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SUMMARY: As I sit outside eating scoops of Ben & Jerry’s Cherry Garcia ice cream under the sun drying the possible corona virus molecules on my clothes, and watch the markets crash, the ice cream and the markets reminded me of Ben & Jerry’s parent company that was formed one month before the stock market crash of Wall Street in October 1929, Unilever. When I started out in VIC, I spent so much time following those Graham&Dodd companies and all in all it was too much wasted energy.  Instead, I like to buy companies whose habit-forming products I regularly use or consume. It is much less exhausting and I notice I don’t have to watch the market everyday when my portfolio is filled with these companies. I recommend that, over the next 18 months, to buy quarter-sized positions over 4 trades in this consumer staple company for an annualized 13% in 5 years, including dividends. (Note: I wrote this report when UL was at $45. With the recent volatility and weak near-term results, I am convinced, Unilever will be purchasable at $45 price over the next few weeks)

TABLE OF CONTENTS

1. NEAR-TERM OUTLOOK: NEGATIVE

2. LONG-TERM POSITIVES

1. Unilever has long-term competitive advantages. Think “Time is the enemy of the fad business, but a friend of the good business”. 

2. Lots of room for improvement in gross margins, and operational expense margins.

3. New Ceo Alan Jope.

4. The announcement of a strategic review of the global tea business, which may be a precursor to further portfolio adjustments by new CEO Alan Jope. 

5. Kraft’s attempted take-over in 2018 at $50 has lit a fire under the management’s behinds to work for shareholders. If management does not perform, they will lose their jobs when Kraft successfully makes another attempt to buy it. 

6. Unilever’s complicated structure will be simplifed to get a higher market multiple.

3. VALUATIONS

4. WHY MISPRICING

5. CATALYSTS

6. OVERVIEW OF COMPANY

7. CONCLUSION

1. NEAR TERM NEGATIVE RESULTS HAVE CAUSED THE STOCK PRICE TO DROP 

“I have never met a cheap stock where the near-term outook is not miserable” -- Marty Whitman

Forget about the next 1 to 1.5 year outlook, it is going to be miserable. 

A weak fourth quarter with organic sales growth of 1.5%, the lowest quarterly growth rate in around a decade, subdued guidance of 2% sales growth for 2020, shows the structural lack of pricing power of a multinational brand these days. Volume growth was 1.1%, and price/mix growth was 0.4% with 1.9% price/mix achieved in the foods and refreshment segment. Divisional volumes fell 0.5%, but if Unilever can better position its portfolio into faster-growing categories, it is possible it can reignite growth in this business unit.

2. LONG-TERM POSITIVES

“Time is the enemy of the fad, but a friend of the good business” - Buffett

However, in the longer-term, some measures are in place to bet that management will take needed steps to increase profitability, ROE for Unilever. I recommend buying a quarter to a third position now, revisit a year later to buy more and have a full position in 1.5 years for a 13% annualized position from year 5 to year 10. 

1. Unilever has long-term competitive advantages. Think “Time is the enemy of the fad business, but a friend of the good business”.

1. Unilever’s track record, where ROIC has averaged 19% during the past five years and 20% during the past 10.  

2. Unilever’s entrenchment in the supply chain of retailers.  The firm’s diversified portfolio of 400 brands, 13 of which generate over $1 billion euros in annual sales, creates a virtuous cycle of competitive advantages, that new entrants simply could not replicate. 

3. Strong negotiating position for limited, scarce physical shelf space among retailers.

4. Retailers minimize their risk when they offer their retail slots to Unilever versus companies with smaller brand portfolios.

5. New entrants must pay a lot higher than Unilver to get shelf space

6. Unilever has one of the strongest cost advantages in the space with the lowest costs per employee, behind only Estee Lauder and L'Oreal. 

7. Unilever’s economies of scale, consistent commitment to advertising and marketing expenses (14% of revenues),  give it a significant competitive advantage against new entrants. This level of spending creates a virtuous cycle, making the products more appealing to distributors and retailers, in turn increasing the likelihood that they will win shelf space. 

8. In the few times upstarts are able to grow their markets against Unilever, Unilever has the free cash flow generative ability to buy these brands, such as Dollar Shave Club.

2. Lots of room for improvement in gross margins, and operational expense margins.

1. Table below shows Unilever’s selected items.  Row E and Row F are the gross margins and operating expense as percentage of revenues.  Compare Unilever’s Opex % of 27%, and Gross Margins of 44% VERSUS Kraft-Heinz has Opex % of 13% , and Gross Margins of 32%.  Lots of room for growth. Kraft saw this with much confidence because Kraft made a purchase offer for Unilever, despite Kraft’s dealing with Kraft’s own problems. 

3. New Ceo Alan Jope.

1. The new CEO who came on board in 2019 is Alan Jope. The hardest part of analyzing a “moat”-type of company is analysing management. I employ executive search firms and expert networks to consult with me to analyze CEO and management team. I admit this is art not science. But I have a good subjective view of Jope.

2. He is more a of a natural marketer than a finance person.

3. He is comfortable in the limelight

4. He is a lifer at Unilever

5. He knows China, North America, North Asia, Russia, Africa, Middle East and India very well, having run divisions there with praise for several years.

6. He understands technology and digital and he founded a tech hub in Tribeca, New York City for digital advertising of Unilever’s products.

7. He bought Dollar Shave Club

8. He has the people skills: funny, amiable. 

9. He knows the food and health&beauty products

10. He is continuing to focus on marketing sustainability of Unilever, which I think is the right approach, contrary to the views of most activist investors.  75% of Unilever’s sales growth comes from the sustainability aspect of the portfolio.

11. You can read the bibliography footnotes section to read more about the CEO.

4. The announcement of a strategic review of the global tea business, the PG Tips and Lipton brands, which may be a precursor to further portfolio adjustments by new CEO Alan Jope. 

1. Tea business will sell for about $9B. 

2. Unilever sold its spreads business for about $8 billion in 2018.

3. There will be more businesses sold allowing Unilever to focus more. This playbook is similar to what P&G did.  P&G stock finally ran up as much as 50% in 2018 to 2019. 

5. Kraft’s attempted take-over in 2018 at $50 has lit a fire under the management’s behinds to work for shareholders. If management does not perform, they will lose their jobs when Kraft successfully makes another attempt to buy it. 

1. The recent approach from Kraft Heinz scared management of losing their jobs. Management established cost-cutting goals and a new set of financial targets is both necessary and achievable.  However, with the firm having rebuffed the approach from Kraft and denied shareholders a potentially material takeout premium, we think the pressure will be on management to deliver. If they don’t, 3G will come back and make another takeover offer at 15 times EBITDA, a premium to today’s price. 

6. Unilever’s complicated structure will be simplified to get a higher market multiple.

1. Unilever’s structure as a dual-holding company with two sets of shareholders is complicated, strategically inflexible, hard to analyze. In 2018, it tried to simplify its structure, but it was cancelled when some British investors complained.  I think simplification is the right move and it will happen in the near future. 

3. VALUATIONS

1. PEER GROUP RELATIVE VALUATION

Source: MarketScreener

HISTORICAL VALUATION

You have to go back to 2012 to see Unilever trade at today’s low valuations. 

Source: Morningstar

VALUATION ANALYSIS:

At 2.2 times EV/Sales 11 times EV/EBIT, 9.8 times EV/EBITDA Less Mtc Capex, 19 times Price to FCF, Unilever has never been this cheap since 2012.  It is also the cheapest among its peers. Most consumer staples companies are bought by strategic buyers at multiples of around 15 times EV/EBITDA. With much room for improvement and justifiable reasons that management can achieve its stated goals after thwarting a takeover bid by 3G,  Unilever’s profitability margins can improve by 3 percent, from gross margin growth, cost-cutting, within five years. Assuming they sell the tea business for $8B and reduce debt by that amount, and they achieve a 10% increase in revenues in 5 years. We have a company with $52B in revenues, $14B in EBITDA, Net Debt of $15B.  Applying a 15 times multiple give us $75 plus another $8 in dividends, equating to about $83, for a total annualized return of 13% per year, from the $45 stock price. 

Relatively speaking, is one of the most inexpensive dominant consumer staple companies in its group.

PRIVATE MARKET VALUATION:

Kraft-Heinz’s 2017 attempted buy-out price gives us a big clue.

When shrewd 3G investors (with the support of Warren Buffett)  made a $50 a share price take-under offer of Unilever about 3 years ago,it was an EV/EBITDA multiple of 15 and  3G applied a discount rate of at least 10% in their valuation analysis. The failed takeover gave us a gift: the appraisal value by the  strategic buyers in the industry of Unilever’s private market valuation. The valuation was EV/EBITDA of 15, Price to FCF of about 22 times.

Today, you can buy Unilever below the price that 3G offered for in 2017, and the company’s profitability has increased, with new management, and still much room for operating improvement.  

4. WHY MISPRICED

There are many reasons for this perceived discount:

1. Recent short-term results have been poor.

2. Listed in Non-US exchanges where money flow for the last 10 years has gone to S&P500 companies

3. Many people do not understand the dual corporate listing structure of Unilever

4. The Brexit discount applied to British companies

5. Brands are not as well known as its competitors like Nestle, Procter & Gamble, Coca-cola, Pepsico.

6. It is not as focused on one niche (food or health & beauty) as other competitors (either food only or heath&beauty only).

7. Unilever has a complicated structure.

8. cancelled its plans to simplify its structure in October 2018 after announcing the simplification plan in March 2018.

5. CATALYSTS

1. Catalyst #1 

Management  got their scare of losing their jobs when 3G offered to buy them out.  They are focused on cost-cutting. I am convinced that within the next five years, 3G will come back to bid for Unilever. This makes sense because 3G has the financing competitive advantage, the cost-cutting advantage to further increase profitability of Unilever. Compare Unilever’s Opex % of 27%, and Gross Margins of 44% VERSUS Kraft-Heinz has Opex % of 13% , and Gross Margins of 32%.  

2. Catalyst #2

In addition to cost-cutting, management wants to get a higher market multiple. 

Management still wants to simplify its complicated structure and that will happen within the next five years.

6. COMPANY OVERVIEW

Unilever is a British-Dutch transnational consumer goods company co-headquartered in London, England, and Rotterdam, Netherlands. Its products include food, energy drink, ice cream and beverages (about 40 percent of its revenue), cleaning agents, beauty products, and personal care products. Unilever is one of the oldest multinational companies; its products are available in around 190 countries.

Unilever owns over 400 brands, with a turnover of at least 53.7 billion euros, and thirteen brands with sales of over one billion euros; Axe/Lynx, Dove, Omo, Heartbrand ice creams, Hellmann's, Knorr, Lipton, Lux, Magnum, Rexona/Degree, Sunsilk and Surf. It is a dual-listed company consisting of Unilever N.V., based in Rotterdam, and Unilever plc, based in London. The two companies operate as a single business, with a common board of directors. Unilever is organised into four main divisions – Foods, Refreshment (beverages and ice cream), Home Care, and Beauty & Personal Care. It has research and development facilities in China, India, the Netherlands, United Kingdom and United States.

Founded in September 1929, Unilever was formed by the merger of the Dutch margarine producer Margarine Unie and the British soapmaker Lever Brothers. During the second half of the 20th century, the company increasingly diversified from being a maker of products made of oils and fats, and expanded its operations worldwide. It has made numerous corporate acquisitions, including Lipton (1971), Brooke Bond (1984), Chesebrough-Ponds (1987), Best Foods (2000), Ben & Jerry's (2000), Alberto-Culver (2010), Dollar Shave Club (2016) and Pukka Herbs (2017). Unilever divested its specialty chemicals businesses to ICI in 1997. In the 2010s, under the leadership of Paul Polman, the company gradually shifted its focus towards health and beauty brands and away from food brands showing slow growth.

Unilever plc has a primary listing on the London Stock Exchange and is a constituent of the FTSE 100 Index. Unilever N.V. has a primary listing on Euronext Amsterdam and is a constituent of the AEX index. The company is also a component of the Euro Stoxx 50 stock market index.

7. BIBLIOGRAPHY

1. https://en.wikipedia.org/wiki/Alan_Jope

2. https://www.wsj.com/articles/unilever-picks-insider-as-new-ceo-1543478395

3. https://fortune.com/2018/11/29/new-unilever-ceo-paul-polman-alan-jope/

4. https://uk.reuters.com/article/us-unilever-results/unilever-stirs-the-pot-with-review-of-global-tea-business-idUKKBN1ZT0M8

5. https://www.fooddive.com/news/unilever-exploring-sale-of-tea-business/571394/

6. https://www.unilever.com/news/press-releases/2018/simplification-of-unilevers-corporate-structure.html 

8. CONCLUSION

I believe Unilever, at $45, is a good price to start buying a quarter position every 3 months for the next year. While the near-term outlook is miserable and will get worse giving you 2 to 3 more opportunities to round up a full position, in 5 years time, the stock is worth $83 dollars including dividends.  Assuming they sell the tea business for $8B and reduce debt by that amount, and they achieve a 10% increase in revenues in 5 years. We have a company with $52B in revenues, $14B in EBITDA, Net Debt of $15B. Applying a 15 times multiple give us $75 plus another $8 in dividends, equating to about $83, for a total annualized return of 13% per year, from the $45 stock price. 

Catalyst

1. Catalyst #1 

Management  got their scare of losing their jobs when 3G offered to buy them out.  They are focused on cost-cutting. I am convinced that within the next five years, 3G will come back to bid for Unilever, especially if management does not perform and do what 3G thinks they can do with operating efficiency. This makes sense because 3G has the financing competitive advantage, the cost-cutting advantage to further increase profitability of Unilever. Compare Unilever’s Opex % of 27%, and Gross Margins of 44% VERSUS Kraft-Heinz has Opex % of 13% , and Gross Margins of 32%.  

2. Catalyst #2

In addition to cost-cutting, management wants to get a higher market multiple. 

Management still wants to simplify its complicated structure and that will happen within the next five years.