Unilever’s Earnings To Witness Lower Revenues From EM After Several Quarters

by Trefis Team
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Unilever Group
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Unilever (NYSE:UL) is slated to release its earnings for the third quarter of fiscal year 2013 on Thursday, October 24. The company delivered exceptional quarter-on-quarter performance in the last two fiscal years, as it shifted its focus from the developed economies towards the emerging markets, an arena where the company believes its biggest growth opportunities lie.

Company-wide underlying sales (sales from continuing operations excluding acquisitions, disposals and currency movements) grew 5% y-o-y in the first half of 2013, as the emerging markets continued to compensate for the slow growing developed markets. However, emerging markets may not continue to hold their strength, leading to lower revenue growth going forward. China, Brazil and India, some of Unilever’s key target markets are suffering from a slowdown and demand may not maintain its robustness. Due to the sluggish growth in emerging markets, and to some extent, flat to negative growth in developed markets. Unilever announced last month that it is expecting lower underlying sales growth of 3% – 3.5% y-o-y in Q3 2013. [1]

Unilever’s food division has also been under-performing compared to the company’s other divisions. Food revenue declined by about 2% in 2012 and 5% in the first half of 2013, owing to the weakness in the spreads business. [2] However, the company is taking initiatives to revive the business.

Our price estimate of $40 for Unilever marks our valuation at a premium of about 5% to the current market price.

See Our Complete Analysis Of Unilever

Emerging Market Slowdown Could Hurt Future Growth

The demand for consumer products in emerging economies such as India, Brazil, China, South Africa and Russia has been increasing year-on-year due to rising per capita disposable income. These markets are expected to continue growing, albeit at a slower pace, as most of these markets have been plagued with currency weaknesses.

Year-to-date, the South African Rand (ZAR) has depreciated 18% relative to the euro (EUR), while the Indian Rupee (INR) and the Brazilian Real (BRL) have depreciated by 13% and 10% respectively. [3] This rapid currency depreciation has created inflationary pressures on buyers, who have reduced their consumption. The situation has aggravated due to fears over the Federal Reserve’s plan to taper off quantitative easing. [4] Relaxing the quantitative easing program would reduce capital inflows into these countries, worsening their current account balance. This in turn would lead to further currency depreciation.

Unilever’s above-market global growth in the last few years has come on its rapidly expanding presence in the emerging markets. It achieves about 85% of its overall growth from these markets. [5] Therefore, the company’s growth could slow significantly, should the emerging market slowdown continue.

The following table summarizes Unilever’s underlying sales growth in emerging markets in last 9 quarters:

Q2 2011 Q3 2011 Q4 2011 Q1 2012 Q2 2012 Q3 2012 Q4 2012 Q1 2013 Q2 2013
10.6% 13.1% 12.3% 11.9% 11.0% 12.1% 10.8% 10.4% 10.3%

Spreads Business Could Improve With Directed Efforts

Consumers in developed economies are switching to private label spreads manufacturers due to high promotional activity and pricing competition by these players. Additionally, health concerns over the presence of trans fats in margarines (an important spreads category) has led consumers to shift back to butter and other healthier alternatives. [6] Much of Unilever’s efforts to close taste gaps and increase health benefits have been in vain. For further insights into Unilever’s spreads business, read our article: Unilever Has The Right Ingredients To Turnaround Its Spreads Business

Despite the sustained weakness in spreads, Unilever does not intend to divest the business since it forms an important part of its overall portfolio and accounts for 7% of total company revenues. Instead, the company is working to improve the naturalness and tastes of its products, in addition to concentrating on fewer and bigger brands. The spreads manufacturer has good scope to get back its market share since it earns higher EBITDA margins on spreads (>25%) compared to the overall foods division (~18%) [7]. It could lower prices in order to make its products more competitive, thereby taking a temporary setback on margins. Based on the above mentioned factors, we believe that Unilever could turnaround its spreads business; however, the turnaround may be protracted.

We will update our price estimate of $40 for Unilever after the upcoming quarterly results.

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Notes:
  1. Unilever sales hit by emerging markets slowdown, NDTV Profit, October 1, 2013 []
  2. Unilever Q2 2013 Earnings Announcement, Unilever Investor Centre, July, 2013 []
  3. www.oanda.com []
  4. Unilever sales hit by emerging markets slowdown, NDTV Profit, October 1, 2013 []
  5. Emerging markets to generate 75% of Unilever sales by 2020, Live Mint, November 22, 2012 []
  6. UL Q1 2013 Earnings Call Transcript, Morning Star, April 25, 2013 []
  7. Best Bits: Unilever Likely To Stick With Spreads, Just Food, May, 2013 []
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