Being boring helps Unilever clean up

Investing

How do you solve a problem like Unilever? It might seem an odd question. On the surface, not much about Unilever needs to be solved.

The Dove soap maker this month overtook drugmaker AstraZeneca to become the UK’s most valuable listed company. Improved first-half profit on steady sales provided the catalyst, with demand for hand sanitiser and ice cream making up the slack elsewhere in the portfolio. It was proof that Unilever’s conglomerate structure can deliver a reliable performance no matter what.

Instead, Unilever’s problems are mostly relative. A gain of about 6 per cent in the year to date puts the stock at the lower end of the global staples sector, which has bifurcated between food and soap. This year’s top performers include Dettol maker Reckitt Benckiser, up more than a quarter, and US-listed bleach specialist Clorox, up more than 50 per cent. Even Colgate-Palmolive, a perpetual turnround project that lacks power brands beyond the two in its name, has outperformed Unilever with a gain of about 12 per cent in the year to date.

The recent trends also disguise the fact that, operationally, Unilever has underwhelmed. Trading since Kraft-Heinz’s failed bid in 2017 has remained lacklustre and strategic direction often seemed absent.

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Unilever’s mass market-focused beauty and personal care division, which provides about 40 per cent of group sales and half of earnings, was unable to catch an Asia-driven wave in demand for luxury skincare. Meanwhile, in groceries, intense competition from weak and wounded rivals meant Unilever lost market share in categories such as ice cream and sauces.

Also unhelpful to confidence was a sales warning in December, less than a month after chief executive Alan Jope had rejigged operations to accelerate and sustain top-line growth.

Effecting structural change on Unilever has always been laborious. Examples include the rejection of plans in 2018 to unify operations in Rotterdam, and complications when trying to ditch products deemed stale. Current efforts to split out its tea operations have a deadline of December 2021 and even then are unlikely to deliver a clean break. Mergers and acquisitions, such as the $1bn purchase of Dollar Shave Club in 2016, have too often involved overpaying for too little.

Shareholders get another chance later this year to vote on a proposal to collapse Unilever’s outdated dual-share class into a single primary listing, this time based in London. Approval of the simplification would lay the groundwork for much bigger changes, such as spinning out the food and drinks division or chasing a truly transformational acquisition.

So what could Unilever buy? According to Société Générale analysts, the most compelling target by far is Reckitt.

Writing in a note this week, SocGen analysts argue that Unilever needs to reinvent itself by adding products aimed at higher income shoppers. Its team argues in favour of doubling down on consumer health and targeting products that lend themselves to cross selling and direct-to-consumer subscriptions, such as baby food and condoms. Reckitt offers all that. Colgate, long rumoured to be Unilever’s most likely bid target, does not.

Scale matters for consumer goods makers, not just in distribution and retailer negotiations but for advertising clout. Combining Unilever and Reckitt’s operations would deliver savings and synergies worth more than €29bn, SocGen analysts estimate.

The size of the mutual benefit removes the need for a bid premium, they say, particularly as nearly three-quarters of Reckitt shares are held by investors backing Unilever. Merging could be as simple as giving Reckitt shareholders 30 per cent of the enlarged group. Perhaps the combined food division could be spun off as a sop to Netherlands shareholders, leaving a pure-play UK listed home and personal care business with €45bn in sales and margins of approaching 21 per cent.

It is a good theory. Such fantasy-league M&A has a tendency to ignore practicalities, however.

Culturally, Reckitt and Unilever are polar opposites. New chief executive Laxman Narasimhan has been working to shed Reckitt of its reputation for sweating assets to exhaustion while at Unilever there’s a push to dismantle legacy bureaucracy, but both have a long way to go before they start to look like each other. Antitrust presents another hurdle, given product overlaps in areas such as dishwasher powder and toilet cleaner.

More importantly, there is no guarantee that the trends powering Reckitt in the early stages of its turnround will endure.

Covid-19 has been an exceptional tailwind for hygiene products, which provide about 38 per cent of Reckitt’s group sales, but its performance in key areas such as infant formula and over-the-counter medicines remains patchy. Unilever, meanwhile, lacks star-performing categories yet has come through the early stage of the pandemic unscathed. In times of uncertainty, there is a lot to be said for boring conglomerates.

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