Unilever – worth buying on the dip?

Unilever were 2,600p, last seen. The Unilever share price has come down a lot since April. I take a look at the shares, hoping to find them a possible ‘buy’ but discover them to be still far from cheap.

Oh how have the mighty fallen?! I speak of Unilever (ULVR), that leviathan of global supermarket commerce that has – with a little help from the ‘great fall of China’ dropped 10% from 2,852p in late July to 2,560p last seen.

The impact of the recent China panic on big international shares like the Anglo-Dutch Unilever was inevitable. However, I pointed out that the shares looked too dear on valuation grounds last July, making them vulnerable to unexpected shocks, like the collapse of the Chinese stock markets and – more questionably – the feared collapse of China’s economy itself. Unilever is regarded as a way into China’s potential massive growth as a consumer market. Just think of all those millions of Chinese buying not only Unilever’s foods and detergents, but also all those beauty products it plans to develop for the Chinese consumer. With the share price 15% down from its last April peak of 3,087p is it now a share to buy?

I begin, by pointing out, that the latest forward estimates of market consensus expectations – the best expert opinion you can get of the future – put Unilever shares on an estimated, forward price to earnings ratio of 19.6 times this year’s forecast earnings per share figure of 130.6p and 18.3 times next year’s estimated earnings per share of 139.6p. That, on the face of things, is still a pretty high rating; particularly given the accompanying fact that earnings are only forecast to increase by 10% this year and 7% next year. That earnings growth is highly priced on a PEG (The price earnings multiple as a ratio of the forecast earnings growth ratio) of 2 times for this year and 2.7 times for next year.

But then, of course, this is not science. Shares are not commodities or bonds but in part mirrors which reflect the market’s prejudices or preferences about a particular business. In the case of Unilever, that includes a premium for the quality of its business, market share, earnings reliability and of course long term prospects. It is that kind of thing that makes investment more of an art than a science. So the question is, as always, where does this share price go next? Are they too dear on PEG grounds? And are there considerations beyond that one measure of value?

So-called ‘technical’ analysis has something in common with tea leaf and palm readings, but it is nevertheless a swift way of knowing what the share price has done long and short term; particularly in terms of standard deviation trend lines. It is their interpretation as an indicator of future moves that is the questionable bit. To make the best stab at that, you really need to put the share price into the context of more fundamental indicators.

Last week was the first time I had looked at Unilever shares since I tagged them as being too highly valued in terms of the price to earnings ratios and the then estimated annual dividend yields. I see that I also said they looked poor value in terms of cash flow ratios and the then price to book measure. It did not seem the right market conditions in which to disregard those financial fundamentals in favour of the simple share price momentum argument.

Looking at the tea leaves now, I note the share has bounced in the last week, and that the five day chart suggests that the very short-term downtrend has been broken; with progress back to a share price of around 2,700p looking arguable. On a year’s chart, it is possible to speculate on a return to a share price close to the previous April high when the shares were over-bought, in my opinion. So what financial, fundamental back up do they have now that the share price has come down?

In terms of operating cash, I see that the cash pile of 3.85 billion euros in Unilever’s balance sheet, last December 31st 2015, had risen, according to my scribbled note, by a further 1.2 billion euros in June 30th last; a handsome increase of 53% according to my arithmetic. So there was cash in the balance sheet worth about 120p a share. Operating cash flow looks to be at about the same level to judge for the December and July accounts. In relation to the capital expenditure figure, dividend payout and financing costs, that does not look particularly conservative unless we see a cut back in capital spending. The six month figure in June was looking a bit better at 0.84 billion euros.

Net assets were up to an estimated 377p per share at the end of last year to December 2014. That represents about 14.5% of the share price. In terms of operating profit, I note that the operating profit margin of 14% as down from 14.7% in the first half of the previous year and well down on the operating margin of 18.17% reported for the six months to June 30th 2012. So, the latest information shows that reported operating profit margins remain on a downtrend, though one that appears on the basis of these figures to be lessening.

The recent market consensus earning per share estimates for Unilever are 130.6p forecast for this year and 139.6p for next year to December 2016. They put the shares on a forward, estimated price to earnings ratio of just over twenty times for this year and 18.6 times for next year. Again, even after the share price fall, that doesn’t look cheap.

Doing my usual thing of taking the estimated net equity value off the share price – to test for what I call a ‘pure’ earnings price ratio – I discover that the estimated PERs on that basis fall to an estimated 17 times for this year and 16 times for next year.

I conclude that the shares look fair value at best, taking net assets into account. That is not to say the shares may not rise again on market sentiment. But if they do, they will soon start to look dear again pretty quickly.

As a dividend share, it yields 3.1% historic which is well below the FTSE 100 Index annual dividend yield of 3.8%. I see nothing in the cash flow of the company to justify much optimism in a big increase in the dividend payout, although the market consensus estimates a dividend yield of 3.3% in sterling terms this year and 3.4% next year. Unless the Euro appreciates strongly its hard to see that increasing in sterling terms.

Despite the fall in the share price and despite the fact that it is possible to read some upside into the share price chart, I still feel the shares to be too fully valued to chase at this stage. I had started out with the hope I would discover value.