Qualiport

The global giant will soon enter the Qualiport

The Motley Fool is all about education, amusement and enrichment. To that extent, our model Quality Portfolio today announces its fourth Foolish buy. The company we are adding to our portfolio is Unilever, capitalised at over £50 billion. In accordance with the Fool's trading rules, we will be purchasing our £4,000 worth of Unilever shares sometime in the next 5 trading days. The buy report follows, but as usual we start with a word of warning.

The Qualiport is a real money portfolio. The Fools are dipping into their own personal pockets to finance this deal, having saved hard over the preceding months and years. We have no credit card debt and are investing money we don't need for at least 5 years, ideally 10 or more. We have done a lot of homework learning about the company and its numbers, and we are confident that it is a quality company worthy of addition into the Qualiport. Although we've shared our thoughts with you on this site, this is always done with education in mind. We are comfortable buying a part-ownership in Unilever, we know the risks and the possible rewards.

We don't expect or want you to buy Unilever just because we are. As ever, it is up to individuals to make up their own mind as to, firstly, whether investing in shares is right for them, and then, which route they should take. Although Unilever is a huge multi-national company, and the risk of them going out of business is virtually zero, there are risks in investing in individual shares. Anyone interested in other, perhaps safer routes of getting into the stock market should read our Ten Steps To Investing Foolishly.

Finally, some of you may be wondering why we're buying Unilever at around 680p when I recently said I'd struggle to do so on valuation grounds. A duelling Fools contest then ensued, in which Dave argued first that a great company like Unilever is a buy, as no-one can predict at what valuation the company may trade at next year, or in ten years' time. I countered by saying the buy point matters, and that you can make reasonable assumptions about a company's valuation 10 years from now.

Since Dave has failed to counter, I figure I won that little duel. One up to me! OK, that's not quite fair, but I'd be foolish not to use the power of the pen whilst it's my turn to write this thing. So, the next question you may be asking yourself is, "why are you buying Unilever, if you thought they could have been overvalued 2 weeks ago?"

Hopefully the buy report will answer that question. In a nutshell, I'm still a little worried about buying Unilever at their current lofty valuation. However, when we tossed a coin here at Fool UK HQ, it came down heads, and as you know, heads always equals a buy. OK, it wasn't quite like that, but for me, buying Unilever at 680p is a borderline decision. The deciding factor is that we want to be invested in the stock market, knowing that it is the best vehicle for the long-term wealth creation.

The following report uses the cut and paste technique (CAPT -- Fool UK patent pending), taking the salient data from the 7 previous Qualiport reports that were specifically written about Unilever. You can access them direct from our archives. The report is rather long, so you may want to print it out. It is ideal bedtime reading.

As ever, your thoughts, comments and feedback are encouraged to the Qualiport message board.

The Buy Report

Background

The Unilever Group was established in 1930 when the Margarine Union and Lever Brothers companies decided to merge their interests. As measured by market capitalisation, Unilever is the second biggest company listed on the London Stock Exchange, valued at over £50 billion. It has two parent companies, Unilever N.V. and Unilever PLC, although for all intents and purposes they operate as a single entity. The company's shares are listed both as pence in London, and in Florins in Holland. They are also traded on the New York Stock exchange. Since March 1982 to date, the UK shares have gone from an equivalent of 30.875p to about 680p. That works out at a compounded annual growth rate (CAGR) of an amazing 21.3%, before dividends.

The Group has joint top men -- Niall FitzGerald is Chairman of Unilever PLC, and Morris Tabaksblat, who is Chairman of Unilever N.V. Both are long-time Unilever men, FitzGerald (aged 52) having joined the company in 1967, and Tabaksblat (aged 60) having started in 1964. Of the other five members of the top Unilever Executive Committee, the latest starter began at Unilever in 1970. It is obviously a company that promotes from within!

Unilever is a truly global company, employing nearly 270,000 people in 88 countries. In their annual report, they state their corporate purpose as "to meet the everyday needs of people everywhere... with branded products and services which raise the quality of life." They split themselves into two main product areas, Foods and Home & Personal Care, which are sub-divided into 12 Business Groups essentially based on geographical markets.

It is slightly difficult to get your head around how the sprawling group is actually structured. Although it has the main product areas of Foods and Home & Personal Care, for reporting purposes the company is divided into 12 largely Regional Business Groups. For example, there is the North East Asia and Central & Eastern European Business Groups, and each of them will be responsible for selling both Foods and Home & Personal Care Products into their respective markets.

Just to confuse matters, the regional operations of Europe and North America are considered too large to be managed as a single group, and so are sub-divided into 3 European Business Groups and 2 North American Business Groups. Finally, DiverseyLever is organised globally.

When it comes to having a closer look at the numbers, there are therefore at least two ways of looking at the company's margins and growth potential. Firstly, by product category, and secondly, by Business Group. Unilever themselves are putting particular emphasis on growth in the developing and emerging markets of the world. They say these account for nearly 90% of the world's population, and are targeting in particular five priority regions: Central and Eastern Europe, China, India, South East Asia and South Latin America. By comparison, the company is concentrating on margin improvement in the much more mature European and North American markets. The enhanced cash flow they hope to produce will be siphoned into the growth regions. Whilst Unilever can only realistically hope to gain market share in the developed economies, they hope to achieve genuine growth and market leadership in the emerging world.

Products and Brands Foods

This product area is split into various sub-categories.

Oil and dairy based foods includes products such as margarine, butter, olive oil, cheese and bakery. Brands are the name of the game for Unilever, so we'll run through a few that may be familiar. Blue Band, Rama, Brummel & Brown and Bertolli. Ice cream and beverages include Walls, Popsicle, Brooke Bond, PG and Lipton teas. Culinary and frozen foods includes Ragu, Five Brothers, Birds Eye, Oxo, Coleman's and Boursin.

  
                      1997     1996
Turnover £m          14,838   16,739
Operating Profit £m   1,314    1,331
Operating Margin       8.9%     8.0%
  

Similarly to Foods, this area is split into various sub-categories.

Home care & professional cleaning includes products for the laundry, household cleaning and dishwashing. In laundry, popular brands include Persil, Omo, Ala, Domestos, and Jif. Professional cleaning goes under the auspices of the DiverseyLever business, which operates in the institutional and industrial markets. The unimaginatively named company came about through the merger of Diversey and Lever Industrial International and is established as one of the leading companies of its type in the world. Personal care includes personal wash, skin care, hair care, oral care, deodorants and the prestige businesses of Calvin Kline Cosmetics and Elizabeth Arden. Personal wash brands include Helene Curtis, Lux soap (over 3.5 billion bars sold worldwide in 1997) and Dove. Skin care brands include Pond's and Vaseline Intensive Care. Hair care has the Helene Curtis brands of Salon Selectives and Finesse. Also included in this area are Sunsilk and Timotei. In oral care, Mentadent has a strong position in North America, and other brands include Pepsodent and Close-Up. Finally, deodorants include the brands of Lynx, Degree, Suave and Rexona.

                      1997       1996    
Turnover £m          12,933     13,205
Operating Profit £m   1,395      1,325
Operating Margin      10.8%      10.0%

These two operational areas provide the Unilever Group with virtually all its turnover and profits. Foods has the greater sales of the two, but Home & Personal Care makes slightly bigger operating profits. The other tiny (relatively) operational area is called Plantations, Plant Science & Trading Operations. This business provides Unilever with a profitable agribusiness and skills base and focuses on the development and sourcing of raw materials for its food businesses.

A Qualiport Company

Looking at the ten criteria of a quality company, the first hurdle is whether we think Unilever are well managed. As a measure of this, I like to look at a company's past record, and in particular their operating margins. According to Hemmington Scott Company Refs, the overall operating margin has increased every year for the past five years, going from 8.71% in 1993 to 9.91% in 1997. So far so good.

The operating margin percentages are certainly nothing to write home about. The average for FTSE 100 companies is 14.3%, so Unilever are certainly lagging in that department. However, they are moving in the right direction, and in their first quarter summary results released on May 1st, the operating margin jumped to 10% versus a comparable 7.7% in the previous year. This is a truly stunning improvement, and confirms that margins are on the still on the up. Unilever's archrival, US based Procter & Gamble (PG) achieved fiscal 1997 operating margins of 15.3%, and on a trailing 12 months basis they are up to 16.2%. You can look at this either as Unilever being far behind the game and struggling or as a target for them to aim at.

If Unilever were not showing this margin improvement, I wouldn't be happy considering them for the Qualiport. Low margins usually means high competition and little competitive advantage. There is no doubt that Unilever operate in competitive environments, witnessed by the ongoing washing powder wars with PG, and the ice-cream battles with Mars. Brands play an important part of these wars, and Unilever have some of the strongest in the business. That, however, is not enough to guarantee success, and brands require ongoing investment in the form of marketing and advertising. If you turn your back for a moment, chances are the opposition will be in there in a flash. Low operating margins mean a company has to work that much harder for its profits.

The predictability of Unilever's earnings is an advantage. Their global reach and strong brands mean that Unilever are relatively unaffected if one market in which they operate (e.g. Asia) is gripped by an economic downturn, because the chances are that other regions are still contributing to their profits. The other great advantage is that many of the products that Unilever sell are essentials. Regardless of your personal economic situation, you still have wash clothes, eat, clean the home and yourself, and brush your teeth. You will undoubtedly cut back on ice-creams and perfume, but not on most of Unilever's other products and brands. All this adds up to a high degree of predictability surrounding Unilever's profits.

On the face of it, Unilever's sales and earnings growth record over the past 5 years is nothing special. As we found out in earlier reports about them, they are in a constant state of change, so much so that they fully expect to spend ½% to 1% of sales per annum on restructuring. So, before looking at the raw growth numbers, it is worth remembering that in July 1997 they sold their speciality chemicals business to ICI for about £4.6 billion. In 1996, this business had sales of £2.7 billion and returned operating profits of £383 million. As a consequence of this transaction, at the year end Unilever had net cash balances of a whopping £3.2 billion. At any time they so desire, they can therefore go out and spend that money and more on an acquisition, instantly increasing their sales and profits.

Since 1993, turnover has increased by a total of 6.8%, or a CAGR of 1.7%. Normal earnings per share (EPS) have grown every year since 1993 and by a total of 31.1% for a CAGR of 7.0%. Hardly inspiring stuff, particularly when you realise the company is trading at a trailing price to earnings ratio (P/E) of about 33.

Continued in Part Two