Although Kraft Heinz swiftly announced that it was abandoning its attempt to buy Unilever (LSE: ULVR), a number of analysts expect Kraft Heinz would look to make a renewed bid for Unilever’s food and refreshments business. That’s because the US food group has big plans to shake up the low-growth foods industry and has the firepower to undertake such a deal, thanks to backing from Warren Buffett’s Berkshire Hathaway and Lemann’s 3G Capital.
But even if Kraft Heinz doesn’t return with another offer, I don’t expect things to return to normal for Unilever. I expect the failed bid to serve as a wake-up call for its management — and it seems that management acknowledges this too, as it released this statement on Wednesday: “Unilever is conducting a comprehensive review of options available to accelerate delivery of value for the benefit of our shareholders. The events of the last week have highlighted the need to capture more quickly the value we see in Unilever.”
Accelerate cost cuts
First and foremost, management will face pressure to boost margins. That’s because its near 15% operating margins lag well behind the 25%-30% margins generated by peers such as Reckitt Benckiser, Colgate-Palmolive and Kraft Heinz. It could look to accelerate its cost savings programme in a bid to match its rival manufacturers’ profitability, but a more aggressive approach may be adopted.
Paul Polman, chief executive, is well known for his long-term value-creation model, following his decision to scrap quarterly reporting at the company. But he may decide this is the time to focus more on short-term value, by adopting a strategy called zero-based budgeting, which 3G Capital’s austere empire-building relies upon.
Dividends/buybacks
Had Kraft been successful in buying Unilever at around 4,000p a share, this would have raised the combined company’s net debt to around 5-6 times its EBITDA. As a standalone company, Unilever has net debt of only €12.6bn, which shows that it has the potential to leverage up to unlock value.
Analysts from Credit Suisse believe that should it increase its leverage to a still modest level of three times EBITDA, that it has the potential to buy back €20bn worth of its shares, or pay a special dividend of around €7 a share, which equates to a yield of around 17%. With interest rates still hovering near record lows, a buyback could be significantly accretive to earnings per share, while special dividends would likely only be slightly dilutive.
M&A
An alternative to returning cash to shareholders could be to bulk up Unilever’s personal care business. Sales of personal care products are growing much faster than they are for foods, while margins are holding up better.
It’s clear that management is already expanding into the market with recent acquisitions, such as the Dollar Shave Club and Dermalogica, albeit it is doing so at a much slower pace. Some have speculated that a tie-up with US consumer company Colgate-Palmolive could be much more transformative.
Bottom Line
Exactly what Polman and his team will do remains to be seen, but if there’s one thing I’m sure will happen, it’s that Unilever will announce big changes in the coming months.
