The Unilever stock is valued as a reliable dividend payer with a crisis-proof business model which are key criteria for a successful long-term investment. However, the problem with quality companies like Unilever is often the price. This is because shares of quality businesses in the consumer goods segment in particular are often expensive. In Unilever, I have found a stock that meets the requirements of a long-term investment and is still trading at a reasonable price. The price of the stock fell during the Corona crisis. In my opinion, the market reaction is exaggerated and offers a good entry opportunity for investors.
|Market Cap.||127.6 billion €|
|Dividend Stability||0.98 (max. 1.0)|
|Earnings Stability||0.95 (max. 1.0)|
Unilever is a Dutch-British business and the world’s largest producer of consumer goods. The company sells products from over 400 brands in the food, care & cosmetics and household product segments. According to the company, these products are used by 2.5 billion people every day and are sold in 190 countries.
These brands include some well-known heavyweights such as Lipton, Knorr and Ben and Jerry’s. 12 of these brands each generate sales of over 1 billion euros. Unilever’s products are everyday goods and it is hard to imagine people’s lives without them. In addition, they are exclusively consumer goods that have to be purchased at regular intervals. Unilever benefits from this by generating stable and predictable sales. Another advantage is the brand loyalty of the customers. At first glance, many consumer goods appear to be homogeneous (similar) goods. However, Unilever can retain customers by offering unique selling points such as quality or taste in food products. Once these customers are satisfied with the product, they will buy it again and again instead of switching. This customer loyalty also promotes the sale of new products. It makes it easier for a satisfied customer to be convinced of new products from a particular brand.
Probably the most important aspect of brand loyalty is the price advantage it gives Unilever. Higher prices can be achieved for well-known brands than for no-name products without recognition value.
For Unilever, customer loyalty means increasing revenues and profits. In the chart below you can see that Unilever has been continuously increasing its earnings and cash flow per share for many years. This also emphasizes the stability of the business model.
Unilever has always recovered from minor setbacks in earnings in the following year. This is thanks to Unilever’s product range, which consists of barely cyclical everyday products. The only cyclical business segment is ice cream brands. Their success varies from year to year, as ice cream consumption is heavily dependent on the summer months. This year, relatively little ice cream will most likely be consumed due to the Corona pandemic. This is not dangerous for Unilever, however, because the other product groups continue to generate sales. Especially the body care products and the textile cleaners are bought regularly.
Although Unilever’s revenue continues to grow, annual growth rates are in the lower single-digit percentage range. This is common for companies in this industry. In contrast to other industries, growth in basic consumer goods is difficult to generate through the volume of individual customers. For example, it is difficult to get a customer to use more shower gel. Therefore, sales growth must be achieved by entering new markets and acquiring new customers. As a result, growth is usually limited to 2-4 percent. This is not a big issue; you just shouldn’t expect any major leaps in growth. In return, you get a robust company that generates secure annual earnings for you. In the chart below you can see the stability of the operating margin, which stands for the profitability of the business model.
Unilever is a so-called Dividend Aristocrat. Dividend Aristocrats are companies that have not only paid dividends without interruption over 25 years but have also increased them continuously. In the last 36 years Unilever has never lowered its dividend. In fact, they increased the dividend for 32 consecutive years. Unilever pays its dividend on a quarterly basis. Currently, the quarterly dividend is 0.44 USD which comes out to 1.77 USD per year. At the current share price this gives Unilever a dividend yield of 3.7 percent. For this reason Unilever is a good investment for people who want a regular income stream in the form of dividends.
Unfortunately, the series of dividend increases will be interrupted this year due to the Corona pandemic. Unilever has already announced that it will maintain the first quarterly dividend of 2020 at the previous year’s level. I think this step makes sense in order to remain flexible in the Corona crisis and to maintain sufficient cash reserves. It is much better to come out of the crisis with a high cash cushion than to run out of cash halfway through. The fact that Unilever can continue to pay a constant dividend even during the crisis speaks for the solidity of its business model.
Let us now take a look at the two most important factors for dividend quality. First, the company’s debt and second, the potential for future dividend increases.
At first glance, Unilever is quite heavily indebted with a debt ratio of 78 percent. However, the debt ratio or the absolute amount of debt is less important here. More interesting is the amount of interest that has to be serviced every year. This tends to increase with higher debt, because interest has to be paid on a higher total. Heavily indebted companies usually also have to pay higher interest on their debt because they are considered riskier. What is important here, however, is the company’s profit and cash flow stability. Companies with stable and secure profits like Unilever have to worry less about not being able to service the debt than cyclical companies. This also means that they are considered less risky and have to pay lower interest rates. Unilever’s operating profit is also far greater than the annual interest payment. In 2019, it was ten times as big. This means that Unilever will not struggle with the interest payments even in bad years. Unilever can therefore run up more debt than companies with less stable earnings.
The payout ratio is also an important indicator of the security and sustainability of the dividend. It indicates the proportion of profit/free cash flow that is used for dividend payments. A ratio above 100% means that the dividend is financed out of substance. Since this is not a sustainable state, you should make sure that the payout ratio stays below 100% in the long run. For Unilever, the payout ratio is currently 70% and thus within an acceptable range. The portion of the cash flow that is not paid out can be used to repay debt, buy back shares or build up a cash cushion. You can see this so-called amortization power marked in green in the chart below. There you can also see that Unilever would have enough cash on hand to finance the dividend for one year entirely from its cash position. Unilever’s dividend is safe because the company has sufficient cash holdings, generates stable profits and, despite its relatively high level of debt, has a fairly low interest payment.
Unilever will continue to be able to increase its dividend in the future. In the long term, however, dividend increases must come from sales and thus from profit growth. As a result, annual increases will be in about the same range as sales growth. Expect increases in the single-digit percentage range.
In my opinion, the Unilever stock was fairly valued before the market crash due to the Corona crisis. This view was also consistent with the fair value based on historical multiples. In the lower graph you can see that the stock price and the fair value dividend overlapped for a while. However, due to the market crash, the price has now fallen well below the fair value. The current price of the stock is 48 USD. The fair value dividend, on the other hand, is 57 USD (52.5 Euros in the chart below), 18 percent above the current price.
I think the markdown is excessive. Unilever is not completely immune to the effects of the pandemic. However, Unilever’s robust business model will continue to deliver solid earnings. The negative effects are therefore much smaller than the decline in the stock price would suggest. Even before the crisis, I considered Unilever a good investment. At this more favorable price, the stock has now become even more attractive, especially since the dividend yield is now higher than before. I consider the price decline to be excessive and the stock to be undervalued at the current price, because I believe that Unilever will safely get through the Corona crisis. I therefore assume that the stock price will recover quickly after the pandemic.
The Unilever stock has been dragged down with the overall market. Although the pandemic will have a negative impact on revenue growth, the underlying business model remains intact and will withstand the crisis. While other companies are experiencing sharp declines in sales and profits, Unilever shareholders only have to deal with temporarily lower sales growth and continue to receive uncut dividends. The business model is not threatened by the pandemic. I expect the price of the stock to recover quickly after the crisis has been overcome.
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