Quantitative Analysis Of Unilever

Summary

• Unilever has strong and well-positioned local and international brands.
• The company has a history of leveraging its strengths and creating value. Our analysis shows a compound annual growth rate of 9%.
• Despite the recent upgrade and rally in price, the company still offers good value.

Investment Thesis

In this installment, we examine Unilever (NYSE:UN) using our quantitative ROCGA methodology (Return On Cash Generating Assets). Our analysis shows that the company has created significant value during the past decade and we see no reason for the company to disappoint over the next few years. Despite the recent rally in price, there is still enough value for those looking for stability and some growth in their portfolio.

Over the course of this article we will attempt to break down the core drivers of value and finally discuss a value range for the forecast years. The compound annual growth rate in ROCGA Valuation has been 9% over the past decade, and our mean hypothesis shows similar growth going forward.

A detailed breakdown of how we calculate our Total Cash Generating Assets, Gross Cash and Return On Cash Generating Assets was in our previous article: Quantitative Analysis Of Colgate-Palmolive. A copy is included in the Appendix.

Unilever: The Business

Unilever was formed when Dutch Margarine Unie merged with British Lever Brothers in 1929. Margarine Unie have roots as far back as the 1870’s when the world’s first margarine factory was set up in Oss, Netherlands. Lever & Co (later to become Lever Brothers) launched the first branded soap, Sunlight in 1884.

Unilever is now a diversified consumer goods producer with over 400 brands and 2.5 billion people around the world using their products every day. Some of its household name brands are Lipton, Knorr, Dove, Axe, Hellmann’s and Omo.

Unilever: A Fundamental View

2017 saw some realignment of Unilever’s portfolio. The lower growth spreads business was sold to US buyout fund KKR for €6.825 billion.

To prepare the platform for long term growth in attractive market segments, the company completed 11 bolt-on acquisitions, including Carver skin care in South Korea, Sundial Brands in the United States, Mãe Terra organic food in Brazil and Pukka Herbs organic herbal tea in the United Kingdom. The strategy ties in with the company’s objectives of transforming into a more resilient and more agile business.

Underlying sales, excluding its spreads business, grew by 3.5% for year ending December 2017. Sales in the reported geographic segment, Asia/AMET/RUB (Asia, Africa, Middle East, Turkey, Russia, Ukraine and Belarus) lead with growth of 5.9%. Overall underlying operating margins were up 110bps to 17.5% and EPS grew by 10.7% to €2.24. Dividend increased by 12%.

Source: ROCGA Research

Let us start with breaking down some of the components that drive value. ROCGA Valuation is dependent on cash and the cash-generating assets.

Source: ROCGA Research

The graph above shows the growth in total cash-generating assets. These have been increasing over the last decade, despite the occasional shrinkage. More notably, there are no big-ticket items, but mostly modest bolt-on acquisitions. 2017 saw acquisitions worth €4.9 billion. In 2016 and 2015, €2 billion was spent each year on acquisitions. Going further back to 2011, where asset growth was a significant 14%, €2.7 billion was spent on Alberto Culver.

For a DuPont like analysis we examine the margins and asset utilisation. These in turn drive Return On Cash Generating Assets. Margins have improved since 2011’s 16% to just over 20% in 2017.

Source: ROCGA Research

The advantages of the improving margins have been somewhat negated by the slight decrease in asset utilisation. Asset utilisation is the sales generated for every dollar of total cash generating assets employed. Decreasing asset utilisation occurs in a growing company when sales growth is slower than asset growth.

Source: ROCGA Research

However, in this case the improving margins are more significant and we see the Return On Cash Generating Assets improving for those years.

Source: ROCGA Research

Unilever: Historic Valuation

So far, we have improving Return On Cash Generating Assets and increasing total cash generating assets. More assets and higher returns from those assets translates to improving valuation. This can be seen in the chart below. To value the company, we use a systematic discounted cash flow method for the cash generated by the company’s assets. Our estimate of the company's value matches the share price range over the last decade quite well. This gives us confidence in estimating the value range going forward. The numbers below are in euros, but for the forecast years we will translate these to US dollars.

Source: ROCGA Research

Unilever: Forecast Value Range

Including the disposal of the Spreads business and the 11 bold-on acquisitions, consensus estimates a 5% increase in EPS for 2018 and a further 10% for 2019. We use these numbers and a conservative 5% increase for 2020 and 2021. 2018 and beyond, Return On Cash Generating Assets improve slightly. In our model, we use the €6.8 billion Spreads sales proceeds to reduce some of the €24 billion of debt. The combined effect is an increasing ROCGA value.

Source: ROCGA Research

Along with the estimate of forward earnings and assets, a ±2 standard deviation for internally sustainable organic growth is used for the value range.

Assuming Unilever does not deviate from the historic model, our value range shows significant improvements. The dark green line is our ROCGA value projection in US dollars. The outer wings showing the range with higher/lower growth.

Unilever: Concluding Remarks

Unilever has strong and well-positioned local and international brands. They have a significant exposure to the growing emerging markets. The company has leveraged on these strengths and this can be seen in the growth in our ROCGA Valuation, a compound annual growth rate of 9% over the last decade. Unilever is not only a value compounder but also offers a dividend yield of just over 3%. Given the progressive dividend policy, the potential for increase in value and limited downside projected by our model, we believe Unilever is a safe bet for every portfolio.

Appendix

The components of Returns On Cash Generating Assets:

Cash generating assets: The reported balances sheet numbers go through a series of adjustments, such as capitalizing operating lease and inflation adjustments so we can have a like-for-like comparison and bring all companies on to an equal footing for valuation. This gives us the total cash generating asset for the company.

+ net current assets

+ other investments

+ land

= non-depreciating assets

+ inflation adjusted PPE

+ inflation adjusted intangible assets

+ capitalized operating lease

+ goodwill

= depreciating assets

Total cash generating assets = non-depreciating assets + depreciating assets

Cash: We looks at a company’s cash generating ability by using the accrual accounting information and converting it into a gross cash number.

+ adjusted net income

+ depreciation and amortisation

+ operating lease

+ interest costs

+ net pension interest cost

± other adjustments

= gross cash flow

Returns On Cash Generating Assets: This is the internal rate of return using the gross cash flow, total cash generating assets and the asset life.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within 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.