Download L-UN

MEMORANDUM
TO:
McIntire Investment Institute
FROM:
Ryan Rechkemmer
DATE:
September 30, 2012 (originally written July 8, 2012)
SUBJECT:
Unilever (UN) Long Memo
Unilever is a Global Fast-Moving Consumer Goods Leader
The Unilever Group is an established multinational fast-moving consumer goods leader. The
Group has a unique corporate structure that maintains dual stock listings for its two constituent
holding companies in the United Kingdom and the Netherlands, but the Group has just one
Board of Directors and binds the holding companies together as a single business entity by an
Equalization Agreement that ensures the mutual rights of the two sets of shareholders and
guarantees a one-for-one equivalence between the shares. Its shares are also traded on the New
York Stock Exchange under the ticker symbol “UL” for the American Depository Shares (ADS)
representing its London-based holding company and as “UN” for the New York Registry Shares
representing its holding company in Rotterdam, which are interchangeable and entitle identical
ownership interests.
Unilever is hiding in plain sight behind an iconic portfolio of top-notch brands like Axe, Ben &
Jerry's, Dove, Hellmann's, and Lipton, among many others. Unilever organizes its brands into
four categories: Personal Care (33% of total revenue in 2011), Foods (30%), Refreshment (19%),
and Home Care (18%). Yet an overwhelming majority of the Group’s operating profits last year
were attributable to its Foods (42%) and Personal Care (39%) segments. Geographically,
Unilever’s 2011 operating profits were split almost equally between the Americas, Western
Europe, and Asia Africa Central & Eastern Europe regions. Unilever’s products are sold in over
190 countries, and 2 billion consumers worldwide use a Unilever product on any given day.
Unilever is differentiated by its high-profile brands and outstanding managerial execution, which
have resulted in 6.5% sales growth in 2011, versus 4.1% in 2010, and operating margins
consistently hovering around 15% despite rising costs for raw materials.
Unilever is Positioned for Strong Growth, Especially in Emerging Markets
The Group has positioned itself solidly in emerging markets, where sales grew at an accelerating
pace of 11.5% last year and now account for 54% of Unilever’s total business. The number of
common household appliances like fridges and washing machines, which parallel new demand
for complementary consumables sold by Unilever, is expected to nearly triple in the BRIC
(Brazil, Russia, India, and China) countries in the next eight years; hence emerging market
development, in addition to a simultaneous expansion of market share in these countries, will
remain a major growth driver for Unilever.
Unilever has a good eye for strategic deal-making, including both acquisitions and divestitures,
as the Group tactically allocates capital in order to meet its long-term Compass strategy aimed at
increasing total annual sales to €80 billion and maximizing shareholder returns. In the process,
there is the risk that Unilever attempts to expand too aggressively and overpays for acquisitions.
This is why Unilever’s free cash flow is an important financial metric for MII to follow, as it has
fallen during both of the past two years in reflection of significant new investments in fixed
assets to support the Group’s expanding emerging market operations. When these capital
expenditures subside and start to pay back, free cash flow should begin to improve in turn.
Widely recognized as the gold standard for its industry in the area of corporate social
responsibility, Unilever has engendered the trust of consumers and attracted loyal employees by
serving to protect the environment and making a positive impact on people’s lives. As part of
the Unilever Sustainable Living Plan, the Group has brought hygiene education to a billion
people and committed to source all of its agricultural raw materials sustainably by 2020.
Accordingly, Unilever is a consistent member of the Dow Jones Sustainability Index. These
efforts create a favorable perception of, and higher demand for, Unilever’s brands. Meanwhile,
not to neglect competitiveness and cost-efficiencies, Gartner has recognized Unilever for having
fostered a low cost business model that optimizes margins at every link in its supply chain.
Investors are Overly Discounting Europe’s Problems in Shares of Unilever
Nonetheless, investors are undervaluing Unilever with a forward Price / Earnings ratio (based on
analyst estimates for fiscal year 2013 earnings) of 13.92 compared to an average Price / Earnings
ratio of 16.17 among its large-capitalization consumer staples conglomerate peers, Procter &
Gamble (15.67), Colgate-Palmolive (17.71), and Nestle (15.13), a 14% discount that ignores
Unilever’s superior business fundamentals. Unilever currently sports a dividend yield of 3.80%,
versus 2.15% for the Vanguard Consumer Staples ETF (VDC), which represents a payout ratio
of about 70% of Unilever’s trailing-twelve-month net income.
Pervasive anxieties over the Eurozone economy and its never-ending sovereign debt crisis are
attributable for part of Unilever’s relative undervaluation. Raj Tanna, a strategist who helps
manage $280 billion at JPMorgan Private Bank in London, acknowledged in a recent interview
with Bloomberg, “The share prices of these high-quality corporations have fallen in sympathy
with the broader market, unveiling very attractive opportunities.” The European Central Bank’s
quarter-percentage point interest rate cut last Thursday extenuated the euro’s decline, by which
Unilever reports its financial results, but the Group’s diverse geographical exposure and currency
hedging efforts will help to buttress earnings against adverse exchange rate fluctuations.
Overall, the Unilever Group should continue to profit handily from its varied product portfolio
and global reach. Emerging markets are most likely to ignite further earnings and dividend
growth for Unilever, while its focus on nondiscretionary consumables insulates Unilever’s
business from the worst of any potential economic calamities.
Recommendation
The analyst recommends that MII initiate a long position in UN at 4.0% of the portfolio’s total
value and occasionally reevaluate the position to potentially increase its portfolio weighting as
market conditions warrant. Additional resources that the analyst consulted in evaluating UN are
listed on the following page.
Sources Consulted
Unilever 2011 Annual Report
http://www.unilever.com/investorrelations/annual_reports/AnnualReportandAccounts2011/Dow
nloadcentre.aspx
Unilever Fact Sheet
http://www.unilever.com/images/ir_UL-fact-sheet_tcm13-283697.pdf
Unilever March 2012 Company Introduction
http://www.unilever.com/images/IntroductiontoUnilever_tcm13-283368.pdf
Unilever Sustainable Living Plan
http://www.unilever.com/sustainable-living/uslp/
“Unilever Leads Sector in Dow Jones Sustainability Indexes”
http://www.unilever.com/sustainableliving/news/news/september2010unileverleadssectorinDowJonessustainabilityindexes.aspx
“Unilever Supply Chain Breaks Into World Top 10”
http://www.unilever.com/mediacentre/pressreleases/2012/UnileverSupplyChainbreaksintoworldt
op10.aspx
“1 Great Long-Term Stock for the Beginning Investor”
http://www.fool.com/investing/general/2012/06/30/1-great-long-term-stock-for-the-beginninginvestor.aspx#.T_hIeFQU3bM
“Unilever: Sustained Growth Likely to Continue”
http://beta.fool.com/theanalystblog/2012/07/05/unilever-sustained-growth-likelycontinue/6644/?source=eogyholnk0000001
“Dollar Gains Most In 10 Months Versus Euro On Demand For Safety”
http://www.bloomberg.com/news/2012-07-07/dollar-gains-most-in-10-months-versus-euro-ondemand-for-safety.html