Death of the consumer conglomerate? Unilever bets less is more

Unilever is betting that shedding food assets and focusing on beauty, personal care and home products will close a valuation gap with more focused rivals. The challenge is convincing investors that a simpler company can deliver higher returns.

The maker of Dove soap, Axe deodorant and Cif cleaning products trades at 11.5 times enterprise value to core earnings, according to LSEG data. That compares with 14.8 for Procter & Gamble, 17.5 for L'Oreal and 22.7 for Coca-Cola.

Those multiples suggest investors place a premium on more focused consumer goods companies.

But investors have two main concerns.

Unilever's deal in March to merge its food business with US spice maker McCormick will leave the British group with an almost 10% stake in the combined company, and its shareholders with a roughly 55% stake.

At the same time, the transaction reduces Unilever's exposure to a relatively high-margin business, increasing pressure on management to show that faster-growing beauty, personal care and home products can make up the difference.

"Until you show me the evidence that you're turning this around, you're sitting on a very low multiple," said Dan Hanbury, a portfolio manager at Ninety One, a major investor in Colgate-Palmolive, Unilever and L'Oreal.

The market is wary of "false dawns" from corporate turnarounds, he added, saying Unilever probably needed three or four quarters of strong volume growth to win over doubters.

The P&G example

Big industrial companies from General Electric to Siemens have spent years simplifying their structures in an effort to eliminate what investors call a conglomerate discount, a penalty applied to companies whose complexity is seen as weighing on efficiency and growth.

That thinking has increasingly spread to consumer goods companies. Where diversification was once seen as a strength that could cushion changes in consumer tastes, investors now increasingly favour category leaders that can focus investment, innovation and marketing on a narrower set of products.

Under CEO Fernando Fernandez, Unilever has accelerated its retreat from food. The company spun off its ice cream business and in March struck a roughly $65 billion deal to combine its food division with McCormick.

The issue is not that food is unprofitable. The business has historically generated attractive margins, but growth has lagged Unilever's beauty and personal care operations.

"Being focused on a single category allows you to be more cost effective and more innovative," said Akeel Sachak, global head of consumer at Rothschild & Co.

Investors often point to Procter & Gamble as a template. The Tide detergent maker exited food and streamlined its brand portfolio, subsequently delivering stronger growth and earning a valuation premium for much of the following decade.

"P&G pulled off the restructuring, drove higher growth and commanded a relatively higher premium for probably 10 years," Hanbury said.

Unilever's decade-long valuation struggle

Packaged food has been a drag on Unilever's sales growth for years, particularly after the Covid-19 pandemic. Since Unilever announced the spin-off of that unit, the British company has gained investors' favour.

Investors and analysts say the focus for Unilever has now switched from portfolio reshuffling to execution.

"If (Unilever) continues to execute, Unilever will continue to see a degree of re-rating ... and then hopefully grow from there," said Will James, portfolio manager at Guinness Global Investors, which holds shares in Unilever and L'Oreal.

Unilever has reported improving results in recent quarters, and in July said sales volumes had reached their highest level in more than a decade.

Yet despite the operational improvement, some Unilever investors are concerned about their continued exposure to the slow-growing food category via their stake in the company resulting from the McCormick merger, Barclays analyst Warren Ackerman said.

Unilever declined to comment.

CEO Fernando Fernandez told an industry event in June: "I believe that every quarter that goes by, and we deliver the numbers that we have been delivering, and we get closer to the closing of a transaction of McCormick, the value of Unilever will be shown."