Qualiport

[ February 28, 2000 ]

Any Reprieve For Unilever?

By Maynard Paton (TMFMayn)

Carburton Street, London -- Qualiport stalwart Unilever (LSE: ULVR) unleashed its 1999 full year results on the world last Tuesday. The stodgy Anglo-Dutch company is currently walking the plank on the good ship Qualiport, charged with miniscule sales prospects. Currently, they are about to be tossed overboard whenever the share price decides to arrive at a half decent level. So, was anything revealed in the results to give the consumer goods company a reprieve?

Well, looking at the actual results, there was nothing too out of the ordinary. Unilever was keen to flatter the financial presentation by presenting the figures using constant 1998 annual exchange rates. But I've ignored them, and instead have gone for the "real life" figures using the current exchange rates. These are the figures shown below.

                        1999      1998   Change
                        (£m)      (£m)    (%)

Sales                  26,994   27,094     0
Operating profit
 (pre exceptional)      3,012    2,871     5
Pre-tax profit          2,860    3,085    (7)
Earnings per share (p)     26.01    26.45 (2)

Uh oh... I'm not getting a very good first impression. Total group sales were flat during 1999. But interestingly though, there is movement beneath the surface.

Region                          Sales
                         1999    1998  Change
                         (£m)    (£m)    (%) 

Europe                  12,378  12,711   (2)
North America            5,822   5,640    3
Africa and Middle East   1,514   1,439    5
Asia and Pacific         4,429   3,888   14
Latin America            2,851   3,362  (15)

Turnover in Europe was hindered by the disposal of a few food businesses, but Unilever did state that volumes had improved by "a full percentage point". Wow. Overall in Europe, strong growth in deodorants (the fourth year of double-digit volume improvements!) and washing powder offset declines in the various food products.

It was a similar sort of story in North America. Personal care products, notably Dove soap, saw their volumes increase 5%. But again, food sales had declined 2%, mainly due to the disposal of an "industrial tomato" business. Slightly more impressive were the 6% volume increases in Africa and the Middle East, washing powder, soap and tea being the outperformers in the this region.

But the best region of all was the Far East, as overall volumes rose 7% to "more than match the economic recovery". Would you believe, volume sales of shampoo increased by 16% in China? And yet again, it was the further sales of soap and deodorants that offset the "less than satisfactory" progress in food revenues.

It's quite interesting to compare these sales growth figures to that other consumer goods company Diageo (LSE: DGE), reviewed recently in the Qualiport column.

Although I've had to jig the numbers around for Diageo, to get comparable figures for the last two calendar years, it's slightly surprising to discover the differences in geographical performances between the two companies. In terms of revenues, whereas Unilever scored a 2% decline in Europe, a 3% rise in North America and a 14% leap in the Asia and Pacific regions, Diageo has recently posted 6% or 7% rises in each of those locations.

In the mature markets of Europe and North America, that was quite an impressive performance from Diageo. But I still have the opinion that for the long term, it's the developing world that holds the key for sustained revenue growth for a global consumer goods business.

Unilever already generates a greater proportion of its sales outside Europe and North America than Diageo, 37% versus 17%. Unilever also has a range of products that possess far more mass-market appeal (with apologies to TMFAlan's wife) than the best sellers in the Diageo stable. I still feel that, as and when revenues in China, Indonesia and India really start to take off, that impact will be far more beneficial to Unilever than to Diageo.

But having dreamed of Asian and Far Eastern riches, back to reality.

The Next Five Years

Back in September, Unilever announced a refocus of its vast array of brands. Around 1,200 brands are to get the chop, as the company concentrates on its strongest 400. With the obligatory e-business implementation and a rationalisation of manufacturing sites, the focus on certain brands will help to "increase annual top line growth to 5% and operating profits to 15%" by 2004.

Unilever also points out that the average growth rate for its top 400 brands over the last two years has been 4.6%. By 2004, the company declares that it will have accelerated the growth of these brands to over 6% per annum. Indeed, Unilever are most considerate in giving indications of both revenues and earnings for the current year. Top-line growth will be in the range of 3% to 4%, and through further margin improvement, earnings per share growth should come in the range of 8% to 10%.

With all these helpful figures supplied by Unilever, it does seem a waste not to try and use them.

Thus, if we assume that sales growth will be, over the next five years, 3.5%, 4%, 4%, 4.5% and 5%, total group revenues produced in 2004 will be £33,943m. Assume also that the 15% operating target is met, and that gives an operating profit of £5,092m in 2004. Tax that at the current rate of 31.5%, and we are left with earnings of £3,488m, or earning per share of 50.05p.

Even assuming that no re-rating occurs on the Unilever share price over the next five years, and that it still remains on the rather undemanding historic price to earnings (P/E) ratio of 13.8 in 2004, the anticipated share price five years out could be around 691p (13.8 * 50.05p). Just to put that price into context, the Qualiport bought Unilever at 672p in July 1998.

At today's share price of 359p, a price of 691p five years forward gives a compound rate of share price of return of 14%. Add in also our total expected five year dividend payout of 70p, and that boosts our compound average return to 16%. Hmmm...

All those calculations rest on the management meeting their stated targets, and I've got no reason to suggest they won't. Looking at a potential doubling of earnings over five years does appear a little enticing, albeit primarily generated through cost-cutting.

But I'm certainly not about to announce a Unilever top-up!

I'm on record as saying that I want to sell Unilever. And the 1999 figures haven't really inspired me to change my mind. But the solid comments about the future sales and profits potential has certainly persuaded me against immediately dumping Unilever. Like Bruce, and especially given the current outlook potential, I am loath to sell Unilever on the cheap. Using the risk-free rate of return from government gilts, around 6%, and apply that to this year's consensus earnings per share expectations of 28.4p, you get a "fair price" of 473p (28.4p/0.06).

Should Unilever approach the dizzy 473p level this year, it will be time to push them overboard.

So, am I wrong to disregard material earnings growth through cost-cutting? Or am I correct to focus purely on companies that have significant avenues for sales growth? Let us know you thoughts over on the Qualiport message board.

Related Links
• Fool Buys Unilever
• Damn These Markets (and Unilever)
• Diageo -- Another Unilever?
• Unilever -- Selling Out On The Cheap? (And at 478p, I wish we had)

Note
The Qualiport was launched on December 19th 1997 with an initial investment of £4040.63, all in Rentokil Initial. Further cash was added as holdings in Emap, Marks & Spencer and Unilever were bought during 1998. The vagaries of the value per share accounting method caused percentage return calculations for calendar 1998 to be somewhat distorted. To avoid confusion and somewhat misleading figures, the Qualiport's returns are being measured from 1/1/99, at which point the total portfolio value, including cash, stood at £16,809.60. An additional £2000 cash is added to the portfolio on April 1st and October 1st each year. The total cash investment in the portfolio to date has been £20,184.62. To access the Qualiport's total trade history, click here.