What Does Unilever's Warning Mean for Industry?

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For many mega-caps operating in the consumer staples sector, emerging markets are currently the place to be for expansion and earnings growth. After all, many more established markets are already highly saturated, and don't offer the same opportunities for increasing the top line. Perhaps this is why a recent profit warning from consumer staples giant Unilever (NYSE: UN  ) came as something of a shock to the market, as the company hinted at slowing growth in emerging markets especially. In reaction to the news, peers also got hit.

Emerging markets slowing
Perhaps in anticipation of this news, Zacks recently downgraded Unilever to underperform, citing sluggish consumer spending in developed and emerging markets and unfavorable currency exchange effects. In particular, growth was seen slowing in the BRICs, which traditionally account for a fairly large portion of the company's growth.

Emerging markets currently account for around 60% of sales, and furthermore they are generally growing a lot faster than the developed economies. Thus, any news of a slowdown in emerging economies hits the company hard. At the time of writing, shares were down 3% in Amsterdam trading.

In its first profit warning in nine years, the company is reportedly expecting growth of between 3% and 3.5% for the third quarter, following a lackluster second-quarter report that missed expectations. According to CEO Paul Polman, the slowdown is largely due to currency effects, as emerging currencies have been getting hit hard this year. For instance, the Indian rupee has weakened around 16% against the euro year to date.

With revenue growth of around 5% in the first and second quarters, analysts had predicted growth of between 4.5% and 5% for the third quarter as well. As such, it was a fairly big miss. In a statement perhaps best characterized by its brevity, Polman stated that growth in emerging markets was slowing down faster than expected, but that the company is still on track to deliver its full-year priorities. Things are apparently expected to improve in the fourth quarter.

Industry ripples
When a company as big as Unilever, currently worth around $107 billion on the market, throws off a profit warning, investors across the industry take note. Shares of Procter & Gamble (NYSE: PG  ) were down 1.7% in U.S. afternoon trading on Monday, as consumer goods investors mulled over the news.

Slightly less dependent on emerging markets, the $207 billion consumer goods titan still gets roughly 40% of sales from emerging economies, and any slowdown there would be sure to hit Unilever's prime U.S. competitor as well. Full-year 2014 guidance calls for sales growth of between 3% and 4%, more or less in line with Unilever's numbers.

Also affected was Kimberly-Clark (NYSE: KMB  ) , another U.S. competitor. The maker of Kleenex tissues was down around 0.5% following the news. Also heavily reliant on emerging markets, the company focuses on the areas of China, Russia and Latin America, accounting for around 55% of its international operations, which overall saw organic sales up 8%.

Just like its competitors, Kimberly-Clark is suffering from volatile exchange rates in emerging markets, which is expected to be a drag of one to two points on the top line. Still, for full-year 2013, the company targets overall sales growth of 3% to 5%. The firm recently confirmed its full-year EPS target as well, still between $5.60 and $5.75.

Valuations and metrics
Following the recent price action, Unilever looks a little cheaper than the competition based on trailing P/E. Unilever trades at 17.77 times trailing earnings against P&G's 19.58 and Kimberly-Clark's 20.03. In general, European valuations look a bit more attractive than those of U.S. stocks at the moment. Unilever furthermore has quite a low price-to-sales ratio of 1.61, as well as a very healthy 37.16% return on equity. Considering that the company doesn't appear to be in dire straits just yet, a case could easily be made for going long based on these metrics.

The bottom line
A recent profit warning from Unilever, its first since 2004, sent shares down and spooked the broader industry. Investors are concerned that slowing growth in emerging markets is happening more quickly than expected. However, the companies discussed in this article still seem to be doing well enough, considering the macroeconomic headwinds. As such, one could consider buying the dip on this recent news.

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5/25/2016 4:02 PM
KMB $127.21 Up +0.45 +0.00%
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