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Unilever - margins improve but poor weather weighs on sales

Nicholas Hyett | 25 July 2019 | A A A
Unilever - margins improve but poor weather weighs on sales

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Unilever plc Ordinary 3.11p

Sell: 4,052.00 | Buy: 4,053.50 | Change 20.50 (0.51%)
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Underlying sales grew 3.3% in the first half, with a stronger second quarter. However, that's still below expectations, with volumes slightly weaker than hoped. Improved margins contributed to a slight increase in operating profit, to EUR4.6bn.

The second quarter dividend will be EUR0.4104.

The shares fell 1.1% following the announcement.

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Our View

We think Unilever is an attractive long-run growth story.

The group makes and sells everyday household items like Dove, Magnum ice cream and Persil. These products fall into the 'little and often' category, so aren't too vulnerable to the ups and downs of the economy.

On a typical day, a third of the world's population will use a Unilever product. And an effective marketing division means Unilever should keep growing market share over time. Strong brands also mean Unilever can increase prices, boosting margins and profits. That enables significant reinvestment in the following year's marketing budget. And there's historically been enough to increase the dividend too.

Consistently repeating this cycle has led to impressive shareholder returns, and Unilever plans to boost profitability even further with cost-saving plans. The dividend is comfortably covered by earnings and cash flows, and we think there's clear potential for the payout to keep increasing, although as always there are no guarantees. At the time of writing, the prospective yield is 3.1%.

While other consumer goods groups share these characteristics, Unilever's emerging markets (EM) exposure separates it from rivals. Its wide range of markets means it can weather difficult conditions in a handful of geographies, while growing and increasingly wealthy populations in EM nations should be a long term tailwind.

The group's drawing closer to the 2020 mark, when it says it will have grown margins to 20%. While progress has been solid so far, a tougher global climate means there's no guarantee it'll hit that target on time.

Looking at the bigger picture, a year or two's delay in reaching margin targets wouldn't be the end of the world. But with sales growth expected to come in at the lower end of guidance, a timely arrival would be welcome.

In addition to the risk of slower than expected progress on profits, we think there's a risk of a de-rating. The shares trade on 20.9 times expected earnings compared to a long term average of 18. But for those prepared to take the long view, we think Unilever has the potential to be rewarding.

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First Half Results

Ignoring changes in exchange rates, Unilever's first half revenue fell 0.7% to EUR26.1bn. That reflects the sale of the spreads business, and weaker growth in developed markets. Underlying sales growth (USG) was driven by a 1.2% increase in volumes, while price increases contributed 2.1%.

In North America, sales declined 0.2% in the second quarter, resulting in turnover of EUR2.4bn. Elsewhere, headwinds from the Brazilian trucker's strike started to ease, which saw Latin America's USG grow 9.3% to EUR1.8bn.

European sales declined 1.6% in the quarter to EUR3.2bn, as deflationary pressures and adverse weather impacted sales. Within the Rest of World division, underlying sales growth improved 6.3%, driven mainly by price increases.

Among Unilever's divisions, Home Care grew particularly strongly, with fabric solutions benefiting from premiumisation, including the Omo brand in Brazil. Within Beauty & Personal Care, Dove and Rexona contributed well to performance. Food & Refreshment saw USG dip 0.6%, as weak tea demand impacted volumes in developed markets.

Free cash flow in the first half of 2019 was EUR1.5bn, down from EUR2bn in 2018. This reflects the disposal of the spreads business, and an extra tax charge associated with the disposal.

Net Debt rose from EUR22.6bn to EUR24.2bn, following the payment of dividends and some negative effects of currency movements.

CEO, Alan Jope said Unilever expects "underlying sales growth to be in the lower half of our multi-year 3-5%" and for margins to improve in line with 2020 goals.

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Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.