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Why I Was Right About Unilever plc (Strong Buy!) & Diageo PLC (Strong Sell!)

Unilever (LSE: ULVR) and Diageo (LSE: DGE) reported their quarterly financial results on Thursday last week, when Diageo was down 3.6% on the day and Unilever ended the trading session up 2.6%. Trends were confirmed on Friday.

In short, Diageo is a bit troubled, while Unilever remains a solid investment at this economic juncture. 

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Diageo & Unilever: So Similar, So Different, In A Way…

These two names are obvious candidates for a diversified portfolio — talking of which, I recently argued Diageo was not a name you should keep in your portfolio. 

“Instead, I’d replace it with Unilever,” I pointed out. There’s no problem if you haven’t followed my advice: you still have time to sell Diageo and buy Unilever, in my view. 

Firstly, the spirits maker operates in a much more volatile sector than Unilever, which is a consumer-goods company that will likely fetch a premium valuation for its assets should it decide to shrink. 

Secondly, Diego’s debt position and dividend policy may come under increased scrutiny if sales continue to fall at a fast pace. This is not to say that Diageo is doomed, of course, but management has a few problems to sort out, both in mature and emerging markets. 

Quarterly Results: Unilever Impresses

Unilever’s first-quarter sales came in above consensus estimates, which supported operating margins — it looks like Unilever still boasts strong pricing power and could also benefit from currency trends into 2016. Unilever could deliver value in different ways, and that reinforces a positive view on its shares. 

By contrast, Diageo’s third-quarter sales figures made for a grim reading almost everywhere, as emerging market weakness continues to weigh on its operating performance. If recent trends are confirmed, I think earnings estimates may soon to come down by 10% or so this year.

On Thursday, SABMiller‘s fourth-quarter results pushed the brewer’s stock up 1.4%. Friday was a good day of trading compared to rivals, too. 

Valuation: Diageo Is Expensive

Diageo is not a bargain. With forward earnings multiples at 22x and 19x for 2015 and 2016, respectively, it trades in line with Unilever, but the latter is delivering on its plan and its forward yield is higher at 3% — its dividend is also stronger than that of Diageo (2.7%), whose net leverage, incidentally, doubles that of Unilever.

Diageo’s equity is overpriced by 20% or so based on its adjusted core cash flow multiples. Of course, Diageo boasts much higher operating margins, but investors are currently focused on the right balance between growth and yield, neither of which provides complete reassurance, I’d argue. 

The average price target from brokers has fallen since early 2014, and downside is in the region of 7% to 15% to the end of the year, according to my estimates. If Diageo hits my short-term price target, it could end the year down more than 10% in 2015. 

By comparison, Unilever trades slightly above consensus, and is up 16% so far in 2015 — I think its shares could soon benefit from upbeat reviews from analysts. Unilever hit a record high of 3,087p on Thursday: a price target of between 3,400p and 3,500p is not overly optimistic in 2015, and that would mean a +34% performance for the year. 

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Alessandro Pasetti has no position in any shares mentioned. The Motley Fool UK owns shares of Unilever. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.