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OPINION

Unilever hit by Asian slowdown

Unilever hit by Asian slowdown
December 18, 2019
Unilever hit by Asian slowdown

A modest sell-off ensued, which extended to industry peers such as Reckitt Benckiser (RB.) and Nestlé (SWX: NESN). But beyond specific trading issues, it raises questions over the extent to which valuations for quality internationally focused defensives have been artificially inflated.

The accompanying chart shows that the group’s enterprise value has easily outstripped sales growth but that should surprise nobody given Unilever’s bond proxy status. Not all risk assets have benefited from the collapse in the risk-free rate of return, but support from income seekers is all but guaranteed when a defensive profile is combined with distributions which have grown at a compound annual growth rate of 10.6 per cent since 2014.

That explains why the shares come with a respectable forward yield of 3.29 per cent even though the share price is up by 66 per cent over the past five years – and even following this week’s sales warning. The group also embarked on a €6bn (£5.1bn) share buyback programme last year, though that was funded through proceeds from the sale of its margarine and spreads business.

Beyond the pure income angle, Unilever has consistently delivered ROCE (return on capital employed) above the industry average, along with profitability that is usually more than matched by the rate of cash conversion, always a healthy sign. You would expect this from a business with fast inventory turn, though the proportion of current assets relative to current liabilities comes in at a rather less impressive 0.82.

No-one is suggesting that the bailiffs are about to be called in. And there is nothing wrong with returning excess capital to the owners of a company, but you’re left wondering if support for the pay-out regime is born out of complacency.

This might also explain the relatively high multiple paid by Unilever for GlaxoSmithKline’s (GSK) Asian health-food drinks business, which includes the Horlicks malted drink brand, something of a stable with Indian school children apparently. The scrip deal represented 6.7 times sales, well above the multiple achieved by the Indian subsidiary of Kraft Heinz Co (US: KHC) when it hived off a comparable product portfolio, though rival interest from Nestlé and Coca-Cola (NYSE: KO) would have undoubtedly bumped-up the purchase price.

It’s fair to assume that support for the shares is partly based on their perceived predictability from an income perspective, though the current yield and dividend cover are both down by around a quarter on the benchmark average. Part of the attraction is that the group throws off so much cash, but with net debt representing 1.8 times shareholder funds, it also has significant financial obligations. The group generated €1.5bn in free cash flow in the first half, but that was eclipsed by the increase in net debt, which was partly utilised to fund dividend payments.

But as Phil Oakley recently pointed out in these pages, “the source of Unilever’s economic moat is its enduring brands”. That equates to hundreds of branded products, many of which might be termed ‘iconic’ – high-margin lines such as Marmite, Domestos and Brylcreem, to name but a few. The breadth and quality of its product offering is perceived as its principal strength, but it would be naive to assume that Unilever is unassailable.

The rise of discount grocers such as Lidl and Aldi demonstrates that price points are now the primary determinant in the personal goods market, also evidenced by the rising tide of generic brands. Unilever will increasingly be forced to contend with disruptive business models, hence its acquisition of Dollar Shave Club. And there are potential cost-base issues in the offing due to the global campaign against single-use plastics. No-one doubts the group’s underlying quality – but investors, like Unilever itself, can't afford to become complacent.