Unilever Plc posted their FY 2020 earnings last week and I must say that they looked pretty decent. Nothing special, neither on the upside or the downside. So why then did the Unilever share price drop by almost 10% in two days?
That’s what I will discuss in this post.
Not everything is always what it seems and as dividend growth investors we are in it for the long run. Maybe this has just become the yearly opportunity to increase my position in Unilever?
Besides that they also announced to hike their dividend with an additional 4%. Isn’t this something that many investors should be happy about?
Let’s check this out in this post and let me know what you think as well.
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The reasons for the Unilever share price drop
To answer this question we would need to listen to the institutional investors and the analysts that cover the company. The big money (not necessarily smart) has a lot of influence on the short term price action of a stock. That’s why I have studied their comments after the earnings release and the following 3 aspects are generally given as a reasons for them to be more bearish:
1. Gross Profit Margins are declining
The most repeated reason given for the price drop is the increased margin pressure. This has led many analysts to update their forecast models and as a result to decrease their fair value price.
So what are we really talking about then? Let’s have a look into their quarterly report.
Overall, Unilever declined 0.6% (60 bps) in their underlying operating margin and the biggest decline comes from their Beauty and Personal Care business unit -1%.
The biggest reason given is the impact from Covid-19 which should not come as a surprise to anyone of us.
Another “large” margin decline was in the European market (smallest geographical area in # sales) and the following reason was given:
Effectively this means to me that there was increased competition for home care products which led to lower prices to the consumers and a bit less profit for Unilever.
And these are effectively the highlights from the report. It is important to mention that we shouldn’t take margin declines lightly, because they can have a large impact when calculating the fair value of a company based on future cash flows.
I will get back to this later.
2. The strategy is not bold enough to get to high single-digit EPS growth
The general narrative is that Unilever has been slow to move into high growth product-market combinations. An example given is the entry into the market of plant-based products to chip-in on the health conscious consumer.
Nestle is by some of the analysts considered to be much more aggressive in its required transition as it struck a deal with Starbucks and it is willing to let go of a part of its water business.
I don’t know why analysts are so much more bullish on Nestle, because I personally did my research half a year ago and I really don’t like that much what I saw.
To the contrary, I actually really like Unilever’s strategy. I believe that this is a way more sustainable strategy of business growth. It’s not talking about leveraging up the balance sheet to appease shareholders. This is rather an example of slow compounding while requiring to be laser focused.
I also like the fact that Unilever wants to further double down on its position in the emerging markets (US included 😘), because there’s still so much more growth opportunity ahead of them in those geographical areas.
To be honest, I’ll take slow high quality growth anytime over quick growth with lot’s of unsustainable debt. I’m not sure if the company will be able to realize their financial goals, but if they do then we can be assured of another 10 years of dividend growth.
3. No large acquisitions over the last 10 years
Another narrative is the fact that Unilever only purchased relatively small companies which didn’t directly impact the bottom-line of the company.
I understand that investors think about Unilever like this, because it’s often a trend to acquire a large company to prevent being eating yourself (as per the 3G capital take-over bid in 2016). Especially in a low-interest rate environment which makes leveraging up the balance sheet to acquire companies very attractive.
Personally I just like that the company hasn’t done it yet. I actually couldn’t tell you which company would be attractive for Unilever to acquire based on it’s valuation other than Danone SA. Therefore I’m fine with the small changes Unilever continues to make in it’s portfolio.
A great example for me is the acquisition of the vegetarian butcher which grew over 70% last year. I think this product has a lot of scalability and I wouldn’t be surprised if we see it as the next 1 billion dollar brand in their portfolio within the next 5 to 7 years.
But not every change is small, because as most of you know, Unilever is also intending to sell its Tea business due to the low margins. It’s a big thing for Unilever and we might see an IPO for it towards the end of the year.
These are the type of adjustments which I totally support.
My reflection on this
As you read earlier, I don’t necessarily agree with all the critics which led to Unilever’s share price drop. But I need to keep an eye on those as well so that I avoid being blindsided due to confirmation bias.
Hence, to sum up my 2 main thoughts about this:
- Margin declines were real, mostly attributable due to covid-19 impact and increased competition. Half of this might be a sustained decline, the other half could potentially be gone once the economy reopens
- The strategy is indeed not bold enough if you’re looking at from a pure shareholder point of view and not a stakeholder point of view. There’s enough fat on the bone if you don’t believe in Unilever’s purpose to support a better planet. Unilever could easily cut costs to make a quick buck and they could also easily leverage up their balance sheet for additional buybacks and expensive acquisitions. Kraft Heinz might be a better option in that case. But I’m in it for the next few decades to come and I very much appreciate being a leader in sustainable production and at the same time keeping a strong balance sheet.
My Fair Value estimate for Unilever Plc
So let’s then run the numbers considering lower margins to see if this created an attractive buying opportunity after Unilever’s share price drop.
The last time I analyzed Unilever I came to the conclusion that the shares were fairly priced at 50 Euro.
What I will do now is to use the latest numbers from Unilever’s FY 2020 report and factor in a sustained 0.75% margin decline (pretty conservative). Hence, I’ll work with a gross profit margin of 18.35% instead of 19.1%.
Using these margin numbers and the derived free cash flows from it leads me to a fair value price of
To get to this number I am using 6.5 bln annual free cash flow as a basis with the following assumptions in the best case scenario (net of cash and debt):
|growth rate next 5 years
|growth rate 5 to 10 years
This means that according to the analysts corrections in their valuations Unilever’s share price drop was justified. The share price currently sits around €45.50 which is just 2% above this fair value estimate.
Final Conclusion about Unilever Share Price Drop
The Unilever Share Price drop is correct if you believe that the analysts are right by using the margin decline as something definite in their calculations. In that case you can assume the 10% share price drop in 2 days after the earnings announcement to be a fair market reaction.
I am personally a bit more bullish on the company, but assuming a sustained lower margin will act as a margin-of-safety in my personal fair value calculation of the company. I might be wrong off course, but I don’t expect further large declines in their margins. Especially not when the economy reopens and covid-19 becomes an event in our rear-mirror.
Until then you can consider me a buyer when the price dips below €45.00. I sold a March put option with a strike price of €42.00 as an alternative to generating some dividend income. I really wouldn’t mind if I could buy an additional 100 shares at that price, because it would also mean a dividend yield of just above 4%.
I’m not sure though whether I will have enough patience, so I might nibble in a few shares beforehand.
Last but not least, let me be specific in answering the main question in the title of this post:
I believe that the current share price provides an interesting opportunity to initiate a small position and to further increase it on any further price drops provided nothing fundamentally changes to the company.
I’m curious to hear about your thoughts as well so feel free to share them in the comment section below this post 👇👇
European Dividend Growth Investor
Disclosure: I’m long Unilever Plc