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By Rob Davies (TMFEssex)
Unilever (LSE: ULVR) reports results tomorrow, Bruce said to me on Thursday, do you want to listen to the conference call? OK, I replied. Oh foolish me. Three hours into the call and analysts are still asking for clarification of market share growth in deodorant sales in Northern Ecuador, was it half a a percentage or one per cent. I mean, really, could there be a more boring company. The whole question time was devoted to analysts delving into the minutiae of sales, operating margins and market shares for products like Dove soap, ice-cream, tea and shampoo. All the numbers being discussed were in single digits and many of the answers were expressed as basis points, i.e. hundredths of percentage points. This clearly is a very mature, and competitive, business.
Anyway, let's have a look at the results.
The figures being reported were for the third quarter, the three months to end of September. The company emphasised the pre-tax profit of £868m, but did not include in the headline that this was 19% less than last year. OK, that figure looks bad but it is only because last year the company recorded an exceptional profit from the sale of the Plant Breeding Institute. Before exceptional items, net profits actually fell 3% even though turnover rose 2%. The story gets more complicated because operating profits actually rose 3%, because margins rose, but the fall at the net level was due to higher tax and the swing to a net interest charge from an interest credit. After paying out its special dividend Unilever now has a small net debt position so it has to pay interest, rather than receive it as it used to.
On a geographic basis Europe had flat sales. But this was because difficult markets in Russia and Eastern Europe offset strong sales growth in Western Europe. North America was another region that showed no growth, but strong gains in Asia (up 10%), Africa (up 5%) and Latin America (up 4%) were enough to make the result a positive 2% for the quarter. Looking at the figures for the year to date sales are up only 1%, no wonder the company gave money back to shareholders.
What it is trying to do and, to be fair, has had some success at, is raising margins, although again the figures were distorted by last year's exceptional item. Adjusting for that, operating margins stood at 11.3% for the quarter and 13.2% for the nine months. Last year's figures were 10.7% and 13.1% respectively, so the strategy is working, but how far can it be pushed?
Turning to analysis by product the strength of oil and dairy based foods and bakery stuffs, thankfully if unglamorously shortened to yellow fats, is maintained with 17% of group sales, even though sales shrank by 6% in the quarter. Ice cream, not surprisingly, had a good quarter with 8% growth and accounted for 19% of sales. The biggest division is personal care with sales of £1,832m. I think half of that goes on my son judging by the way that he sprays Lynx around the house and only occasionally on himself. Today's Financial Times carries an article on the lengths Unilever executives got to in order to keep in touch with this section of the market. The company has set up a "Youth Board" so that the company keeps in track with a fast changing market. Brand managers are obliged to go to discos and fashionable bars on Park Lane to make sure that they are in touch with latest trends. Wouldn't you just love their expense account?
It is clear to me that this is a company struggling hard, and doing all it can, to extract the last ounce of profit from its business. But in a fundamentally low growth environment is it really going to deliver good returns to shareholders? Let's have a look at some of the analytical ratios.
Unilever had £11,907m of capital employed as of the end of September. On that it earned it £895m, or 7.52%, equivalent, on an annualised basis, to 30%. Now that is impressive. With only £400m of net debt on shareholders' funds of £4,999m the company is still extremely conservatively financed and has plenty of scope to take on more debt. That would reduce its cost of capital even more, which in turn should feed through into improved returns for shareholders.
This company might be in a boring business, but the ability to generate £2,500m of operating cash flow in the first three-quarters of this year is anything but mundane. And, as the company only spent £680m on capital expenditure, it has plenty of financial firepower to increase the dividend.
So after all that how does Unilever stack up as an investment? I recognise the strengths of the company: good financial management, strong brands and a great position in products that people have to buy regularly; like foods and cleaning products. But the sales growth rate is painfully slow. Sure, there is lots of scope for high growth rates in emerging markets like India and Asia, but the reality is that the consumer in the US and Europe is always going to outspend these regions. Sales in Europe are three times that in Asia, so a 10% growth rate there gets rather diluted around the whole group.
My concerns about the potential to raise margins have already been made, so what does that leave us with? A large multinational that will have a tough time growing organically in the developed markets but has scope for better, if more volatile, growth in emerging markets. The stock is yielding 2.25% and the traditional risk free alternative, 10-year gilts, are yielding 5.1%. So the stock only has to rise 2.85% to equal that return. That doesn't seem too demanding, and I am sure the stock can do it. But I feel no great urge to rush out and buy the stock. On balance I tend to agree with the reaction of the market today, pushing the shares down 76p to 465p.
One last point about Unilever, and one that follows on from the last Friday's Qualiport article, is the Y2K effect. Today's report announced that all the preparatory phases are complete and that there is now virtually a freeze on new projects to minimise the risk of disrupting the work that has already been done. The firm estimates that the total cost, through to the end, will be £250m but it admits that there is still the risk of minor failures that might cause business interruptions. This supports the argument put forward by musketk in post 1665 on the Qualiport message board. Why don't you have a look there and see what others said in reply.
Bruce is back on Monday to give an in-depth report of the Misys (LSE: MSY) briefing at the Savoy yesterday. And don't miss his Tuesday bribble on tomorrow's match.
Company Change Bid DELL(US)+0.60 42.50 EMA -0.26 8.15 IIG -0.05 2.88 MSY +0.02 5.89 PIZ 0.00 7.80 RTO +0.06 2.06 ULVR -0.75 4.65 LLOY -0.07 8.50 Qualiport Stocks Last Rec'd Total # Company Buy Current Change 29/09/99 356 Lloyds TSB 7.56 8.50 12.5% 27/10/98 1133 Indep Ins 2.60 2.88 10.8% 22/04/99 542 Misys 5.57 5.89 5.7% 04/11/98 245 Pizza Exp 7.93 7.80 (1.6%) 27/01/99 74 Dell (US) 44.63 42.50 (4.8%) 19/12/97 783 Rentokil 2.55 2.06 (19.2%) 17/04/98 301 Emap 10.20 8.15 (20.1%) 17/07/98 266 Unilever 7.53 4.65 (38.2%) Last Rec'd Total # Company In At Value Change 29/09/99 356 Lloyds TSB 2723.20 3026.00 302.80 27/10/98 1133 Indep Ins 2990.63 3263.04 272.49 22/04/99 542 Misys 3065.85 3192.38 126.54 04/11/98 245 Pizza Exp 1966.34 1911.00 (55.34) 27/01/99 74 Dell (US) 2007.42 1906.06 (101.36) 19/12/97 783 Rentokil 2046.53 1612.98 (433.55) 17/04/98 301 Emap 3139.85 2453.15 (686.70) 17/07/98 266 Unilever 2052.00 1236.90 (815.10) Cash: £ 9.01 Current Total : £18,610.52 Total Invested: £20,184.62 Profit/(Loss) : (£ 1,574.10) Value Per Share Day Month Year Qualiport -1.45% 3.66% -11.88% FTSE 100 0.40% 1.61% 8.06% FTSE All Share 0.41% 1.91% 10.70%