Ask a group of investors to name some defensive companies and you can bet that the Unilever name will come up at some point. It’s a big company with a huge list of well-known brands ranging from Wall’s Ice Cream to Domestos, Radox and many more.
It’s the classic defensive company which sells small-ticket, non-durable items that people need every day. Deodorant, tea bags, soap; they’re all in the Unilever stable. It’s a strategy that has seen the company go from humble beginnings to massive global operations over more than a century.
So I think there’s little doubt that Unilever will be the sort of company that defensive investors (like me) would want to invest in, but let’s check the numbers just to be sure.
Solid and reasonably consistent growth, but no fireworks
Solid growth rate – Unilever has grown by around 7% a year over the last few years. That’s pretty good going and compares well to the sub-3% performance that FTSE 100 companies have managed in aggregate. However it is slightly below the average of other consistently dividend paying companies, which have managed an average growth rate of 7.9% over the last decade.
Reasonable growth quality – While growth has been strong, it hasn’t been especially stable. Unilever managed to increase the dividend in every year, but overall it only managed to increase, revenues, profits or dividends 79% of the time. That’s slightly better than other dividend payers which one or another of those factors 75% of the time, and it compares well to the 58% hit rate of the FTSE 100. However, many defensive companies produce far more consistent growth.
A large but not unreasonable debt pile
If there’s one thing that can put a stop to progressive growth in a hurry it’s debt. Having too much debt is like sailing in a top heavy boat; it’s no problem in good weather, but if a storm comes along things can go badly wrong very quickly.
So it’s a bit of an eye-opener to see that Unilever has borrowings of more than £9 billion. That’s quite a lot.
However, in the past decade Unilever has produced – on average – adjusted post-tax profits of about £3.3 billion a year, and I estimate that it could earn an average of around £5 billion a year over the next decade. That gives a debt ratio of 1.9 which is well within my preferred maximum of 5 times, and so for me this is a reasonable amount of debt for a company with Unilever’s earnings power.
Pension obligations run to just over £20 billion, but again, relative to an estimated future earnings power over the next decade of £5 billion a year, that gives a pension ratio of 4.1 which is within my preferred maximum of 10 times.
No surprises – It’s a high quality, defensive company
As expected, Unilever does have the financial evidence to back up the idea that it’s a defensive company. It has a long history of growth, and that growth is above average in terms of both magnitude and consistency.
It doesn’t carry an excessive amount of debt or other financial obligations, and it sells products that a growing proportion of the world’s population will continue to need and use every day for the foreseeable future.
But is the price right?
Every company has a fair price, but thanks to the volatile nature of the stock market investors can often buy companies well below their fair value, and occasionally sell them far above fair value.
So what about Unilever? Is a price of around 2,400 pence per share a good price for buyers, a good price for sellers, or just a fair price with no obvious advantage to either side?
Currently each share is priced at 20.7 times the average earnings per share over the last decade. This is much higher (and therefore more expensive) than the equivalent number for the FTSE 100, which at 6,550 is at less than 13.8 times its average earnings. However, Unilever is growing much faster than the average FTSE 100 company, and so a premium price should be expected.
Looking at the 240 consistent dividend paying companies on my stock screen, I can see that on average they are priced at 21.4 times their average earnings.
So Unilever shares are very slightly cheap (according to this measure) relative to their peers.
Turning from earnings to dividends, Unilever currently has a yield of 3.8% which is virtually identical to the FTSE 100 yield of 3.7%. However, given my assumption that Unilever will grow faster than the average company (and average is what you get with the FTSE 100) then I would normally expect Unilever’s yield to be lower.
Looking at those 240 consistent dividend payers again, their median yield is just 2.8%, which is as I would expect. On average those 240 companies have better growth rates than the market average, and so they should command a premium price, i.e. investors should forfeit some of their income today in exchange for more income (courtesy of higher growth) tomorrow.
With its relative high yield Unilever shareholders can, to some extent, have their cake and eat it, with a decent yield today and solid prospects for growth tomorrow.
A defensive company at close to fair value
Putting that all together, with Unilever we have a company which is growing about as fast and consistently as most other solid, dividend paying companies. The shares are perhaps slightly cheap, which shows up in the dividend yield, which is quite high for such a low risk, defensive company.
Having said that, at 2,400p the shares are not nearly cheap enough to get me excited. They don’t look expensive, but they don’t look like an obvious bargain either. So for now Unilever will remain on my watch list (at position 96 out of 239 on my stock screen), but personally I won’t invest until the yield and the valuation become significantly more attractive.
Disclosure: I don’t own any shares in Unilever.