Unilever: Priced for Perfection?

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Unilever: Priced for Perfection?

Unilever’s Q1 results were encouraging. The shares, as usual, look highly rated. They have understandable and legitimate technical reason to move downwards, particularly in the run up to the momentous referendum in June. These are not shares for chasing, despite the positive results, because of the high rating, which discounts almost everything positive and could leave the share vulnerable to any unexpected bad news, as well as the Brexit referendum in two months’ time.

Unilever in Q1 got the kind of results which propelled its share price upwards and onwards into new share price territory, a new high at 3,284.5p, and into the category as one of the year’s high capital gainers. Unilever, to judge from the chart, is one the market’s great momentum buys.

Over twelve months the Unilever share price, even in a minefield of a market like this one, has risen nearly 13% whilst the market, in the shape of the FTSE 100 Index has imploded by 10%. Beating the Index by near 23% over twelve months is handsome indeed. In a world going to pot, these shares, to the tired and jaded eyes of managers of institutional performance funds, must look wonderful, if they have them. Being in stocks that beat the index is what (even when the share price goes down) institutional investment management success is all about!

Unilever shares are a classic momentum buy. That is to say, you buy them because they go up! They are also an antidote to the ills of this year’s economic and market uncertainty. You may worry and wonder about most of the world, but people around the globe will go on buying the things that Unilever sells – Persil; Dove Soap and beauty products; a tub of Tom and Jerry’s (have I got that right?) chocolate chip; a Walls ice cream and items from the company’s biggest growing segment of business in health and beauty. These give the share its reputation for defensive attributes and quality of earnings.

The only problem is that the shares are very highly rated. The historic price to earnings ratio for last year is 23 times. That translates into an earnings yield (earnings per share divided by the share price) of a tiny 4.2%. That too is a product of quantitative easing! The historic dividend yield is of course even smaller at 2.7%. Unilever is thus a share which is particularly susceptible to unexpected bad news.

All shares are risky, but without risk there is no reward. If you are in this share or thinking about joining as an investor now, you need to be keeping a weather eye out for any squalls on the horizon. The most fundamental risk is in a high valuation which will not tolerate much disappointment. So where might disappointment come from, if at all?

The company identifies its markets as being Europe, the Americas and the Rest of the World, which are principally: Asia, the Middles East, Africa, and Eastern Europe. The largest of these is Asia and the rest, which contributes 43% Group of turnover, the America’s which contributes 32%, and Europe which is now the smallest, providing just under 25% of total Group sales revenue.

The results for Q1 tell us that a deflating Europe remains the weakest geographical market, both in terms of growth in the volume of products sold and in product price increases.

Dividing turnover between that originating in ‘emerging’ markets and that originating in ‘Developed’ markets, the former now accounts for nearly 60% and the latter, slightly more than 40%.

In the biggest, Asia etc., the 5% increase in sales revenue was made up of a 4.2% increase in volume and a 0.8% increase in prices. The message being, that in this zone of activity Unilever was evidently able to raise prices a bit and still get a big increase in volume. Despite all the general fretting about emerging markets on the back of China fears, the basic consumer economies seem to be in robust health.

In the Americas there was a 1.1% increase in volume and a 7.3% rise in prices. Latin America has what Europe and the US desperately seek to get back – inflation. Europe by contrast saw a 1.8% increase in volume and a 2.4% fall in product prices, leading to a 0.6% decline in regional sales.

The interesting thing, to my mind, is the good performance in the emerging markets. The unsurprising thing is the dull, lacklustre returns in Europe, the continent long dominated by Germanic economic antediluvian fiscal conservatism and constitutional paralysis. Europe, at its snail’s pace of progress, is only just, under economic threat, getting around to fixing the balance sheets of European Banks, in contrast to the ‘Anglo Saxon’ variety. A late starter in Quantitative Easing (because of German constitutional court resistance to it), the EU is now taking to it with gathering familiarity and seems to be in the process of upping the tempo of bond buying, in the latest attempt to get economic demand moving forwards.

So in summary, we seems to have a picture of Unilever demand, which on the face of things is doing well in most of its largest geographical markets – essentially the emerging ones which we have all been fretting about – and less well, as drearily anticipated, in its now smallest regional markets in Europe. There things might possibly improve in the longer term, for the reasons just stated, to which I add the words ‘God willing’.

For the Group as a whole, the salient facts (I resist using the ‘metrics’ word) are that in the three months to 3rd March 3, underlying sales rose by 4.7% (emerging markets plus 8.3%) and underlying growth in volume was a reported 2%. In money terms, reported turnover of euro 12.5 billion was actually down 2.5%, reflecting a currency effect (Unilever does its reporting in Euros).

As a confidence indicator, the management increased the quarter’s dividend payout by 6%. There was also an improvement in operating margins.

The Chief Executive of Unilever had the following to say:

“With markets remaining volatile, we continue to focus on driving agility and resilience in our business through the key programmes which we set out at the end of last year: net revenue management, zero based budgeting and the next stage in our continued organisational transformation. This will position us well to deliver another year of volume-driven growth ahead of our markets, steady improvement in core operating margin and strong cash flow. These underpin sustained long-term value creation for our shareholders.”

So what does the market expect? The last seen consensus of market estimates in relation to this current year is for a 2% reduction in sales revenue and a 4% increase in earnings to 146p. The annual dividend per share is estimated to be 98.3p a share. For next year, revenue is estimated to rise 3.7% and earnings per share by 7% to 155p with a forecast dividend of 105p.

These estimates value the shares, at 3,284p (last seen), on prospective price to earnings ratios of 22 and 21 times earnings for this year and next year respectively, with forward estimated dividend yields of 3.0% and 3.2%. That reasonably puts a constraint on any further significant rise in the share price in the short term. The share price appears to be discounting quite a lot at this level after such a strong run. My interpretation of the share price chart in light of the forgoing statistics and estimates is that the shares, now in new territory, could in a natural way of things easily move down to 3,000p or so.

There is of course one obvious short-term risk to the share price at this rating because of its exposure to the euro (in which it accounts) in the run up to the ‘Brexit’ referendum on 23rd of June. That might persuade nervous dollar currencies to reduce holdings, given that a UK vote to leave would do psychological damage to the euro and the pound as well as uncertain perceptions of the future for Europe and the UK. So far as sterling holders of the shares are concerned, much will depend on which sees the most weakness short term – the euro or sterling. It is my guess that it would probably be the euro. In any event, I suspect that there will be enough uncertainty at that point to go around.

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