Terry Smith, influential fund manager of one of Unilever’s top 10 shareholders (NYSE:UL), Fundsmith, blamed Unilever for “losing the plot”. In his annual shareholder letter to Fundsmith investors, he wrote the following:
Unilever appears to be suffering under the weight of management obsessed with publicly displaying its sustainability credentials at the expense of focusing on business fundamentals.
He cited the public row over Ben & Jerry’s decision not to supply its products to the West Bank as an example of dubious and unnecessary action. Also, he criticized Hellmann’s “mayonnaise with a purpose”.
In this article, I will analyze Unilever’s recent performance against some of its peers and try to understand whether its focus on sustainability is likely to lead to poorer business results.
Past performance against peers
Unilever’s recent performance has not been good. While most of the market saw strong gains throughout 2021, Unilever’s stock was left out and its price even fell.
Performance of Unilever and some of its peers over the past 3 years (Source: YCharts)
As we can see in the chart above, Unilever underperformed some of its larger peers. While Nestlé (OTCPK: NSRGY), Procter & Gamble (NYSE:PG), and Mondelez (NASDAQ:MDLZ) posted gains of more than 50% during this period, Unilever shares remained flat.
In fact, the stock has been sitting for more than five years. Even since Kraft Heinz made an offer for the company and its share price has rapidly appreciated, Unilever seems to have moved nowhere. The offer was quickly rejected, but the increased emphasis on margins and the increased dividend were welcomed by more shareholders at the time. But after that, stock prices remained more or less stable.
Focus on sustainability leading to poorer results?
Mr. Smith argues that management’s public display of sustainability credentials hurts the rest of the company. It’s very difficult to measure or verify how much truth is in this claim (since it suggests a causal effect between the two), but let me do my best.
Regarding his examples, I also criticize the story of Ben & Jerry’s West Bank, because it’s a slippery slope once companies start dealing with very sensitive political issues (regardless of your political position on the subject ). Although, according to Unilever CEO Jope, Ben & Jerry’s took the decision on its own, it has become a hot topic, leading to divestments by some (state) governments of Unilever stock.
So Mr. Smith may be right about his Ben & Jerry’s example, but that has nothing to do with sustainability. And I don’t see why redefining the purpose of Hellmann’s Mayonnaise to become more sustainable was such a blunder.
The focus on sustainability also has significant benefits for Unilever, such as attracting quality employees. Unilever is among the most wanted employers in almost all of their markets. In addition, the credibility that its focus on sustainability gives Unilever in negotiations with governments and NGOs is a real advantage. Furthermore, food sustainability is likely to be one of the most important sustainability challenges in this century. Things like plant-based meat and other more sustainable protein sources are important areas of innovation for decades to come, and if Unilever plays its cards right, it could be at the forefront of these innovations.
The focus on sustainable development also allows Unilever to make promising acquisitions that could prove to be real growth engines. Some of these acquisitions would have been harder to sell to shareholders without corporate direction. And more importantly, smaller companies that focus on sustainability might prefer to be acquired by a larger company that is also focused on the same topic. Without his lens, Unilever might never have made acquisitions like The Laundress and The Vegetarian Butcher.
Margins higher than growth
Procter & Gamble, Nestlé and Mondelez are Unilever peers that have performed exceptionally well over the past two years. Let’s zoom in a bit and look at a possible reason why the shares of these companies have outperformed Unilever.
Unilever’s annual revenue growth versus some of its peers over the past 5 years (Source: YCharts)
When we compare Unilever’s annual revenue growth to these three companies, a pattern emerges. After 2018, Unilever significantly underperformed these three companies in the area of revenue growth. In 2019, 2020 and 2021, Unilever even reduced its revenues, while its competitors performed better on average.
Looking at the EBITDA margins of Unilever and these same three peers, we can conclude that Unilever’s margins are actually in line with those of its best performing competitors.
Unilever EBITDA margin versus some of its peers over the last 5 years (Source: YCharts)
As Jamie Isenwater of Ash Park Capital, who also owns Unilever shares, put it:
(Unilever’s stock underperformance is) “a manifestation of having raised margins too much in response to Kraft Heinz’s bid, and nothing to do with them publicly flaunting their sustainability credentials”
As such, the focus on margins even since the Kraft Heinz bid could have come at the expense of some of the company’s growth. The good news is that Unilever already has plans to increase its growth. In its latest third-quarter results, the company announced investments in high-growth areas such as functional nutrition.
Commodity inflation – the real reason?
In my previous article on Unilever, I highlighted three risks the company faces in the short to medium term. Among these risks, one of them has probably had a major impact on the performance of the company.
Unilever is much more exposed to certain raw materials (namely soybean oil and palm oil) than some of its competitors. In my article, I looked at the price trends of these two vegetable oils and concluded that the prices have indeed increased. Let’s take the same chart with a few more months of data:
Chart: Soybean and Palm Oil Futures Price
I was only able to find Malaysian palm oil futures on YCharts, but here you can see this chart looks quite similar to international prices
As can be seen, prices for soybean oil and palm oil have remained high and have increased further in the case of palm oil. It is therefore likely that Unilever will continue to suffer from these high prices, as not all price increases of their raw supply products can be passed on to consumers.
To take with
Terry Smith worries that Unilever’s focus on sustainability is coming at the expense of business performance. While I agree with him that Unilever has not performed well over the past two years, particularly compared to some of its peers, I think the focus on sustainability not to blame here.
I believe the main reason for Unilever’s underperformance is that the company is much more exposed to certain commodity inflation. Soybean oil and palm oil prices have risen significantly over the past two years and remained high in the last half of 2021. Unilever’s lackluster growth was also likely a significant reason for underperformance. If Unilever focused even more on growth and less on margins, it could lead to stronger long-term results. By slowly diversifying away from inputs like palm oil and soybean oil, the company could reduce its exposure to these two products.
Unilever’s focus on sustainability offers the company some hard-to-measure benefits, such as a better negotiating position with governments and NGOs, a supply of motivated and talented employees and a place at the forefront. of one of the most important challenges in terms of sustainable development. this century: food sustainability. I believe that these benefits outweigh the “costs” of a focus on sustainability, and I think the claim that Unilever’s focus on sustainability comes at the expense of its performance is wrong.
Unilever is a great company with a bright future, but it currently has two main problems: lackluster growth and high exposure to commodity inflation. Despite these issues, I remain a long-term investor in Unilever and this is one of my most important positions.
Thanks for the reading! Please let me know in the comments section what you think of Unilever.