Unilever PLC’s (UL, Financial) stock has good outperformance potential, having received a boost from solid financials, strong brands and a new management team.
First-half results showed the consumer staples company recorded growth across all its segments, achieving a remarkable 9.1% increase in underlying sales, driven by a substantial 9.4% rise in prices, albeit slightly offset by a 0.2% reduction in volume. Notably, Unilever's underlying operating profit demonstrated an encouraging ascent of 3.3%, totaling $5.7 billion, accompanied by a slight increase in the margin to 17.1%. Underlying earnings per share witnessed a commendable improvement of 3.9%, while the diluted earnings surged 23.6%, supported by gains from disposals and a reduction in restructuring expenses.
Unilever successfully concluded the third phase of its ongoing share buyback program, amounting to $825 million. An exceptional highlight emerged from the performance of the company's billion-plus euro brands, contributing to 55% of the group's turnover and showcasing an impressive 10.8% growth in underlying sales. This achievement was primarily attributed to stellar performances from renowned brands such as Rexona, Hellmann's, OMO, Sunsilk and Lux. The company's commitment to strategic portfolio management remained steadfast, exemplified by the strategic acquisition of frozen yogurt brand Yasso and the strategic divestment of the Suave brand within the North American market.
Price action
Despite this good performance, the stock is barely up over the last year. I think this is partly because large, well-known consumer staples companies are often seen by the market as "bond proxies" and that has caused the stock to suffer due to rising interest rates. Although stability is a desirable trait in any economic climate, the steadiness exhibited by consumer staples now must compete with enticing yields available on both corporate and government bonds.
Nonetheless, taking a more neutral perspective on interest rates, historical evidence underscores the appeal of consistent cash flows and growing dividends.
Cost pass through
Unilever’s good results were helped by it continuing its 2022 strategy of passing on elevated costs to consumers to safeguard and enhance profit margins. This manifested in a 30 basis point elevation in the gross margin and a 10 basis point rise in the underlying operating margin during the first half.
Some people in the media have raised allegations of "greedflation" in response to these margin gains, despite the company's profitability remaining below pre-pandemic levels. In 2019, the underlying margin stood at 19.1%, a 2 percentage point difference from current figures.
Comparatively, Unilever's performance shines when contrasted with the fiercely competitive grocery sector, which remains ensnared in an unending price battle. The company's ongoing pursuit to restore margins to pre-Covid levels remains underway, with the board projecting margin enhancement over the entire year. I would expect the company to reinvest gains from improved margins into growth and market share recovery.
Unilever's strategic direction has faced turbulence, eliciting shareholder pressure following a period of lackluster performance. Although its shares exceed the value Kraft Heinz (KHC, Financial) offered back in 2017, the gap is not significant. In comparison to fast-moving consumer goods counterparts like Procter & Gamble (PG, Financial), Unilever's sales growth has disappointed.
A failed acquisition attempt for GSK's (GSK, Financial) consumer arm in the previous year led to shareholder backlash. Despite these strategic uncertainties, Unilever's reliable dividend and cash flow profile offer stability, a quality that endears the stock to me at least. Strong cash generation complements dividend growth, with projected free cash flow growth expected through 2026. Over five years, Unilever's free cash flow margin averaged 12.2%, lagging behind Procter & Gamble's 18.4% and Colgate-Palmolive's (CL, Financial) 16.2%.
Brand value
Beneath these figures resides a robust brand portfolio, evidenced by steady volume performance despite price growth. The success of brands like TRESemmé and Dove in maintaining sales volumes, even with higher prices, underscores the brand equity and diversification. Brands generating over a billion euros in annual revenue, such as Hellmann’s and Rexona, showcased an underlying growth of 10.8%.
While Unilever's first-half results for 2023 are promising, we should shift our focus to long-term growth drivers. The company's expanding geographical footprint outside of legacy European markets is a key aspect to watch. With nearly 60% of sales emanating from emerging markets, it is poised to capitalize on significant consumer and demographic trends. A revamped operating model, yielding an anticipated $660 million in cost savings, complements this strategy.
Furthermore, new leadership, including CEO Hein Schumacher and Chairman Ian Meakins, brings much-needed change at the top. This management change, importantly, had the support of activist investor Nelson Peltz (Trades, Portfolio), who knew Schumacher from his days at Heinz and was pushing for the change. Schumacher's emphasis on "science-backed innovations" aligns with Unilever's new trajectory, aiming to enhance market share and invest in high-growth areas and channels. Despite the unexciting share price action in the last year, forward earnings sit below the five-year average. As such, I am optimistic about the share price catching up on the back of free cash flow generation-led growth.
Value
The company scores strongly on GuruFocus metrics. Its GF Score is 87 out of 100, driven partly by a strong profitability rank of 8 out of 10.
Unilever also has a high Piotroski F-Score of 7 out of 9 and a fairly safe Altman Z-Score of 3.30.
Further, the GF Value Line suggests the stock is modestly undervalued based on its historical ratios, past financial performance and analysts' future earnings projections.
In conclusion, Unilever's defensive brands, expanding presence in emerging markets and innovative management team signal a brighter future. Despite short-term uncertainties about a potential economic slowdown and fears the average consumer might be trading down from established brands, the company's stability, attractive dividend and cash flow offerings make it an appealing prospect for investors looking toward the long term.
