Unilever is almost an obligatory holding for many dividend growth investors. That’s no surprise because the company’s consumer products (including brands such as Dove, Flora and Magnum) are well suited to a world in which a growing number of people are willing and able to buy those products.
That tailwind of growing consumerism has enabled the company to grow its dividend every year for more than 40 years. That’s quite some achievement.
However, since the financial crisis growth has slowed and while the dividend went up in 2014 by about 6%, that was in Euros (the dividend is declared in Euros). In GBP terms the dividend fell slightly.
So is this the end of the road for dividend growth or can Unilever keep on growing, ultimately fulfilling its strategic goal of doubling in size relative to 2009?
Rapid dividend growth may not be sustainable
Let’s get some context by looking at Unilever’s revenue, earnings and dividend growth over the last decade (in GBP rather than EUR):
As I just mentioned the company’s goal is to double its size relative to 2009. Exactly what “size” means is up for debate but for me, a fair definition would be for Unilever to:
- Grow revenues from £35 billion to £70 billion
- Grow earnings per share from 120p to 240p
- Grow dividends per share from 70p to around 140p
Those are lofty goals for a company that already has a market cap of more than £80 billion. Let’s see how it’s done so far in the 5 years since 2009, when it announced the goal to 2014. The company has:
- Grown revenues from £35 billion to £38 billion (6% gain)
- Grown earnings per share from 120p to 121p (1% gain)
- Grown dividends per share from 70p to 90p (29% gain)
Of the three, only dividends seem to be on track for a 100% gain and that’s a problem. Without sufficient growth of revenues and earnings, dividend growth cannot be sustained.
Across the entire period in the chart above, Unilever grew its dividend at the lofty rate of 8.5% a year. That’s great news for defensive and dividend investors, but it only managed to grow revenues and earnings at a barely inflation-beating 4% a year and 2.5% a year respectively.
Either Unilever is going to have to find some major revenue and earnings growth that it hasn’t been able to find before, or it’s going to have to cut its dividend growth rate in half.
With slower dividend growth, valuation and yield become more important
If Unilever’s future dividend growth can only match the growth of its revenues and earnings, which have grown at less than 4% a year over the last decade, how will investors fair?
In the long-term total returns equal dividend growth plus dividend yield, so with an assumed future dividend growth rate of 4% and a current yield of 3.2% (with the shares at 2,850p) investors could reasonably expect a return of about 7% a year.
Of course in reality nobody knows what the future will bring, and things may work out much better or worse than that, but I would say 7% a year is a reasonable estimate of future returns for these shares.
Unfortunately, that is no more than the expected long-term return of the UK market. In other words, at their current price, Unilever shares may be no better than an investment in the FTSE 100 (where the yield is closer to 3.5%).
Buy, hold or sell?
Personally, I’m targeting a return of at least 10% a year which means that at the moment Unilever’s shares are just not attractive enough. So I don’t own Unilever, but if I did I’d sell it and reinvest the proceeds into something that was growing faster, yielding more or both.
For me to buy Unilever shares I’d either need to see the company step up its overall growth rate closer to 7% a year (primarily by increasing its revenue and earnings growth rate) or I’d need to see the dividend yield closer to 5%.
For the yield to reach 5% the share price would need to drop to about 1,800p, which is a fall of some 35% from where it is today. At that price, I’d probably be a buyer.
A 35% fall may sound like a lot but it’s where the shares were until early 2011, and the company has not grown significantly since then.
Of course, a 5% yield from a company like Unilever, beloved of dividend investors, is unlikely. But in reality that just means it would require a good dose of bad news in order to get there.
And as Rolls-Royce has shown with its 30% decline from previous highs, it doesn’t take much bad news to knock even the most defensive shares down a long way.
John –It’s a puzzle but at the moment everyone is flocking to ULVR, IMT, BATS, DGE as ultra defensive and yes they all look expensive but perhaps people are spending the proceeds of the sale of any oil stock money they may have left on these stalwarts. This and the fact no one believes the banks anymore, if they ever did, and commodities and supermarkets have probably frightened a lot off – so you the sector options have shrunk significantly. – Still there’s always cash for the patient.
I think IMT has surpassed yours and my expectations. I didn’t sell on your last note, more out of lethargy but it’s tempting now the big divi is locked in. I started buying ULVR at 2200 and bought tranches all the way up to 2700 and stopped. Finger hovering over the sell button.
Problem is, the dearth of quality stocks to go for — have you looked at Premier Farnell of late, must have crept into your value bracket by now I expect ?
LR
Hi LR, yes the defensive dividend consumer non-durables are having a good time of it. Fundsmith had another good year out of them although how much higher they’ll go is anybody’s guess. They’re mostly too hot for me anyway.
Imperial certainly shot right up, probably from the moment I sold it! However lots of other things have gone up too, including quite a few UK retail stocks. It’s all part of the random walk I’m afraid.
Premier Farnell is getting there, but even though the yield is 6%+ it has quite a choppy history with slow growth and declining earnings. The dividend isn’t massively covered and the debt levels are near the maximum I would allow. I can’t say much more than that as I haven’t looked at it in detail, but the price needs to drop a bit further to factor in the risk of a dividend cut.
John, I agree with you. I would sell Unilever too. Interested to know what you think of PZ Cussons as an alternative? It’s recently crept into my stock screener.
Hi M, PZ is currently at 80 on my screen while for context Unilever is at 148 and the FTSE 100 is at 175 (out of a total of 235 companies).
So I’d say that PZ looks “okay” from a valuation point of view, but most of my holdings are in the top 50 of my screen so I wouldn’t be looking to buy it now.
However, different screens favour different things and so somebody else’s screen might have the order the other way around (e.g. a more yield-focused screen).
Yes, you have to go with your own way of screening. Otherwise, you’re a sheep! And thankfully, you are not, that is why we love your site and value your way of estimating which shares are potential, solid, long-term goers.
Cheers
A question on the maths. How does a dividend of 3.2% with dividend growth of 4% give a return of 7%?
Hi David, I’m not a big fan of decimal places in estimates of equity returns, so I just rounded the result to 7%. There are huge uncertainties involved in the future of any company and even more so in its shares and so even 7% is just a very rough figure.
Sorry, I obviously didn’t explain my question sufficiently. A dividend yield of 3.2% that increases by 4% is then a yield of 3.3% isn’t it? The 4% increase is not a return on the whole value of the share, simply on the dividend and therefore can’t be added to it to make a 7% return as you suggest.
Hi David, okay I see what you mean.
The assumption is that if the dividend goes up by 4% then the share price goes up by 4% as well in order to keep the yield the same.
So investors will get the 3.2% dividend and 4% in capital gains in the first year. Then in the following year they’d get another 3.2% plus another 4% capital gain (if the dividend went up by 4% again)… and so on.
Obviously that’s not actually going to happen, but it’s a reasonable simplifying assumption.
Hope that all makes sense.
Okaaayyy, not sure I’d bank the 4% capital growth as a return until it happened but I see what you mean!
Thanks
Hi John
It is of course difficult to predict the future, but this job is much harder when factoring in the currency risk. For example, you mention “… so with an assumed future dividend growth rate of 4%”.
If you look at the dividend growth for 2014 and for 2015 (estimated) on Stockopedia, the figures in Euros are nearer 6% (rounded). The difference is of course the currency conversion, which could conceivably go either way in the future. This is why I’ve so far always run my calculations in the reporting currency.
I appreciate your research as always, and based on your figures may well run my model over ULVR again this week.
Cheers, Ric
Hi Ric, of course you’re right, currency exchange rates are yet another uncertainty that the future holds for us. Generally I think the future is so uncertain that any assumptions I or anybody else makes about returns, like assuming 4% dividend growth, should be interpreted as very loose ball-park figures and nothing more.
Unilever is a mixed bag at the moment, but there are very few stocks which are not. What I learned that is sometimes better to have some mixed bag stock than not. Business like Unilever are resourceful, they could buy other great businesses etc.
We have to think stock markets have grown for 6 years and they cannot grow forever.