When Unilever (NYSE:UL) (OTCPK:UNLYF) reports Q4, and full 2022 results, on the 9th of February, it is expected to report more of the same. Throughout the first three quarters of 2022, Unilever reported constantly double-digit growth in sales that has been fuelled by price inflation, while volume sales have been stagnant or recording slight drops.
In Q3 of 2022, underlying sales grew by 10.6%, fuelled by 12.5% growth in prices and balanced by a small 1.6% drop in volumes. Currency movements provided a further boost to sales of Unilever, resulting in total growth of 17.8% in the third quarter, and 16.1% in the first nine months of 2022. The growth in prices has been exponential; 11.2% in Q2, 8.3% in Q1 and 4.9% in Q4 of 2021. The drop in volumes, on the other hand, has been disproportionately lower; -2.1% in Q2, -1% in Q1 and flat in Q4 of 2021. Aside from Beauty & Personal Care which has the fattest profit margins, all other categories have been growing prices by underlying double-digit figures, and even more inflated total sales figures post currency effects. Home Care led the way with prices growing by 17.8% in Q3, Personal Care by 13.5%, Ice Cream by 12% and Nutrition by 11.7%. All the business categories have been solid and strong.
The exponential growth in sales revenues though is expected to be mostly eaten up by price inflation in input cost - EUR 4.5 billion in total of expected input price inflation in 2022, representing a 27% jump versus 2021. Nevertheless, Unilever would end up maintaining its operating margins at around 16% - similar to the average of the past few years, and inflating its overall balance sheet, which has positive implications on reduction of leverage while maintain dividend strength. Unilever's credit rating of A+ is as Stable as ever, and it allows the group to continue accessing relatively cheap credit, and keeping free cash flow healthy for investment and for investor pay-outs.
Unilever has highlighted the inflation in its input costs in the Q1 analysis, although there was no further detailed reporting on input costs in Q2 and Q3. Out of EUR 17 billion of input costs in 2021, 15% was spent on palm products - used in anything from cosmetics to detergents to ice cream. Although palm oil prices jumped by 40% in the aftermath of the Ukraine war, prices are 50% lower than the April peak, and are trading at levels last seen in July of 2021.
Other agricultural products represented 26% of input costs - the price of this basket did not jump as significantly. Soybean prices dropped by a third from April's peak, wheat is almost 50% lower than May's peak, while sugar and cocoa remain at elevated levels, close or at last year's highs. Other non-agricultural commodity inputs have dropped comfortably, with crude oil dropping by a quarter from last year's peak of USD 100, and US natural gas prices falling off the cliff by 80% since the peak of last summer.
Unilever's estimates of input cost inflation have so far been accurate within range and manageable. A squeeze on consumer and government budgets caused by inflation, higher interest rates and possible pockets of global recession will definitely lead to a slowdown in economic activity, which will have to slowdown demand for hard commodities. The sharp drops in market prices of many commodities over the past few months will give a boost to Unilever's profitability and cashflows in 2023.
Unilever's share price is trading at the highs of the past 52 weeks, but is still a fifth lower than the record high of GBP 52.5 per share, set in August 2019. Net income and operating cashflows, in the meanwhile, have grown by a third since 2017 - so the share price and financial results have been going in opposite directions. Current valuation of 20 times P/E and 13 times market cap to operating cashflow seems rich, compared to 17x and 10x earlier this year. Current valuation still compares favourably though to Procter & Gamble's (PG) P/E of 25 times and market to operating cash flow of 19x. Unilever has always traded at a steep discount to that of Procter and Gamble.
As I noted in my article published on the 20th of May last year, there are good reasons for the discount, since Procter & Gamble's product portfolio is stronger and more monopolistic in some categories. In addition, P&G's exposure to the U.S. market is much larger than Unilever's, and P&G's exposure to emerging markets is much smaller. Nevertheless, a discount that large in Unilever's valuation is compelling and provides an attractive entry.
Earlier this week, Unilever announced that it is making a dramatic change in the way it selects the head of the group. After company veteran Alan Jope retires in July, Unilever's board - with a big push from activist investor Nelson Peltz - settled on an outsider as the successor. Hein Schumacher was the head of RoyalFrieslandCampina, a leading international Dutch dairy co-operative.
The clear challenge for the incoming CEO is how to make the mammoth group, that has struggled to match peers in growth and profitability, turn around - and without taking making massive acquisitions, such as the attempt last year to acquire GSK's consumer goods business, Haleon. Unilever has been growing volume sales at anaemic levels for years, underperforming Nestle and Procter & Gamble, and deservingly earning persistently lower valuations than both peers.
Unilever started disposing of underwhelming food divisions over the past few years, and Mr. Schumacher is likely to accelerate this process while trying to reinvest proceeds in faster growing categories. Accelerating cost savings is always a popular option - Unilever has been constantly reporting its progress on that front, and Mr. Schumacher is likely to continue with that programme. The 60% exposure of Unilever in emerging markets is always a double-edged sword; potential high growth versus more developed markets, balanced by currency and economic volatility that is more common in developing markets than in developed ones.
However, Mr. Schumacher is starting from a good base. Unilever might be a slow-moving titan, but it is a solid and safe investment that has been generating decent dividend yield for shareholders for years. With its diversification of product portfolio and markets, defensive nature of its products, inflation-linked products and solid credit rating, Unilever remains a key investment to keep in any portfolio.
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