Consumer goods giant Unilever (LSE: ULVR) delivered a nasty surprise for investors just before Christmas when it warned that sales would be lower than expected in 2019.
The Unilever share price responded promptly, falling more than 7% in one day.
It wasn’t a profit warning — the owner of brands including Dove, Knorr, Magnum and Hellmann’s says that “earnings, margin and cash” should not be affected. But it was a surprise for a business that’s become a byword for reliability.
Today I want to explain what I think might have gone wrong — and why I think Unilever shares should still be a great long-term investment.
How did we get here?
Unilever says that sales growth will be lower than expected this year, due to an economic slowdown in South Asia and difficult trading conditions in West Africa. These challenges are real, but I think that Unilever may be facing other issues as well.
In February 2017, it rebuffed a takeover approach from US rival Kraft Heinz Company, which is part-owned by Warren Buffett’s firm Berkshire Hathaway.
The Anglo-Dutch consumer goods group’s response to this unwanted approach was to cut costs, ramp up debt and spend more money on dividends and share buybacks.
Unilever had previously steered clear of this kind of short-term focus on profits. Instead, the group had invested for the long-term and maintained a very safe, conservative balance sheet. I liked it the old way, but this strategy had left the door open to a hostile takeover bid. Something had to be done.
The changes introduced by former CEO Paul Polman increased the group’s underlying operating margin from 16.4% in 2016 to 18.4% last year. Unilever shares have risen by more than 30% since February 2017, and shareholders have enjoyed double-digit dividend growth.
It’s an impressive result. My only concern is that the cost-cutting reported by the company could mean that less money is being spent on developing new products and brands.
Finding the right balance between short-term profitability and long-term growth isn’t always easy. Perhaps CEO Alan Jope will need to fine tune this mix over the next couple of years.
Still a great company
I have some concerns about the short-term outlook for Unilever. But over the long term, I still believe this is a great business that’s likely to deliver market-beating returns for shareholders.
Unilever’s accounts show a long history of high profitability and strong cash generation. These factors have enabled the firm to pay attractive dividends and invest in new products without excessive borrowing.
This business can trace its history back more than 100 years. I don’t see any reason why it won’t continue to perform well for many more years to come.
Would I buy the shares today? At the time of writing, Unilever stock trades on about 20 times 2019 forecast earnings, with a dividend yield of 3.3%.
Given the recent bad news, I think the share price could fall a bit further next year. But even at current levels, I think Unilever stock should be a profitable long-term buy.
Roland Head has no position in any of the shares mentioned. The Motley Fool UK owns shares of and has recommended Berkshire Hathaway (B shares) and Unilever and recommends the following options: long January 2021 $200 calls on Berkshire Hathaway (B shares), short January 2021 $200 puts on Berkshire Hathaway (B shares), and short January 2020 $220 calls on Berkshire Hathaway (B shares). Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
Motley Fool UK 2019