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Small Caps vs Large Caps: Should You Buy Premier Foods plc Instead Of Unilever plc Or Associated British Foods plc?

Unilever

Unilever’s (LSE: ULVR) strength is underpinned by its range of globally recognised brands and the scale of its operations, which allows it to maintain wide profit margins. But, the company faces stiffer competition, and economic headwinds continue to put pressure on its growth.

Underlying volume growth in 2014 slowed to just 1.0%, down from 2.5% in 2013. Although core EPS still rose by 2%, higher prices are largely the cause. The ability to raise prices reflects the strength of its brands, but it will become more difficult to do the same with increased competition.

Despite lower expectations of earnings growth, Unilever shares have a forward P/E of 21.2, and have a prospective dividend yield of 3.1%.

ABF

Associated British Foods  (LSE: ABF) is not just a food manufacturing business, as food brands ranging from Twinings to Ryvita account for just over a quarter of the group’s revenues. But, its brand-focused business does share many similarities to the other two companies. Its size and diversification enables it to generate stable cash flows that differ to the volatility of smaller rivals.

Unfortunately, its valuation is even more expensive than Unilever, despite slowing earnings growth. It shares trade at a forward P/E of 29.9, with forecasts of a 6% decline in earnings for 2015. ABF’s prospective dividend yield is just 1.2%.

Although continued expansion in Primark and its other brands is likely to put pressure on earnings growth, revenue growth is only forecasted to be 1% in 2015 and 7% in the following year. A combination of slower growth and a pricey valuation is unattractive for value investors.

Premier Foods

Premier Foods (LSE:PFD), the owner of Bisto, Loyd Grossman, Mr Kipling and many other well known food brands, has long been suffering from a high debt load and massive pension liabilities. Many of its brands have also lacked modernisation, making them appear as if they were more suited for post-war austerity.

Over recent years, management has made tremendous effort to address its problems. Net debt has fallen from £1.26 billion in 2011 to £585 million now. In the last year alone, the pension deficit has been lowered by £392 million to currently £212 million.

The company has also invested heavily in new products, ranging from smaller cake sizes designed for kid’s lunch boxes and higher margin gravy granules made from real meat juices.

In modernising its brands, the company spent an additional £8 million on television adverts in 2014, causing marketing costs as a proportion of branded revenues to rise to 4.8%. This has put pressure on trading profits, which continue to decline. Looking forward, spending on advertising could rise further, as the proportion of marketing costs to revenues is three times higher for Unilever.

As incumbent supermarkets lose market share, Premier Foods has been seeing its volume and revenues continue to decline. Recognising that the grocery industry is rapidly changing, Premier Foods has been expanding the availability of their products to online retailers and convenience stores. Together with the increase in brand investment, this should help to offset the loss from supermarkets.

With food deflation, growing revenues has become even more challenging; but with further cost savings, underlying profits before marketing expenses should continue to grow in the medium term. It shares trade at a forward P/E of just 4.8, based on expectations for adjusted EPS of 8.85 pence.

Prefer Premier Foods

Expensive valuations for Unilever and ABF make Premier Foods relatively more attractive. With such a low valuation and so many strong brand names, Premier Foods is an attractive turnaround play.

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Jack Tang has no position in any shares mentioned. The Motley Fool UK has recommended Unilever. 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.