Unilever Earnings Preview: Home And Personal Care Products Should Mask Weakness In Foods’ Portfolio

Unilever (NYSE:UL) is scheduled to report Q3FY14 results on October 23, 2014. Last month, the company warned of slower market growth for consumer goods during its presentation at the Sanford C. Bernstein Strategic Decisions Conference. In the first half of FY14, the Anglo-Dutch conglomerate had revenues of €24.1 billion (~$33 billion), down almost 5.5% from a similar period last year. In addition to volatile exchange rates, underlying sales slowed down considerably in H1FY14. Underlying sales grew 3.7% between H1FY13 and H1FY14 compared to 5% between H1FY12 and H1FY13.

On the flipside, Unilever has been able to prudently preserve its margins by trimming its product portfolio. Its core operating profit margin, which excludes the impact of disposals, acquisitions, impairments and other one-off expenses, remained steady at H1FY13 levels of 14% in H1FY14. Operating profit margins (including impact of all the above expenses) expanded from 15% in H1FY13 to 18% in H1FY14, driven by a strong increase in margins from its Foods segment and offset partially by a decline in margins in its Refreshments segment. Other segments such as Personal Care and Home Care registered strong underlying sales growth during H1FY14, in addition to marginal swings in their profit margins.

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HPC Brands Should Boost Volume Sales in Key Emerging Markets

Despite their weakening domestic currencies against the U.S. Dollar in 2014, inflation in emerging markets such as India has come down considerably. For example, preliminary data from the Reserve Bank of India for the month of September 2014 shows that retail inflation in India has declined sharply to 6.46% from over 11% a year ago. The lower inflation number should aide a recovery in volume sales for fast moving consumer goods (FMCG) companies.

Unilever operates in India through the Hindustan Unilever Limited (HUL), in which it owns a controlling stake of 67%. Last quarter (April – June 2014), HUL reported sales of nearly $1.3 billion, with approximately $990 million and $229 million in sales from Home and Personal Care (HPC) and Foods and Beverages segments respectively. On a proforma basis, this amounts to about $663 million and $155 million in sales for Unilever from its Indian subsidiary.

The HPC segment in India accounts for nearly 9.9% of total HPC sales for Unilever, making it a very important market. Unilever plans to further strengthen its presence in specific product categories such as Home Care in key emerging markets such as India. The company generates more than 80% of total Home Care sales from emerging markets, with detergent brands such as Ariel, Skip, Surf and Radiant generating nearly 70% of Home Care sales.

In India alone, soaps and detergent sales for HUL witnessed a year-on-year growth rate of approximately 13% last quarter. Similarly, HUL’s personal care product line, which includes brands such as Dove, Pepsodent, Sunsilk etc., reported a year-on-year growth rate of over 14% in the April – June 2014 period. The Foods segment on the other hand makes a smaller portion in Unilever’s global geographic portfolio, amount to nearly 2.6% of total Foods and Refreshments’ sales.

For the upcoming quarter, we expect this robust growth trajectory from key emerging markets like India to partially offset any weakness from developed markets such as Western Europe. However, overall results will be weighed down by a decline in volumes from developed markets due to sluggish demand from consumers, coupled with significant currency headwinds from the considerable depreciation of the Euro against the U.S Dollar.

Foods Segment Should Drag Down Overall Sales and Volumes

Contrary to the HPC segment, Unilever’s share from emerging markets is small in the Foods segment. Unilever’s Foods portfolio includes product categories such as spreads, sauces, soups and stocks, which are widely used in developed markets. This smaller contribution from the high growth emerging markets has limited growth prospects for Unilever’s Foods segment, where underlying volumes shrank by nearly 1% on a year-on-year basis. To boost volume sales in these markets, the company divested its Ragu and Bertolli pasta sauce brands in the U.S. and its Slim.Fast brand later in H1FY14.

Despite the disposal of under-performing brands, we expect volumes from the Foods segment to decline year on year due to weakening consumer sentiment, particularly in Western Europe. Improving consumer sentiment in the U.S could partially offset this weakness, although the lower presence in emerging markets should weigh on overall volume growth for the segment.

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