Emerging Markets Hold Back Unilever’s Growth

Unilever’s (NYSE:UL) results for the third quarter of 2013 confirmed the slowdown in emerging markets that the company warned about last month. In line with the firm’s recent guidance, underlying sales (sales from continuing operations excluding acquisitions, disposals and currency movements) increased 3.2% y-o-y, lower than 5% growth achieved in the first half of the year. Although underlying sales were positive, revenue fell by 6.5% y-o-y primarily due to currency headwinds in the emerging markets that reduced sales by 8.5%. ^[1]

The ongoing currency weakness in emerging markets also impacted underlying sales growth in these markets as consumers reduced their consumption due to inflationary pressures. The lack of sufficient economic reforms further weighed on the growth. Underlying sales in the emerging markets rose by only 5.9% y-o-y, the worst in ten quarters. However, the management is optimistic about the growth picking up in Q4. ^[2]

With a strong brand recall, expanding international footprint, volume growth ahead of the markets, and focus on innovation and disposal of low margin businesses, we believe the consumer staples can overcome its woes.

Our current price estimate of $40 for Unilever is in line with the market price.

See Our Complete Analysis Of Unilever

EM Slowdown Hurting Growth Trajectory

Unilever’s key emerging markets include Brazil, India, Indonesia and South Africa, where the demand for consumer products has increased year-on-year due to rising per capita disposable income. Lately, these markets have become victims of currency devaluation, which has impacted Unilever’s revenues via lowered demand and negative exchange rate impacts.

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 for Unilever due to the exchange rate impact of the currency headwinds.

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. ^[4] Therefore, the company’s growth slowed significantly in Q3 2013. Things could worsen for Unilever should the emerging market slowdown continue, as the company intends to earn 75% of its revenues from the emerging markets by 2020.

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

Personal Care and Home Care Outperform

Despite increased competitive pressure, the Home Care and Personal Care segments outperformed other divisions in Q3 2013 with year-on-year underlying sales growth of about 6%. The majority of the growth in these categories came on the back of strong volume growth. Home Care underlying volumes grew by 5.5% while Personal Care volumes were up by more than 4%. Strategic alignment, R&D, market development and premiumization provided support to volumes. The company experienced broad-based market share gains in the home and personal care categories across the world as it continued to innovate.  ((Unilever NV Management Discusses Q3 2013 Results – Earnings Call Transcript, Seeking Alpha, October 24, 2013))

Personal care is the highest revenue generating segment for Unilever with a contribution of about 35% to total company revenues. It includes popular brands such as Axe, Pepsodent, Lux, Dove and Sunsilk in deodorants, oral care and skin & hair care product categories. The company has leading market share in personal care, particularly in deodorants where the company accounts for close to 50% of global sales. We expect Unilever’s market share in personal care to continue to rise in the future, driven by rapid innovation and high penetration rates across both developed and developing economies.

Unilever derives close to 20% of its revenues from home & fabric care products. The company has been focused on aggressive expansion of this category in the emerging markets, which has led to strong volume growth. We believe Unilever will experience further market share gains as it expands into newer geographies.

Foods Still A Concern, Expecting Slow Recovery

The foods division continued its decline in Q3 with underlying sales falling by 0.3% y-o-y. The business has been suffering particularly due to the sluggish performance of spreads. 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. (Read: Unilever Has The Right Ingredients To Turnaround Its Spreads Business)

Unilever is working to improve the taste profiles and increase the health benefits of its products. The high EBITDA margins on spreads (>25%) compared to the overall foods division (~18%) offer the company scope to get back its share from competitors. ^[5] The company 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 are in the process of updating our $40 price estimate for Unilever based on the Q3 earnings results.

Understand How a Company’s Products Impact its Stock Price at Trefis

1. Unilever Q3 2013 Trading Statement, Unilever Investor Relations, October 24, 2013 [↩]
2. Unilever NV Management Discusses Q3 2013 Results – Earnings Call Transcript, Seeking Alpha, October 24, 2013 [↩]
3. www.oanda.com [↩]
4. Emerging markets to generate 75% of Unilever sales by 2020, Live Mint, October 24, 2013 [↩]
5. Best bits: Unilever likely to stick with spreads, Just-Food, May 1, 2013 [↩]