Unilever (LSE: ULVR) (NYSE: UL.US) shares are up 8.4% this year, but if the British consumer behemoth speeds up divestments, upside could be 20% or more for shareholders in the next 12 months.
Here’s why.
Divestments
An oft-rumoured break-up of Unilever doesn’t really make sense, in my view. Its four business units are too big to attract bids, so the obvious alternative right now is to focus on operations with higher margins and better growth prospects. If anything, Unilever should be more aggressive, but there’s a lot to like in its current strategy.
At the end of June, Unilever completed the sale of its Ragu and Bertolli brands in North America for $2.15bn. A couple of smaller deals also took place earlier this year. In April, the group completed the divestment of its meat snacks business to Jack Link’s for an undisclosed amount. In January, it sold its Royal pasta brand in the Philippines to RFM Corporation for $47.8m. Last year, it got rid of its Unipro bakery and industrial oils business. Additional disposals are on the cards in the next 12 months.
Valuation
If Unilever’s divestment strategy continues, the shares will surge. It’s as simple as that. Mature markets are troubled, while emerging markets offer less appealing prospects of growth than in previous years. So, portfolio rationalization is the way out, particularly for producers.
Unilever stock is not expensive. It trades on a price to earnings ratio of 18x and 16x for 2015 and 2016, respectively. As it shrinks, Unilever may become a more profitable entity. As a result, its shares would command higher trading multiples.
Full attention and resources should be devoted to the core ‘personal care’ unit, which, based on growth prospects, profitability, and capex requirements, should be valued at a 20%-plus premium to Unilever’s trading multiples. I expect more acquisitions in the region of $1bn in this field. Of course, upside could be greater if Unilever speeds up divestments in its ‘refreshment’ and ‘home care’ divisions, both of which would trade at a discount to the group’s valuation if they were run as independent entities.
What’s Next
Unilever boasts a solid free-cash-flow yield and a dividend yield of 3.5%. Net leverage is manageable, and is expected to drop over time, although it doesn’t have to. In fact, Unilever seems well managed and its capital structure shows a good balance of equity and debt. I am convinced that Unilever shares are likely to hold up if volatility returns, and are also likely to beat the market if confidence in riskier asset classes doesn’t fade away.
Unilever shares trade about 9% below the record high they recorded in early 2013. Last year was particularly tough for shareholders, but I don’t see any reason why, if management continue to deliver on their promises, investors shouldn’t build long positions into the stock. They may also enjoy further weakness in the euro to the end of the year, which would boost Unilever’s results.
