Unilever (NYSE:UL), the world’s leading consumer goods company, delivered exceptional performance quarter-on-on quarter in the last two fiscal years as it slowly shifted its focus towards emerging markets, an arena where the company believes its biggest growth opportunities lie. Unilever continued to build on the growth momentum in the first quarter of fiscal year 2013 as well, with 4.9% y-o-y increase in underlying sales (sales from continuing operations excluding acquisitions, disposals and currency movements).
The growth was fueled by higher investments in innovation, improved product quality and the introduction of brands in new markets. However, sales grew by only 0.2% y-o-y to $16.2 billion on account of currency weakness in some of the emerging countries including Brazil, India, South Africa, Indonesia and Argentina that reduced revenue by 3.5%. The disposal of the Skippy peanut butter brand in the U.S. also contributed to the decline. Underlying sales in Europe plunged by about 3% as sales in Spain, Italy and Greece took a hit due to the financial crisis. 
Unilever is set to release its Q2 2013 earnings on July 25. In our view, Unilever’s underlying sales will remain suppressed in developed markets, particularly Europe, in Q2 2013, as there was no significant improvement in the prevailing macro-economic scenario. However, high growth rate for Unilever’s sales in emerging economies will counter the impact. We also estimate that the depreciation of the INR (Indian Rupee) and BRL (Brazilian Real) relative to the EUR (Euro) will keep the increase in sales capped, as Unilever reports its financials in EUR.
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How Well The Emerging Markets Will Compensate For European Headwinds?
Unilever was confronted with unhealthy market conditions in Europe in Q1 2013, which contributes about 25% to the total revenue. Driven by a decline in consumer confidence due to fiscal tightening in Northern Europe and the unabated financial crisis in Southern Europe, underlying sales plunged by close to 3% y-o-y. The ice cream business took the worst hit across the continent as additional factors such as the coldest March in 50 years in the U.K. that dragged ice cream sales down by over 10%. However, management urged investors to look at half yearly financials as appropriate reflection of performance rather quarterly due to higher base in the first quarter of the previous fiscal year, 2012. How the European market performs will therefore be the epicenter of discussion in Q2 2013.
Emerging economies played a major role in offsetting the European decline and accounted for 57% of the company’s turnover in Q1 2013. These markets have demonstrated good strength with underlying sales growing in double-digits (10%–13%) y-o-y for the last eight consecutive quarters. Prices and volumes both remained healthy and contributed equally to the growth. However, emerging markets may not continue to hold their stength, leading to lower growth in turnover going forward. China, Brazil and India, some of Unilever’s key emerging markets, are suffering from a slowdown and demand may not maintain its robustness. This has impacted the earnings of a number of European companies in Q2 2013, and Unilever could also feel the heat. 
We estimate currency weaknesses in INR (India) and BRL (Brazil) will weigh on Unilever’s earnings in the quarterly results, as the company reports its financials in EUR; INR and BRL depreciated by close to 2% relative to EUR in Q1 2013 compared with the previous quarter. 
The following table summarizes Unilever’s underlying sales growth in emerging markets in last 9 quarters:
|Q1 2011||Q2 2011||Q3 2011||Q4 2011||Q1 2012||Q2 2012||Q3 2012||Q4 2012||
Pressure On Foods Business As Other Categories Outperform
With a revenue contribution of close to 30%, food is the highest revenue generating segment for Unilever after personal care. The business delivered a mixed performance in Q1 2013 as revenue growth in dressings and savoury was offset by a decline in spreads, which resulted in slightly less than 1% y-o-y decrease in underlying sales of the segment. Despite recent innovations in spreads to close taste gaps and increase health benefits offered, consumers switched to alternatives due to high promotional activity by competition, particularly in Europe. The management backed the strategy and feels that the turnaround will kick in as the taste innovations and health benefits are communicated to consumers; however, the turnaround could be protracted. It also expressed that growth in processed and branded food will follow as consumers become increasingly affluent in developing economies. 
Food is growing slowly compared to other consumer products in emerging markets and is also a smaller part of Unilever’s product portfolio.  For instance, only 18% of Unilever’s sales in India come from its food brands. In addition, Unilever has been disposing off its non-core food business to realign its portfolio and focus on faster growing products. The company sold its North American frozen meals business to ConAgra Foods for $265 million in 2012, and the peanut butter brand, Skippy, to Hormel Foods for $700 million, earlier this year.   It also recently announced that it will be divesting the Wish-Bone and Peperami food brands.  
Despite the company’s efforts to increase sales, we believe Unilever’s market share in foods will remain close to current levels due to high promotional activity in developed markets, recent brand divestitures, and smaller size and pace of the food business in emerging markets.
We will soon update our price estimate of $39 for Unilever based on the latest results.Notes:
- Unilever Q1 2013 Earnings Call, Seeking Alpha, April 2013 [↩] [↩]
- China Slowdown Weighs On European Earnings, Financial Times, July 2013 [↩]
- www.oanda.com [↩]
- Unilever’s Strength In Non-Food Could Offer Long Term Boost To Food, Just Food, July 2013 [↩]
- ConAgra Buys Unilever’s Frozen Biz, Zacks Investment Research, Aug 2012 [↩]
- Unilever Agrees To Sell Global Skippy Business To Hormel Foods, Unilever Website, Jan 2013 [↩]
- Unilever Looks To Sell Snack Brand Peperami, International Business Times, July 2013 [↩]
- B&G Foods, Pinacle Foods Eye Unilever’s Wish-Bone, Reuters, June 2013 [↩]