Does Unilever have "expensive defensive" written all over it?

10th Nov '17 by UK Value Investor

14 comments 8298 reads

Unilever is one of those defensive income stocks investors love to love.

In fact, investors love Unilever shares so much they’ve pushed the price up from £25 in 2015 to a recent high of £45.

Does this mean Unilever is an "expensive defensive"? High quality, but overpriced?

Unilever: A defensive growth stock in a world of frightening volatility

Investors love Unilever because it’s pretty much the closest thing you’ll find to a sure thing in the stock market.

It sells everyday branded consumer products like Domestos detergent, Dove soap and Magnum ice cream to millions of people around the world.

These items are priced at a premium relative to unbranded alternatives, and that premium ends up as profits on Unilever’s income statement and dividends in shareholders’ pockets.

Because these products are bought every day by millions of people, Unilever’s revenues, earnings and dividends have been very steady over many, many decades.

The company’s recent performance looks like this:

As you can see, the general trend is upwards, and while earnings declined for several years following the financial crisis, the normal state of affairs (i.e. earnings growth) has been resumed.

Cautious, defensive dividend investors just cannot get enough of this stuff, especially when the Unilever Fact Sheet says that Unilever’s dividend has increased by 8% per year since 1979!

And the latest annual report has this to say:

Over the last 5 years our dividends have increased 7% per annum and our share price is up by around 50%

The company also has other attractive features, including:

High profitability: High margin branded products have given Unilever an average return on capital employed (ROCE) over the last decade of 15%, well above the market average of 10%.
Reasonable capex requirements: With no need to build retail stores or relatively little need to invest in factories and other equipment, Unilever’s capex-to-profit ratio has averaged an undemanding 44% over the last decade.
No excessively large acquisitions: Acquisitions can destabilise an otherwise stable business, but Unilever has not been overly aggressive with its acquisitions. Over the last ten years, total acquisitions came to just 23% of total profits.

In summary then, Unilever appears to be a genuinely great company and up to this point, I’ve been unrelentingly positive about it.

However, it is possible to view Unilever through glasses which are decidedly less rose-tinted.

Unilever’s days as a growth…

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Housemartin2

17th Dec '17

Interesting analysis and I don't really see anything to which I disagree. I think we would all agree that in general stocks are overvalued (that is on an historic comparison) but the reasons for this looks slow to change.

I wondered how Unilever's sale of it's Spreads business sits with your analysis ? It has good margins but flat sales growth: a microcosm of the company itself perhaps. Personally I am not impressed with the idea of passing the proceeds to shareholders (unless there are value accreting acquisitions to be had). I would much rather it was used to reduce debt than give it to shareholders.

(As an aside, I see that my shareholding was acquired at an average of £18.74 with the last purchase at £24.45 back in April 2012)

timarr

For an alternative view Lindsell Train did an analysis of the compounding effect on Unilever back in February - which was just before the Kraft bid, although the PE now is pretty much the same as back then, so I don't think it would alter their view:

So, to our final question: what PE would have represented a fair price for Unilever 20 years ago? (i.e. to discount its subsequent outperformance)? Well, given the observed 11.3% pa return attributable to Unilever’s dividend yield and growth, we’d need a -5.1% hit from PE contraction (and consequently lower starting yield) to get us to the MSCI World’s 6.2%. Hence for Unilever to have ended up at its current valuation of 22x earnings after the 20 years had elapsed, only a starting PE of 46x would have produced the required headwind. This isn’t perhaps unheard of for a low earnings/high growth, speculative tech stock, but is for most investors an almost unthinkable valuation for a ‘mature’ consumer staples company. It tops even the 44x millennium bubble peak - the highest adjusted PE ratio observed for the US market as a whole in 145 years. So with Unilever’s shares trading on a PE of 22x, can they continue to outperform over the long - term? We’re optimistic.

It's at http://www.lindselltrain.com/i...

("Confounding Compounding")

It's a pretty startling finding. Of course, LT's holding period is pretty much forever, but you can see why they'd be buyers at this level, rather than sellers.

GrahamF

Not so sure that Amazon is a substantial threat. If consumers want an unbranded, or let’s say value branded product, there’s already plenty of them out there with low prices by way of supermarket own label, that can be delivered to your door through the distribution systems of the supermarkets. I think I am right in saying that Lidl don’t do home delivery yet. So perhaps Amazon are more a threat to Lidl than to manufacturers like Unilever.

UK Value Investor

18th Dec '17

I don't really have a strong opinion about the sale of the spreads business. In its latest annual report, Unilever said "Sales in spreads declined as modest growth in emerging markets was offset by the continued but slowing decline in developed markets", so the business wasn't exactly setting the world on fire. I also prefer most companies to be narrowly focused rather than widely diversified, so from that point of view it also makes sense to get rid of spreads. But from a valuation point of view it doesn't change my view.

As for where the proceeds go, a bit less debt might be a good idea. Failing that, as you say it should just go where ever expected returns are highest, be that within the company or with shareholders.

The math is undeniable, but it involves looking back 20 years. Unilever's fundamental growth has been far less impressive over the last few years, closer to 3% than 11%. So although a high price was justified 20 years ago, I think it is much harder to justify today and as Train points out, it requires much optimism (which I lack!).

Hi Graham,

Possibly, but I see Amazon's own brand being a threat with middle of the road products as well as value products.

The only suitable products (i.e. ones that people don't want to feel or taste or try on in store) that might be safe are luxury items where the brand name is part of the product. Some of Unilever's products fall into that category, but many don't. And if shoppers trust Amazon, then they'll buy Amazon Shampoo because it'll be cheaper and easier to get from one place (Amazon) and automatically ordered and delivered once each month (or whatever).

Having said that, I could be completely wrong and my point about Unilever being expensive doesn't depend on Amazon taking over the world. It just depends on Unilever not continuing to double in size every decade.

Rusty2

Not everyone wants home delivery either, I have almost stopped doing online buying unless I know the product because most of the time I either have to send it back or I don't like it and would not have bought it in the first place if I had seen it in the shop, this is mostly for clothes. Unless you spend over £20 you have to pay postage and many things on Amazon are not any cheaper. For brands I think you are better off buying in Wilko, own brands then Aldi or Lidi, I would not consider buying Unilever type products online. Of course we are mainly talking UK, Amazon is hardly known in some of the Unilver markets. Amazon sales are 67% USA. Alibaba maybe a bigger threat?

JohnEustace

Amazon has 34 different private label brands in the US. Most, including Presto! (soaps, detergents, dishwasher tablets, tissues) are not explicitly identified as Amazon brands.

I wouldn't have any problem trying them out, but then we already buy the Costco Kirkland brand for those purchases.

https://www.amazon.com/b?node=15435505011

Look very expensive. I usually buy from Aldis or I buy brands on special offer, handwash is about 70p, so Amazon is a considerable premium. Shampoo I buy Aldi Tea Tree Shampoo £ 0.49 100ml, I find that as good as any branded one. So no I doubt agree it will be cheaper.

19th Dec '17

Well, if Unilever had been on a PE of 44 back in 1987 I doubt that anyone would have considered that fair value, but they'd have been wrong. And in considering returns you've got to look at inflation and interest rates to come up with an accurate comparison - a 3% return over the past few years is equivalent to a higher return in years of yore.

In any case, if Unilever is unable to extract the level of returns commensurate with their array of brands they will get taken over, we already know that Kraft have run their rule over them. Unilever's paternalistic model of management has depressed returns somewhat, but there's nothing like the threat of extinction to galvanise management.

Meanwhile Amazon may have perfected a no growth business model but that can't last forever: even post-modern investors will eventually want some real earnings to go with their stock: if a thing can't go on, it won't, eventually.

Anyway, Nick Train and Terry Smith think Unilever is good value at this level, you don't. In 20 years we can look back and see who was right :-)

timarr

"Nick Train and Terry Smith think Unilever is good value at this level, you don't. In 20 years we can look back and see who was right :-)"

Assuming I'm still alive, I look forward to it!

Albertos

In answer to the original question, a wholesale yes!

When pondering a strategy for a potential downturn I looked into "Consumer Defensives" - the only thing a found here was massively overpriced shares.

I note today in the SCVR thread that people were asking why Nichols (LON:NICL) had fallen when the update was only slightly downbeat - its because firms in "Consumer Defensives" are judged to be worth at least a 5 addition to their acceptable EPS compared to the rest of the market - any slight wobble and they crash.

There's loads of stuff out there better than this sector.

Phil

My opinion, no advice and I don't hold any shares in this sector.

Meant 5 addition to their PER - sorry!

Phil

Stephen Bland

21st Dec '17

I agree that from a value investor's viewpoint, ULVR is way too dear. VI's seek certain cheap fundies such as for example low price/tangible book, low P/E, high yield, low or nil debt and so on. I can't see that ULVR exibits any traditional value features and the discussion, judging by the author's handle, presumably is to do with its merits as a value play, not any other approach.

However I can see that for some investment styles it might be attractive, in particular the approach of simply buying a diversified portfolio of blue chips to be held in perpetuity, almost regardless of fundamentals. Anathema probably to most here, but I am aware of some people who do just that.

I've picked it in the past for my equity income newsletter but that was at far lower prices when its yield was much more attractive and HY is a component of value. But since the price shot ahead, the yield is no longer in this territory so some time ago I dropped it to a hold.

Does Unilever have "expensive defensive" written all over it?

Unilever: A defensive growth stock in a world of frightening volatility

Unilever’s days as a growth…

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