Unilever's lingering uncertainty

If 2009 proved one thing in the groceries industry, it was that branded goods weren't the have-at-any-cost products their owners had assumed. In particular, Unilever, the Lynx-deodorants-to-Flora-spreads group, learned the hard way that, when consumers were worried about their finances, maintaining premium prices was a sure-fire way to prompt them to seek out cheaper alternatives, such as supermarkets' own-label products.

The decision by the bosses of the Anglo-Dutch giant at the start of the year to keep prices firm saw sales volumes come under serious pressure - in the first quarter, Unilever raised prices by 6.8 per cent but saw global sales volumes fall 1.8 per cent. True, prompt action on pricing restored the business to volume growth by the end of the next quarter, but Unilever had already lost valuable market share.

A 7.6 per cent increase in underlying sales volumes in the first quarter of 2010 indicates that some market shares has been regained. But Unilever appears to be buying its way back into consumers hearts. Price reductions of 3.3 per cent on average were considerably higher than the 2 per cent that City analysts had anticipated - and that was not the first time that Unilever's prices had been softer than expected. And the company said it was unlikely to see prices moving higher until the fourth quarter of the year.

Partly, that's because the cost of producing goods has fallen over the past 12 months. Lower costs of raw materials and energy mean that Unilever can now drop its prices without damaging profit margins. Indeed, underlying operating margins improved by 60 basis points in the third quarter of 2009, even though the group spent heavily on advertising and promotions.

In addition, prices are being held down by intense competition from branded rivals - especially the US giant, Procter & Gamble - and by local competitors in key emerging markets. So far Unilever has fought off the challenge in countries such as Turkey, India and China. Indeed, it notes that, where competitive intensity has been highest, growth has accelerated. Asia and Africa now account for nearly 40 per cent of sales, and volumes there climbed 11.7 per cent in the first quarter of 2010.

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However, the outlook looks less benign. Unilever says it expects commodity costs to rise in the second half of the year, reversing the earlier beneficial impact of falling input costs. As Mr Polman puts it, "tailwinds from commodity costs will turn into a headwind". The risk is that this curtails promotional spending unless, of course, Unilever is prepared to take a hit to its profit margins or can accelerate cost-cutting over and above the £1bn a year already expected from its restructuring programme.

There is also a worry that the debt-crisis currently rocking Europe could swing the continent back towards recession, and derail the so-far short-lived recovery of Unilever's troublesome Western European business, now the smallest of its regions, but still responsible for 28 per cent of sales.

Several quarters of heavy price reductions had already failed to restore volume growth in the region, and it was only after price cuts of 3.7 per cent in the first three months of 2010 that changes in sales volumes moved into positive territory again, up 4 per cent. The company pointed to the improved contribution from Italy and Spain in the trading turnaround. But, given the fragility of the Italian and Spanish economies, such a recovery could be easily reversed.