Thesis For Reference

ACCOUNTING AND FINANCE DIVISION
AN INVESTMENT ANALYSIS OF UNILEVER
THANH HUONG VU
SUBMITTED IN PART FULFILMENT OF THE DEGREE OF MSc IN INVESTMENT ANALYSIS THE UNIVERSITY OF STIRLING
AUGUST 2009
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Acknowledgements
I would like to express my gratitude to the Accounting and Finance Division - Stirling Management School, and Mr. Russell Napier for granting me the Karen Napier Scholarship to enter the MSc in Investment Analysis programme. I would like to thank all the lecturers and university staffs who have offered me the great knowledge and experience during the programme. I would like to thank my supervisor, Darren Henry, for his valuable advice, guidance and encouragement during my dissertation period. Finally, I would like to thank my family and my friends. The love they give to me has always been my greatest motivation.
ABSTRACT
The Case study is conducted as the fullest possible investment analysis of Unilever, which is among the largest multinational groups operating in the Consumer Products industry. The analysis covers both the economic environmental factors affecting Unilevers operations, as well as the internal characteristics of the firm. This helps build up the indepth knowledge of the firm, which is the basement for the valuation process to estimate the intrinsic value of Unilevers share. Despite the current unfavourable economic conditions, Unilever has still positioned well to overcome the difficult time, thanks to the experience, the scale, the popularity, the strategies, the management capacity, and the financial strength which it has built up over 80 years of development. That is the foundation for the expectation that the firm will weather the current economic volatility, and emerge stronger with the recovery of the global economy. The following estimated intrinsic value of Unilevers stock price, combined with the fact that the stock is outperforming the market, has strengthened the BUY recommendation for Unilevers share.
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TABLE OF CONTENTS
CHAPTER 1 - INTRODUCTION 1.1 The objective of the case study.............................................................................. 1 1.2 The structure of the case study .............................................................................. 1 1.3 Business description .............................................................................................. 2 1.4 Limitations ............................................................................................................. 3 CHAPTER 2 - THE ECONOMIC OUTLOOK 2.1 Introduction ........................................................................................................... 4 2.2 The Global economy ............................................................................................. 4 2.3 The Advanced economies ...................................................................................... 7 2.4 Emerging economies ............................................................................................. 8 2.4 The UK economy................................................................................................. 10 2.5 Conclusion ........................................................................................................... 11 CHAPTER 3 - INDUSTRY ANALYSIS 3.1 Introduction ......................................................................................................... 13 3.2 Industry overview ................................................................................................ 13 3.2.1 Global industry overview ............................................................................. 14 3.2.2 Geographical industry overview ................................................................... 16 3.3 Porter Five Forces analysis .................................................................................. 17 3.3.1 Rivalry among existing firms ....................................................................... 17 3.3.2 Threat of new entrance ................................................................................. 18 3.3.3 Bargaining power of buyers ......................................................................... 19 3.3.4 Bargaining power of suppliers...................................................................... 20 3.3.5 Threat of substitutes ..................................................................................... 20 3.4 Conclusion ........................................................................................................... 21 CHAPTER 4 - LITERATURE REVIEW 4.1 Introduction ......................................................................................................... 22 4.2 Mergers and Acquisitions .................................................................................... 23 4.2.1 Definition and classification ......................................................................... 23 4.2.2 Motivations ................................................................................................... 24 4.3 Mergers and Acquisitions in the Food and Beverage sector - Benefits and Prospects .................................................................................................................... 24 4.3.1 Forms of Mergers and Acquisition ............................................................... 25 4.3.2 Benefits and Prospects .................................................................................. 26 4.4 Implications for Unilever..................................................................................... 34 4.5 Conclusion ........................................................................................................... 35 CHAPTER 5 - COMPANY ANALYSIS iii
5.1 Introduction ......................................................................................................... 37 5.2 Strategy and corporate governance analysis ........................................................ 37 5.2.1 Strategy analysis ........................................................................................... 37 5.2.2 Corporate governance analysis ..................................................................... 40 5.3 Financial analysis ................................................................................................ 41 5.3.1 Ratio analysis................................................................................................ 41 5.3.2 Cash flow analysis ........................................................................................ 49 5.4 SWOT analysis .................................................................................................... 52 5.5 Conclusion ........................................................................................................... 53 CHAPTER 6 - VALUATION 6.1 Introduction ......................................................................................................... 54 6.2 Discounted Dividend Valuation (DDM) ............................................................. 54 6.3 Discounted Cash Flow Valuation (DCF)............................................................. 55 6.4 Discounted Abnormal Earnings Valuation (DAE) .............................................. 56 6.5 Sensitivity Analysis ............................................................................................. 57 6.6 Price Multiples ..................................................................................................... 58 6.7 Conclusion ........................................................................................................... 59 CHAPTER 7 - CONCLUSION 7.1 Introduction ......................................................................................................... 60 7.2 Investment recommendation................................................................................ 60 7.2.1 Investment analysis summary....................................................................... 60 7.2.2 Stock performance ........................................................................................ 61 7.2.3 Investment recommendation ........................................................................ 62 APPENDIX 1 - Financial Statements64 APPENDIX 2 - Industrial average ratios..67 APPENDIX 3 - Forecasted Financial Statements.69 APPENDIX 4 - Forecast assumptions72 APPENDIX 5 - Valuation assumptions. 76 BIBLIOGRAPHY....82
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Chapter 2 The Economic Outlook
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CHAPTER 1 - INTRODUCTION
1.1 The objective of the case study

The main objective of the case study is to apply the knowledge gained from the MSc Investment Analysis program in analyzing a chosen firm, to come up with the appropriate value of the firms share. In this process, the fundamental analysis will be used as the main approach. The final recommendation of BUY, HOLD or SELL the stock will be based on the valuation result, by comparing the intrinsic value obtained from the analysis with the market price of the share. In line with this objective, this case study will be conducted as the fullest possible investment analysis of Unilever, coming up with the intrinsic value and the appropriate investment recommendation about the Unilevers stock.
1.2 The structure of the case study

In order to achieve its objective, the case study will be structured into seven main chapters, as the following: The first chapter is the Introduction of the case study, outlining the objective and the structure of the analysis. It also provides the brief business description of Unilever. Chapter 2 will be The economic outlook of the global, the advance, the emerging and the United Kingdoms economy. Chapter 3 will be The Industry Analysis. In this chapter, the industry of Unilever will be examined, complemented by the use of Porters Five Forces model. 1
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Chapter 4 is the Literature review with the topic Merger and Acquisition in the Food and Beverage sector - Benefits and Prospects. This is the sector in which Unilever is operating and the topic is relevant to the subsequent analysis of the firm. Chapter 5 will be Company Analysis, in which the firms strategies, corporate governance and financial performance will be analysed. The SWOT analysis will also be used in the chapter. Chapter 6 with the content of Valuation will apply appropriate valuation models to determine the intrinsic value of Unilevers share. Chapter 7 will be the Conclusion of the investment analysis with the final recommendation of BUY, HOLD or SELL the stock.
1.3 Business description

Unilever Group was established in 1929 with the merger between British soap maker Lever Brothers and the Dutch margarine company Margarine Unie. The two parents companies, which are now under the name of Unilever PLC and Unilever NV, together with their group companies, operate as a single entity - the Unilever Group1. Unilever has long been considered as one of the leading firm manufacturing packaged consumer goods. Products of the firm are classified into four segments of Savoury, dressing and spreads; Ice cream and beverage; Personal care and Home care 2 . The
Unilever Annual Report and Accounts 2008: Unilever PLC is registered in the United Kingdom and listed on the London Stock Exchange and as American Depository Receipts on the New York Stock Exchange. Meanwhile, Unilever NV is a Dutch public limited company which has shares and depository receipts for shares on Euronext Amsterdam and of New York Registry Shares on the New York Stock Exchange 2 Unilever Annual Report and Accounts 2008
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products can also be grouped into two categories for the purpose of analysing, including the Food division3, and the Home care and Personal care division4,5. Over 80 years of development, Unilever has become a giant company, with various well-known brands all around the world including Lipton, Slim-Fast, Persil, Dove, Walls, Hellmanns, Lux. Those popular names are parts of the huge range of world-class brands that Unilever has built up, both organically and through mergers and acquisitions throughout its history. Starting trading on the LSE from 1939, Unilever is among the top ranking firms in the sector with the market capital of 47,2356 million. With 174,000 employees, around 270 manufacturing sites and operations in about 100 countries worldwide 7 , Unilever is implementing its mission of adding Vitality to life, satisfying everyday needs for nutrition, hygiene and personal care with brands that help people feel good, look good and get more out of life.
1.4 Limitations
The Case study dissertation has the cut-off date of August 15th 2009. All the available relating information before this date will be used to analyse Unilever. The valuation process of Unilevers share is based on prospective assumptions about the future performance of the firm, which have certain limitations, despite being created through the analysis of the firms past performance and the current business environment.
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Including soups, bouillons, sauces, snacks, mayonnaise, salad dressing, olive oil, margarine, spreads, liquid margarines, tea, ice cream and frozen foods 4 Including deodorants, anti-perspirants, oral care, laundry powders and liquid, and a range of cleaning products 5 Thomson ONE Banker, <URL:http://banker.thomsonib.com >, accessed on 06/2009 6 Thomson ONE Banker, <URL:http://banker.thomsonib.com>, accessed on 15/08/2009 7 Unilever Annual Report and Accounts 2008
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CHAPTER 2 - THE ECONOMIC OUTLOOK
2.1 Introduction
The macroeconomic environment always has a substantial impact on firms business performance. Indicators such as Gross Domestic Product (GDP), consumer price index and inflation, unemployment rate are very important in evaluating the past, current, as well as the future performance of firms. In the case of a multinational group like Unilever, which has operations spread around 100 countries, the economic outlook will be examined with the global view, then from the perspective of advance and emerging economies, respectively. Considered as the home market location, the United Kingdom economic outlook will be analysed at the end to come up with the conclusion for the macroeconomic analysis.
2.2 The Global economy

The global economy is now suffering a serious recession that had its root from the outbreak of the US subprime crisis in 2007. The dramatic write-downs of subprime mortgage loans and derivatives had led to the subsequent financial crisis which exploded in September 20088. The crisis in the banking system spreads all over the world in different degrees between countries and created a domino reaction in nearly every industry in the so-called deepest post-war depression9.
The collapse of the giant investment bank, Lehman Brothers, was on September 15, 2009 Guardian (2008) Banking crisis: Lehman Brothers files for bankruptcy protection, The Guardian, 15 September, <URL: http://www.guardian.co.uk >, accessed on 05/06/2009 9 IMF (2009) World Economic Outlook - Crisis and Recovery, <URL: www.imf.org>, accessed on 11/06/2009
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The global economy is in a severe recession inflicted by a massive financial crisis and an acute loss of confidence10 The general situation of the global economy is not favourable at the present and so is its prospective outlook, at least in the short term: Gross domestic product (GDP): The global economy had enjoyed a long prosperous period with the average annual growth rate of 4.7% in the five years preceding the crisis11. With the blowout of the crisis in 2008, the GDP growth rate declined to only 3.2%. In the World Economic Outlook 2009, IMF expected that GDP growth rate would decline to 1.3% in 2009, then increases to 1.9% in 2010 and reach 4.8% in 2014. The predicted figures can be seen in the following graphs:
With great efforts being implemented throughout the world in the form of aggregate interest rate cuts, massive government bailout and credit accelerating policies, forecasts
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IMF (2009) World Economic Outlook - Crisis and Recovery<URL: www.imf.org/ >, accessed on 11/06/2009 Morgan Stanley (2009) Global Forecast Update, <URL:www.morganstanley.com>, accessed on 18/06/2009
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show that the global economy is expected to recover in 2010, however, it will take a long time for the economy to achieve the pre-crisis level. The great threat is that the global recession can be deeper than predicted, with unforeseeable consequences in emerging economies. Consumer Prices Index and Inflation: There were great changes in commodity prices within 2008 due to the impacts of the crisis. With the growth trend of the global economy, commodity prices rose continuously during 2003-2008. However, the slowdown of the economy has decreased the inflation pressure, creating the particularly sharp drop in commodity prices12,13. Commodity prices are expected to remain at the current level through 2009 and only rise modestly from 20101415, much lower than the peaks of 2008. Inflation is expected to continuously decrease through 2010, before surging again with the recovery of the global economy.
The oil price collapsed to $30.28 a barrel on 23/12/2008 from its peak of $145 on 14/07/2008 Energy Information Administration, <URL:http://tonto.eia.doe.gov>, accessed on 11/06/2009 13 Food price declined by 34 percent in the second half of 2008 IMF (2009) World Economic Outlook Crisis and Recovery, pp.54 14 IMF (2009) World Economic Outlook Crisis and Recovery, Prospect 15 UBS (2009) Global Outlook
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However, a persisting sharp fall in house and equity prices, coupled with the low growth rate and the consequent high unemployment rate could further threatening consumer prices, depressing the inflation expectation, even increasing the concern of deflation which can make downside risks more serious.
2.3 The Advanced economies

The advanced economies have suffered seriously from the current recession. During 2003-2007, they enjoyed a reasonably high growth rate of 2.7% annually. However, the crisis has created the dramatic changes and these can be seen from the decline of GDP growth rate to only 0.9% in 2008 and, more severely, it is expected to be as low as negative 3.8% in 2009, to be zero in 2010 and to recover to its prior level of 2.6% in 2014. With these GDP growth rate projections, the unemployment rate is forecasted to continue rising, and to be over 9% in 201016. IMFs GDP forecast for the advance economies can be seen in the chart:
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IMF (2009) World Economic Outlook Crisis and Recovery, Appendix A1
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The United States has a significant influence on the global economy. The US GDP is expected to drop 2.8% in 2009, and then the economy will only slowly recover from the middle of 2010 with an annual growth rate of zero. The worlds biggest economy is forecasted to achieve the growth rate of 2.4 percent in 201417. This projection highly depends on the effectiveness of government monetary policies, including rate cuts and credit facilitating, as well as on the recovery abilities of its core financial institutions. Euro zone - Fears about losses from US-related-assets in major banks caused the wholesale market to freeze, and credit constraints spread over the Euro zone, affecting various aspects of the economy. Annual growth of 0.8% is the slowest since the early 1990s. Inflation moderated to only 1.1% in January 2009, from the level of 3.2% in January 200818. Japan seems to be in the better situation to weather the crisis, thanks to its limited exposure to the toxic assets that the US and Europe are struggling to deal with. The GDP growth rate in Japan fell quickly from 2.4% in 2007 to a mere 0.6% in 2008, mainly due to sharp drops in exports and private investment 19 . GDP is expected to decline 6.2% in 2009 then reaching 0.5% in 2010, and 2.5% in 201420.
2.4 Emerging economies

The influences of the global recession on emerging economies are said to be through both financial and trade channels.
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IMF (2009) World Economic Outlook - Crisis and Recovery, Appendix A1 ADB (2009) Asian Development Outlook 2009 19 ADB (2009) Asian Development Outlook 2009 20 IMF (2009) World Economic Outlook - Crisis and Recovery, Appendix
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The GDP growth rate of these economies could not remain at the average annual level of as high as 7.4% during the five pre-crisis years, obtaining only 6.1% in 2008. This figure is expected to be as low as 1.6% in 2009, before recovering to 4% in 2010 and returning to 6.8% in 201421. East Asian economies, which rely heavily on the manufacturing exports, are experiencing lower demand from main importers like the US and European countries. In India and China, however, the impacts of the recession are less severe thanks to the lower shares of their export sectors being in the domestic production, and more resilient domestic demand22. Meanwhile, the downturn seems to be more serious in the African, Latin American as well as the Middle East, which are suffering due to plummeting commodity prices, financial strains as well as weak export demands23. The more important impact of the crisis to emerging economies is in the financial aspect. The economic uncertainty and the deteriorating investors confidence created the rise of flight to safety and home bias, under which, capital flows to countries with the most liquid and safe government securities market, and out of emerging ones, creating the increase in threats to solvency.
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IMF (2009) World Economic Outlook - Crisis and Recovery, Appendix A1 IMF (2009) World Economic Outlook - Crisis and Recovery, pp.5 23 IMF (2009) World Economic Outlook - Crisis and Recovery, pp.5
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These economies are expected to suffer from the net capital outflows of more than 1% of their GDP in 200924. Moreover, the exchange rate depreciation would place more pressure on borrowers with large currencies exposures, and this has also been a very vulnerable development so far. Emerging economies have to deal with these challenges for a long period to come, due to the severity of the global crisis.
2.4 The UK economy

The UK economy is struggling with the global crisis. Starting in 2008, the recession dampened the growth rate of the economy to 0.7% and is expected to persist throughout 2009 with the GDP growth rate falling by around 3%, and the rate will only recover slowly in 201025.
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IMF (2009) World Economic Outlook Crisis and Recovery, pp.9 PWC (2009) UK Economic Outlook - March 2009 HM Treasury (2009) Forecast for the UK economy - May 2009
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GDP growth rate (%) Inflation rate (%) - CPI - RPI Claimant unemployment (mn)
2009 2010 2011 2012 2013 -3.9 0.2 1.9 2.4 2.6
1.6 -1.3
1.5 1.7
1.5 2.3
1.8 2.9
2 2.5
1.74 2.27 2.23 2.09 1.91
The inflation rate is falling, largely due to the significant drops in petrol and fuel prices since the middle of 2008. Moreover, the reduced VAT which applied from December 2008 also contributed to the decrease in inflation in the UK economy. The unemployment rate is also rising, and this is a trend that started from the second half of 2008. The higher unemployment rate will continue putting pressure on consumer confidence and spending in the coming period. Various macroeconomic policies have been used to deal with the recession, including the aggressive interest rate cuts and the huge rescue package and substantial intervention of the Government into the banking system. The financial service sector, which played a major role in the economic growth of the UK in the past, has now become the core of its crisis. The UK economy has been hit hard by the crisis, facing a long and difficult period to come, with the relatively slow pace of recovery.
2.5 Conclusion
In conclusion, the macroeconomic outlook is dominated by the recession that spread throughout the world and in nearly every aspect of the global economy. The prospect for the economy from the late period of 2009 is better with the likelihood of modest
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recovery, and in line with this prediction, the economy may recover to its level prior to the crisis in around 2014. Unilever is a multinational group, so different trends from different economic areas can partly offset each other. However, with the main part of the companys turnover being contributed by advance economies, as analysed in the following chapters, the impact of the deep recession in those economies on Unilever will be significant.
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Chapter 3 Industry Analysis
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CHAPTER 3 - INDUSTRY ANALYSIS
3.1 Introduction
Industry analysis provides a detailed picture about the external business environment of firms and plays an important role in the fundamental analysis because the profitability of certain industries differs systematically and predictably over time, and this has a significant influence on firms profitability26. With this point of view, the chapter will examine the outlook of Unilevers industry, with particular focus on applying the Porter Five Forces model.
3.2 Industry overview

Unilever has two main categories of products which are Food and Beverage, and Personal care and Home care. In accordance with the classifications of Unilevers listing markets27, the firms industry is Food producer. However, if the wide range of Unilevers products is taken into account, the firm is operating in the Consumer products sector, which consists of three principle segments: brewery; food and beverage; and household and personal care28. The following industry analysis will combine the two classification forms. The industry to be analysed will be the Consumer products industry, with more focus on the subsector of Food and Beverage. This is also in line with the contributions to sales from
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Palepu, K.G., Healy, P.M., Bernard, V.L. and Peek, E. (2007) Business and Analysis and Valuation (IFRS edn), Thomson Learning, London, Chapter 2, pp. 43 27 London Stock Exchange, NYSE, Euronext 28 Ernst&Young (2008) Consumer products industry and working capital management, pp.1
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these products, and the development strategies of Unilever, which will be examined in following chapters. 3.2.1 Global industry overview The Consumer products industry has the highly desirable feature of being non-cyclical, where firms would not experience a significant downturn during a recession, but also would not experience a strong increase during an economic expansion. However, due to the profound effect of aggregate economic events, the industry will not be immune to whatever is happening in the macro-economy. The collapse of housing prices, the dramatic drop in market capitalization in stock markets, the rising unemployment rates, and the difficult business environment have negatively impacted on the wealth of consumers. This combined with the tighter credit conditions, the dramatic fall in confidence, and the strong likelihood of a deeper economic downturn has resulted in consumer spending reducing significantly. Moreover, the spending patterns of consumers have also changed with the recession. Namely, price and value is becoming the central issue for consumption decision making29. As a result, firms have to deal with decreasing demand, as well as the cost-cutting pressure which leads to lower margins. Cost reduction has emerged as the top priority for businesses in 2009, as the key area to protect and improve trading performance30. As the deep recession in many economies is expected to last for a long period, many firms are responding to the situation by focusing on growth in emerging markets,
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Deloitte (2009) Industry Outlook - Consumer Products In the last few months alone, more than 12 of the leading Consumer products companies in the Fortune 500 have announced cost reduction programs, from Coca Cola to Procter&Gamble. Ernst&Young (2009) Driving sustainable enterprise cost reduction within the consumer products sector, pp. 2
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mergers and acquisitions, and product innovations. These will be the growth drivers of the industry in the coming period. Supply chain management is also one of the main issues in the industry at the moment. Global sourcing and market expansion, consumer safety and quality concerns, and changing consumer preferences are making the task of supply chain management more and more complicated. Of which, the issue of food safety has become particularly prominent following the recent contaminated milk scandal in China and e-coli related recalls in the US. This issue is very important to brands reputation, and is attracting more and more concerns from firms managers31. Moreover, greening and sustainability issues also have great effects on the industry. Consumers are paying more and more attention to brands sustainability and social responsibility initiatives32. For many companies, green products sales have grown faster than overall sales, therefore, consumer products companies can take advantage of this available growth field, through implementing product innovations and appropriate marketing campaigns. In conclusion, most consumer products companies face a difficult time ahead, or at least a period of no growth as the recession persists. Nevertheless, if firms can track and anticipate changing consumers needs with appropriate brands, products and services, there are still opportunities for the successful business.
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In the 2008 CIES Top of Mind Survey of Food Retailers and Manufacturers, food safety rose from eighth to second place in the rank of senior executives priorities, and has maintained its position in the recent 2009 survey. Deloitte (2009) Industry Outlook - Consumer Products 32 The Retail Forward Intelligence System study in March 2008 Deloitte (2009) Industry Outlook - Consumer Products
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Chapter 3 Industry Analysis 3.2.2 Geographical industry overview
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The markets for the industry can be divided into three geographic segments with different characteristics:
The United States
Euro zone and other advanced economies

- Represent a
- The worlds biggest
economy, account for 32 percent of Unilever 2008 turnover - In the prolonged recession, to ultimately recover by the start of 2010 but with a slow GDP growth rate, and even slower rate for consumer spending - The stronghold of P&G and with the presence of all famous corporations: Nestle, Kraft, Unilever, Mars - The mature market in the downturn - sign for shifting focus for future growth towards other market segments
significant proportion of the global consumer spending, and contributed 32 percent of Unilever turnover in 2008. - Consumer spending has also exhibited a downward trend, as the phenomenon spreads from the US - Experiences the long existence of giants in the industry, also the home markets of Nestle, Unilever, Danone - The mature market in the downturn, not the favourable places for continuing investing
Emerging economies
- Raising the importance in the worlds economy with the fast growing populations, the
continuing economic growth trend and increasing living standards - Suffering from the contagion of the recession which started from advanced economies, due to the slump of both foreign trade and financial investments. However, GDP only moderately decreased and will recover soon by its internal strengths, e.g. China with huge domestic demand, India with strong growth in middle-class consumers - The growing markets - the current best place to invest, with the rising presences of all giants: Nestle, P&G, Unilever
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3.3 Porter Five Forces analysis

3.3.1 Rivalry among existing firms The consumer products can be considered to be in the stabilization and mature stage of its industry life cycle. The industry has so far experienced a moderate growth rate, of which the largest subsector - Food and Beverage - is the most mature one with slow growth33. This is the industry that experiences fierce competition from a large number of worldclass multinational groups, including Nestle, Pocter&Gamble, Kraft, Danone and Unilever, as well as small private players with local operations. Consumer products can be described as having low differentiation and low switching costs. The substantial differentiation, which may only exist, is between branded and private label products, through quality differences. However, the quality gap is now closing and can be considered to be near zero in many categories 34 . Consumer spending patterns are also changing with less discrimination between private labels and branded products. This is the basis for the expectation that the current recession will caused a notable shift of consumer purchasing into cheaper private label brands. Economies of scale play a very important role in the industry, which allows firms to reduce costs, secure the supply of inputs, establish wide distribution chains to build up market segments and create innovative products with advance technology. As cost
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Deloitte (2009) Industry Outlook - Consumer Products Ernst&Young (2009) Driving sustainable enterprise cost reduction within the consumer products sector, pp. 3
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reduction has currently been the top ranking concerns among firms in the industry, large-scale firms can have significant competitive advantage over smaller ones. In the industry, there will still be two main competitive strategies: cost reduction and product differentiation. While cost reduction faces margin pressure and volatility in inputs prices, firms might try to differentiate products and persuade customers that their products are safer, of higher quality, or tastier, to make it worth paying the higher prices. 3.3.2 Threat of new entrance Economies of scale offer existing firms in the industry a great deal of advantage over new entrants. Of which, existing large scale firms can enjoy the cost advantage which is the very important competitive advantage in the current economic situation. Investing in large capacity will be a significant challenge for new entrants, especially in the current tightened credit market. R&D can provide significant competitive advantages for firms over cost reduction, differentiation and innovation. However, R&D capacities have to be developed over time, creating substantial barriers for new entrants, unless they have sufficient financial resources to invest in R&D at the beginning or collaboration with other R&D facilities. Consumers spending decisions are affected by their habits and brands loyalties which are related to their quality perception. Existing brands have already had their quality assurance evaluation and have set their standards. Advertising can help new brands become more familiar with customers, but their qualities need time to prove and this creates the advantage for first movers in the industry.
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Furthermore, new entrants in the consumer products industry also face difficulties in building up their suppliers and distributors network. Existing firms have already had long lasting, or even exclusive arrangements with suppliers of cheap raw materials. Besides, while new entrants finds it difficult to obtain supermarkets shelf-space for their products, existing firms products have already been in good locations and have been exposed through other distribution channels as well. Therefore, the threat of new entrants in the industry is not significant, because there have been significant barriers developed to deter new entry which have been built up through economies of scale, first mover advantage, and relationship with suppliers and distributors. 3.3.3 Bargaining power of buyers In the Consumer products industry, the bargaining power of buyers is increasing over time. This is because the industrys products are not differentiated substantially, and there are also no switching costs. These characteristics have made buyers become highly sensitive to prices. Moreover, there are various firms operating in the industry, from world-class brands to private labels, providing buyers with a wide range of choices. Buyers can be considered to include product retailers and the final consumers. In the case of retailers, such as supermarkets, volumes of sales are large and have great influence on the total revenue of firms. Large distributors, such as Tesco, Wal-mart and Morrison, have the power to set consumer prices and determine the assortment of goods to be sold, therefore, they have significant bargaining power. Moreover, there is also a substantial threat for firms from the fact that large supermarkets are producing more and more own-brand-products with much cheaper prices, replacing other brands on the 19
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front-shelves. This makes distributors become more independent and have more power to bargain in relation to prices. The end-users of the industrys products are customers, who are free to switch between brands. Given the fierce competition, firms have to adopt the shopper-centric perception. The volume of sales from each individual customer is small, but their trend of shopping is really vital to firms. Cost reduction is considered to be the popular tactic during the current difficult economic situation, when shoppers are becoming more and more priceoriented. 3.3.4 Bargaining power of suppliers In the consumer products industry, especially in the food and beverage subsector, raw materials account for a major proportion of production costs. The raw materials are often from less advanced agriculture countries in Asia, Africa, and South America, which normally highly depend on manufacturers, and so having less bargaining power. However, from the experience of the commodity price spike in 2008, manufacturers have awakened to the need for securing the supply sources. Underlying trends such as volatile price fluctuation in the current deep recession, population growth, and climate changes have created great threats for the security of raw material inputs. 3.3.5 Threat of substitutes There is no substitute for consumer products in general. The products of the industry are indispensable for the daily needs of customers; therefore, they cannot be replaced by other products.
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However, if taking into account the characteristic that products manufactured by firms in the industry are in the form of packaged products, their substitutes will be fresh or unpacked products. In advanced economies, the threat from these substitutes is not significant due to the tradition of buying products in supermarkets or stores offering a wide range of packaged products. The practice in other less advance countries is not the same, particularly considering the popularity of shopping in open markets with fresh and unpacked products. This is the characteristic that multinational firms have to take into account when considering entrance into such markets.
3.4 Conclusion
In conclusion, the Consumer products industry is a mature, highly consolidated industry characterised by the fierce competition and the fast movement of participants to deal with the continuously changes of the environment and consumption behaviours. The current economic conditions are not favourable for all industries, including the Consumer products industry. However, in such a difficult situation, firms still manage to explore the opportunity for growth, by focusing on their expansion to emerging markets, innovation and cost reduction. Unilever is one of the leading firms implementing these strategies. With the high profile and the strength built up through the groups long history of establishment and development, Unilever has positioned it well to overcome this hard time.
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Chapter 4 Literature Review
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CHAPTER 4 - LITERATURE REVIEW
4.1 Introduction
Mergers and Acquisitions (M&A) have gained popularity in nearly every sector in the global economy. M&A experienced a high wave of transactions from 2003, and especially in 2006 when global M&A transactions were at an all-time record level of $3.79 trillion 35 . Their popularity still exists even in the current difficult economic condition36. The Food and Beverage sector is not an exception, in which M&A has been said to be one of the main growth drivers, with increasing numbers of acquisition cases over the years, including the participation of giant firms such as Nestle, Unilever, Mars, and Procter&Gamble. From this viewpoint, the Literature Review will focus on the topic of Mergers and Acquisitions in the Food and Beverage sector - Benefits and Prospects. The chapter will begin with outlining the general knowledge about M&A, before analysing the M&A activities in the Food and Beverage sector.
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Harry, G., Barkema (2008) Toward unlocking the full potential of acquisitions: The role of organizational restructuring, Academy of Management Journal, 51:4, 696 36 Richey, Jr., Kiessling, Tokman and Dalela (2008) Market growth through mergers and acquisitions: The role of the relationship marketing manager in sustaining performance, Industry Marketing Management, 37, 394406
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4.2 Mergers and Acquisitions

4.2.1 Definition and classification Business combination is the bringing together of separate enterprises into one economic entity, as a result of one enterprise obtaining control over the net assets and operations of another37 M&A is a form of business combinations, in which one entity (the acquirer) obtains control over the net assets and operation of another (the acquiree) in exchange for the transfer of assets, incurrence of liabilities, or insurance of equity38 M&A can be classified based on the relatedness of firms business activities. This classification form is particularly useful for the purpose of analysing different transactions. Under this classification, there are three basic types of M&A39: Horizontal M&A is the first type, in which both the acquirer and acquired companies are in the same kind of business, and usually are competitors. Vertical M&A involves firms at different steps of the production process. If the acquirer purchases a target that is ahead of it in the production process, it is called backward integration. Meanwhile, a purchase of a firm that is further down in the chain represents forward integration.
37
Epstein, B.J., Jermakowicz, E.K. (2008) IFRS 2008 Interpretation and Application of International Financial Reporting Standards (electronic version), John Wiley & Son Inc, New Jersey, pp.402 38 Epstein, B.J., Jermakowicz, E.K. (2008) IFRS 2008 Interpretation and Application of International Financial Reporting Standards (electronic version), John Wiley & Son Inc, New Jersey, pp.402 39 Ross, Westerfield, Jaffe and Jordan (2008) Modern Financial Management (8th International edn), McGrawHill, New York, pp. 814
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Conglomerate M&A is the situation where the acquiring and acquired firms are not related to each others businesses, and are normally undertaken for the purpose of diversification. 4.2.2 Motivations There are a variety of motivations for M&A. The most common motivation for M&A is to achieve Synergy, which is defined as the difference between the value of the combined firm (VAB) and the sum of the values of separate firms (VA and VB)40:
The main sources of Synergy are growth, cost reduction, revenue enhancement. Moreover, there are also other sources creating synergies for M&A, such as capturing tax gains, diversification. Those sources will be examined in detail in the following parts in the context of the Food and Beverage sector.
4.3 Mergers and Acquisitions in the Food and Beverage sector - Benefits and Prospects
Food and Beverage is a mature sector, in which the structure and performance have been significantly impacted by M&A activities41. In this sector, the technology is relatively mature, the competition is intense and the market growth in various segments is substantially below the annual rate of 5 percent42. The slow growth rates, together with
40
Ross, Westerfield, Jaffe and Jordan (2008) Modern Financial Management (8th International edn), McGrawHill, New York, pp. 814 41 Adelaja, Nayga Jr. and Farooq (1999) Predicting Mergers and Acquisitions in the Food Industry, Agribusiness, 15:1, 1-23 42 Ramsay, B. (2000) The global food industry: Conclusion and implication, Financial Times Retail and Consumer, London, pp.193-210
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the increasing competition, and the rising bargaining power of distributors, created strong waves of M&A in the Food and Beverage industry, which can be seen in 2000 with the $10.5 billion acquisition of Pillsbury by General Mills, $19 billion acquisition of Nabisco by Phillip Morris, $12.4 billion deal of Quaker Oats by PepsiCo, and the prominent acquisition of Bestfoods worth $21.4 billion by Unilever43. In this industry, M&A has always been used actively as one of the key engines for growth. 4.3.1 Forms of Mergers and Acquisition In the Food and Beverage industry, M&A have been implemented in various directions, including horizontal, vertical or conglomerate. According to Weston and Chiu (1996)
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, prior to 1980s was the period of
diversification, when firms rushed to use M&A to diversify their portfolio, combining both food and beverage products as well as non-related ones. Following the 1980s was the period of contrast direction, as the correction of the earlier trend, with firms ceasing acquiring non related products into their portfolio, and even divesting those products due to impractical benefits. Food and Beverage companies are now focusing M&A on sharpening their core products and rationalising their portfolio. Unilever is concentrating on its 400 core brands, assisting those brands with further M&A of relating products while divesting other non-core brands. Nestle is also concentrating M&A on its strengths in baby products, ice cream, pet foods45. The current trend in the industry is the use of M&A in
43
Thompson and Strickland (2002) Strategic Management: Concepts and Cases, 13th Edition, McGraw-Hill, New York, pp. 476 44 Weston and Chiu (1996) Growth strategies in the food industry, Business Economics, 31:1, 21-28 45 Bolling, C. and Gehlhar, M. (2005) New Directions in Global Food Markets, Economic Research Services/ USDA, Chapter 5, 62-73
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virtually every case to support the existing core products portfolios, either nationally or internationally46. 4.3.2 Benefits and Prospects 4.3.2.1 Motivations and Benefits of Mergers and Acquisitions As with the general M&A motivation, M&A in the Food and Beverage industry also bases around synergy as the sources of value creation. As such, synergy, and its various sources, will be examined in the Food and Beverage cases as followed: Growth Companies can grow through investing internally, which is called organic growth, or through buying resources externally to achieve external growth. M&A is the typical external growth strategy, and is especially common in mature industries like Food and Beverage where internal growth faces great difficulties from increasing competition and restricted capacity. Bolling and Gehhar (2005) 47 found that firms in the Food and Beverage industry, uncommonly, used the introduction of new products and brands as a strategy for expansion. Firms typically expand through M&A, and this strategy had been employed by most of the largest firms when they entered new markets in recent years. Firms are generally seeking targets to expand production lines and to broaden geographic scope, especially into international markets48. Multinational firms as Unilever, P&G and Nestle
46
Lynch, R. (2006) International acquisition and other Growth strategies: Some lessons from the Food and Drink Industry, Thunderbird International Business Review, 48:5, 605-622 47 Bolling,C. and Gehlhar,M. (2005) New Directions in Global Food Markets, Economic Research Services/ USDA, Chapter 5, 62-73 48 Weston and Chiu (1996) Growth strategies in the food industry, Business Economics, Vol. 31, No.1, 21-28
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have long been involved in international expansion to broaden market reach, increase manufacturing facilities and secure materials sources, and M&A is their popular strategic tool to achieve those targets. According to Lynch (2006) 49 , M&A was the most widely used form of expansion among firms in the industry, both for international and national sales growth50. This is because in this mature market, the time and cost involved in creating organic growth may not deliver targeted growth quickly enough to meet short-term shareholder pressures. The authors conclusions were also consistent with previous researches, indicating that companies which pursued M&A, such as Nestle, Unilever, Phillip Morris and Heinz had achieved higher sales growth rates than the normal rates offering by this mature sector to firms that only grew organically51. Cost reduction M&A can take advantage of economies of scale, as the combined firm can perform a function more efficiently than two separate firms, by reducing duplicate functions and excess capacities, sharing technologies and R&D facilities, and by reducing the general and administration costs52. This results in a lower cost per unit of production and an
49
Lynch, R. (2006) International acquisition and other Growth strategies: Some lessons from the Food and Drink Industry, Thunderbird International Business Review, Vol. 48, No. 5, 605-622 The research based on 400 listing announcements made by medium and large-sized firms in the Financial Times Food Business during 1998-2001, and examined in depth 35 leading firms in the sector from 1985 to 2001. 50 There are six main strategies for international expansion, including acquisitions, joint ventures, alliances, licensing or franchise operations, developing wholly owned subsidiaries, and using agents or distributors. Lasserre, P. (2003) Global strategic management, Palgrave Macmillan, Houndmills 51 Ramsay, B. (2000) The global food industry: Conclusion and implication, Financial Times Retail and Consumer, London, pp.193-210 52 Palepu, K.G., Healy, P.M., Bernard, V.L. and Peek, E. (2007) Business and Analysis and Valuation (IFRS edn), Thomson Learning, London, pp.435
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improvement in competitive position. Moreover, the combination of complementary resources can help firms improve the usage of existing resources of the two partners. As in the food and drink industry, the common patterns of M&A in recent years are the acquisitions of multinational giants over smaller, but valuable, firms. The notable examples are the acquisitions of Ben&Jerrys, Bestfoods and Slimfast by Unilever; Jenny Craig by Nestle; and Walkers Crisps by PepsiCo. Austin and Leonard (2008)53 found that large acquiring firms have brought the huge economic and organisational resources to smaller acquired firms whose pace of growth were often constrained by the scarcity of resources. Namely, the general managerial prowess in planning and execution, the capital access, the capability to scale operations into larger markets, which are brought by large and successful businesses, can create dramatic increases in the scale of the smaller parties. These are essential resources helping small brands to reach the sufficient scale to be more profitable, to strengthen their business operations, and therefore, to become more competitive. The authors found that while the purchase of Ben&Jerrys offered Unilever the leading position in the US super-premium ice cream markets, Unilever also offered Ben&Jerrys operation greater efficiencies. Unilever used its operating expertise and infrastructure to rationalise Ben&Jerrys manufacturing and distribution systems, therefore, helping Ben&Jerrys enjoy significant cost savings and also reduce its environmental footprint. Moreover, while Ben&Jerrys previously efforts to expand into the European market were not very successful, Unilevers presence and capabilities in this market have enabled Ben&Jerrys to gain significant success in Europe. In return, Ben&Jerrys,
53
Austin, J. and Leonard, B. (2008) Can the virtuous mouse and the wealthy elephant live happily ever after, California Management Review, Vol. 51, No. 1, 77-101
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having the highest percentage sales growth rate in Unilevers portfolio, have significantly improved Unilevers position in Europe. The authors concluded that through M&A, the production cost of the acquired firms may be reduced and, therefore, higher margins and profits can be achieved. This effect can be achieved through reducing redundancies, through economies of scale in production, distribution or other costs, through increasing efficiencies using the expertise of the acquirer, or through supply chain economies resulting from greater scale. Moreover, in the case of vertical M&A, better coordination between phases of the production process also helps firms to reduce costs. Vertical integration can help create efficiencies by reducing the transaction costs associated between phases of production, assuring supplies or markets for the production, diversifying risk from the uncertainty of the market, and capturing economies of scale54. Revenue enhancement55 M&A can make a significant contribution to firms abilities to increase revenue. Firstly, M&A can helps firms to reduce the number of competitors and gain more influence on market prices, especially through horizontal M&A in a concentrated industry with few competitors, or vertical M&A of strategic input sources or important distribution networks. Revenue can also be enhanced if M&A is used for the purposes of acquiring
54
Bhuyan (2002) Impact of Vertical Mergers on Industry Profitability: An Empirical Evaluation, Review of Industrial Organisation, Kluwer Academic Publishers, pp. 61-79 55 Ross, Westerfield, Jaffe and Jordan (2008) Modern Financial Management (8th International edn), McGrawHill, New York, pp. 815
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strategic capacities and competences that the acquirer lacks, for example, strong R&D capacity, needed material sources or intellectual capital. According to Grimpe (2007)56, one of the major motivations for firms to carry out M&A is to gain access to technology knowledge and to increase new product innovation. However, given the dominance of the acquirer, more changes have typically occurred in the target than in the acquirer. Nevertheless, firms with advanced technologies are normally the attractive targets for M&A, and in this case, acquirers can take great advantages from those targets. According to Barney (1991)57 and Graebner (2004)58, the knowledge resources that were acquired are used to complement the acquirers existing resources and they, together, create the basis for implementing strategies to improve innovative capabilities and competitiveness of acquirers. M&A can especially be used to improve the reputation of firms, by using the social value of acquirees brands. Lynch (2006)59 found that a social brand, which represents a distinctive value to customers, becomes an attractive target for large firms. The distinctiveness and special connection with customers of such valuable brands can stem from the high quality, taste, functionality and, moreover, from their additional intrinsic social benefits such as environmental sustainable, socially progressive, natural organic, better the community. Through M&A, large companies tried to incorporate these social values into their operations. For instance, through the acquisition of Ben&Jerrys,
56
Grimpe (2007) Successful Products Development after Firm Acquisitions: The Role of Research and Development, The Journal of Product Innovation Management, Vol. 24, 614-628 57 Barney, Jay B. (1991) Firm resources and Sustained Competitive Advantage, Journal of Management, Vol. 17, No.1, 99-120 58 Graebner, Melissa (2004) Momentum and Serendipity: How Acquired Leaders Create Value in the Integration of Technology Firms, Strategic Management Journal, Vol. 25, No. 7, 51-77 59 Lynch, R. (2006) International acquisition and other Growth strategies: Some lessons from the Food and Drink Industry, Thunderbird International Business Review, Vol. 48, No. 5, 605-622
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besides taking the leading position in the US super-premium ice cream market, Unilever also aimed at absorbing the deep value of Ben&Jerrys, which has excellent quality, fun and social dimension, into its ice-cream category world-wide60. Moreover, there are also vertical downstream-processing acquisitions in the Food and Beverage industry 61 . According to Bolling and Gehlhar (2005) 62 , the benefit of the vertical M&A to firms in the industry is the link it can create between the primary production and the final consumers. For firms undertaking vertical M&A, this will enable them to tailor products to match specific markets, and the changing consumption patterns from the very primary stages of the production process. Moreover, firms also can enhance product quality though higher control over the raw products, while reducing the transaction costs. This is the structure that has successfully propelled the New Zealand dairy sector, as well as Unilevers tea and oil businesses so far. Firms also have other motivations for M&A, for instance, taxation factors have a significant influence on M&A63. Although successful M&A have to be based on sound business strategies, firms can use M&A to take advantage from tax losses, when tax payment is reduced by combining the losses of the M&A partners, therefore, the acquired firms are worth more than their prices64. Moreover, in developing economies, and particularly in Asia-Pacific and North America, governments often use tax
60
Austin, J. and Leonard, B. (2008) Can the virtuous mouse and the wealthy elephant live happily ever after, California Management Review, Vol. 51, No. 1, 77-101 61 Fischer and Schronberg (2007) Assessing the Competitiveness Situation of EU Food and Drink Manufacturing Industry: An Index Based Approach, Agribusiness, Vol. 23, No. 4, 473-495 62 Bolling,C. and Gehlhar,M. (2005) New Directions in Global Food Markets, Economic Research Services/ USDA, Chapter 5, 62-73 63 Weston and Chiu (1996) Growth strategies in the food industry, Business Economics, 31:1, 21-28 64 Stevenson (2009) Economy forces advisors to change to keep up, International Tax Review, Vol. 20, No. 2, 12-33
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exemptions or other reliefs to stimulate foreign investment, under which M&A will create more benefits for firms. 4.3.2.2 Prospects for Mergers and Acquisitions Having a great deal of benefits, M&A will still be the key future growth driver in the Food and Beverage industry. This is because the industry is mature, with a high level of consolidation and fewer opportunities for growth, and so far M&A has been the popular and practical choice65. Moreover, the patterns and attributes of various geographical and product markets are very different to each other, and in the progress of moving between markets, M&A is considered to be a wise choice. In terms of geographical markets, as Western European, American and Japanese markets are becoming more and more saturated with moderate growth in consumer incomes and populations, firms are moving rapidly to emerging markets for higher growth, as well as for diversification against economic downturn other than only staying in individual markets66. In this progress, using M&A helps firms reduce time and risk in entering new markets. From the viewpoint of products ranges, firms are increasingly attempting to take advantage of their existing strengths (Lynch, 2006 and Bolling, Gehlhar, 2005). Firms with extensive expertise in certain products, which include inherent technological and marketing advantages, are proceeding with M&A deals to support their core profit
65
Lynch, R. (2006) International acquisition and other Growth strategies: Some lessons from the Food and Drink Industry, Thunderbird International Business Review, 48:5, 605-622 66 Bolling and Gehlhar (2005) New Directions in Global Food Markets, Economic Research Services/ USDA, Chapter 5, 62-73
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making products. In order to achieve these objectives, both horizontal and vertical M&A can be used, to secure the focused products categories. This strategy is consistent with the case of Unilever with the focus on ice cream and nutrition products. In the current downturn of the global economy, the role of M&A is considered to be larger, as researches have stressed the suitability of this corporate strategy in this environment. Companies with sufficient capital resources can take advantage of the current difficulties, by acquiring other firm and create the business shapes which ensure that they can weather the storm and emerge strongly as the crisis pass. According to Wan and Yiu (2009)67, such an economic jolt offers lucrative opportunities for firms, and if firms can recognise opportunistic M&A deals, they would enjoy great benefits. Previous studies focusing on period of economic difficulty also found results consistent with this view; that the active firms which can take advantage of abundant M&A opportunities will experience better improvements in future performance 68 . M&A in these conditions offers firms lucrative opportunities to deepen their existing resource bases and obtain substantially different resources and capabilities, and be more likely to change and to survive69. However, the current drought in the capital market makes such strategies less practical, as only firms with sufficient capital raising abilities can take advantage of the opportunistic deals. The capital difficulties have reduced the M&A activities in almost all markets from the middle of 2008, including the Food and Beverage sector. However,
67
Wan, W.P. and Yiu, W.D. (2009) From crisis to opportunity: Environmental Jolt, Corporate Acquisitions, and Firms Performance, Strategic Management Journal, Vol.30, 791-801 68 Burton, G.D., Ahlstrom, D. and Wan, J.C.C. (2003) Turnaround in East Asia firms: evidence from ethnic overseas Chinese Communities, Strategic Management Journal, 24:6, 519-540 69 Karim, S., Mitchell, W. (2000) Path-dependent and path-breaking change: reconfiguring business resources following acquisition in the US medical sector, Strategic Management Journal, Vol.21, 1061-1081
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due to the strategic role of M&A in the sector, M&A still have good prospects, and will likely regain their high popularity once the credit markets recover.
4.4 Implications for Unilever

M&A have long been one of the traditional business activities of Unilever, and the company can be considered as the most prominent successful case of using such corporate strategies in the Food and Beverage sector. According to Jones and Miskell (2005) 70 , Unilever had been created and has grown through M&A rather than organically. Established through the merger of the Dutch and the British companies in 1930 71 , Unilever has continuously used M&A to expand its products range world-wide. The period of 1970s and 1980s saw the dramatic diversification of Unilever beyond its main food and household products, into chemicals, advertising, packaging, market research, and equipment. However, the 21st century has experienced the significant change in the pattern of M&A being used by Unilever. In 2000, Unilever launched the Path to Growth initiative to reduce its portfolio from 1600 brands to 400 core brands, which accounted for 85 percent of the firms revenue at that time, and were determined to be the growth drivers for Unilever. In this strategy, Unilever paid special attention to food and beverage products. After the historic acquisition of Bestfoods in 2000 for $21.4 billion, which is the largest ever undertaken acquisition by Unilever, the Food
70
Jones and Miskell (2005) European integration and corporate restructuring: the strategy of Unilever, c.1957c.1990, Economics History Society 2005, Blackwell Publishing, 113-139 71 The Dutch firm was Margarine Unie, and the UK firm was Lever Brothers
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division72 was established to implement the groups Food focus strategy. With a series of prominent acquisitions including Slimfast, Ben&Jerrys and a number of other M&A deals, the Food division now accounts for more than half of Unilevers revenue. Although the five year Path to Growth strategy did not create the targeted annual growth rate of 5-6% for Unilever during the implementation period 73 , it had added significant value to Unilever, from the high expertise of Bestfoods, the social icon of Ben&Jerrys, the strong nutrition profile of SlimFast, which are effectively supporting the core strengths of Unilever. At the present, Unilever has still continued using M&A for supporting core strengths of the group, with the latest development being the acquisition of Romanian ice cream business -FrieslandCampina - into its portfolio, further strengthening its leading position in the global ice cream market74.
4.5 Conclusion
M&A is the important corporate issue to firms in the Food and Beverage industry, because of its benefits and its role in the future development of the industry. Various literatures have shown that M&A can create great benefits for firms, including growth contribution, revenue enhancement, cost reduction and other lucrative results. These characteristics make M&A attractive and necessary for firms in the increasingly fierce competition and difficult economic environment. Having enjoyed substantial benefits from M&A, from the early establishment and through various different patterns of
72 73
Unilevers Foods division is known as Unilever Bestfoods Patrick Cescau CEO (2007), Unilever Investor Seminar 2007 74 Fame, <URL: https://fame.bvdep.com>, accessed on 27/07/2009
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implementing this corporate strategy, Unilever is considered as the prominent successful case of using M&A in the Food and Beverage industry.
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Chapter 5 Company Analysis
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CHAPTER 5 - COMPANY ANALYSIS
5.1 Introduction
Company analysis is one of the main parts of the fundamental analysis, providing the indepth knowledge about firms strategies and performance, and building up the foundation for the following forecasting and valuation processes. In line with this purpose, the company analysis of Unilever will firstly provide an understanding about the firms strategies and then its performance in the context of these strategies. The SWOT analysis technique is also used to give the summarised picture regarding the firm.
5.2 Strategy and corporate governance analysis

5.2.1 Strategy analysis At the corporate level, Unilever has always directed its strategies to achieve the competitive advantage in every of its business units market75. Previously, Unilever built up its business in a highly autonomous way, with its own portfolio priorities and all the resources it needed, to develop the business in whatever way it saw fit 76 . With the increasingly globalised competitive landscape, in which global scale and strategically driven allocation of resources determine the business success, the management board realised the need for focusing resources on Unilevers real strengths. By implementing the Path to Growth strategy from 2000, Unilever has successful consolidated its over-
75
Johnson, Scholes and Whittington (2008) Exploring Corporate Strategy Text and Case (8th edn), Prentice Hall, Edinburgh, pp. 224 76 Patrick Cescau CEO (2007), Unilever Investor Seminar 2007
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diversified portfolio into 400 core brands with sustainable competitive advantage, which can help Unilever compete better locally by drawing on its global position, as A Truly Multi-local Multinational77 Starting from 2004, the mission Adding Vitality to Life is still being implemented, as the roadmap for the development of the group - making the reshaped portfolio work harder. With this mission, Unilever is determined to exploit the highly potential uncovered growth space - Vitality - within the current core portfolio. Help people feel good, look good and get more out of life That is the way Unilever differentiates its products from other brands in the Consumer products industry, which has decreasing differentiation and mostly depends on pricebase competition strategy. Moreover, Unilever continues using the advantages from well-known global brands, marketing skills and technology to differentiate their products in the global competition, providing customers with Unique products with proven benefits. This is the great competitive advantage, because differentiation is considered as the key for competitive advantage in the sector from now on78. Unilever also uses the price-based competition strategy, drawing down the costs by using its strong supply chain, including its own raw material sources and applying achievements from its strong R&D facilities. Moreover, with the slogan Growing as One79, the One Unilever program has improved the management structure, reducing the overhead costs and increasing the efficiency in resources allocation within the groups
77 78
Unilever Annual Report and Accounts, 2000, 2001, 2002, 2003 Deloitte (2009) Industry Outlook - Consumer Products 79 Unilever Annual Report and Accounts, 2007
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global portfolio. This helps Unilever save costs and focus resources in higher margins products, therefore, increasing the business performance. The differentiation, and especially the cost-reduction capabilities, offers Unilever a great deal of competitive advantages in the D&E strategy of the group. This is the abbreviation for the firms current international strategy - expanding operations in developing and emerging markets80. The One Unilever program introduced in 2006 also helps the group coordinate effectively its geographically dispersed operations around the world within its global strategy81. Moreover, organic growth is determined to be the main growth strategy for the group, as Unilever focusing on unlocking the potential to achieve the global leadership position within the existing portfolio of categories, brands and geographies. M&A is used as the means to accelerate this growth strategy, through helping the group fill in a geographical gap or weakness in priority categories, with an example of this being the Foods category in Asia82. Unilevers current strategies focus on exploiting the core strengths of the group, with the main use of organic growth. These are the consequences of the active process of developing, implementing and adjusting strategies of the groups management boards.
80
Asia, Africa and Central and Eastern Europe (AACEE) markets Unilever Annual Report and Accounts, 2008 81 Johnson, Scholes and Whittington (2008) Exploring Corporate Strategy - Text and Case (8th edn), Prentice Hall, Edinburgh, pp. 306 82 Patrick Cescau CEO (2007), Unilever Investor Seminar 2007
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Chapter 5 Company Analysis 5.2.2 Corporate governance analysis
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Unilever NV and PLC are the two parents of the Unilever Group, and together with the group, they operate as a single economic entity. Under the Equalisation Agreement, the Anglo-Dutch group operates under united management boards with the same Directors and the same Chairman for the effectively cooperation between NV and PLC in all areas, ensuring that all the group companies act accordingly83. Unilever has long pursued the tradition of developing home-grown managers; therefore its managers must have in-depth knowledge about the firm as well as expertises relating to its businesses. The high experienced management boards have contributed significantly to the success of Unilever so far. The most notable recent development is the retirement of former CEO Patrick Cescau, and the consequence appointment of Paul Polman. While Patrick Cescau had made outstanding contributions to Unilever as the founder of the Path to Growth strategy and had 35 years working at Unilever, Paul Polman is the former top executive of P&G and Nestle, joined Unilever from October 2008, and became the first CEO from outside the group. This may create certain changes to the group in the coming period. In conclusion, the corporate governance of Unilever is transparent with positive sign from high experience managers. The wide operation range and the complexity of a giant multinational group have made Unilevers management become the worlds most
83
Unilever Annual Report and Account 2008, pp. 44: The Boards are one-tier boards which comprise Executive Directors and the majorities are independent non-executive Directors.
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difficult corporate-management job84 and the great performance achieved by the group so far has reflected the success of its management boards.
5.3 Financial analysis

Financial analysis is the important step to evaluate the past, the trend, the current position, as well as the prospects of the firms performance. Consistent with these purposes, the financial analysis of Unilever will be conducted using the two principle analytical tools: ratio analysis and cash flow analysis85. 5.3.1 Ratio analysis 5.3.1.1 Overall profitability: Profitability ratios are the most important ratios while analysing the particular firm. In the case of Unilever, the set of profitability ratios shows a mixed picture.
84 85
Goeffrey Jones (2005) Unilever: Transformation and Tradition, Oxford University Press, Oxford Palepu, K.G., Healy, P.M., Bernard, V.L., and Peek, E. (2007) Business and Analysis and Valuation (IFRS edn), Thomson Learning, London, pp. 196
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While gross profit margin and operating profit margin experienced a moderate fluctuation through time, the pretax has enjoyed a steady increase. Anyway, all of Unilevers profit margins have always stayed higher than the industry average86:
In recent years, cost of goods sold has risen with much higher rate than the revenue growth rate, creating the decreases in Unilevers gross margin from 2007. Especially in 2008, while revenue increased only 0.84%, cost of goods sold climbed up by as much as 3.81%, driving the gross profit margin down to 47.33%, which was 2.3% lower than 2007. This is because of the rising commodity prices by the middle of 2008 that increased the production costs significantly, while competition restrained the ability to raise goods prices. In 2008, Unilever had already changed its pricing policy to meet with the rising cost. As a result, sales growth was primarily driven by price changes while volume was flat. With the improved costs control under the One Unilever program, costs such as general and administrative overheads have been driven down, helping Unilever generate the increasing operating, pretax as well as net profit margins. In particular, the operating margin has benefited from the increasing credits from business disposal activities, enjoying smooth growth throughout the period, staying much higher than the industry averages over the 2004-2008 periods.
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Appendix 2, pp. 67
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The pretax margin also benefits from the interest reduction in the current economic situation, driving down Unilevers financial costs, partly offsetting the contrary effect from the 16.13 percent increase in debt in 2008. Moreover, the investment income is still in the rising trend, and significantly contributes to the rising pretax margin. This is because of Unilevers focus on investing in assets in developing markets like India87. Joint ventures, associate and other non-current investment also contribute the increasing profits for the group, and those investments are mainly in Unilevers newly expanded markets where the impacts of the crisis are still limited and there is still high potential growth. M&A also created the moderate difference between profiles of pretax and net profit margin through profits from discontinued operations, with the prominent case in recent years being the disposal of the majority of Unilevers European frozen food business in 2006. Finally, net profit margin has still managed to go upward, outperforming the industry, offering a bright prospective for the future performance of Unilever.
In recent years Unilever saw the decrease in assets, which is largely due to the higher value of business disposals compared to acquisitions, and the reduced value of pension
87
Unilever Annual Report and Account 2008, Note 11, pp. 101
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assets due to the current financial crisis. Moreover, goodwill and indefinite-lived intangible assets, which account for approximately 45 percent of total assets, are subjected to annual impairment review, creating a significant reduction in Unilevers balance sheet value. These characteristics, combined with the slight increases in return, have increased ROA and operating ROA for the group. This is also the common phenomenon for other composited profitability ratios such as ROE, ROCE; the small rise in return can create the significant rise in the ratios due to the decreases in the balance sheet denominators. However, those ratios are still higher the average levels of Unilevers competitors88. 5.3.1.2 Investment management The ratios being analysed in this part relate to asset turnover, which reflect the effectiveness of the firms asset management to generate revenue. Working capital management
88
Appendix 2, pp. 67
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Those ratios reflect how efficiently Unilever has utilised its working capital. To a consumer products manufacturer like Unilever, those ratios lie at the heart of the operations. It can be seen that the inventory management has been improved through time, with the increasing inventory turnover, and therefore, the shorter inventory holding period. The inventory turnover of Unilever is now slightly lower than the average level of direct competitors, which was 5.73 in 200889. This is the result of the One Unilever program launched in 2006, helping Unilever coordinate its supply chain more efficiently through the centralisation of regional supply chain management.
Receivable turnover has increased over the period, resulting in a decrease in the days of receivables. Unilevers receivables turnover is higher than the industry average 90 , reflecting that the credit and collection policies of the firm are relatively more stringent. Given the growing power of retailers and the increasing competition in the industry, there is the high possibility of sales being lost to competitors offering more lenient
89
Appendix 2: Conducted from the ratios of Nestle, P&G, Danone, Colgate-Palmolive, Kraft and Campbell Soup - Thomson One Banker 90 Appendix 2: The average Days of receivables of the industry is 43.93 in 2008, the average receivables turnover is 8.31 for the same year. In 2007, industrial average receivable turnover was 8.62
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terms, which may partly explain for the decreasing sales growth of Unilever in recent years. The payables turnover has also increased in recent years; however, Unilevers ratio is still much lower than other competitors like Nestle or Procter&Gamble91. This may be explained by the fact that Unilever has its own raw material supply facilities for many products like olive oil, tea, while Nestle pursues the strategy of using outside sources. Moreover, with the experienced production management and the high bargaining power of Unilever over suppliers, the relative low payable turnover may arise because Unilever can take advantage of early payment discount. However, the decreasing working capital turnover is not a good sign for the operations of Unilever, because it reflects the firms decreasing efficiency in using its working capital to generate revenue. Non-current assets management
In contrary to the working capital utility, the fixed assets turnover has increased significantly, which might reflect the higher efficient use of non-current assets in generating revenue. However, this can be explained that while revenue experienced decreasing growth rates, Unilevers assets, and in particularly, its fixed assets actually
91
The payable turnover of Nestle is 8.72 in 2008 and 7.59 in 2007, while the figures of Procter&Gamble are 12.35 in 2008 and 13.39 in 2007. Thomson One Banker, <URL:http://banker.thomsonib.com>
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reduced at quicker rates as a result of high disposal activities, driving those assets utility ratios up significantly. 5.3.1.3 Financing management Liquidity ratio
The current, quick and cash ratios are the three measures of Unilevers ability to pay current liabilities, and the higher the ratios are, the more liquidity the firm has. The ratio table shows that Unilever has managed to increase its liquidity in recent years, due to the improvement of profits and available funds, as well as the less use of liquidity for M&A activities compared to the earlier period. However, those liquidity ratios are still lower in comparison with the average level of the industry92, indicating that current assets have received fewer investments than other items in Unilevers balance sheet. However, the operating cash flow ratio, which is the additional liquidity ratio that focuses on the ability of firms operation to generate the needed resources to pay current liabilities, has been relatively stable over the analysed period. This is also in line with the figures of other competitors, therefore reflects that liquidity is not a concern for Unilever.
92
Appendix 2, pp.67: The 2008 industrial average current ratio is 1.17 and the quick ratio is 0.72. The figures in 2007 were 1.15 and 0.68, respectively.
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The companys debt ratios have experienced moderate changes in recent years with evidence of a slight increase from 2006. Unilever are using more and more debt to finance its operations, the debt figure achieved 10,655 million in 2008, representing an increase of 16.8 percent compared to 2007. The increase in the gearing ratio of Unilever has pushed the leverage of the group close to the normal rate among competitors 93 , while in the past, Unilever was less geared than its competitors and investments have often been made using equity. The recent increase in leverage can help Unilever take advantage of the capital markets and tax shield from debts. The majority is long term debts denominated in major currencies. In 2008, 43 percent of total debts are US bonds and 30 percent is Euro notes, and the remaining are in various currencies including Swiss Francs, Canadian dollar, Japanese Yen. The diversity of currencies reduces the exchange rate risks for Unilever. Using external financing sources like debt offers Unilever a great deal of benefits and represents no major threats to the firm because it is in the very sound finance position.
93
Appendix 2: the average debt-to-capital of the industry is 44.66 percent in 2007 and 46.28 percent in 2008, while the figures of direct competitors are 49.76 percent in 2007 and 50 percent in 2008
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The significant rise in debts has been partly offset by the decrease in interest rates, making the cost of borrowing in 2008 lower than in previous years. The interest coverage ratios are increasing, indicating the stronger solvency of the firm. This also offers greater assurance about the effectiveness of Unilever operations that it is able to comfortably service its debts. 5.3.2 Cash flow analysis The majority of cash flow is from the operating activities, which is normally seen in such a mature company like Unilever. The operating cash flow has experienced a significant decline in recent years 94, due to the decrease in revenue associated with the large disposed business in 2006, and reduced financial income from the start of financial crisis in the same year. Moreover, the decrease trend in operating cash flow also accounts for the reduced working capital required, with the declining receivables. The trade credit help Unilever partly absorbed the increase in inventory due to rising commodity costs 95 . Moreover, the increasing
94
Appendix 1, pp.64: Operating cash flow declined from 5,547 million in 2004 to 3,871 million in 2008, of which the most recent notable change happened in 2007 with 15 percent decline 95 In 2007, the working capital employed by inventory increased 113 percent.
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effective tax rates96, combined with some legal issues in foreign units, such as the recent problems in Brazil97, will create certain constraints in the operations of the group. The investing cash flow of Unilever has largely depended on the M&A and disposal activities, with the current rise in business disposals of non-core businesses, providing the firm with significant investment inflow, which was 1.7 billion in 2006, and 2,476 million in 200898. The acquisition activities, which are used to accelerate core strengths of the group, has created regular investment cash outflow, reaching 211 million in 2008 and 2007.
Within the financing activities, there have been significant changes in recent years. The dividend payment increased from 2006, and reached 2,086 million in 2008, accounting for 66.6 percent of net financing cash flow. However, the dividend payout ratio declined substantially in 2008, due to the lower dividend paid, and more importantly, due to the significant increase in net profit, which was accelerated by earnings from disposals. The increased leverage created the higher inflow from additional financial liabilities, while the repayment outflow decreased. This factor has contributed substantially to the
96
Tax cost about 30 percent of the operating cash flow and 26 percent of pretax profit in 2008, compared with 2007 figures of 28 percent and 22 percent, respectively. 97 Unilever Annual Report and Account 2008, Note 25, pp. 127 98 Unilever Annual Report and Accounts: The most active years are 2006 and 2008. In 2006, Unilever disposed the majority of its European frozen foods businesses for 1.7 billion. In 2008, Unilever sold its Boursin, Lawrys and Adolphs, North American laundry business, Komili oil, the Cte dIvoire oil, and Bertolli oil, creating cash inflows of 2,476 million.
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increases in net financing cash flow from 2007, despite the implementation of the share buy-back program from the same year with the annual cash outflow of 1,500 million. In conclusion, Unilever has enjoyed the increase in net cash flow in recent years. While the operating cash flow has declined, the improvement in net cash flow is mainly due to the disposal activities and the changes in financing policies. However, these policies may create significant impacts on the future performance of the group, through discontinued business profits and financial costs, which have to be taken into account in forecasting and valuation processes.
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5.4 SWOT analysis

The SWOT analysis is used to draw the overall picture of Unilever:
Strengths
Weaknesses
Well-known brands with market leadership in ice cream, laundry, savoury and dressing Strong R&D and innovation capability Experienced Management Experienced in M&A High benefits from economies of scale Wide range of products for nearly every daily family needs Worldwide presence with united management Home-market is EU Early presence and strong base in Asia and other emerging markets Environmental protection focus Strong financial position Clear and consistent strategy management Non-cyclical sector Strong capabilities in branding and marketing
Legal complexity for the multinational Anglo-Dutch group Sales depend on weather Raw material inputs are impacted by environment conditions Complexity from dual listing Limited competencies in the popular organic field High taxes Assets value significantly declined during the crisis
Opportunities
Threats

Expansion in emerging markets with scales and differentiation advantages Benefits from Vitality profile Sound base for the nutrition segment with aging and overweighting population Effective M&A takes advantage of cheap deals in crisis, further supporting core strengths Sufficient resources to overcome the crisis and emerge stronger Focus on Food Division
Quality control in a broad supply chain Brand reputation protection Uncertain impacts from current strong business disposals Higher debt pressure from rising leverage Changing tastes and consumption pattern Environment changes impacts on consumption pattern and raw materials Increasing competition Rising power of distributors Side-effects of higher pricing policy in the crisis Risks from exchange rates and regulatory changes Prolonged and deep crisis
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5.5 Conclusion
While the effectiveness of recent changes in Unilever business structure takes time to be observed, the past performance has shown the groups success in its strategic decisionmaking as well as the operating, investment and financing management. As commented by Jones (2005) 99 , Their success rested on the choice made on strategy and organisation, on the recruitment and development of managers, on the allocation of spending between capital investment, acquisitions and innovation, and on the negotiation of a safe path through the complexity of official regulations and government.
99
Jones, G. (2005) Unilever: Transformation and Tradition, Oxford University Press, Oxford
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Chapter 6 Valuation
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CHAPTER 6 - VALUATION
6.1 Introduction
Valuation is an important stage of investment analysis, in which appropriate valuation methods are applied to estimate the shares intrinsic value. In this chapter, the intrinsic value is estimated using the Discounted Dividend Model, the Discounted Free Cash Flow Model, the Abnormal Earnings Model and the Price Multiples techniques. The valuation processes are based on certain assumptions about the firms activities and the estimated cost of capital. These assumptions and the resulting forecast financial statements are provided in the Appendix100.
6.2 Discounted Dividend Valuation (DDM)

This method is based on the perspective that the value of common share is the present value of all the future dividends expected to be received from the share.
The discount rate used in this method is the cost of equity of 7.80 percent, which is determined by the Capital Asset Pricing Model (CAPM)101.
100
Appendix 3: Forecasted Financial Statement Appendix 4: Forecast Assumptions Appendix 5: Valuation Assumptions 101 Appendix 5, pp.76
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In order to simplify the DDM, the dividend growth rate is estimated to be at the constant level of 3.5 percent beyond the terminal year102.
Given this growth rate, the DDM indicates the intrinsic value of 20.12 for a share of Unilever.
6.3 Discounted Cash Flow Valuation (DCF)

The DCF valuation technique uses the present value of the expected available cash flow to calculate the intrinsic value of the share. In this part, the Free Cash Flow to Firm (FCFF) is discounted back using the cost of capital which is calculated as the Weighted Average Cost of Capital (WACC), with the resulting rate being 6.45 percent. FCFF is the cash flow from operation minus capital expenditure.
102
Appendix 5, pp.78
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To simplify the model, the constant growth rate of FFCF beyond the terminal year is estimated to be 2.5 percent103. Under this valuation method, the intrinsic value of the share is 23.96
6.4 Discounted Abnormal Earnings Valuation (DAE)

Under this method, the expected abnormal earnings of the firm are discounted back using the cost of equity, and together with the current book value of equity it reveals the present value of firms equity.
With the expected constant growth rate of abnormal earnings beyond the terminal year to be 2 percent, the intrinsic value taken from this method is 23.56104.
103 104
Appendix 5, pp.79 Appendix 5, pp.80
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6.5 Sensitivity Analysis

The discounted valuation methods results greatly depend on the assumptions about the growth rates and the discount rates, and even small change in these assumptions can make significant changes in the intrinsic value. Consistent with this perspective, the sensitivity analysis will show the possible fluctuations in intrinsic prices under different circumstances:
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The sensitivity analysis shows that the value of Unilevers share is relatively sensitive to forecasting assumptions. Among the three discounted valuation models, the DAE is the least sensitive one with the range from 21.42 to 26.16.
6.6 Price Multiples

The Price Multiples can be used as the comparable method to estimate the intrinsic value of Unilever share, based on the multiples of Unilevers peer group. The Price Earnings Multiple (P/E) is used in this analysis. The average P/E of the selected peers is 13.64105.
105
Appendix 5, pp.81
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Given Unilevers current Earnings per Share (EPS) of 1.79, the intrinsic value of Unilevers share is estimated as: P = Industrial mean P/E x Firms Recent EPS The price of Unilevers share is calculated to be 24.41. The Price Multiples Valuation can be implemented using the forecasted fundamentals as: P = Leading P/E x Forecasted EPS Leading P/E = (1-b)/ (re-g) Of which, (1-b) is the firms expected dividend payout ratio of 0.55, and g is Unilevers targeted growth rate of 4 percent. The forecasted EPS for 2009 is 1.50. The result for the share price is 21.65
6.7 Conclusion
In conclusion, the valuation of Unilevers share was conducted using a number of techniques which are based on different approaches to the intrinsic value of the share. The valuation results have the range from 20.12 for the DDM, 23.56 for the DAE to 23.96 for the DCF, 21.65 and 24.41 for the P/E multiple. All of these estimated intrinsic values are higher than the market value on 15/08/2009 of 19.21106, therefore, this result in a Buy recommendation for Unilevers share.
106
Unilevers stock price on London Stock Exchange on 15/08/2009 was 16.49 GBP which was equal to 19.21 if converted with exchange rate of 1.1651 on the same date
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Chapter 7 Conclusion
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CHAPTER 7 - CONCLUSION
7.1 Introduction
The investment analysis of Unilever shares lead to the final recommendation of BUY. This recommendation is based on the analysis of the outside and inside factors influencing the growth and risks of the firm, as well as the intrinsic values estimated through the forecasting and valuation processes.
7.2 Investment recommendation

7.2.1 Investment analysis summary The macroeconomic situation is expected to remain in the slowdown at least in the short term. Although having a non-cyclical characteristic, the Consumer Products industry, in which Unilever is operating, is still suffering certain challenges with lowering demand, rising competition, rising cost pressure and quality concerns, and changing consumption patterns. Unilever is not an exception and is trying to cope with such difficulties. The operations of the group have certain risks that cannot be ignored. The most prominent risks, which Unilever is facing at the moment, are also from the impacts of the crisis. The main markets of Unilever are the advanced economies, which are suffering from the crisis, and their complicated economic problems cannot be solved in the short term. This fact combined with other economic uncertainty like exchange rates, the risk from trade protectionism creates significant dangers for the future performance of the group.
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However, Unilever still has great growth prospect, from its strong management and strategic capacity, from its active business expansion to emerging markets, and from the business opportunities that the group can take advantage thanks to its financial strength. While smaller competitors may not overcome the current hard time, Unilever has sufficient resources to weather the crisis, emerge stronger once the crisis pass, and retain the market leadership which it has built up through 80 years of operation. 7.2.2 Stock performance The chart below shows the fluctuation of Unilevers share prices in comparison with the FTSE ALLSHARE index. This reflects that the non-cyclical characteristic has helped the share prices outperform the market so far:
Prior to the crisis, the price of Unilever was underperformed the market; this may due to the immediate impacts of strategic changes within the group in its transformation while the benefits take time to be observed. Particularly, 2006 is not the favorable year for the performance of the stock. However, from 2007 the stock regains the favorable trend and 61
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outperforms the market, as the transformed operations and core strengths start accelerating profits. The peak of the share price was reached on 07/01/2008 with the close price of 1927p107. Compared to this peak, the current price has drop 14.43 percent, due to the downturn of the general economy, but has still remained outperforming the market108.
7.2.3 Investment recommendation Through this share price development, it can be seen that Unilevers stocks have a high prospect of outperforming the market; moreover, the results of the intrinsic valuation process also strengthen this judgement. The valuation was implemented with four methods of DDM, DCF, DAE, and Price multiples. The four techniques result in intrinsic values within the range from 20.12 for
107 108
Reuters, <URL:http://www.reuters.com>, accessed on 15/08/2009 The FTALLSH index has drop 24.56 percent from 07/01/2008, and 29.89 percent from its peak on 12/10/2007 Thomson One Banker, <URL:http://banker.thomsonib.com.ezproxy.stir.ac.uk>, accessed on 15/08/2009
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the DDM, 23.56 for the EVA to 23.96 for the DCF, 21.65 and 24.41 for the P/E multiple, which are all higher than the market price on 15/08/2009 of 19.21. As a result, the recommendation for Unilevers share is BUY. This is based on the business environmental analysis, the company analysis and the results of the intrinsic valuation process conducted. Therefore, the BUY recommendation is reasonable for such a great potential, undervalued, and market-outperforming share.
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APPENDIX 1 - Financial Statements
64
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65
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APPENDIX 2 - Industrial average ratios

In the Consumer Products industry, there are great deals of firms operating, which sizes vary greatly from multinational groups like Unilever, Nestle, P&G to small local firms. For the purpose of comparing Unilevers performance to other firms in the industry, the following firms are selected based on the similarity of size, products, markets, strategies and performance.
The selection of the industrys firms is based on Unilever Annual Report and Account, the DataStream, and other sources. From this selection, the industrial ratios are calculated as the followings:
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However, among firms operating in the Consumer products industry, there are six firms that can be considered as Unilever direct competitors. Those direct competitors include Nestle (Swiss), Procter&Gamble (U.S.), Kraft Foods (U.S.), Group Danone (France), Campbells Soup (U.S.) and Colgate-Pamolive (U.S.). The average financial ratios of those selected direct competitors:
Source: Self conducted from Thomson One Banker
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APPENDIX 3 - Forecasted Financial Statements
69
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70
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APPENDIX 4 - Forecast assumptions

Operating activities Being affected by the crisis from 2008, the operating activities of Unilever in 2009 will decrease significantly, namely with the sales down by 0.55% mainly due to the sales drop in Western Europe, and this segment will also recover more slowly than other segments. This is a moderate decline due to the current favourable environment conditions for the sales of ice cream and the stable food and personal care sales. With the sign of recovery in America and developed economies, and the continuous strong growth in developing markets, and the recent lower pricing policies implemented by Unilever, the sales are forecasted to increase 3.2% in 2010, 4.8% in 2011 and have the strongest growth rate of 5.6% in 2012 before returning to the long term target sales growth rate of 4%. Operating costs in the short term will not be as high as the 2007 and 2008 level, which will help in accelerating the gross profit. This is due to the lower commodity prices after the peak in 2008 and the gradual implementation of the One Unilever program for the accelerating cost efficiency. However, in the longer term, commodity prices, which highly impact on the cost of sales, will return to its high growth rate corresponding to the recovered level of global economic growth. Working capital management of the group will also be influenced by the changing economic conditions. With the higher competitiveness, the rising power of distributors, the trade receivables are expected to increase significantly in the future. The inventory management under the One Unilever Program, and the establishment of regional supply
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chain management centres will lead to the higher inventory turnover, to be at the level of 5.5. The trade payable items might slightly increase due to the possible further disposal of raw material facilities like the recent disposal of tea plantation in Cote dIvoire. The nonrecurring items like restructuring and business disposals have always accounted for a significant part in the operating results of Unilever. Due to the ongoing restructuring process of Unilever, they will continue influence the future performance of the group. However, the disposals activities might not be as prominent as in the past, due to the fact that Unilever has almost created its prospective shape with determined core strengths, and therefore, there is expected to be less major disposals relative to previous years. In addition, M&A will still be used to support the core strengths of the group, and these activities will cause the continuous rises in the balance sheet items like goodwill, intangible assets as well as fixed assets. The fixed assets will also receive the higher investment for R&D and business expansion. Therefore, the depreciation charges also increase significantly in consistent with those investments. On the other hand, they will also enjoy the higher turnover which results from the upgrading management capacities and the rising effectiveness of core strengths. The tax rate to be implemented in 2009 is expected to be 27%. Unilever expect that the long-term tax rate will be 26%. Under these assumptions, the net profit of the group will reduce in 2009 and then recover gradually to reach the long term growth level of 3 percent.
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Appendix Financing activities
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The most prominent trend in financing activities of Unilever is expected to be the significant increase in debt financing of the group, mainly with the long term publicly traded notes. This movement will drive the leverage ratios of the group up in the next years, to the expected target level of 45%. Both the additional liabilities and repayment of liabilities items in the cash flow statement will increase as a result. While financing assets might reduce due to the economic vulnerability, creating the amount of interest received reduce, interest payments will rise with the increasing debt financing. Dividend payments are expected to gradually increase. The average dividend payout over the past five years was 0.59, and it is expected to be 0.5 in 2009 due to high priority for investing and the difficult economic situation. The long term dividend payout ratio will reach 0.55 beyond the terminal year, due to the solid financial strengths build up over times and the tradition of smooth dividend of the group. The share buy-back program, which was implemented in 2007 and 2008, is expected to be discontinued due to the tougher economic and financial circumstances, with the group having various more important priorities needed to allocate resources. This policy might receive the previous attention of the management board in the future. Investing activities There will be active investing activities in the next few years, and the highest level is forecasted to be in 2009, as the group proceeds with fulfilling its core portfolio. The investments have been used for supporting both organic and external growth. 2009 has 74
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seen the acquisition of TIGI hair care for $411.5 million, Baltimor ice cream in Russia, the investment in a Romania ice cream business after the acquisition of Napoca, and the investment in Inmarko ice cream production complex in Tula. These investments are expected to continue in the long term with the business expansion of the group and continue giving rises to both properties, plants, equipments as well as goodwill, intangible assets like brands, software, technology, know-how. Especially, R&D has also received large investment within the group for the priority for innovation. There are plenty of fields that R&D are making progress such as nutrition, vitality and they will receive continued funding in the future.
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APPENDIX 5 - Valuation assumptions

Discount rate estimation The cost of capital used in the Discounted Cash Flow Valuation model is the Weighted Average Cost of Capital with the following formula:
Vd: the market value of debt Ve: the market value of equity rd: the cost of debt re: the cost of equity T: the tax rate The cost of debt applied to Unilever is estimated to be 6.5 percent which is based on the average yield to maturity applied to the firms notes. As in the past, long term debt accounted for about nearly 60 percent Unilevers total debts; this percentage is expected to rise in the coming years, due to changes in leverage policy by the increase in long term debt, which can be seen in early this year. The short term debt rates, which depend on the economic factors like growth rate and inflation rate, have the rising trend in the coming recovery phrase of the global economy. The long term debts of the firm are mainly in the form of long term bonds and notes from the two main financial sources, the US and European economies. Based on the historical bond yields issued by Unilever, the rate of US bonds is expected to be at about 7 percent. Meanwhile, the European notes are estimated to stay at about 6 percent. These lead to the 6.5 percent assumption for the cost of debt.
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The cost of equity is based on the Capital Asset Pricing Model (CAPM), which is calculated using the following formula:
Rf is the risk free rate and has the value of 4.5 percent. This estimation is based on the ten year government bonds rates, which have the 2001 - 2009 average figure of 4.32 percent for the United State 10 year Treasury Notes109, and the 2001-2009 average rate of 4.79 percent of ECB Government 10 year Bonds, of which the rate for United Kingdom 10 year Gilts is 4.64 percent 110. Those are the main market and also are the main financing sources of Unilever; therefore the corresponding risk free rate should be 4.5 percent. The risk premium [E(rm) rf] is estimated through historical risk premium to be 5.5 percent111. The Beta estimation is based on the regression of the monthly stock return and the market return data FTSE ALLSH achieved in the five year period. The regression result is 0.6
SUMMARY OUTPUT Regression Statistics Multiple R 0.51 R Square 0.26 Adjusted R Square 0.25 Standard Error 0.03 Observations 292.00 ANOVA df Regression Residual Total 1.00 290.00 291.00 SS 0.08 0.22 0.30 t Stat 0.80 9.98 MS 0.08 0.00 F 99.63 Significance F 0.00
Intercept X Variable 1
109 110
Coefficients Standard Error 0.00 0.00 0.60 0.06
P-value 0.42 0.00
Lower 95% 0.00 0.48
Federal Reserve Statistical Release, <URL:http://www.federalreserve.gov> , achieved on August 4th 2009 European Central Bank Statistic, <URL:http://www.ecb.int> , achieved on August 4th 2009 111 Koller, Goedhart and Wessels (2005) Valuation Measuring and managing the value of companies (4th edn), Mc Kinsey & Company, John Wiley & Sons, New Jersey, pp. 269
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Based on these estimated figures, Unilevers cost of equity is calculated to be 7.80 percent and WACC is 6.45 percent. Dividend Discount Model Assumptions
Div: dividend payment re: cost of equity The expected dividend during the period of 2009 2013 will be discounted back using this above formula. The discounted expected dividend beyond the terminal year will be added to this formula using the constant growth rate gd of 3.5 percent with the formula:
This constant growth rate assumption is consistent with the targeted long term sustainable growth rate of 4 percent that Unilever has determined to itself 112 . This expected long term growth rate is also reasonable with the influencing factors like the projected World GDP long term growth rate of 4.8 percent113 and the population growth rate of approximately 1.1 percent 114 . In addition, Unilever has the long tradition of constant growing dividend which will be changed from semi-annual dividend payment to quarterly dividend payment from 2010. This fact partly reflects the attention of the management board to the dividend policies to maintain the attractiveness of the shares to investors. Given Unilevers targeted growth rate of 4 percent, the dividend growth rate is projected to be slightly lower at 3.5 percent due to the emphasis that Unilever has to
112 113
Unilever Annual Report and Accounts 2008, pp. 98 IMF (2009) World Economic Outlook Crisis and Recovery, pp. 189 114 United Nation Data, <URL:www.un.org>, accessed on 30/07/2009
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put on investing and expanding its business. This is also consistent with the smooth dividend policy of Unilever which can be seen from the dividend payment history of the group. Beside this cash dividend payment, Unilever also use other forms to pay dividend like share repurchases which had the amount as high as 1,500 million in 2007 and 2008. Therefore, the growth rate of 3.5 percent is expected for Unilevers dividend payment, and in the better scenarios, any excessive dividend might be in the form of share repurchases. Discounted Cash Flow Model Assumptions The Discounted Cash Flow Model, which is used in the valuation chapter, discount the Free Cash Flow to Firm back to present to get the total value of the firm, and then subtract the value of the debt component, the result is the Equity value of the firm.
NOPAT: net operating profit after tax BVA: book value of the firms assets The constant growth rate of FFCF is also used to simplify the calculation, and this figure is expected to be 2.5 percent. This growth rate has been adjusted for the possible impacts of increasing leverage to the FCFF. Moreover, the active investment is expected to continue in the future, both into new fixed assets or M&A deals, making the Book value of Assets rise continuously, and faster than the growth rate of profit, which depends on assets utilisation abilities and other economic factors. That leads to the estimation of 2.5 percent for the growth rate of FFCF beyond terminal year.
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Appendix Abnormal Earnings Discounted Model Assumptions
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Abnormal earning is the residual income after deducting the common shareholders opportunity cost from net income.
NI: net income BVE: book value of equity The constant growth rate expected for abnormal earnings beyond terminal year is 2 percent. In theory, in the long term, competition will drive the earnings to the mean level, and abnormal earning cannot be sustained115. However, due to the strengths that Unilever has built up through time, and through the consistent investing activities, Unilever is expected to remain the constant growth rate of 2 percent for the abnormal earning. This is still less than the growth rate applied for the DDM and DCF because although the size of Unilevers balance sheet is mainly driven by the increase of leverage, the book value of equity will also increase, due to the constant increasing retained profit. Moreover, there will be the less use of reserves due to the higher use of debts to finance operations. The increase in book value of equity will create significant rise to the required normal earnings figures. Moreover, unlike the NOPAT, the net profits are also expected to endure the increasing interest rate with the higher leverage, adding more factors to reduce the expected growth rate for abnormal earnings. Those estimations lead to the expected growth rate of 2 percent used in this valuation model.
115
Palepu, K.G., Healy, P.M., Bernard, V.L. and Peek, E. (2007) Business and Analysis and Valuation (IFRS edn), Thomson Learning, London, pp.264
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The Price Multiple Valuation uses the Price to Earnings (P/E) to compare between Unilever and peer groups multiples. Among 30 chosen companies operating in the Consumer Products industry, the peer group are selected as having the similar characteristics. The criterion used to select firms into peer group for P/E multiple valuation are the similarity of P/E, which is considered as the expectation of the market for the growth of firms, and the Return on invested capital ratio (ROIC) which represents the ability to generate growth of firms. The comparison based on P/E and ROIC results in the selected peer group of Unilever for the valuation process, including:
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UNILEVER
BIBLIOGRAPHY
Books: - Bhuyan (2002) Impact of Vertical Mergers on Industry Profitability: An Empirical Evaluation, Review of Industrial Organisation, Kluwer Academic Publishers, pp. 61-79 - Bolling,C. and Gehlhar,M. (2005) New Directions in Global Food Markets, Economic Research Services/ USDA, Chapter 5, 62-73 <URL: www.ers.usda.gov/publications/AIB794/aib794.pdf> - Chang, R.P. and Moore, K.M. (2009) Corporate Finance (CFA Level II), Pearson Custom Publishing, Boston, pp.238 - Epstein, B.J., Jermakowicz, E.K. (2008) IFRS 2008 Interpretation and Application of International Financial Reporting Standards (electronic version), John Wiley & Son Inc, New Jersey, pp.402 - Hitt, M.A., Ireland, R.D., and Harrison, J.D. (2001) Merger and acquisitions: A value creating or value destroying strategies?, The Blackwell handbook of strategic management, Blackwell Publishers Ltd, Oxford, pp.384-408 - Johnson, Scholes and Whittington (2008) Exploring Corporate Strategy Text and Case (8th edn), Prentice Hall, Edinburgh, pp. 224 - Jones and Miskell (2005) European integration and corporate restructuring: the strategy of Unilever, c.1957-c.1990, Economics History Society 2005, Blackwell Publishing, pp.113-139 - Jones, G. (2005) Unilever: Transformation and Tradition, Oxford University Press, Oxford, <URL: http://hbswk.hbs.edu>, accessed of 15/06/2009 - Koller, Goedhart and Wessels (2005) Valuation Measuring and managing the value of companies, Forth Edition, Mc Kinsey & Company, John Wiley & Sons, New Jersey, pp. 269 - Lasserre, P. (2003) Global strategic management, Palgrave Macmillan, Houndmills - Palepu, K.G., Healy, P.M., Bernard, V.L. and Peek, E. (2007) Business and Analysis and Valuation (IFRS edn), Thomson Learning, London, Chapter 2, pp. 43 82
Appendix
UNILEVER
- Ramsay, B. (2000) The global food industry: Conclusion and implication, Financial Times Retail and Consumer, London, pp.193-210 - Ross, Westerfield, Jaffe and Jordan (2008) Modern Financial Management (8th International edn), McGraw-Hill, New York, pp. 814 - Sloman, J. (2007) Essentials of Economics (4th edn), Frentice Hall, Edinburgh, pp.90 - Thompson and Strickland (2002) Strategic Management: Concepts and Cases, 13th Edition, McGraw-Hill, New York, pp. 476 - Walton, P. and Aerts, W. (2007) Global Financial Accounting and Reporting Principle and Analysis, London: Thomson Learning, pp. 313
Academic Researches: - Adelaja, Nayga Jr. and Farooq (1999) Predicting Mergers and Acquisitions in the Food Industry, Agribusiness, 15:1, 1-23 - Austin, E. and Leonard, B. (2008) Can the virtuous mouse and the wealthy elephant live happily ever after, California Management Review, 51:1, 77-101 - Barney, Jay B. (1991) Firm resources and Sustained Competitive Advantage, Journal of Management, 17:1, 99-120 - Burton, G.D., Ahlstrom, D. and Wan, J.C.C. (2003) Turnaround in East Asia firms: evidence from ethnic overseas Chinese Communities, Strategic Management Journal, 24:6, 519-540 - Carpon, L. (1999) The long-term performance of horizontal acquisitions, Strategic Management Journal, Vol. 20, 987-1018 - Fischer and Schronberg (2007) Assessing the Competitiveness Situation of EU Food and Drink Manufacturing Industry: An Index Based Approach, Agribusiness, 23:4, 473-495 - G. Barkema, H.G. (2008) Toward unlocking the full potential of acquisitions: The role of organizational restructuring, Academy of Management Journal, 51:4, 696
83
Appendix
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- Graebner, Melissa (2004) Momentum and Serendipity: How Acquired Leaders Create Value in the Integration of Technology Firms, Strategic Management Journal, 25:7, 51-77 - Grimpe (2007) Successful Products Development after Firm Acquisitions: The Role of Research and Development, The Journal of Product Innovation Management, Vol. 24, 614-628 - Karim, S., Mitchell, W. (2000) Path-dependent and path-breaking change: reconfiguring business resources following acquisition in the US medical sector, Strategic Management Journal, Vol.21, 1061-1081 - Lynch, R. (2006) International acquisition and other Growth strategies: Some lessons from the Food and Drink Industry, Thunderbird International Business Review, 48:5, 605-622 - Richey Jr., Kiessling, Tokman and Dalela (2008) Market growth through mergers and acquisitions: The role of the relationship marketing manager in sustaining performance, Industry Marketing Management, Vol.37, 394-406 - Stevenson (2009) Economy forces advisors to change to keep up, International Tax Review, 20: 2, 12-33 Weston and Chiu (1996) Growth strategies in the food industry, Business
Economics, 31:1, 21-28
Reports: - Unilever Annual Report and Accounts, <URL://www.unilever.com > - Patrick Cescau CEO (2007), Unilever Investor Seminar 2007, accessed on 08/07/2009 <URL: www.unilever.com> - Ernst&Young (2009) Driving sustainable enterprise cost reduction within the consumer products sector <URL: http://www.ey.com/consumerproducts>, accessed on 03/07/2009
84
Appendix
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- Ernst&Young (2008) Consumer products industry and working capital management, pp.1 <URL: http://www.ey.com/consumerproducts>, accessed on 03/07/2009 - Deloitte (2009) Industry Outlook Consumer Products, www.deloitte.com, accessed on 16/06/2009 - IMF (2009) World Economic Outlook Crisis and Recovery <URL:http:// www.imf.org>, accessed on 11/06/2009 - Morgan Stanley (2009) Global Forecast Update, <URL:http://www.morganstanley.com>, accessed on 18/06/2009 - UBS (2009) Global Outlook, <URL:http://www.ubs.com>, accessed on 10/06/2009 - ADB (2009) Asian Development Outlook 2009, <URL:www.adb.org>, accessed on 30/06/2009 - PWC (2009) UK Economic Outlook - March 2009, <URL:www.pwc.co.uk>, accessed on 23/06/2009 - HM Treasury (2009) Forecast for the UK economy - May 2009 <URL: www.hmtreasury.gov.uk>, accessed on 20/06/2009 - Karantininis, K., Sauer, J. and Furtan, W.H. (2008) Innovation, Integration and Product Proliferation Empirical evidence for the Agri-Food Insudtry, Agriculture and Applied Economies Association 2008 Annual Meeting, pp.6 <URL:ageconsearch.umn.edu>, accessed on 29/07/2009
Websites: - Thomson ONE Banker, <URL:http://banker.thomsonib.com> - DataStream - Fame, <URL: https://fame.bvdep.com> - Unilever, <URL: http://www.unilever.com>
85
Appendix - HM Treasury, <URL: http://www.hm-treasury.gov.uk>
UNILEVER
- Federal Reserve Statistical Release, <URL:http://www.federalreserve.gov> - European Central Bank, <URL:http://www.ecb.int> - United Nation Data, <URL:www.un.org > - International Monetary Fund, <URL:http://www.imf.org/external/index.htm> - The World Bank, <URL: http://www.worldbank.org> - UBS, <URL: http://www.ubs.com> - Asian Development Bank, <URL: http://www.adb.org> - Financial Times, <URL: http://www.ft.com> - The Guardian, <URL: http://www.guardian.co.uk> - Morgan Stanley, <URL:http://www.morganstanley.com> - Reuters, <URL: http://www.reuters.com> - Yahoo Finance, <URL: http://finance.yahoo.com> - Hemscott, <URL: http://www.hemscott.com> - London Stock Exchange, <URL: http://www.londonstockexchange.com> - Euronext, <URL: http://www.euronext.com> - New York Stock Exchange, <URL: http://www.nyse.com> - Ernst&Young, <http://www.ey.com> - PriceWaterhouseCoopers, <URL: http://www.cfodirect.pwc.com> - Deloitte, <URL: http://www.deloitte.com> - Food & Drink Europe, <URL:http://www.foodanddrinkeurope.com> - Bnet UK, <URL: http://industry.bnet.com/food> - Foodproduction Daily, <URL: http://www.foodproductiondaily.com> - Economic Research Service, <URL: http://www.ers.usda.gov> - Energy Information Administration, <URL:http://tonto.eia.doe.gov> 86

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ACCOUNTING AND FINANCE DIVISION

AN INVESTMENT ANALYSIS OF UNILEVER

Chapter 2 The Economic Outlook

1.1 The objective of the case study

1.2 The structure of the case study

Chapter 2 The Economic Outlook

1.3 Business description

Chapter 2 The Economic Outlook

Chapter 2 The Economic Outlook

CHAPTER 2 - THE ECONOMIC OUTLOOK

2.2 The Global economy

Chapter 2 The Economic Outlook

Chapter 2 The Economic Outlook

Chapter 2 The Economic Outlook

2.3 The Advanced economies

IMF (2009) World Economic Outlook Crisis and Recovery, Appendix A1

Chapter 2 The Economic Outlook

2.4 Emerging economies

Chapter 2 The Economic Outlook

Chapter 2 The Economic Outlook

2.4 The UK economy

Chapter 2 The Economic Outlook

1.74 2.27 2.23 2.09 1.91

Chapter 2 The Economic Outlook

Chapter 3 Industry Analysis

CHAPTER 3 - INDUSTRY ANALYSIS

3.2 Industry overview

Chapter 3 Industry Analysis

Chapter 3 Industry Analysis

Chapter 3 Industry Analysis 3.2.2 Geographical industry overview

The United States

Euro zone and other advanced economies

- The worlds biggest

Chapter 3 Industry Analysis

3.3 Porter Five Forces analysis

Chapter 3 Industry Analysis

Chapter 3 Industry Analysis

Chapter 3 Industry Analysis

Chapter 3 Industry Analysis

Chapter 4 Literature Review

CHAPTER 4 - LITERATURE REVIEW

Chapter 4 Literature Review

4.2 Mergers and Acquisitions

Chapter 4 Literature Review

Chapter 4 Literature Review

, prior to 1980s was the period of

Chapter 4 Literature Review

Chapter 4 Literature Review

Chapter 4 Literature Review

Chapter 4 Literature Review

Chapter 4 Literature Review

Chapter 4 Literature Review

Chapter 4 Literature Review

Chapter 4 Literature Review

Chapter 4 Literature Review

4.4 Implications for Unilever

Chapter 4 Literature Review

Chapter 4 Literature Review

Chapter 5 Company Analysis

CHAPTER 5 - COMPANY ANALYSIS

5.2 Strategy and corporate governance analysis

Chapter 5 Company Analysis