Unilever is a hotly debated dividend growth stock right now and it should come as no surprise that their management is under severe pressure. Alan Jope (CEO) has yet to deliver anything significant under his tenure and he seems to become very desperate.

I mean, trying to acquire the consumer business of GSK at an exuberant price was just plain stupidity. Luckily institutional investors agreed with this and their intervention has prevented wasting major shareholder value.

I don’t know about you, but I wouldn’t be surprised if we see some news that Alan Jope will retire this year (fingers crossed!).

Having said that, today I would love to share my thoughts with you about Unilever. They recently released their annual report, so it’s the right time to have another look at it.

Unilever’s paradox

As most of you have probably observed, Unilever’s stock price hit a 5 year low this week around 40 Euro.

To me, this has always been a price where the stock presents an attractive risk/reward to shareholders who are in it for the long term. You are able to buy some shares at a dividend yield of 4.19% based on today’s share price. The dividend still grew in 2021 by 2.97% compared to the total amount of dividends paid in 2020.

Sounds pretty Okay for a boring company, don’t you think? Or is it maybe not as attractive as it looks?

This is where the value investor mindset kicks in. Unfortunately, Unilever has not been able to grow its revenue since 2015. It literally went nowhere since then!

But honestly, this is nothing new and not something I’m very much interested in. Companies like Unilever and Proctor & Gamble are holding companies and they often dispose and acquire new brands as part of their portfolio management activities.

What I am therefore really interested in are growing earnings and increasing cash flows. Luckily they were able to improve their margins during the last 7 years and that’s why we have seen those increasing cash flows.

However, this has stalled right now as can be witnessed in their annual results. High inflation costs are putting their operating margin under strong pressure. Their increased sales forecast will not be able to compensate for that according to my analysis.

Their Free Cash Flow was back at 2019 levels and their outlook doesn’t provide us any optimistic view. This means that I will have to revisit my growth assumptions for the company as well, which will ultimately have to impact the fair value price of the stock (more about that later on).

This understanding of an attractive dividend yield vs weak growth prospects makes it one of the most difficult paradoxes for me as a dividend growth investor.

But let’s look at it from a dividend safety point of view. This is one of the most important criteria for a dividend growth investor.

Is Unilever’s dividend safe?

I realize that some of you might be afraid of a dividend cut because Unilever declared the same dividend as in the last 4 quarters. This is not something unique and the company has been doing this from time to time (i.e. in 2020). It is their way of navigating tough times by being conservative.

But if history can be seen as any guidance, then I expect the company to announce a small dividend hike by the end of this calendar year.

I’m OK with that because I’m getting an attractive yield in return for this. It also allows me to reinvest my dividends at more attractive prices while I’m still in the accumulating phase.

In the meanwhile, I’m expecting management to fix their issues and to return to growth in the long term. This won’t be easy and I believe that management has to be replaced to make that happen. However, Unilever is bigger than an individual CEO and I’m quite convinced that the company will find a return to growth.

But I must confess here, this is only a feeling I have based on studying their whole history since 1929.

If I purely look at the data, then I can’t judge anything else than that their dividend safety is questionable right now. This is mainly due to high payout ratios, a few poor balance sheet metrics, and generally weak earnings growth prospects.

Time will tell if my understanding of Unilever beats pure data analysis 😉

Unilever’s fair value

It’s time to look at Unilever’s fair value right now. Even a no-growth company can be attractive at the right price and Unilever still has some growth.

First things first, my last fair value assessment in April 2021 resulted in an estimate of 45 Euro per share. It assumed a 7 billion Free Cash flow growing at a rate of 7% over the first 5 years and 4% thereafter.

I believe that those assumptions have proven to be overly optimistic. That’s why I’m modeling a 6.5 billion annual Free Cash flow going forward. I also expect this to grow less than earlier assumed. Hence, “just” 5% over the next 5 years and 3% thereafter.

Taking these assumptions into account, together with a 10% discount rate and a 16 multiple gives me a fair value price of 39.75 Euro.

This means that I find Unilever slightly overvalued right now even though it dropped quite significantly in price over the recent weeks. In my opinion mr. Market is right and the stock trades at a level where it belongs.

Or in other words, it deserves to be downgraded!

Summing up my thoughts

Let’s be clear: I see absolutely no reason why I should sell Unilever. Its fundamentals are still good enough and its dividend has not been cut.

And as you might know, Dividend growth investors don’t sell a stock easily. A company’s commitment to its dividend is not to be taken lightly.

However, there are quite some amber warning signs right now, so I’m neither doubling down. Unilever is already my 6th largest portfolio position and 6.75% of my total dividend income depends on it. I feel comfortable with where it is right now.

It’s a pity though because it means that I’ve overpaid for the stock in the past 3 years.

Ah well, investing was never supposed to be easy!

In the meanwhile, I will just continue to enjoy the quarterly dividends coming in.

Yours Truly,

European Dividend Growth Investor

What are your thoughts about Unilever? I’m really curious to hear those so feel free to leave your thoughts in the comment section below this article.

This article is written from the perspective of a dividend growth investor, not as a total return or value investor. If you are more interested in such a narrative, then I would highly recommend you to take a look at one of the more recent videos from Cameron Stewart. He highlights Unilever’s growth issues from a cashflow point of view in an excellent manner.