Think blue-chip, think Unilever (UNVR). I am looking for some blue chips to invest, is there an opportunity? A good company may not be a good investment because a stock's value has an expectation embedded in it. When the expectation is too high to be realistic, that is called overvalued, and one does not rationally expect a positive return from that. Valuation matters, a lot.
There is no question that UNVR is a great company. It produced positive EVA as much as IDR 6,3 T last year and has been consistently growing its EVA for a three-year average of 1,2%, scaled by sales. That is fantastic. Undisputed result in acting in the best interest of shareholders spirit. As far as performance goes, there is no need to dig deeper to find that it is amazing. But, let's do it anyway for a bit of fun.
Looking deeper into EVA, I have found that there is a strong clue that decisions in Unilever are made to maximize value. You see, back in 2017, EVA growth came by being fast and profitable. In 2018, the growth engine slowed down by half, and yet management was still able to pull an amazing feat by maintaining EVA momentum. It was mostly accomplished by selling its BlueBand (spreads) products to KKR. At that time, all of the people I have met thought that it was a bad move because of the pressure from Heinz who wanted to acquire Unilever. But that is an opinion. I look at EVA, and it tells me that the divestiture was NPV positive. BlueBand divestiture was a move that saved Unilever from significant slower growth in EVA. It takes value-minded management to divest a legacy brand to earn more value. That is a prime example of capital stewardess for the benefit of shareholders.
As far as business performance goes, there is nothing wrong with Unilever. True to popular belief, Unilever is one of few companies in Indonesia that has strong competitive advantages. We can tell by looking at its EVA margin that is consistently in the mid-teens. Its ROIC is also telling us that by being far above its WACC which I presume to be 11%. This roided out ROIC is largely thanks to its strong position with its suppliers which enables UNVR to have negative working capital.
That's about the key points of business performance. What about its valuation? Its PBV is around 35. A more important multiple, Enterprise Value/Invested Capital is 38 at the current price of IDR 41,600/share. That looks high. With its recent EVA of IDR 6,3 T, or NPV of IDR 58 T assuming EVA stays the same, the market effectively expects that management could add another IDR 252 T of NPV by bidding its share price up to its current price. Future Growth Reliance (FGR) has been hovering around 79%-85% for the past three years, which means, without growth expectation in EVA, UNVR share price would plummet, and that growth expectation, as I would show, is enormous.
Let me put it another way. UNVR peak at IDR 56.000/share was in 2017. At that point, the market is effectively expecting that EVA could grow from IDR 5,8 T back in 2016 to IDR 55 T five years later. A growth rate, adjusted to sales, of 25% (MIM) per year for the next five years. That is wildly unrealistic and there is little sense to dig deeper to see whether it was plausible. It was not. That MIM 25% a year, if achieved, would bring EVA in 2017 to IDR 15,7 T. In reality, UNVR EVA in 2017 was only IDR 6 T. Its EVA growth rate, adjusted to sales, in 2017 was just 0.8%. That is the reality. To be clear, EVA momentum of 0.8% is still great, especially for a big and mature company like Unilever. But clearly, it was still a far cry from what was being expected. At the current price, that MIM is 17%. The expectation has been lowered, but it is still in La-La Land.
On the note of having high expectations: Having a very high expectation from investors is a very potent shield from takeover. We know that Heinz backed away from its acquisition plan to buy Unilever. The reason why would be confidential, but I believe it has to do with Unilever value in the market place. If global Unilever has similarly high expectations embedded in its share price, then the decision to leave Unilever alone was a smart move by Heinz. Paying too much for acquisition is a sure way to destroy value.
This exercise gave me a sad reflection that the investment industry has not been doing its job well. I would bet that almost all of the mutual funds include UNVR in their basket and has been persistently accumulating it throughout the years believing that it is prudent to invest in great companies no matter what. That is when a good idea is taken too far. Do a proper valuation and see if what I say is right. I believe anyone who recommends UNVR is mesmerized by its strong performance and stories from La-La Land. I, myself, am quite tired of stories. I let EVA shine my way. There would be a day of reckoning. It may already be started. When that time comes, people would scour over the news because they would want to believe that UNVR has changed for worse. People who do not understand valuation has no other way, but to believe so. Valuation is not just a factor, it is the only reliable guide for astute investors.
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