What should investors in Unilever (LSE: ULVR) be worried about?
With its strong clutch of category-leading consumer brands and growing emerging market presence, Unilever (LSE: ULVR) (NYSE: UL.US) is a business with very definite attractions. A £67bn FTSE 100 (UKX) constituent, last year the company earned a pre-tax profit of £6.2bn on revenues of £47bn.
And with margins like that, no wonder this defensively positioned business is popular with many investors. Better still, with its shares changing hands today at 2,334p, the company offers income investors a reasonably tempting forecast dividend yield of 3.4%.
But how safe is that share price? And -- of vital importance to income investors -- how safe is that dividend? In short, how could an investment in Unilever adversely impact investors' wealth?
In this series, I set out to answer just these questions. My starting point: Unilever's latest annual report, where the company's directors are obliged to address the issue of risk.
One immediate thing that I'm looking for is an acknowledgement that risks do exist, and that they need managing.
The good news? As you'd expect from a business of Unilever's size and calibre, the company has in place a risk-management policy, a system of regular reviews and a number of high-level committees tasked with monitoring the risks that the business has identified.
But what, precisely, are those risks that the company faces?
Read the small print, and Unilever identifies no fewer than 13 risks as having a significant prospective impact on the company's financial performance. They range from political risks and natural disasters to changing consumer tastes, and from own-label brands to supply chain disruption.
So let's take a look at three of the biggest.
Unilever operates in one of the world's toughest marketplaces -- selling premium branded products to supermarkets such as Tesco (LSE: TSCO), Sainsbury (LSE: SBRY) and Morrisons (LSE: MRW). And not only are these supermarkets tough negotiators, capable of de-listing brands and shrinking available shelf space, but they are also competitors, too. Competitors? That's right: competing against just about every Unilever brand is a cheaper supermarket 'own label' offering. As the company puts it:
"Successful customer relationships are vital to our business and continued growth. Maintaining strong relationships with our customers is necessary for our brands to be well presented to our consumers and available for purchase at all times... [and] our retail customers frequently compete with us through private label offerings."
Here, Unilever's strength in emerging markets -- where it makes 54% of sales -- helps significantly. As the company points out, it aims to build and maintain trading relationships across a broad spectrum of channels ranging from centrally managed multinational customers through to small traders accessed via distributors in many developing countries.
Also, both brands and customer relationships are focused around areas where Unilever thinks it can add value, and where it can build sustainable competitive advantage -- positioning it firmly away from price-led markets and customers, and more into ones where its strengths in innovation, sustainability and other non-price characteristics are valued.
And speaking of sustainability, Unilever has set itself a tough challenge. Sustainability, it recognises, is important to consumers -- and so it is important to Unilever. But can this importance be reflected without impacting growth and profitability? As the company puts it:
"Unilever's vision to double the size of our business while reducing our environmental impact will require more sustainable ways of doing business. This means increasing the positive social benefits of Unilever's activities while reducing our environmental impact."
To me, the risk here is around growing the business. In terms of ensuring sustainability, the company can point to the Unilever Sustainable Living Plan, which sets clear long‑term commitments for environmental impact, underpinned by specific targets in areas such as sustainable sourcing, water availability and usage, waste and greenhouse gases. These, in turn, are monitored by the Unilever Sustainable Development Group, comprising five external specialists in corporate responsibility and sustainability.
But growing the business -- and its profits -- at the same time? Beyond acknowledging that progress towards the Unilever Sustainable Living Plan is monitored by the Unilever leadership executive team and the Board, nothing is said.
Supply chain risk
Unilever is a global business, with global supply chains. But what happens to profits and revenues when those supply chains are disrupted? As Unilever puts it:
"Our business depends on securing high quality materials, efficient manufacturing, and the timely distribution of products to our customers. Our supply chain network is exposed to potentially adverse events such as physical disruptions, environmental and industrial accidents or bankruptcy of a key supplier which could impact our ability to deliver orders to our customers."
How are these risks dealt with? By policies designed to ameliorate risk in the first place, and contingency plans to deal with the aftermath of disruption that does materialise.
Such plans, for instance, are designed to enable the company to secure alternative key material supplies at short notice, to transfer or share production between manufacturing sites and to use substitute materials in our product formulations and recipes. Additionally, these contingency plans also extend to an ability to intervene directly to support a key supplier should it for any reason find itself in difficulty or be at risk of negatively affecting a Unilever product.
Risk vs reward
Two superstar investors who are well used to weighing risks are Neil Woodford and Warren Buffett.
On a dividend re‑invested basis over the 15 years to 31 December 2011, Woodford delivered a return of 347%, versus the FTSE All-Share's distinctly more modest 42% performance. Buffett, for his part, has delivered returns of over 20% per annum since 1965, transforming himself into the world's third-wealthiest person.
Each, as it happens, are the subject of two special reports prepared by Motley Fool analysts. And they're yours to freely download, without any obligation.
So click here to download this free special report profiling the investment logic behind eight of Mr Woodford largest and most successful current picks.
And click here to discover which beaten-down British share Warren Buffett has been buying of late -- and why he bought it, and the price he paid.
> Malcolm owns shares in Unilever, Tesco and Sainsbury, but not in any other companies mentioned here. The Motley Fool owns shares in Tesco.