Friday Morning Coffee Nr. 138 : Anatomy of a compounder

110221 Friday Morning Coffee

Friday Morning Coffee Nr. 138 : Anatomy of a compounder

In a recent interview with YouTuber Kiana Danial, the renowned value investor Guy Spier was asked to give an example of one of his core holdings in his portfolio. He mentioned Nestlé as one of these compounding businesses whose brands are household names that would be appreciated by the consumer for many years to come, therefore generating strong earning power for the company that is compounding over time.

We do not own Nestlé: while we fundamentally like the company, we are somewhat intimidated by its valuation and missed good entry points into the stock. We are invested in Unilever instead, a company that has many of the characteristics making us put the company into the category of the compounders we will continue to hold independently of market conditions. Every day, 2.5 bn people use Unilever products to “feel good, look good and get more out of life” as the company states on its website. In food & refreshment, brands like Magnum ice-cream, Lipton tea or Knorr soups are universally known. The same goes for its beauty and personal care brands like Axe or Dove and its home care brands like Cif and Domestos. I would argue that there is a high probability you have used one of Unilever’s products if not today than at least this week. With 60% of its sales in emerging markets, Unilever is a key beneficiary of favourable long term growth trends for consumer goods that become accessible to a growing middle class in these markets.

Unilever PLC

Quality Value framework

Source : ECP, data as of 31/1/21

In our quality-value framework Unilever has been constantly showing a much higher quality score than the average European company over the past decade (red line). This is not surprising for a business that has produced a median ROE of 33% and a net profit margin of 10% over the last 10 years. EPS has also been  growing by 3.5% and dividends by 7% annually over the period.

The fundamental value score (green line) is showing that Unilever is now significantly cheaper than the market. Unilever currently trades at 17.9 times this year’s consensus earnings, a 10% discount to the 10 year median. Dividend yield for this year is estimated by 3.8%, the highest dividend yield Unilever has traded at over the last decade.

As we write there may indeed be an opportunity knocking as the stock price of Unilever has corrected by some 11% this year. Reasons are twofold: first the consumer staples sector overall is under pressure as investors are privileging the more cyclically exposed sectors due to the reflation trade. Secondly, the company came out with quarterly results that disappointed investors. While the top-line performance was good, margins were below consensus as the company had extra costs to run its factories safely during the pandemic and was negatively affected by a worsening product mix. If history is any guide this will normalize over time. Meanwhile, the compounder continues to compound.