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Unilever Marked Down on Margins

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This article has been adapted from Fool U.K., our sister site across the pond.

Federal Reserve Chairman Ben Bernanke may well be as "relaxed" about inflation as he told Washington's press corps at this week's inaugural news conference, but not everyone is so sanguine.

Some shareholders in Unilever (NYSE: UL  ) (NYSE: UN  ) , for example, are decidedly anxious. On Thursday, the consumer-staples giant warned:

The markets for our input materials remain volatile. As a result of the continued rise in crude oil, we now expect the impact of commodity cost inflation to be around 500-550bps of turnover in 2011. This is leading to further upward pressure on prices.

And unfortunately for investors if not consumers, Unilever is either unwilling or unable to raises prices on Persil, Marmite, and the rest of its many brands as quickly as its costs are increasing. As a result, the company now says the underlying operating margin is expected to fall in the first half of 2011, before improving later in the year.

No pain, no gain
In February, Unilever's chief operating officer didn't sound too worried about rising commodity prices: "With all the data points at my hand today, the situation is definitely less serious than 2008, [though] let's not be naive: [It] does remain volatile and uncertain, and while we have a good view on the first six months of the year, we will need to see how this progresses."

Given that Unilever has now warned of a bigger-than-expected hit to margins in the period where it claimed it had good visibility, you can't blame investors for fearing there's worse to come.

This is especially the case because rather than raising prices at the same clip as commodity prices, Unilever has instead been slashing other costs. The company, which reports in euros, now expects full-year savings to be around 1.3 billion euros.

That's probably the best strategy; Unilever didn't grow to a 25 billion-pound valuation by raising prices for long-term loyal customers too swiftly in the face of (hopefully) short-term cost spikes. But it does mean that earnings growth will be curtailed for now.

Emerging opportunities
I've concentrated on margins because for a multinational, multibrand behemoth like Unilever, a change in margins is like a tweak on the rudder that shifts the path of a supertanker.

Scaling back up to the headline figures in its first-quarter results, it's steady as she goes. 

Turnover increased by 7% to 10.9 billion euros, or 4.3% on an underlying basis. Emerging-market sales were ahead by 9.9%. The quarterly dividend was lifted, too, by 8.2%.

It's that emerging-market growth that will drive Unilever's long-term expansion. As the Chinese, Indonesians, and Indians get more spending power, they should increasingly look toward Unilever's higher-end brands to address wants they may not even be aware of yet. Cynics may scoff that this time it's different, but as anyone who has watched the hit series Mad Men will know, these trends have been in play for decades, and I don't see any reason for them to stop just yet.

Unilever's newly acquired Sara Lee personal-care products, and the Alberto Culver business that it is in the process of acquiring, provide new fuel for this multinational marketing and distribution machine. Current highlights in Unilever's global rollout include taking Magnum ice creams to the U.S. and pushing Dove hair care into China.

Shop until you drop
I've decided I'm in the camp that suspects the similarities between different people around the world will outweigh the differences, and thus that dominant brand-driven companies such as Unilever have a great opportunity to grow even bigger over the next few decades. As a result, I own the shares.

If you're mulling over taking a stake in this company that makes up a good swath of what you put into your shopping cart, now looks like a reasonable time to take the plunge. 

Its shares are on a 2011 P/E of 13.6, which I think is good value given the high quality of Unilever's earnings. There's a 3.8% yield on offer, too, which should grow well ahead of inflation.

In fact, in the short term, input price increases are being given as a reason to dump Unilever's shares. But in the long term, inflation is a pretty good reason to buy them.

More from Owain Bennallack:

Owain Bennallack owns shares in Unilever.

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10/21/2016 4:04 PM
UL $42.54 Down -0.23 -0.54%
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