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Unilever plc (NYSE:UL) is a British-Dutch multinational consumer goods company that operates globally, with over 60% of its business coming from emerging markets. Established in 1930 through the merger of British soap maker Lever Brothers and Dutch margarine producer Margarine Unie, Unilever has grown to become one of the largest and most diversified consumer goods companies in the world. The company operates in five business groups: beauty & wellbeing, personal care, home care, food & refreshments, and ice cream.
Despite its extensive product portfolio and well-known brands across all these categories, Unilever’s performance over the past decade has been disappointing. A new CEO, Hein Schumacher, was appointed in July 2023, following activist investor Nelson Peltz’s appointment to Non-Executive Director the year before. During the third quarter, Schumacher launched a “new” action plan focused on accelerating growth, driving productivity & simplicity, and creating a performance culture.
While both the activist on the Board and the CEO may give the organization new impulses, none of the actions put forward so far are truly game-changing. The current valuation reflects that Unilever will be able to accelerate growth to over 3% per year going forward, while restoring margins towards pre-Covid levels. The company’s proven track record over the past 10 years is a flat business. While better execution under the new management could drive a more positive trend in the future, Unilever lacks clear catalysts for a sustained step-change in growth and margins, and thus does not have market-beating potential from the current price level.
Looking Back At Years Of Poor Performance
Despite a dividend yield close to 4%, Unilever investors lost money over the past three years and barely made any over the past five. The total shareholder return over 10 years was about 5.5% per year, most of which came from dividends. That was better than leaving your money in a savings account given how low-interest rates were, but much worse than investing in either the S&P500 index or competitor Procter & Gamble (PG), both returning over 10% per year for the last decade.
In short, Unilever was not a great investment in recent history, and a particularly poor performer in the past 3 years, as illustrated by total shareholder returns in the chart below.
One look at Unilever’s financial performance is enough to understand why the stock has not gone anywhere: the business has not either. Whether revenue, gross profit, operating income or free cash flow: all key measures have essentially been flat (+/- 1% CAGR) over 10 years.
The shareholder value creation was limited to a moderately growing dividend and share buy-backs. The 13% reduction in share count since 2013 enabled a dividend per share growth of close to 3%, although actual dividend payments only increased by 1.5% per year.
But wait: Unilever grew EPS by 4.5% p.a. over 10 years and even by 11% p.a. over the past 3 years. How does that fit with the poor stock performance? Well, this is a great example of why I personally prefer to look at free cash flow rather than net income. Earnings tend to be impacted by a number of one-off factors. In Unilever’s case, extra profits occasionally come from the sale of brands and product lines.
As the company is in the process of refocusing resources on its top 30 brands, management has accelerated divestitures of non-key assets in both 2022 and 2023, contributing billions to the bottom line. A sizable example is the divestiture of tea business ekaterra (well-known for its Lipton brand) in 2022 for a profit of 2.3 billion euros. To be clear, divestitures can be good for shareholders, as they are a quick way to unlock value (at the right price).
However, selling assets is not a sustainable way of creating long-term shareholder value, which is why the market does not give Unilever much credit. The current TTM P/E multiple of 13.8 should not be misinterpreted as the stock is cheap. The FWD P/E multiple of 18.4 (which excludes one-time gains from asset sales) is in line with the sector median and only somewhat below Unilever’s 5-year average of 22.
Moving to Unilever’s balance sheet, the company sits on $25 billion of net debt, a level it has been hovering around ever since it took on about $14 billion of fresh debt back in 2017. Unilever largely used this debt to buy back its own shares in 2017 and 2018 in an attempt to keep shareholders happy after rejecting the $143 billion takeover offer from U.S. rival Kraft Heinz. The rest is history: today, close to 7 years after Kraft made the offer, Unilever is trading at $123 billion. A great example of shareholder value destruction…
But let’s not dwell in the past: the key question today is whether the debt level is acceptable, or if it presents any significant risks to Unilever shareholders. For a business as stable as Unilever, a leverage ratio of just over 2 times EBITDA is certainly nothing to worry about. The low credit risk is also reflected in the A+ and A1 credit ratings from Standard & Poor’s and Moody’s, respectively. Also, Unilever’s interest coverage ratio, as measured by dividing the EBIT by net interest expenses, is a comfortable 18 times.
New CEO, New Action Plan: A Game Changer?
“Past performance is not indicative of future results“. What is often used as a disclaimer to temper greedy investors’ expectations is what Unilever investors must hope for. But can the new CEO Hein Schumacher, his “renewed” management team and the company’s new action plan really turn things around for the better?
Let me start with a few words about Hein Schumacher. He was appointed CEO in July 2023 after 8 years at Royal Friesland Campina, the first 3 years as CFO, the next 5 years as CEO. Before that, ironically, he worked for Kraft Heinz for a decade and originally started his career as a finance manager for Unilever in the Netherlands and Germany. In other words, Schumacher was born and raised in the FMCG industry, knows the competition inside out, and has what I believe is a valuable dual background as CFO and CEO. In short, he certainly brings what you need for the job. You can listen to his fire side chat with Warren Ackerman from Barclays (available on YouTube) to form your own opinion. Mine is rather positive so far.
As for the rest of the “renewed” management team, none of the newly appointed leaders is actually new to Unilever. All of them, including new CFO Fernando Fernandez (former Head of Unilever for Latin America), already had very senior roles in the company before, notably during the past 3 years of poor performance. So while the internal daisy chains will no doubt trigger some fresh thinking, investors should not expect disruptive changes.
Talking about lack of disruption, let us take a look at the new action plan, which was presented in more detail during Q3 earnings back in October.
I read a few articles on Seeking Alpha with positive reactions to this action plan: faster growth, productivity & simplicity, performance culture. Sounds amazing. Exactly what Unilever needs, right? Except that the action plan does not really say how Unilever will actually achieve those outcomes. The recent Q4 earnings update did not offer much new information in this regard either.
Let me give you a couple of examples of what I mean, starting with the focus on the top 30 brands. Focus is great. You tend to achieve more by bundling your time and money behind fewer, material initiatives. The issue is that so far, there is little substance about how Unilever will drive “unmissable brand superiority” for its “30 Power Brands” in a way that will actually change the growth trajectory. Quoting slide 34 of their Q3 earnings presentation, Unilever will “focus investment in areas that drive impact” (sounds good, but means everything and anything), “ensure consistent execution” (kind of admitting execution was an issue before), and “invest more in digital media” (fine, but still very general).
In a similar fashion, their roadmap to build back gross margin could be taken straight from a business textbook. Quoting slide 38 of their Q3 earnings presentation, they will “improve mix through premiumization”, “drive volume leverage”, and focus on “competitive buying”, “operational efficiencies”, “SKU simplification” and “network optimization” for productivity improvements. What is also interesting is that Hein Schumacher explicitly rules out a broader restructuring at this point.
I hope and believe that none of the above is really new to Unilever. What could make a difference is if the execution improves under the new CEO, but only time will tell. Meanwhile, the answer to the question is: no, the action plan is not a game changer. Whether the CEO can be one, we shall see. And then there is Peltz, the activist on Unilever’s Board…
Nelson Peltz: A Potential Catalyst?
Nelson Peltz is a famous activist investor and founding partner of the Trian Fund. He has been in the news again lately for demanding seats on Disney’s (DIS) board after taking a $3 billion stake in the company. Back in 2022, Peltz took a 1.5% stake in Unilever and was appointed to Unilever’s Board in May 2022. Since then, the stock price has been virtually unchanged. So what to expect from the activist investor moving forward?
As this short biography shows, Peltz has been appointed to the Board of many companies before. One way to assess what to expect from his appointment as Non-Executive Director of Unilever is to look at how the previous companies performed after he joined.
This is exactly what Jeffrey Sonnenfeld and Steven Tian did in their analysis published by Yale Insights. It is a quick read if you want to have more details, but in a nutshell, Peltz’ track record is hit-and-miss at best. Half or more of the companies underperformed the S&P500 index during the entire duration of his Board tenure, including Wendy’s (WEN), Mondelez (MDLZ), Sysco (SYY) and Legg Mason. And if you wonder if any of these performed greatly thereafter, the answer is: most of them did not.
To be honest, this statistic should not surprise anyone. It is impossible to pick winners all the time. What the analysis underlines very clearly though is that having Peltz (or any other activist) on a company’s Board is absolutely no guarantee for better performance. Activists are no magicians. They can certainly set impulses and hold management accountable for execution, but there are many other reasons why a company may underperform that no activist in the world will resolve.
About Dividend Safety And Share Buybacks
We discussed earlier how dividends and share buy-backs were the only sources of shareholder value over the past 10 years as the business itself was essentially flat. While it is fair to assume (hope for?) some growth in the coming decade, it seems important to validate that Unilever will at least be able to continue paying dividends and buying back shares with excess cash.
For that, let us assume that Unilever will maintain a similar level of (net) debt as today and that on a net cash basis, future acquisitions and divestitures will balance each other out. This essentially means that Unilever can use its free cash flow (FCF), as calculated by operating cash flow (OCF) minus capital expenditures (Capex), to pay dividends and buy back shares.
Unilever’s average FCF over the past 10 years was around $6.8 billion. Meanwhile, the average dividend payment was $4.5 billion, and the average annual buy-back was $2 billion (with years of zero and years of massive buy-backs). This means that the current dividend payments and average annual share buy-back volume are covered by the average FCF of the past 10 years.
The new CEO announced an increase in Capex from between 2 and 2.5% of sales in recent years to 3% starting in 2024, an increase of $400-$700 million. This means that to keep FCF flat, these investments must return an increase in cash from operations by the same amount (a 6 to 8% step-up in OCF). This corresponds roughly to a 100bps improvement in operating margin or a 5% increase in revenue at steady operating margins.
In summary, the current dividend, yielding close to 4%, as well as share buy-backs in the range of $1.5 to 2 billion annually, should be well covered by Unilever’s steady free cash flows. However, dividend growth will require actual and sustained revenue and FCF growth, which is less certain based on the company’s track record. For 2024, the Board just approved a buy-back program of €1.5 billion (about $1.6 billion), and kept the March dividend of €0.4268 in line with previous quarters.
Unilever’s Fair Value
When assessing a company’s value, I like to run multiple scenarios to get a sense of the range of possible outcomes.
I played around with several key assumptions, including revenue growth (2 to 4%), profit margin (13 to 15%) and multiple ranges (16 to 20 times FCF). I assume that Unilever will pay out 60% of its annual FCF in dividends and use the rest for share buybacks. Applying a 10% discount rate, I get to a fair value range of roundabout $40 to $60, which essentially means that Unilever is fairly value right now. A discounted cash flow model gets me in the same ballpark.
All scenarios above require growth, which we have not seen over the last 10 years. To get a sense of the risk, I also ran a scenario assuming no revenue growth with stable operating margins (pretty much the story of the past decade). Using a 10% discount rate, this leads to a fair value of around $30, or -40% below current levels.
Finally, let us look at the valuation sensitivity to different discount rates. Keeping all else equal, lowering the rate to 7.5% moves the fair value range up to $50 to $70, while increasing the rate to 12.5% moves it down to $35 to $50. Which rate you want to apply ultimately depends on your desired return and margin of safety. For my personal investment choices, I tend to use 12.5% to identify investments with market beating potential. Clearly, Unilever is not likely to deliver market beating returns when investing at $50.
Q4 & Full Year 2023 Results
Unilever had a solid fourth quarter of 2023, delivering on both key measures I was focused on going into earnings: volume growth and margin expansion.
Underlying sales growth of +4.7% came in just -30bps short of analyst consensus. Importantly, volume returned to growth in the fourth quarter, up +1.8% (vs. expectations of +1.1%), leading to overall flat volume for the year. The return to volume growth is a critical proof point for Unilever’s ability to drive sustainable growth at higher prices moving forward. Meanwhile, price growth decelerated to +2.8% (vs. expectations of +3.8%) in the fourth quarter, a bigger than expected drop from the +5.8% in the third quarter.
While price growth decelerated across all geographies, Asia Pacific, where Unilever made 44% of total sales both in Q4 and FY 2023, represents the largest drag to overall results, with price down to +1.1% in Q4 from +4.3% in Q3. Meanwhile, unlike other geographies, volume growth also decelerated slightly in Asia, down to +0.7% from +1.7% a quarter ago. This reflects the impact of a deflationary market environment and low consumer confidence in China, commodity price pressures in India, as well as the “boycott” of multinational brands in Indonesia in response to the geopolitical situation in the Middle East.
North America price growth was lowest at +0.7%, while volume growth jumped to +6.3% in the region driven by the strong performance in Beauty & Wellbeing, Personal Care (notably Dove) and Nutrition (notably Hellmann’s). Latin America continued to grow double digits across all markets, with +4% from price and +9.1% from volume, again driven by Personal Care (notably Rexona) and Nutrition, where Hellmann’s became market leader of the premium Squeeze segment in Brazil.
While remaining high at +9.4%, price growth in Europe also decelerated substantially from +13.2% in Q3. Conversely, while volumes still declined -6.3% in Q4, this represents a sequential improvement from the -9.7% and -10.7% declines in Q2 and Q3, respectively. Volume declines, led by the Ice Cream and Home Care segments, reflect Unilever’s share loss to private label brands as European consumers are trading down in a high inflation environment.
Another positive trend to highlight from Q4 earnings is the +200bps gross margin recovery Unilever achieved in 2023 compared to 2022 lows. Following a dip to 40% in 2022, Unilever’s gross margins are back around 42%, in line with the 10-year average. Despite the slowdown in price, the rebound was particularly strong in H2 2023, supported by easing inflation, better mix and structural portfolio changes.
Analysts are projecting 3.6% underlying sales growth for 2024 (1.4% price and 2.1% volume), which is directionally aligned with Q4 trends and sits on the lower end of management’s 3-5% annual growth guidance range. Margins are expected to continue expanding back towards pre-pandemic levels, while management also reconfirmed its intent to maintain sustainable dividend payments and approved a €1.5 billion share buy-back program.
In short, no surprises to either side, and overall the market seems to appreciate as the stock initially jumped over 5% and ended the day over 3%.
Unilever has had no market beating investment in the past 10 years, and based on all information known today and given its current valuation, I do not believe the company has the potential to beat the market in the next 5 to 10 years either. However, the combination of recent management changes, a clearer strategic focus and an activist Board member to hold management’s feet to the fire should set Unilever up for positive total shareholder returns in the coming years, marking an improvement relative to the recent past.
For investors looking for a reliable dividend with moderate risk and volatility, Unilever is a fair pick. Personally, I like to trade in and out, buying when the stock goes to the lower $40s, and selling when it reaches the high $50s while collecting dividends in between. This strategy can be enhanced with the use of options, selling puts to get in, and calls to get out at the aforementioned levels.
At the current price of $50, I am giving Unilever a hold rating.