This consumer goods group owns a number of household brands, making it a classic defensive stock with huge attractions for fund managers at times of crisis. But that’s precisely why it looks vulnerable to a pull-back.
Unilever (ULVR), tipped as a BUY by The Sunday Telegraph
Consumer goods group Unilever owns a stable of well-known household brands, from Dove soap and Hellmann’s mayonnaise, to Wall’s ice cream and Persil. It is a classic defensive stock with huge attractions for fund managers at times of crisis. But due to its “safe haven” appeal, the stock now looks over-bought and is vulnerable to a sharp pull-back. Let me explain.
Unilever has for years been trailing its peers in the food and personal/homecare sectors such as Reckitt Benckiser and Nestlé. It has also infuriated investors in the past with its unwieldy bureaucratic culture and poor management. Two years ago, Patrick Cescau took charge as chief executive and has already started to make inroads. Under-performing units, such as Bird’s Eye and Boursin, have been sold, while its North American laundry business is now also on the block.
As well as focusing on fewer products, the group is cutting jobs at its overstaffed factories and bloated head-office. This will mean hefty restructuring charges of up to e1.0bn in 2007. This slimming down helped deliver better-than-expected Q3’07 results. Like-for-like revenues rose 4.5%, with operating profit margins improving by 0.2% to 13.7%. This was despite the headwinds of a weakening dollar, rising commodity prices, a poor summer for ice-cream sales and customer destocking in the US.
Going forward, the board is aiming for profit margins of 15% by 2010 and plans to accelerate the restructuring programme at a cost of a further e2bn over the next two years.
But although this is all encouraging, there is a strong sense of déjà vu here. The “path to growth” plan launched in 1999 by Cescau’s predecessor, Niall FitzGerald, aimed to pep up revenues and deliver 15% margins, but largely failed.
What investors need to remember is that – regardless of its rising exposure to high-growth emerging nations – Unilever’s addressable markets are primarily mature and cut-throat. It faces aggressive competition from both its rivals and from supermarkets’ own brands.
In a booming economy a firm can get away with charging a premium as consumers trade-up to more expensive goods. In a more frugal environment, where discounting becomes essential, consumer goods groups have to slash prices, sacrificing profitability for market share. So over the economic cycle, I suspect margins of 15% are unlikely.
Meanwhile, growth remains a problem. Developing markets, contributing 44% of turnover and growing at 11.7% a year (with China up nearly 20%), are responsible for virtually all of Unilever’s growth. In spite of an improving Western European economy, sales there remain sluggish.
So while the board expects to hit the top end of its 3%-5% revenue growth target this year, it still lags its peers. Reckitt Benckiser delivered twice that rate in the first half, whilst Nestlé is running at about a 7.5% clip.
Moreover, 2.1% of Unilever’s 4.5% growth in Q3’07 was due to price rises, which are unlikely to be repeated if consumer spend tightens. Additionally, some of the improvement in Unilever’s margins was driven by a fall in advertising spend, which raises questions over future expansion.
The City is forecasting 2007 sales and earnings per share of £28.2bn and 95.4p respectively, rising to £29.5bn and 101.5p in 2008. That puts the shares on a toppy p/e ratio 18.7. I would value the stock on a multiple of 15 times earnings, or about £14.30 per share.
Recommendation: TAKE PROFITS at £17.78
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments