Kraft Heinz’s bid for Unilever (LON:ULVR) will not be the last takeover approach for the Anglo-Dutch business, in my opinion. The strength of the US dollar makes it an obvious move not only for Kraft Heinz, but for other US-based consumer goods companies who wish to tap into the stunning growth potential of emerging markets.
Although the dollar has slipped back 2.2% since the start of the year when compared to a basket of currencies, it is still close to its highest level in 14 years. I feel it will strengthen over the medium term, as Donald Trump’s fiscal stance forces the Federal Reserve to raise rates multiple times over the next couple of years. At the same time, the pound and euro may face pressure from continued loose monetary policies maintained due to the uncertainty which Brexit may bring.
Aside from it being cheaper for a US rival for forex reasons, I also think Unilever has a fair valuation. Therefore, I believe at least one more bid will surface in future months.
Dollar strength
Judging by the volume of media coverage, it may seem as though Donald Trump has been exceptionally busy since assuming office. However, he has signed a similar number of Executive Orders compared to his predecessor at this stage of his Presidency and is yet to divulge exactly what his fiscal policy will be. However, it can be reasonably assumed Trump will adopt a loose fiscal policy. His comments during the campaign indicated higher levels of spending on defence and infrastructure in particular, while he has repeatedly stated a major tax cut for businesses and individuals is on the way.
A loose fiscal policy is likely to stimulate economic growth and cause a higher rate of inflation. In response, the Federal Reserve is unlikely to have much wiggle room, in my view, to maintain a dovish monetary policy. In any case, the Fed has stated recently it does not wish to be behind the curve. This means it may react relatively quickly to signs of an overheating economy and attempt to cool it through a more hawkish stance.
In turn, a rising interest rate is likely to cause the dollar to strengthen. Although the market is presently anticipating six interest rate rises by 2020, in my view there could be more if Trump’s fiscal policy is more aggressive than anticipated. Therefore, I feel the dollar could easily test its previous highs which occurred in the early 2000s when it reached a level of 120 versus a basket of world currencies. Today, it is at 101, but will move higher in my view over the medium term.
Weak euro and sterling
At the same time as upward pressure on the US dollar, I believe there will be downward pressure on the euro and sterling. I’m not underestimating the uncertainty which Brexit could cause over the 2-year negotiating period, nor in the period thereafter when the UK and EU part ways.
…favourable forex movements could make a bid approach much more likely in future months.
In my opinion, policymakers will adopt a cautious standpoint regarding monetary policy and maintain a relatively dovish stance. This doesn’t necessarily mean interest rates will remain at historic lows. But it does mean that unlike the Fed, the ECB and BoE will not be too concerned about being behind the curve when it comes to eventually raising interest rates. Rather, I think they will be more worried about being ahead of the curve, which could risk choking off any strong economic performance.
This combination of a weak euro/sterling and a stronger dollar makes European stocks more appealing to their US peers. At a time when interest rates are expected to move higher in the US but remain historically low, I believe many US companies could seek to take advantage of low borrowing rates and buy their European peers. Unilever is an obvious example of this in my view, and favourable forex movements could make a bid approach much more likely in future months.
Unilever’s appeal
Unilever is appealing not only since its shares may become cheaper to a foreign rival, but also because of its emerging market exposure. Around 57% of its revenue is sourced from the developing world and I feel this could make it a good fit for a US rival which is seeking to tap into the emerging market growth story.
For example, demand for consumer goods is forecast to increase at an annualised rate of around 7% in China between now and 2030. This will be backed by rising wages in China, where the average salary is expected to be 46% higher in 2020 than today. This will help the economy to successfully transition from being infrastructure-led to consumer-led, with Unilever having the opportunity to be a central part of this due to its strong position within consumer staple and discretionary markets.
It’s a similar story across the rest of the emerging world, where demand for the food, personal care and grooming products which Unilever sells is likely to rise at a faster pace than in the developed world. Although the company has a large exposure to this continuing growth story, it has a P/E of 22.2. In my view, this represents fair value for money when it is forecast to register EPS growth of 8% per annum in the next two years and has high and dependable growth potential thereafter.
Outlook
In my opinion, bid activity involving Unilever is not over. Kraft Heinz may have withdrawn its offer this week, but I think currency movements will make a bid from them or from elsewhere relatively likely in future months. I think the dollar will strengthen as Trump unleashes his tax cuts and higher spending plans, while a Fed which craves to be ahead of the curve may react quicker to rising inflation and higher growth than the market anticipates. Rising interest rates and a stronger dollar could result.
In my opinion, bid activity involving Unilever is not over.
Simultaneously, I think the ECB and BoE will seek to avoid being ahead of the curve regarding interest rate rises. Instead, they could maintain a relatively dovish stance and keep rates low over the medium term, as they seek to support what may prove to be a difficult period for the European economic region. Therefore, European companies, such as Unilever, will become more appealing to US rivals.
Additionally, Unilever’s exposure to the emerging world and its fair valuation make it more attractive even with forex movements cast aside. In my opinion, it’s a great stock to buy now for the long term. I also think there is a good chance it will register high capital gains in the shorter term due to the potential for a bid approach in future months.