Qualiport

Find out if they make the grade.

On Wednesday, readers will have seen that I was as yet unsure as to whether Unilever is a quality company and therefore eligible to enter the Quality Portfolio (a.k.a. Qualiport). In my relatively short investing life (9 years) I have realised that my search for the perfect company is doomed to failure. I will never be satisfied on that front. Here standing in front of me is the 2nd largest company by market capitalisation in the UK, whose share price alone (excluding dividends) has risen from the equivalent of 30.875p in March 1982 to the 680p they hover around today. Over a period of 16 years their share price has achieved a compounded annual growth rate (CAGR) of an amazing 21.3%. Even if the current share price was now down at 300p -- a trailing price to earnings ratio (P/E) of close to 15, their average over the past 5 years -- that would still give them a CAGR of 15.3%. This is a fair bit better than the return you'd get from a bank account, and a hell of a lot better than keeping your money under the bed!

Unilever look like they are in the process of turning themselves into a lean, mean fighting machine. According to most observers of the company, head man Niall Fitzgerald (in the job for about 2 years) is driving the company forward, concentrating on its profitability and use of assets rather than just going for size. The sale of the capital intensive speciality chemical business is an example of the company forgoing size to concentrate on their core businesses of home and personal care.

The fact that the company is sitting on over £3 billion worth of cash, which it has had for almost a year, shows that management are not in a hurry to blow it on any old acquisition. They are biding their time, waiting for the right opportunity and the right company. Rumours in the past (and we never act on rumours here at Fool UK, but it gives you an idea of the type of companies that Unilever may be interested in) have suggested Colgate Palmolive or the consumer products division of SmithKline Beecham would fit well in Unilever's portfolio.

After further consideration, and some very valuable feedback from the message boards, I am giving Unilever the Qualiport stamp of approval. They pass many of the 10 criteria of a quality company that we spell out and, above all, under the leadership of Niall Fitzgerald, are, in my view, in the process of becoming a company that is concentrating on getting the best possible return for shareholders. The joint Chairmen say in the Unilever 1997 annual review, "Our objective is the creation of value through sustainable growth. Our strategy remains to focus on a portfolio of product categories and geographic regions which together offer the best prospect of achieving that objective."

Valuation

Once we've decided a company is a worthy member of the Qualiport, the next step is to assess its value. Valuation is important, as the initial buying price has a big bearing on your total return. The Qualiport's aim is to buy and hold great companies for the long term, ideally for a period of 5 years minimum and preferably for 10 or more. You may be thinking that makes it pretty boring, but if a portfolio of great companies can return 15% compounding growth per annum, we'll take that any day. To put that compounding return in perspective, £20,000 compounding at 15% per annum will be worth £81,000 in 10 years' time, and £327,000 in 20 years' time. And that's without adding any additional fuel to the compounding fire.

The great and yet often confusing thing about stock analysis is that there are so many ways of assessing a company's worth, and each one could be very correct or very wrong. Even the basic earnings per share (EPS) number is open to interpretation. I spent a large part of this morning trying to work out what I perceived as the true EPS number. It is made difficult by the various factors, such as the profit from the sale of the chemicals business and the restructuring costs. The Hemmington Scott site lists Unilever's trailing EPS as 27.0p. I calculate it as 20.4p, a full 32.4% less. The difference basically boils down to my interpretation of their £469m restructuring costs. You may remember that Unilever said they expect to spend between ½% and 1% per annum on on-going restructuring and rationalisation. On turnover of almost £30b, that works out at between £150m and £300m. In getting to my EPS of 20.4p, I have deducted the full £469m from their normalised profits, but Hemmington Scott haven't deducted anything, hence their higher earnings number. You may think that's me being conservative again, and you're probably right. But costs are costs, and this clearly is not a one off charge, although it may be higher in 1997 than it will be in the future.

Anyway, as we intend to hold Unilever for 10 years or more, it is appropriate to look 10 years down the track when trying to assess their value. This is where a few judgement calls come into play. It is difficult enough to predict a company's 1998 earnings, let alone its 2008 profits. However, as Unilever is a huge global company with great brand names and predicable earnings, it does become a little easier and viable to make these long term assumptions. If we were talking about a company that was small, in the early stages of its development and in the technology sector, I would feel far less comfortable with these long term predictions.

Next Step

In line with most of the country, I'm planning to watch the England v Colombia game on TV tonight. I could finish the valuation part of the report tonight, but I would be rushing, and I don't want to make an error. So, I'm going to delay that part of the Unilever equation until Monday, when a special Qualiport update will be released.

In the meantime, here are a few assumptions that I'm intending to use. Please feel free to debate them with me on the message boards. Also, on the Qualiport message board, I've posted a message from a person who used to work at Unilever.

Assumptions

Current Share Price: 680p 1997 EPS: 20.4p 1998 Forecast EPS: 25.0p 1999 Forecast EPS: 27.0p

1997 P/E: 33.3 1998 Forecast P/E: 27.2 1999 Forecast P/E: 25.2

Long term growth rate: 12%

Return On Equity: 14% for 3 years, then 16% for the next 3 years, and 18% for the next 4 years.

Dividend Growth: 10%

Have a good weekend.

Bruce Jackson (TMF Googly)

Qualiport Numbers

Today's Numbers            Date    26/06/98


          Change     Bid
          pence       £

RTO        0.08      4.35
EMAP      -0.34     12.08
MKS        0.03      5.46         


Rec'd       #    Stock     Buy     Now  % Change  £ Change

19/12/97  1565  Rentokil  2.55    4.35    70.6%    1.80 
17/04/98   337  EMAP     11.85   12.08     1.9%    0.23 
11/05/98   722  M & S     5.535   5.46    -1.4%   -0.075


19/12/97  1565  Rentokil  4,040.63  6,807.75  68.5%  2,767.12 
17/04/98   337  EMAP      4,043.37  4,070.96   0.7%     27.59
11/05/98   722  M & S     4,052.24  3,942.12  -2.7%   -110.12

Cash                             33.96

Total                        14,854.79 


                Day    Month    Year    History

Qualiport       0.2%   -0.5%    52.7%    56.1%
FTSE 100        0.3%    0.1%    14.4%    17.1%
FTSE All Share  0.2%   -1.4%    14.6%    17.0%