Unilever rebuffs Kraft Heinz, focuses on future value creation

Steve Clayton - Fund Manager

23 February 2017

There aren’t that many exceptional businesses in the UK, but we regard Unilever as one of them. Its brands are well loved all over the world and have been around for decades. Its ability to charge premium prices for these brands translates into high margins and very strong cash flows. The strength of its distribution networks, particularly in emerging markets, presents a formidable barrier to competition. It is a unique asset, which is why we made it one of our biggest positions in the HL Select UK Shares fund (4.3%, prior to Friday’s price move).

A number of investors have chosen to overlook these strengths. Some have argued that Unilever, along with the rest of the consumer goods sector is overvalued, because it is trading on a slightly higher P/E than it has done historically. In our view, this completely overlooks the long term value that the company is capable of creating.

The same short term sentiment prevailed on the day of Unilever’s full year results. The share price fell by around 5%, as its quarterly sales figure came in slightly below analysts’ expectations. We added further to our position, since the results did nothing to diminish our positive long term stance.

Our view

We viewed the approach from Kraft Heinz on Friday as opportunistic and at roughly 4000p per share, we agreed with Unilever’s management in thinking it significantly undervalued the company’s long term growth prospects. Unilever has raised its dividend for many years and has generated a total shareholder return of around 230% over the last decade, meaning it has trounced the FTSE All Share index (up c. 70% over the same period). In that context, the c. 20% premium that Kraft Heinz offered looked way too cheap.

Initially, Kraft Heinz seemed undeterred by Unilever’s disdain, but clearly Kraft quickly found Unilever to be less receptive than they might have hoped for. So despite having come across the Atlantic, reportedly armed with $143bn of cash and stock, they promptly got on the first flight home. Kraft Heinz’s backers, Warren Buffett and the 3G investment group of Brazil are known to strongly favour friendly, rather than hostile deals, which may explain the abrupt volte face, but either way, announcing a merger proposal on the Friday, only to scrap it on the Sunday is pretty unusual stuff.

The joint statement announcing that talks were over was brief and courteous, suggesting they parted on good terms. Where Kraft Heinz were really prepared to go to, we may never know. Of course, if they really did part as good friends, then like any good friends, they will no doubt talk to each other in the future. But $143bn was obviously not nearly enough to persuade the Unilever board to sit down at the table and parlay.

Wider implications

Kraft Heinz’s approach underlines the long term value that successfully managed consumer brands can create. These businesses are defensive; people do not stop buying shower gel, pasta sauces, stock cubes or mayonnaise just because GDP came in a tad below consensus. And in the good times, when consumer purses are that bit easier to prise open, these businesses are reliable sources of growth. Kraft Heinz’s approach to Unilever suggests they believe that combination to be so powerful, they would risk taking on the best part of $100bn of debt to acquire more of it.

Investors now have a new benchmark to use when valuing these sorts of businesses and they also now know that there is a large player looking to bulk up. That should all be supportive of valuations across the consumer goods sectors as investors try to second guess Kraft Heinz’s next move. With big positions in Unilever, Reckitt Benckiser, Diageo and British American Tobacco, we are very happy with the HL Select UK Shares fund’s positioning.

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