Like it or not, all of us are trapped in our past. For investors, that can have costly consequences. To see why, let’s focus on the household products group Unilever (ULVR) and explain why investors were right to buy its shares in the 2010s, though generally for the wrong reasons, and why it’s probably right to sell the shares now.
For the 10 years 2009-19, Unilever’s share price performed wonderfully, rising almost fourfold to nearly £52, which was approaching three times faster than the FTSE All-Share, an obvious benchmark index. Investors who grabbed a slice of that action thought they were buying shares in a marvellous fast-moving consumer goods conglomerate whose success was built on owning a stable of premium brands that occupied the top slots in their product groups – the likes of Dove in soaps, Hellmann’s in mayonnaise, Knorr in stock cubes, and Magnum in ice cream. Owning brands such as these was something like an enormous corporate equivalent of a saver holding the maximum number of Premium Bonds – an acceptable stream of income was pretty well guaranteed. After all, these products were not discretionary purchases. Run out of Hellmann’s and a new jar is needed. If the freezer is low on Magnum Classic, it has to be topped up; price does not come into it. For companies that make and sell such non-discretionary, small-ticket items, bought for cash week after week it is almost like owning a fabled money tree.
Plus, there was the bonus that Unilever’s global footprint – it claims sales in 190 countries – meant it had a big presence in emerging markets, stuffed full of would-be western-style consumers whose rising disposable income would be reflected in their growing demand for the branded consumables that affluence requires.
There was just one snag with this logic. It didn’t seem to accord with the facts. If Unilever’s products were so wonderful, then why was its sales growth always so sluggish? Why was is it that its bosses seemed far more likely to announce disappointing rates of sales growth than uplifting rates?
For proof, take the pace of sales growth that Unilever has generated in the past 10 years, as shown in the table – an annual compound rate of 1.1 per cent. Granted, Unilever isn’t the slowest performer. Its bigger rivals Procter & Gamble (US:PG) and Nestlé (CH:NESN) lag behind. But that doesn’t let Unilever off the hook – by no stretch of the imagination is it a growth machine.
|Unilever and its closest rivals|
|Unilever||Procter & Gamble||L'Oréal||Johnson & Johnson||Nestlé||Colgate-Palmolive|
|Share price (local currency)||33.87||152.83||349.35||176.92||119.20||74.78|
|Fall from five-year high (%)||-36||-8||-19||-2||-8||-13|
|Mkt cap (£bn)||86.9||277.7||155.7||352.6||273.2||47.6|
|Div'd yield (%)||4.2||2.3||1.6||2.5||2.5||2.6|
|Div's payout ratio (%)||73||59||58||54||46||70|
|Operating ratios (Latest full year)|
|Operating margin (%)||18.4||24.4||19.1||26.1||17.4||22.3|
|Return on assets (%)||8.4||11.9||10.6||11.7||12.8||14.0|
|Capex/dep'n & amort'n (%)||77||102||74||49||155||102|
|10-year growth rates (% pa)|
|Dividend per share||6.5||5.1||9.1||6.4||3.7||4.7|
This was the odd thing that I couldn’t get my head around. From the late 2000s Unilever’s share price surged, but it seemed to be much the same sort of business that I had followed since the early 1980s – lots of good, though usually unexciting, brands that Unilever’s bosses seemed to churn with regularity partly because the ones they controlled had outlived their usefulness while the ones they had just bought would be wonderful (until they weren’t). Sure, I exaggerate and, besides, it is the lot of a consumer-goods group that brands will come and go. Coca-Cola and Kit Kat are the rarities that just go on and on. Even successful brands have a life cycle. Small wonder therefore that Unilever finds it necessary to cull brands or product groups from time to time – the likes of Batchelors processed peas, Birds Eye fish fingers or Wall’s sausages; or, as we speak, its PG Tips and Brooke Bond tea business.
Yet back in the 1980s and 1990s, when Unilever was much the same sort of group as it was in the 2000s or is now, no one mistook it for a glamour stock or a growth machine. In the ’80s, if its stock was a must-have in an institutional investor’s portfolio it was because of its size. It was too big to ignore. Simultaneously, investors saw Unilever as a capital-intensive processor of foods and fats whose performance was weighed down by the heavy costs needed to maintain marketing-hungry brands; nothing to get excited about.
What really changed to give Unilever the appearance of glamour was zilch to do with the group itself and lots to do with the rate at which its extremely predictable earnings were capitalised. It is no coincidence that Unilever’s surging share price performance started in early 2009 as the world was climbing out of the financial crisis largely caused by the implosion of the US sub-prime mortgage market and central banks were obligingly shunting interest rates lower and lower.
Given that backdrop, it was almost impossible for Unilever’s annuity-like earnings to become anything other than more valuable. Capitalise the 127p of earnings the group produced in 2011 at, say, 6 per cent and you get a per-share value of £21.17, not far from Unilever’s actual share price in the middle of that year. Four years later the group’s earnings had drifted down to 125p. No matter. Capitalise those earnings at, say, 4 per cent and the share value becomes £31.25, a level the shares hit in early 2016. The point is that, despite the fall in earnings, the share price rose by approaching 50 per cent in that period without anything whatsoever happening to the group to make it more valuable. And so it continued. Interest rates drove towards zero, Unilever’s share price motored upwards, peaking at almost £52 in August 2019.
All good things come to an end and it is difficult to say why Unilever’s share price began to drift off its peak from the second half of 2019. It might be nice to think investors became annoyed by the tediously self-righteous tone the group increasingly projected; as if brushing with Signal toothpaste or dribbling Ben & Jerry’s Phish Food down your shirt front would somehow make the world a better place. More likely – and more prosaically – the botched attempt in late 2018 by its bosses to make the holding company Netherlands-domiciled really angered shareholders, prompting them to examine the group’s performance more closely.
As the table indicates, what they would have found was not overly impressive. Sure, Unilever produces great profit margins. The rate was 18.4 per cent in 2021, but it has averaged 17.4 per cent since 2011 and was never been less than 14.2 per cent in that period. Enviable though that margin is, it is the second lowest of the six similar groups shown in the table.
Similar comments could be made about other performance ratios. Since return on equity tends to be meaningless (because shareholders’ funds are distorted by so many accounting rules), return on assets (RoA) is a better broad-brush measure of profitability. At 8.4 per cent for 2021, Unilever’s profit looks sufficient to cover the most demanding cost of capital. In other words, the group adds value to the capital it employs. That’s good. Even so, its RoA is the lowest of the six.
Linked to that, one wonders if it is a coincidence the group’s capital spending in relation to sales is also the lowest. The implication is that Unilever’s bosses don’t spend enough on renewing existing assets (tangible and intangible) or adding new ones. This suggestion might be reinforced by its capital spending being much lower than its charge for writing down existing assets. In fairness, though, 2021’s ratio of 77 per cent looks untypically low; in the years 2011-16 the ratio was always well over 100 per cent.
Alternatively, slowing capital spending might be a function of necessity since Unilever’s debt levels – whether expressed as net debt in relation to operating cash profit (ebitda) or to total capital – have been rising since the early 2010s. True, those ratios remain comfortable and Unilever’s bosses might even argue they have been making the balance sheet “more efficient”. Yet that’s often a euphemism for distributing too much to shareholders; in Unilever’s case, not just via dividends but through £15bn-worth of share buybacks since 2014.
The impression is of a group that, while hardly floundering, isn’t going anywhere, and certainly not fast. With a 40-year perspective on Unilever, I might say, 'what’s new?' That impression would also help explain why Unilever’s bosses were so keen to get their hands on the consumer healthcare arm of GlaxoSmithKline (GSK). The market’s shocked response to Unilever’s approach in January was odd. It seemed perfectly logical its bosses would want a £50bn portfolio of toothpastes, over-the-counter medicines and wellness products to add to its smaller range of soaps, deodorants and skin-care creams. Whether they would be the best people to manage it is another matter.
Either way, Unilever’s share price may well continue to head south. If so, that’s likely to have little to do with the way the group is run or, indeed, in relation to the financial returns it generates. The prime factor will be wholly exogenous. What’s happening is the reverse of the process explained a few paragraphs ago, which propelled Unilever’s share price upwards so relentlessly in the 2010s. Inflation is back, possibly with a vengeance. At the very least that will make Unilever’s largely static earnings less valuable. To the extent that interest rates rise, it will make those earnings less valuable still. When a given profit is capitalised using a higher rate of interest, value must fall. There is no alternative; that’s just arithmetic. Those who bought Unilever shares for the wrong reasons in the 2010s, but got it right, should now sell for the right reasons.