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Unilever - a buy for patient investors

Unilever's shares are out of favour. But the long-term potential of its strength in developing economies makes this a buying opportunity for patient investors
October 31, 2013

Consistent growth in emerging economies - until recently almost taken for granted - now looks less certain. That has put pressure on Anglo-Dutch food and household goods giant Unilever (ULVR), which derives roughly 57 per cent of its sales from the developing world, and its share price dipped 20 per cent in next to no time some weeks ago. But we believe the dip in the share price presents an opportunity to buy into the long-term investment case of a global blue chip with a consistent track record of market-beating growth, heavy exposure to faster-growing developing economies and scope to expand profit margins, create new products and cut costs. Additionally, the lower share price offers the chance to pick up the shares at a higher-than-average yield - 3.3 per cent on 2014's forecast payout.

IC TIP: Buy at 2538p
Tip style
Growth
Risk rating
Medium
Timescale
Long Term
Bull points
  • Taking market share in emerging economies
  • Greater focus on big brands
  • Ability to improve profit margins
  • Solidity of the business
Bear points
  • Foods business dragging growth
  • PE multiple looks high

Markets reacted badly when Unilever, which makes household brands such as Ben & Jerry's ice cream, Dove soaps and Flora spreads, reported first-half results for 2013 that slightly missed EPS forecasts. The shares were dealt a further blow when underlying sales growth in the third quarter fell short of City forecasts, driven by a slowdown in emerging markets. Although the shares have reclaimed some lost ground, they're still 13 per cent off 12-month highs in May.

But we think that Unilever's long-term growth story remains intact. First, its strong position in emerging markets is a key asset enabling long-term growth, despite the occasional hiccup. Analysts at Berenberg agree, arguing that the third-quarter slowdown doesn't suggest any structural weakness in the business. They point out that the reported sales slump and subsequent earnings downgrades were almost entirely due to currency movements.

Besides, Unilever's slowdown in growth from emerging markets - from 10 per cent in the first half to 6 per cent in the third quarter - followed several quarters of double-digit growth. Management had already flagged that such a pace was unsustainable anyway. And, even if times are tougher, Unilever is still growing faster than its markets, delivering higher volumes and price increases across most product categories. So the group is on track to meet its full-year targets and expects to post underlying sales growth of 4.2 per cent, improved operating margin and strong cash flow.

Unilever's ability to improve margins through product mix, pricing and cost savings is another advantage. A focus on fewer, bigger products that have the potential to generate wider profit margins is paying off and cutting the time it takes to get new products to market helps, too. This year, City analysts expect an operating margin improvement of up to 0.4 of a percentage point, aided by a strong innovation pipeline, cost control and productivity savings. Martin Deboo, an analyst at broker Investec Securities, says decent margin progression could "propel high single-digit EPS growth on a 12-month view, with potential for a re-rating if earnings quality can be improved through foods disposals".

UNILEVER (ULVR)
ORD PRICE:2,538pMARKET VALUE:£75.4bn
TOUCH:2,536-2,538p12-MONTH HIGH/LOW:2,908p2,281p
FWD DIV YIELD:3.3%FWD PE RATIO:18
NET ASSET VALUE:367pNET DEBT:87%

Year to 31 DecTurnover (€bn)Pre-tax profit (€bn)Earnings per share (¢)Dividend per share (p)
201044.36.1315171.2
201146.56.2515177.6
201251.36.6815878.9
2013*50.26.6315279.7
2014*51.16.9816284.6
% change+2+5+7+6

Normal market size: 1,000

Matched bargain trading

Beta: 0.7

*Investec Securities forecasts - profit & EPS not comparable with historic figures; dividends translated into sterling at £1=€1.17

Indeed, food products are Unilever's weakness. Their performance lags that of the fast-growing home and personal care (HPC) segments, and the gap seems to be widening. Unilever "owns the world's fastest-growing major HPC business," adds Mr Deboo, "and its slowest-growing foods one". But, with the slowdown in emerging markets exposing Unilever's weakness in foods, which accounts for 28 per cent of group turnover, analysts think Unilever will focus more sharply on rationalising these operations.

Meanwhile, the London-listed shares in Unilever plc trade on 18 times forecast earnings for 2014. That's a steep multiple for shares in a company that's never going to grow fast, and there is no getting away from it. One solution is to focus on the solidity of Unilever's growth - it may not be that quick, but it sure is heavy. Another solution is to look beyond accounting earnings and focus on the fact that Unilever is growing faster than global rivals Nestle and Danone, according to figures from Berenberg, and produces a superior return on capital.