Why Unilever is my favourite consumer goods play

One of my best performing investments in recent years has been Unilever (LON:ULVR). It has risen by 33% in the last year even though the outlook for emerging markets has at times appeared uncertain. However, it is those same emerging markets which provide Unilever with a stunning growth outlook. For me, Unilever’s exposure to developing world economies such as China and India makes it the best consumer goods company in the world.

Growth story

A key reason for Unilever’s gains in the last year is its long-term emerging market growth story. Its decision to focus advertising, marketing and supply-chain resources on the emerging world looks set to pay off. The growth opportunity on offer is above and beyond anything that the developed world can offer and this should positively catalyse Unilever’s earnings.

For example, China’s GDP per capita is forecast to rise from $6,416 to $8,330 between 2016 and 2020. That’s a gain of almost 30% in just four years. This is expected to cause a rise in average wages of nearly 46% during the same period. This will provide a significant boost to the Chinese economy, in my opinion, as it seeks to transition towards a more consumer-focused state. Demand for consumer goods is likely to rise rapidly, with spending on consumer discretionary items forecast to increase by over 7% per annum between now and 2030.

It’s a similar story in other emerging economies such as India. It is expected to record a rise in GDP per capita of 94% over the next four years. This is forecast to cause a rise in average wages of 31% over the same time period. This provides Unilever with growth opportunities, although China’s growth rate and consumer goods market is expected to dwarf all other emerging economies (including India) over the medium to long term.

Strong position

Clearly, growth in emerging markets is only part of the reason why Unilever has a bright future. Its ability to successfully position itself in order to capitalise on the developing world’s growth outlook sets it apart from its global consumer goods peers in my view.

For example, Unilever has developed significant local management expertise which helps it to manage rapid change in government policy, consumer trends and demographics. In its emerging-markets businesses, over 80% of Unilever’s management team is local. This allows it to remain nimble and highly adaptable so as to capitalise on the high growth potential of the emerging world.

Lower risk

Of course, Unilever’s performance of the last year has masked the situation on the ground in emerging economies such as China. The world’s second largest economy is enduring a challenging period as it transitions away from a capital expenditure and infrastructure-led economy towards a consumer-focused economy. Government stimulus has helped to boost the short-term performance of China’s economy, but the changes taking place are unlikely to be frictionless.

Therefore, the fear which engulfed investors in August 2015 and in the early part of 2016 could be repeated in future. This caused the FTSE 100 to lose 675 points and 530 points respectively on those two occasions. However, despite 58% of Unilever’s sales being derived from emerging markets, including China, its shares have been relatively resilient. In fact, Unilever’s shares have fallen by a maximum of 8.2% in the last year in any one downtrend before gaining upward momentum once more.

Sector peers

Despite their 33% rise in the last year, Unilever’s shares continue to offer good value for money versus global consumer-goods peers. For example, Unilever has a P/E ratio of 24.6. This is lower than Diageo’s (LON:DGE) P/E ratio of 25.1 and Reckitt Benckiser’s (LON:RB.) P/E ratio of 27.9. However, Unilever’s EPS growth forecast for the next financial year is lower than for Diageo and Reckitt Benckiser. It is expected to record a rise in EPS of 9% versus 15% and 11% for Diageo and Reckitt Benckiser respectively.

Beyond next year, Unilever’s growth could surpass that of Reckitt Benckiser and Diageo. Unilever is exposed to the fastest growing consumer sector in China: discretionary items. Between today and 2030, discretionary item spending in China is set to grow by 7.6% per annum, which is a faster rate than consumer staples. They are expected to grow by 6.5% per annum and this is the arena in which Reckitt Benckiser is predominantly based. In my view, this gives Unilever a long-term growth advantage over Reckitt Benckiser.

Similarly, its exposure to a diverse range of products including personal care and food items provides Unilever with a lower risk profile than Diageo. Although alcoholic beverages have excellent growth prospects in my view, Diageo is a pure play beverages company while Unilever has a more mixed product stable.

Financial strength

As well as organic growth potential in the emerging world, Unilever has the financial firepower to make acquisitions in order to improve its sales and earnings outlook. In a rapidly growing emerging world, consumer tastes can change quickly. I believe that Unilever has the balance sheet and cash flow to adapt quickly through acquiring popular, local brands.

For example, Unilever’s net debt to equity ratio was 77% as at 31 December 2015. Further, in the 2015 financial year its debt servicing costs were covered 20 times by operating cash flow, and 15 times by operating profit. This shows that more debt can be accommodated on its balance sheet, especially since interest rates are low.

Outlook

I believe that the long-term prospects for Unilever are bright thanks to the unrivalled growth potential from emerging markets. In the short term, volatility seems inevitable from China’s transition towards a consumer-focused economy. However, Unilever has risen by 33% in the last year even with significant fears in that regard.

With Unilever’s financial strength, relatively appealing valuation, diverse product range, exposure to consumer discretionary goods and its bias towards the emerging world, I feel optimistic about its future share-price prospects. For me, it continues to be the best consumer goods company in the world.

Disclosure: Robert Stephens, CFA, owns shares in Unilever.