Unilever is one of the most popular companies among dividend-focused investors. As one of the world’s largest consumer goods companies it makes a huge range of well-known products, from Dove soap to Magnum ice cream and Comfort fabric softener.
Over many decades the company has grown its dividend above the rate of inflation, which is precisely why it is so popular with investors.
But despite Unilever’s impressive track record, I think the odds are that its shares will not perform as well in the future as they have in the past.
In the rest of this post I’ll explain why.
Unilever has a great track record, of that there is little doubt
Any company which can grow its dividend for decades on end is likely to have a very strong competitive position, and that is certainly the case with Unilever.
Many of its products have leading market positions and are highly regarded by customers, which enables the company to compete on factors other than price.
In other words, Unilever can sell Magnum ice cream at a higher price point than less well-known ice creams, even if its competitors are of equal quality.
Many shoppers will still choose Magnum, despite its higher price, simply because they have seen the glitzy adverts and perhaps even tasted the ice cream before, whereas they have probably never heard of or tasted the other brand.
This allows Unilever to generate higher profit margins than it would be able to otherwise, which in turn allows it to invest heavily into product development through R&D and brand development through advertising.
This virtuous circle has driven the company’s growth for decades and continues to drive it today:
Here is a snapshot of the company’s performance, compared to the FTSE 100:
- 10-Year growth rate = 3% (FTSE 100 = 2%)
- 10-Year growth quality = 67% (FTSE 100 = 50%)
- 10-Year profitability = 15% (FTSE 100 = 10%)
(To understand those metrics in more detail download these handy investment spreadsheets).
Unilever manages to beat the FTSE 100 across each of the key financial metrics that I use, so its performance is clearly above average (assuming the FTSE 100 represents the average large-cap company).
Investment in acquisitions and capital assets is not excessive
As part of my value trap analysis I also look at a company’s capital expenses and acquisitions. My goal is to be especially careful around companies that have to or have chosen to invest heavily in either capital assets or other companies.
In terms of capital expenses, over the last ten years Unilever spent an average of 38% of its post-tax profits on capex. That figure of 38%, which I call the capex ratio, is relatively low.
My rule of thumb for capex is:
- Be wary of investing in companies where the capex ratio is above 100%
With a capex ratio of just 38%, Unilever’s capex requirements do not raise any alarm bells.
In terms of acquisitions, Unilever has also managed to avoid this sometimes dangerous path to growth.
Although it does consistently acquire other companies, none of its recent acquisitions have cost it more than a single year’s profit (my definition of a large acquisition), which means it passes another one of my rules of thumb:
- Be wary of companies that have made large acquisitions in the last ten years
As with capex, a high level of acquisitions doesn’t necessarily mean I won’t invest in a company, but it does mean I’ll have a good look at any large acquisitions to see how their integration is progressing.
Financial obligations also appear to be manageable
There are two balance sheet items which I pay close attention to: borrowings and pension liabilities.
I compare each to the company’s five year average normalised post-tax profits, the result of which I call (somewhat uninspiringly) the debt ratio and the pension ratio.
Unilever’s total borrowings are currently £10.6bn, its pension liabilities are £17.0bn and its average profits are £3.5bn.
As a result Unilever has the following financial obligation ratios:
- Debt ratio = 3.0
- Pension ratio = 4.8
The associated rules of thumb are:
- Only invest in a defensive sector company if its debt ratio is below 5
- Only invest in a company if its pension ratio is below 10
- Only invest in a company if the sum of its debt and pension ratio is below 10
Unilever passes all of these tests and so once again it ticks the box as a relatively safe company, at least in terms of its financial obligations.
By every measure then, Unilever is just the sort of company I like to invest in. It is growing steadily, with a reliable dividend, has good competitive advantages from strongly branded products and relatively conservative financial obligations.
So why am I not investing?
Quite simply, I don’t think the share price currently represents good value for money.
The price paid for a company is just as important as the quality of that company
Unilever’s share price is currently 3,160p. At that price it has the following valuation ratios (compared to the FTSE 100 at 6,200):
- Dividend yield = 2.8% (FTSE 100 = 4.2%)
- PE ratio = 24.4 (FTSE 100 = 28.0)
- PE10 ratio (price to 10yr average earnings) = 26.1 (FTSE 100 = 14.3)
- PD10 ratio (price to 10yr average dividend) = 41.8 (FTSE 100 = 28.5)
The only measure where Unilever appears to be cheaper than the market average is the PE ratio, which is also my least favourite metric as it can be very unreliable.
Looking at the other ratios, Unilever currently trades at a fairly hefty premium to the market with higher valuation ratios and a lower yield.
However, that premium price could be justified if the growth, quality or profitability of the company made up for it. After all, a Phantom is more expensive than a Mondeo for entirely justifiable reasons.
In this case, while Unilever’s track record may be good enough to justify its current share price, I don’t think it is good enough to make that share price look particularly attractive.
For example, if Unilever can continue to grow by 3% a year (as it has in the recent past) and if the dividend yield stays at 2.8%, then shareholders will receive a total return of 5.8% per year.
I don’t know about you, but an expected return of 5.8% per year does not exactly set my pulse racing.
Of course I could be wrong and the company could grow much faster than 3%. Or perhaps the share price will continue to go up faster than the dividend, withering away at the already thin yield. But I don’t think it’s obvious why either of those outcomes should occur.
What price would I pay for Unilever’s shares?
As a general rule I want my defensive value model portfolio to be:
- High return: Beat the FTSE All-Share by at least 3% a year (or alternatively to get a return of at least 10% a year)
- High yield: Have a yield which is at least 110% of the All-Share’s yield
- Low risk: Be less volatile and less risky than the All-Share (which is why I’m interested in companies like Unilever)
Given Unilever’s mediocre rate of growth, I need a much higher dividend yield than 2.8% in order for my capital gains and dividend income targets to be met.
As things stand today, Unilever comes in at 161st position on my stock screen of almost 240 stocks.
That’s only slightly ahead of a boring old FTSE 100 index tracker, which has a rank of 167.
For me to even consider investing I would want Unilever’s share price to drop back down to 1,800p at the very least.
At that price the the dividend yield would be 5% and the company would rank near the top 50 stocks on my list, which is where I like to go shopping for new investments.
Of course for the share price to fall that far the company would have to be facing some obvious problems, but that would not bother me, as long as those problems were fixable and unlikely to cause permanently damaged to the company’s long-term prospects.
At 1,800p, with a yield of 5% and an estimated dividend growth rate of 3%, the expected return would be 8% per year.
That’s still below my target rate of 10%, but with a bit of luck, and if the storm clouds cleared, the shares could be re-rated back upwards within a few years. That would probably add at least another couple of percentage points to the rate of return.
But currently there are no storm clouds, and until they appear Unilever will have to stay on my watch list as an attractive company with an unattractive share price.
(Just out of interest, when I reviewed Unilever a year ago my target price was also 1,800p. Despite Unilever’s growth since then, other stocks have become cheaper as the market has declined, which is why Unilever’s target price has not moved upwards)
Andy Curtis says
I revisited my ‘Buffet Equity Bond’ calculator spreadsheet as I have Unilever in my portfolio. It broadly agrees with your performance figures
Unilever Annual Growth Rate = 3.31% @ 30.34/share
and that is way below my 10% threshold, so why dd I buy? I bought in a dip but that does not make a huge difference. I did not buy because of the divi, I do like the fundamentals. I think the main reason why was because I believe that as China moves towards a Consumer driven economy (and I do believe they will) it will drive higher demand.
But also, when I find a company with a competitive advantage and attractive fundamentals I can’t buy it at a price to give a 10% return, it would take something like you say, a short term problem to knock it down. Ummm Tesco comes to mind ….. I’ll go and look at them 🙂
John Kingham says
Hi Andy, your point about China is a fair argument. If you believe that future growth will be higher than the 3% of recent years (say 7%) then the current price may well be attractive. Or if you think the shares may be re-rated upwards from where they are today because of positive investor expectations about China.
As for Tesco, I already own that one; although unfortunately I bought in before it all fell apart. The lessons I gleaned from that mistake were 1) pay more attention to profitability (ROCE) and 2) be more conservative about debt. And of course don’t be overexposed to any one company, which I already knew and Tesco only made up about 3% of my personal portfolio and the UKVI model portfolio.
I still hold Tesco, but whether I continue to hold for much longer will depend on the next set of annual results.
I owned Unilever in the past, but not now. I just believe there are better companies out there, Johnson & Johnson is one of them.
Their rate of growth is just too small for me. However I do believd it could be part on investors portfolios.
John Kingham says
Hi Eugen, yes I think Unilever is a reasonable holding for most people, but as you say, it’s growth rate is pretty weak so while it’s a reasonable stock I wouldn’t expect it to shoot the lights out performance-wise.
Sold Unilever at 3100 for similar reasons. It’s price is overstretched. Closer to 2100-2400 and I’d be happy to buy back, something I’ve done a couple of times.
So much for buy and hold!!
Quite a few companies are overpriced at the moment, and many of these are in the consumer staples and consumer discretionary sector.
Many analysts, fund managers and the press lump Unilever in consumer staples.
I think this is highly inaccurate, since all of it’s products are premium priced and alternatives can be bought in the form of cheaper brands or virtually unbranded supermarket own products.
Reckitt Benckinser is another overpriced company. Also a consumer discretionary company — take Cilit Bang for example, it’s 3 times the price of a plain packaged bottle of bleach (the chemical formulae are only slightly varied between brands).
It’s all in the marketing to a highly gullible public.
John Kingham says
Hi LR, definitely: marketing mixed with small unique innovations is key. I do own RB but it is slowly edging towards the exit, especially if the price keeps going up.
Stephanie Holland says
I have 2000 unilever shares which were part of my divorce settlement 10 years ago the prices have gone up a lot since then from £15 50 to £32 should I sell my shares now
John Kingham says
Hi Stephanie, I’m not allowed to answer that for regulatory reasons. If you need advice you should seek out a regulated independent financial advisor.
John, a while since this article was written, and it looks like Unilever has indeed surprised on the upside.
The yield is also 3.4%, not sure it was ever down at 2.8% at the time the article was written, and certainly not since.
Looking into next year, the P/E (your least favourite measure) is down at 18 and the earnings growth is now expecting 9%, not 3%.
It does look like Unilever is bucking it’s historic trend, and with an enormous emerging market wealth happening, it’s possible to see why.
Unilever now sells over 1 billion Magnums a year. It’s also bought $ shave club.
Something else that could have be covered in future articles is the high margins and high ROCE. Even if ULVR has low growth, it’s still giving back exceptional returns on capital.
I held PZ Cussons from it’s low points and I’m now looking to switch out of it and back into Unilever.
Unilever’s Dividend at 3.4% is higher than PZ at 2.5, although Unilever dividend cover is only 1.5 compared to 2 at PZ.
The thing that swings it back in Unilever’s favour is the high ROCE and that is what matters over time, perhaps less than the entry price.
Never thought I’d hear myself say that, but it’s also supported by relative P/E’s which are about equal at 18 — So I prefer Unilever with an ROCE of 67% compared to PZ at 15%.
John Kingham says
Hi LR, the forecast yield is 3.4% but the historic yield (which is the one I use) is currently 2.8%. I haven’t really changed my opinion of Unilever at all. It’s a very good company with very strong competitive positions, earning very good rates of return on capital.
However, I still don’t think the price or yield is that interesting given its low growth rate over the last decade (below 5% per year). Perhaps things will work out better for it over the next decade, but I don’t like to invest on the basis of optimistic forecasts of future growth. So I’m out, as the Dragon’s Den gang would say.
One thing I would say is that if its growth rate does pick up then my target price will also go up, although I’ll have to wait until the annual results are out before I can crunch the numbers again.
John, I can see it’s a relative thing of course and you have a long list above it to chose from.
Still a bit confused how you get 2.8% on the historic yield, given that it was 4.3% in 2011, 4.1% in 2012, 3.0% in 2013, 4.3% in 2014, 4.1% in 2015, forecast 3.4% 2017 and if you do a simple calculation on Friday’s close of 3,152 and take the current dividend that is committed 106.8 it’s bang on 3.4%.
At today’s price I think the yield is comfortably going to be 3.6% next year.
Still, irrespective of this, yield is no basis for true valuation nor indeed a reason to buy into a company.
John Kingham says
On the dividend issue, when I talk about yield I always use historic yield which to me means using the dividend from the last full financial year. So for Unilever that means the 2015 divided, which was made up of four payments of 21.8p, 21.1p, 22.59p and 23.0p. That’s a total of 88.49p which is 2.8% of that current share price of 3,152p.
You’re using TTM (trailing 12-month) and/or forecast dividends, which is fine of course, but I’m quoting a different figure.
As you say this is really a trivial difference. What matters is that you’re consistent in whatever approach you take and even more importantly, the current yield should be a fairly minor factor when weighing up potential future returns.
I see what you have done now. I guess the more realistic assessment is to take the average share price during the 2015 period to work out a historic yield that represents the historic payments.
Going forward, and appreciating your article is older now, I think it’s reasonably conservative to at least as of now to take the current payments for 2016, which have already set the base and have been paid. These are Q1-2016 – 25.56p and Q2-2016 -26.89. It’s fair to believe, that Q3 and Q4 will be at least at that level and realistically higher – so let’s say it stays flat, you are still looking at 104.9p, giving a yield of 3.3%.
Given that we are already at the end of Q3, I think it’s pretty safe to say that 3.3% is the very bottom yield for Unilever’s fiscal 2016.
We shall see in a couple of months for sure!