%). To understand how a company rewards its shareholders, it is important to consider buybacks in addition to dividends.

Over the last few years, Unilever did not invest much in share buybacks. For example, in 2015, the company invested only €276M. A similar amount has been invested in the first six months of 2016. As a result, the number of shares declined only by 3% in 10 years. However, it is important to note that the company bought back shares at the right time, during the financial crisis. P&G, on the other hand, is much more aggressive. Its share count decreased by 20% in 10 years. Nestlé recently announced that it has completed its CHF 8B share buyback programme initiated in August 2014. Since then, Nestlé has repurchased 112.6M (out of approximately 3B shares) of its shares for a total of CHF 8B at an average purchase price per share of CHF 71.02 (today market price is CHF 73.48). It is important to note that only a third of these shares has been retired, and retiring the remaining shares would slightly boost earnings per share.

Annual letter to shareholders

As always, we like to read or listen to what the management has to say. We usually read the annual letters and try to find videos about the CEOs. This exercise helps us to grasp a feeling of their personality and intentions. The three CEOs agree that in 2016 their companies faced a difficult macro-economic environment. For example, Unilever CEO Paul Polman writes that:

"the tough market conditions which made the end of the year particularly challenging are likely to continue in the first half of 2017. Against this background, we expect a slow start with growth improving as the year progresses."

Paul Polman recurrently talks about social responsibility. For example, in the following video he talks about how Unilever can contribute to society. We agree that a good corporate social responsibility program is a vital characteristic of a multinational corporation, but we believe that he is focusing on this aspect too much. If you google "CEO Unilever strategy," you get the following results.

The previous screenshot shows that he emphasizes corporate social responsibility, and declares that he doesn't want to be a "slave to shareholders". In this last article, he actually argues that he can't be a slave to short term shareholder at the expense of long term developments. We actually like his emphasis on long-term strategies, but we also would like to hear from him how he plans to manage the company, other than through sustainable activities. Overall, we are not inspired by this CEO.

On the other hand, we like the P&G CEO David Taylor for his clear focus on strategy. In the 2016 letter to shareholders, he focuses on the company's transformation.

"We made progress in a challenging environment, but we know we need to do better. We are focused on streamlining and strengthening our product portfolio, improving productivity and our cost structure, building the foundation for stronger top-line growth, and strengthening our organization and culture. These are the choices we're focused on to raise the bar on P&G's performance to consistently deliver balanced growth and leadership value creation."

He continues:

"We're organizing our portfolio around 10 category-based business units and about 65 brands. These are categories where P&G has leading market positions and where product technologies deliver performance differences that matter to consumers. We're focusing on categories where product performance drives purchase decisions-where there are clear consumer jobs to be done and objective measures of performance. These are products in financially attractive categories, which consumers purchase and use on a daily basis. These 10 category based business units have historically grown faster with higher margins than the balance of the company. Within these core categories, we are streamlining our product lines."

The CEO also emphasizes cost-cutting measures:

"We continue to improve cost and cash productivity with significant upside ahead. Productivity is the fuel for top- and bottom-line growth. We have delivered and exceeded $10 billion in savings over the past five fiscal years across cost of goods sold, marketing spending and overhead… We believe we can deliver up to an additional $10 billion in productivity improvements over the next five years. As with the first $10 billion, we expect the large majority of our savings will come from cost of goods sold."

The following video is an interesting summary of P&G CEO David Taylor. We like the P&G strategic changes being implemented.

Finally, Nestlé is currently undergoing a management restructuring. At the 150th Annual General Meeting of Nestlé (April 2017), Peter Brabeck-Letmathe, chairman of the Board of Directors, will not stand for re-election in line with the company's Articles of Association. Mr Brabeck-Letmathe, having served Nestlé for 50 years, of which 14 years were on the Executive Board, 11 years as CEO and 12 years as Chairman, will have reached the mandatory age of retirement and will relinquish all his Board functions. The Board of Directors has decided to propose Paul Bulcke, Nestlé's current CEO, for election as Chairman. Mr Bulcke has resigned from his position as CEO on the 31st of December 2016.

The Board of Nestlé decided to appoint Ulf Mark Schneider as the new CEO of Nestlé, starting on the 1st January 2017. Ulf Mark Schneider, 50 years old and a German and U.S. citizen, has been CEO of Fresenius Group since 2003. He is a graduate of the University of St. Gallen with both a graduate and a doctoral degree, and also holds a Harvard Business School MBA. In his 13 years at the helm of German health care company Fresenius, Schneider oversaw a series of deals that brought a twelve-fold increase in net income. Nestlé, meanwhile, has been laboring with faltering progress in its traditional food business, missing growth targets for the past three years (source: Forbes).

It is yet unclear what the new CEO has in mind. However, Forbes speculates that the new CEO could trigger a series of acquisitions to further its ambitions in nutrition and medical foods. The journal argues that Nestlé wants to transform the business and not just do a little bit of health and wellness on the side. In fact, Nestlé's health science and skin health divisions will report directly to Schneider rather than operating as standalone businesses. We think that there is a trend toward health-oriented products, and this strategy might pay off in the long term, especially considering that consumers are losing interest in unhealthy products such as sugary chocolate.

Conclusion

When Unilever's stock price lost 5% on Jan. 26, we decided to investigate whether the stock has the potential to offer satisfactory long-term returns. We have analyzed Unilever and compared it with two other consumer products' giants, Nestlé and P&G. Unfortunately, all three stock prices are not very cheap, trading above a P/E of 20 in exchange for limited growth. The stocks are considered "high"-yielding investment opportunities in a world with low bond yields. In terms of fundamentals, it is not easy to choose a company. The returns offered are generally similar. Unilever boosts better return on equity, capital and assets, and is cheaper on various multiples.

Going forward, we like the strategic changes of P&G as well as the potentially new strategic direction that Nestlé might take thanks to the incoming CEO. On the other hand, we are not impressed by the strategic emphasis of Unilever's CEO.

All in all, the three stocks do not seem to be able to offer extraordinary gains above a 3% dividend yield and maybe 3-5% long term growth. Higher growth might be fueled by renewed inflationary pressures, but there is a risk that multiples will compress limiting capital appreciation even more. We might consider starting a position in the three stocks if prices fall by 3-5%. Unilever, despite the recent drop in stock price, is not a buy yet, and we are not convinced by the CEO, so we apply a deeper discount.

In sum, the three companies are equally valued at generous multiples. It is difficult to choose one of them based on fundamentals or valuations, but we like the strategy of Nestlé and P&G more than Unilever. Therefore, we recommend investing in these companies only if someone is interested in a limited but relatively safe upside potential. Good entry prices would be as follows: Nestlé (OTCPK:NSRGF) at CHF 70.1 or $70.1 for the ADR , P&G at $83.6 and Unilever (OTCPK:UNLVF) at €34.1 or $38 for the ADR (NYSE:UN).

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Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in PG, NSRGF, UN over the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.