Qualiport

>"Never mind the width, feel the quality," says David Berger of global company, Unilever.

Over the last few weeks, Bruce has been through Unilever with his usual fine tooth comb. He's been asking not only whether it is a quality company and thus worthy of becoming a Qualiport purchase, but whether it is worth buying on valuation grounds. Anyone who has read Bruce's outstanding work recently will be left in no doubt that his answer to the first of these questions is a resounding yes and his answer to the second is a thumping, "Mmm, maybe, probably, hmm no, I think not..."

The market has moved on since the first Qualiport buy back in December last year. Then, Bruce was wavering about Rentokil at 250p with a 1997 P/E of 24 and, between you, me and the 500 million or so other people connected to the Internet, if he hadn't just spent two months toiling on the Rentokil series, I think Rentokil would have been heading for the bin on valuation grounds along with last Tuesday's quiche. It was arguably overvalued then. Now, at a price of 430p and a 1998 P/E of 35, Rentokil's valuation is truly cosmic.

I'm not going to go into the details of Bruce's Unilever valuations because he has already done that. Suffice it to say that they do not give phenomenal growth rates and with a range from around 3% to 12% per year, we can't exactly get too excited about Unilever on these kinds of valuation grounds alone.

On the other hand, this is clearly a quality, well-managed company with tremendous brand presence and operations in all the countries of the world, bar Iraq, Iran, Burma and Spitsbergen (which, of course, isn't a country). Their products are used every day, many times, by a large proportion of the world's population. Unilever sold three and a half billion bars of Lux soap last year. How many Magnum bars did you eat? Or fish fingers? Or Ragu ready-made spaghetti sauces? They really are everywhere. They're also profitable, with improving margins and are currently sitting on £3 billion or so of cash which they would like to invest, or else possibly give back to shareholders.

Since 1962, Unilever has returned 12.8% annually for shareholders, not including dividends, and since 1983 it has been a massive 21%, again not including dividends. We don't have the required information to hand to calculate how Bruce's earnings growth models would have predicted future growth back then. However, it may be fair to speculate that the depressing effects of the sixties (a poor decade for shares) and the early eighties (smarting from the aftermath of the seventies and faced with a series of radical Thatcherite reforms and high inflation) would have had a sobering effect on the mind of someone seeking to predict growth ten years out. It seems likely to me that these kinds of rates of growth would not have been predicted back then. At many times in the past thirty-five years, Unilever will have looked overvalued, but it will always have been a buy.

And that brings me back to the long term. Yes, Unilever has a steady, predictable business with predictable earnings, but estimates ten years out? It is hard for me to give overmuch credence to predictions of earnings growth this far down the line. The ifs, buts, ands and maybes are simply piled up one on top of another. Anything could and probably will happen before then, but let's look at what we have now. Now, right now, we have a global company with incredible brands, a profitable business and a forward-looking management. Yes, on current valuations it is highly valued. But so is the whole market. To argue against buying this kind of quality simply because it is highly valued and because estimates of forward growth -- based on large dollops of conjecture -- don't come up to scratch seems to me more an argument against investing in shares at all at the moment. That's an interesting debate too, but different to the one we're having here. One fund manager I read about recently has been bearish on shares and predicting doom for so long that the market will now have to fall 60% to vindicate him.

In fact, I'd argue that if you're a bear, if you think the market might turn down because everything is overvalued at present, then Unilever is just the company to buy. Its downside cushion is a lot plumper than that of many other companies. My old mum always said, "David, the world will always need doctors. You'll never be out of a job." She's right, but it will also always need soap and fish fingers (not necessarily in that order). Whatever's coming, Unilever has the power to ride out. Eventually. And that's the key. Unilever is always going to be a long-term investment. Its rapid share price appreciation in recent months will have to be seen as anomalous for the long term, but the question is whether that has taken the wind out of Unilever's prospects for the next few years. The answer is, "Who knows?" Maybe we are seeing a re-rating of equity valuations and companies in a couple of years will be trading at much higher P/Es than they are now. In the Barclays Capital Equity-Gilt Study, economist Michael Hughes values the current state of the market (end 1997) in a number of ways and concludes:

"There is no reason to believe that equity valuations which appear high by past standards cannot be maintained for some years. The lesson of history is that the benchmarks for valuations do change."

Of course, you can always find an economist with an opposing point of view, but if he is right then Bruce's valuations are going to be knocked sideways. Which brings us back to what we have now and what we know for certain. We have a quality company with an excellent past record, global presence, top brands coming out of its ears and a forward-looking management. Unilever is a buy. It's always a buy, whatever the markets or its price are doing. Isn't it?

And if Unilever isn't a buy because of its valuation, then surely Rentokil is now a sell. How about it, Bruce? Let's see some earnings growth valuations on Rentokil at its current price. Should we still be holding? And if the only reason we're holding Rentokil now is because it's a quality company, then we should definitely be buying Unilever.

Tune in Friday, folks, for the next installment of this mighty clash between two titans of the investing world.

In the meantime, the message boards await your comments on this thorny issue. What price long-distance valuations?

David Berger (TMF FoolUK)

Qualiport Numbers

Today's Numbers            Date    01/07/98


          Change     Bid
          pence       £

RTO        0.12      4.40
EMAP       0.25     12.33
MKS        0.05      5.48         


Rec'd       #    Stock       Buy       Now  % Change £ Change

19/12/97  1565  Rentokil     2.55      4.40  72.56%    1.85
17/04/98   337  EMAP        11.85     12.33   4.1%     0.48
11/05/98   722  M & S        5.535     5.48  -1.0%    -0.055


19/12/97  1565  Rentokil 4,040.63  6,886.00  70.4% 2,845.37
17/04/98   337  EMAP     4,043.37  4,155.21   2.8%   111.84
11/05/98   722  M & S    4,052.24  3,942.12  -2.4%  - 95.68

Cash                                    33.96

Total                               15,031.73


                Day    Month    Year    History

Qualiport       2.1%    2.1%    54.5%    58.0%
FTSE 100        1.5%    1.5%    15.3%    17.9%
FTSE All Share  1.2%    1.2%    15.2%    17.6%