Shares of Unilever (LSE: ULVR) are currently trading 10% lower than where they ended last week. Furthermore, the company’s market cap is about 12.5% lower than it was when Warren Buffett attempted to acquire it in 2017. Despite this, I don’t anticipate making an investment in Unilever shares currently.
At first sight, Unilever shares look cheap. The company currently has a market cap of £91bn, around £5.5bn in cash, and around £35bn in debt. Last year, Unilever produced around £7.5bn in free cash, implying a business return of around 7.12%. I think that looks quite attractive.
The trouble is that Unilever has found growth hard to come by. Over the last decade, Unilever has increased its revenue by a total of 8%, with marginal further improvements at the level of net income. If Unilever continues to grow at the 3%-5% range forecasted by management for the next decade, the result would be an average business return of between 8.35% and 8.95% per year. I think this is okay, but it doesn’t make me want to buy Unilever shares.
In an attempt to boost revenue growth, Unilever’s management has announced an intention to shift the company’s portfolio away from underperforming food categories and towards personal care products, where growth prospects appear more promising. To this end, Unilever recently made a £50bn offer for the consumer products division of GlaxoSmithKline. The deal was rejected but the news sent Unilever shares lower.
Unilever’s plan to pivot towards higher growth categories might work well. GlaxoSmithKline’s management forecasts annual growth in its consumer products division of 4%-6%, so replacing an underperforming food business with Glaxo’s consumer products business should increase the company’s overall growth prospects. But I don’t think that this automatically means that Unilever shares would be a more attractive investment.
There are two considerations that make me hesitant with Unilever shares. The first is the risk that Unilever might end up overpaying for its acquisition. Spending £50bn would involve debt, which makes Unilever shares less compelling from an investment perspective. The acquisition would then need to generate enough free cash to justify the outlay and there is always a risk that it might not. In my view, this represents something of an investment risk.
The other risk is that Unilever might struggle to sell the food business that it needs to dispose of. Whilst the company has some strong brands, there is no guarantee that Unilever will be able to find a buyer at a price that would meaningfully offset the debt incurred in the acquisition. Again, this would leave Unilever with excess debt on its balance sheet, reducing the attractiveness of Unilever shares as an investment proposition.
Most of the time, I see Unilever shares as a solid, predictable investment. Currently, I see them as something of an unknown quantity. I think the attempt to ignite revenue growth from the management by replacing a food business with a personal care products business could be successful. If Unilever can avoid paying too much for its acquisition and get a lot back for its disposal, I think there is a possibility that Unilever shares become a much more attractive proposition as a result. But the uncertainty around the deal is enough to put me off buying the dip in Unilever shares.