Unilever: Attractive Valuation With Pockets Of Growth Opportunity
Summary
- Unilever has experienced slowing growth in recent years which we believe will change with management’s renewed focus on organic growth and portfolio shifts towards higher growth areas.
- Looking beyond disruptions from the coronavirus, we see pockets of growth opportunities for Unilever particularly in luxury skincare, health and well-being.
- The company has consistently delivered margin expansion, high cash generation and stable ROIC, which are testaments to its brand quality and economic moats.
- The valuation is attractive in our view, with a dividend yield of 3.7% and multiples trading at 7% below its historical average. Our target price suggests a 23% upside.
Summary
With over one-third of the world population using its products per day, Unilever (UL) is a high-quality company that consistently generates decent cash flow and returns. The company has several years of slow growth due to competition and changing consumer preferences, and had to issue a sales warning at the end of 2019. With a number of organizational changes and a renewed focus on growth, we believe Unilever is at the start of a journey to reignite organic growth to the higher end of its 3-5% target.
Although the current priority is to manage the coronavirus situation and adapt to rapidly changing consumer purchasing patterns, we believe the medium growth plan remains intact. We see pockets of growth opportunities within Unilever's portfolio including luxury skincare, health and well-being. Combined with a continued focus on cost savings and an economic moat from its strong brand portfolio, we believe Unilever will continue to generate values for its shareholders and is a stock that long-term investors want to hold. With a purpose-driven corporate vision, it also scores highly on a number of ESG metrics which we see as favorable as ESG issues are becoming more important for both consumers and investors.
With a dividend yield of 3.7% and the stock currently trading at a significant discount compared to its peers, we see the current valuation as attractive. Our target price suggests a 23% upside, which represents a good buying opportunity, in our view.
Source: Chart created by author based on Unilever annual report
Plan to reignite growth after a challenging 2019
Organic growth for Unilever has been slowing in recent years, with volume and pricing growth averaging 1.4% and 1.9% respectively in the last 5 years, driven by changes in consumer preferences and intense competition from emerging and value brands. 2019 was a particularly difficult year for the company with organic growth below its annual target. The new CEO has clearly stated that organic growth around the 3% mark was disappointing and has introduced a new strategy to reaccelerate growth back to the higher end of the 3-5% range.
Source: Unilever FY2019 result presentation
Although the consumer sector is very competitive and companies need to keep innovating to stay ahead of trends, we believe there are pockets of growth opportunities for Unilever to capture. The company has been shifting away from Food & Refreshment towards Beauty & Personal Care, which now accounts for 42% of revenue and is a higher growth and margins business. Premium skincare and vitamins, minerals and supplements are two high growth areas highlighted by the company, with the Prestige portfolio (which houses the premium beauty brands) growing at double digits in the last quarter. In addition, Unilever is tapping into the plant-based meat market with the acquisition of the Vegetarian Butcher in 2018, which has won a contract to supply the Rebel Whopper to 2,500 Burger King branches in Europe.
Source: Unilever 2019 Investor Day presentation
Portfolio management remains an important part of the strategy as Unilever looks to shifts towards higher growth areas. It has initiated a strategic review on the global tea business (revenue of €2.9bn) which has been a drag on group overall growth and margins. There has been some speculation that its valuation could be in the range of €6-8bn, which could provide a decent return for shareholders for a business that is stable but in structural decline. On acquisition, the company is adopting a more focused approach and management has mentioned it will focus on integrating the 33 businesses it has acquired since 2015 and could see a slower pace of acquisitions going forward. We believe this is the right strategy in order to develop brands to their full potentials by leveraging Unilever’s marketing and technology capabilities.
Impact of coronavirus
The growth trajectory was temporarily impacted by the coronavirus, as the company has to adapt quickly to changing conditions. During Q1 2020, Unilever achieved flat organic revenue growth, as the decline in foodservice, out of home ice cream and the negative impact from China and India was partially offset by household stocking.
Although the scale of the impact remains uncertain, we see growth in North America particularly promising with organic growth accelerated to 4.8% compared to 0.6% in the previous quarter. Although part of the growth is due to consumer stockpiling, the company sees turnaround and market share gains in some key areas. Management also mentioned the growth and margins progress was on track prior to the coronavirus, which adds to our confidence that the fundamental growth strategy remains intact.
Source: Unilever Q1 2020 presentation
Consistent track record of margin improvement and cash generation
Margin improvement is a success story for Unilever in recent years, with EBIT margin improved by 350bps since 2015. This is particularly driven by the cost-saving program which delivers €6bn savings 2017-2019, and the company is committed to deliver €2bn savings per year going forward supported by a number of efficiency programs.
Unilever has generated stable cash flow and ROIC and has been delivering increasing dividends for its shareholders. With a dividend cover of 1.4x (assuming FY2020 dividend remained the same as FY2019) and total cash and undrawn facilities of €11bn, we believe Unilever will be able to maintain its dividend, which is particularly attractive currently with a dividend yield of 3.7%.
Source: Unilever 2019 Investor day presentation
Best in class in ESG rankings
What stood out for us about Unilever is also its commitment to deliver social purposes alongside financial returns. ESG issues have become increasingly important to investors in recent years. Unilever has been scoring highly in various ESG and sustainability metrics and achieving best in class in the industry. It has also introduced progress towards a range of sustainability measures as one of the determinants for executive remuneration, showing the company's commitment to achieving the goals.
Apart from generating greater interests from ESG investors, we believe the focus on sustainability enables Unilever to continue to stay relevant to its customers especially as many surveys show millennials are more sustainability-conscious than previous generations. According to Unilever, its Sustainable Living Brands (which currently include 28 brands) grew 69% faster than the rest of the business and delivered 75% of the company's revenue growth in 2018. It also generates cost savings of €1bn in the last decade through better resources management and energy savings.
Forecast and valuation
Unilever is currently trading on a 1-year forward P/E of 18.3x and EV/EBITDA of 12.4x based on consensus number. This is about 7% lower than its 5-year historical average. It is also trading at a significant discount to some of its peers.
| Forward PE | Forward EV/EBITDA | |
| Danone | 19.6 | - |
| Nestlé | 23.1 | - |
| Henkel | 16.4 | - |
| Reckitt Benckiser | 18.3 | - |
| Procter & Gamble | 22.7 | 16.1 |
| L'Oreal | 30.2 | - |
| Beiersdorf | 30.2 | - |
| Kraft Heinz | 13.1 | 10.1 |
| PepsiCo | 24.1 | 16.8 |
| Colgate-Palmolive | 25.1 | 16.7 |
| General Mills | 16.9 | 13.6 |
| Coca-Cola | 24.5 | 21.6 |
| Peers average | 22.0 | 15.8 |
| Unilever | 18.3 | 12.4 |
| % difference | -17% | -22% |
Source: Table created by author based on data from Koyfin. EV/EBITDA for some companies are not available on Koyfin.
We derive a target price of £53 ($65 based on today's FX rate) based on an average of the DCF and multiple approach (using both 1-year forward P/E and EV/EBITDA). This suggests an upside potential of 23% to the current share price. We believe using the two methods allows us to capture the value of the growth potential in the medium term and also near-term expectation on earnings.
We believe we have been conservative in our base-case scenario and forecast revenue decline by 2.9% in FY2020 before recovering to 5% in FY2021 and 3.3% in FY2022. We expect EBIT margin to decline to 18.5% in FY2020 before recovering to 20.1% in FY2021 and 20.9% in FY2022.
1. Multiple approach: We have used Unilever's 5-year historical multiples to derive the target price (see table below)
2. DCF: In the terminal growth period, we assume a growth rate of 2%, EBIT margin at 21.8% and WACC of 7%.
| P/E - 20x 2020 earnings | 47.3 |
| EV/EBITDA - 13x 2020 EBITDA | 49.4 |
| DCF | 62.8 |
| Average | 53.2 |
| Current share price (29 May 2020) | 43 |
| Upside/downside | 23% |
Source: Estimates by author
Downside/upside scenario
We have considered both an upside and downside scenario to see the sensitivity of near-term organic growth to the share price. By increasing organic growth by 2% for the upside scenario and decreasing it by 2% for the downside scenario, we derive a price target range of £45 to £62. The stock is currently trading below our downside scenario, which shows the margin of safety in the case of organic growth being lower than our expectation.
| Revenue growth | EBIT margin | Target price | % upside/downside | |||||
| 2020 | 2021 | 2022 | 2020 | 2021 | 2022 | |||
| Base case | -2.9% | 5.0% | 3.3% | 18.5% | 20.1% | 20.9% | 53.2 | 23% |
| Upside scenario | -0.9% | 7.0% | 5.3% | 19.6% | 22.2% | 24.1% | 62.2 | 44% |
| Downside scenario | -4.9% | 3.0% | 1.3% | 17.3% | 17.8% | 17.6% | 44.5 | 3% |
Potential risks
The main risks are Unilever not being able to increase its organic growth and competitive pressure. To achieve its growth target, the company needs to shift its focus to higher growth areas and keep investing in brands to maintain market share. Management has mentioned growth is now the number 1 priority for the company, and we believe there are growth opportunities available looking beyond the coronavirus.
Bottom line
Although the growth strategy is temporarily affected by the coronavirus, we believe the medium-term strategy to increase organic growth back to the higher end of 3-5% is achievable. The non-cyclical product demand and a diverse portfolio should also provide some protection in the case of a recession. As a high-quality company that consistently delivers value for shareholders, we believe the current share price is a good entry point for long-term investors.
This article was written by
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.
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Comments (16)
You have not delivered main reason why UL is trading below its peers, especially vs. Nestle & P&GGiven Covid, (and also before to an extent) markets focus one one thing mostly: Balance Sheet strenght and leverageProcter and Nestle are superior in both, with a way stronger balance sheet and lower debt/equity ratio. In addition, markets are still not convinced by Unilever's emerging market growth ambitions.Nevertheless, I think Unilever is slightly undervalued and would prefer it to its peers at current valuation with regards to higher dividend as well.
If growth is stable, leverage is not that much of an issue bust still bear in mind that markets have punished high leverage firms most in Covid period and there is a strong argument for this that makes sense.Also, higher dividend payout ratio at Unilever vs Procter - they do have way more room to grow dividend. Unilever just recently announced that they consider keeping dividend stable this year. So they would lose they Dividend Aristocrat status.Also, quite important:Unilever has a lot of good will in its balance sheet which even exceeds its equity. Good will is accounted for all the acquisitions they made in the past. Good will stands currently at 124% of its equity, so if acquisitions don't work out as expected there is quite a high probability of good will that must be written off directly from equity.(Just in comparison, Procter has roughly 30% of Good Will accounted in its balance sheet)(What you also have not discussed is the current double structure with Netherlands/UK. I see this problematic in the long term as there are many double positions and too much bureaucracy to make quick decisions quite hard.)To cut everything short. I do not see the stock undervalued by 20% right here and don't see it moving into the mid 50s anytime soon. Slight undervaluation right here still makes a good investment case for Unilever at mid to low 40s as in Euro.
Add the fact that for tot portfolio they stopped growing in developed markets (-0,5% in 2019), becoming more and more reliant on emerging markets growth to match their guidance. Volumes share in these markets it is already 60%, so they will just keep growing at the rate of the market, nothing more. I will start adding position only when I will see some of their acquired premium skin/beauty brands starting to perform, for instance in Asia where they have already a good geographical footprint. Otherwise, I struggle to see a bullish argument here.
could you publish an article about the marketing strategy of UL and its brand strategy
where are the new brands ?
I see many old brands in the portofolio, the anglo-dutch UL is an old lady, respectable certainly, but i have some doubts about its future prospects
would be great to see brands in the growth segments, i.e. skin care vs. its peers from L'oreal, LVMH etc.