Consumer goods giants Unilever (LSE: ULVR) (NYSE: UL.US) and Reckitt Benckiser (LSE: RB) (NASDAQOTH: RBGLY.US) are regularly cited as examples of firms where you pay a premium for quality.
Until recently, I’ve agreed with this view: in recent years I’ve purchased shares in Unilever at around 2,000p and 2,400p, and have no intention of selling them.
However, shares in both companies have climbed by between 15% and 20% over the last 12 months, and I’ve reached my limit: I won’t buy either firm at today’s prices.
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Why not?
Unilever and Reckitt don’t seem to be able to meet City expectations — consensus forecasts for Unilever’s 2015 earnings have fallen from 148p to 134p over the last twelve months, leaving the firm on a 2015 forecast P/E of almost 21.
That seems too high, to me, given that in its 2014 results, Unilever warned that market conditions were not expected to improve significantly in 2015.
It’s a similar story at Reckitt, which currently trades on a 2015 forecast P/E of 23 times and offers a prospective yield of just 2.4%.
In fairness, I think the problem might be that City forecasts are too optimistic: Unilever and Reckitt have been quite open about soft conditions emerging markets in their trading updates.
Changing shape
Neither company is standing still in the face of sub-par growth.
Reckitt demerged its pharmaceuticals business into a new London-listed firm, Indivior, earlier this year, in order to sharpen its focus on its core health and hygiene ranges.
Back in December, Unilever said it would move its slow-growing spreads and margarines business into a standalone unit, a move widely seen as a precursor to a sale of this business. This would enable Unilever to focus more heavily on personal care products where profit margins and sales growth are higher.
How much would I pay?
Unilever’s adjusted earnings per share have grown by an average of less than 5% since 2009, while the equivalent figure for Reckitt is 11%.
In my view, Unilever would be more reasonably valued on a P/E of 17, which would give a yield of about 4%, and a share price of around 2,300p.
Reckitt has delivered strong growth and enjoys higher operating profit margins than Unilever, but earnings are expected to fall this year. I’d be happy to pay around 4,500p for Reckitt, which would equate to a 2015 P/E of 18, and a prospective yield of around 2.9%.
