If no one's formally greeted you, dear investor, welcome to uncertain times.
In the economy, key indicators flash green while others scream red. Meanwhile, the stock market is neither cheap nor super pricey, but somewhere in between.
On the upside, the current environment lends itself to savvy stock picking. I've been eyeing one particular dividend-paying consumer-staples name that could be oversold.
Pulling all the right levers
Though it's home to brands that are familiar to U.S. investors, including Lipton, Dove, and Breyers, Unilever (NYSE: UL) is at its core a global operation. In fact, 50% of the company's sales come from fast-growing developing and emerging markets. And that's good news for investors who are wary about the overspending, undersaving U.S. consumer.
As for recent financial performance, Unilever's been on a roll. First-quarter results, released several weeks ago, were highlighted by 4.1% organic sales growth, a wider operating margin, and a 32% gain in earnings per share (but just 12% if you look only at improved operations). Also, organic volume grew for the fourth consecutive quarter, at 7.6%. Finally, the company boosted operating cash flow by dramatically shortening its cash conversion cycle to 15 days, faster than that of competitors Procter & Gamble (NYSE: PG), Kraft (NYSE: KFT) and Colgate-Palmolive (NYSE: CL). That means Unilever's cash cycles back into the company very quickly.
Oh, and did I mention that supply-chain improvements and restructuring activities are on track to deliver at least 1 billion euros in annual savings this year?
But to no avail
Nonetheless, based on Friday's closing stock price, shares are down 18% from their 52-week high (hit in January), and 14% from late April's levels, right before the broad market began to correct. If you guessed that currency movements are responsible for the disconnect between business fundamentals and stock action, you win a handful of euros -- or pounds.
See, Unilever shares traded on the New York Stock Exchange are actually American Depositary Receipts (ADRs), which represent shares listed in pounds on the London Stock Exchange. Since the beginning of the year, the pound has declined roughly 11% versus the dollar, which means that dollar-denominated ADR shares should've fallen by at least that much in a similar timeframe.
To complicate matters further, Unilever reports its financial results and sets its dividend payout in euros. In that regard, we should note that the euro has fallen against the dollar by an even greater 13% since we kicked off 2010.
To put all this in perspective, London-traded Unilever shares have slipped only 7% or so, while American-traded ADRs are off 18%. But that seems reasonable: Unilever derives about 30% of its sales from Western Europe, and consumers in this region may be in for a tough slog. Government spending is responsible for about 50% of European Union GDP, and it's no secret that nations are under pressure to rein in spending and benefits. In the case of Spain, that's taken the form of public wage cuts, and I wouldn't be surprised to see similar austerity measures ripple through the EU.
All told, the potential erosion in business fundamentals would seem to justify a stock haircut of 5%-7%, especially if we consider that Unilever's year-over-year comparisons will grow tougher in coming quarters. Add in dollar strength in the low single digits, and the recent downward move in Unilever's ADRs does indeed appear warranted.
In the long run, though ...
The above points considered, Unilever trades at a forward price-to-earnings ratio of 13.1 -- fairly low in all but the ugliest macro environment. Furthermore, ADRs offer a 2010 yield of about 4%, and the company only recently began paying dividends on a quarterly basis. In other words, the euro could continue to dive against the dollar, and investors would likely still enjoy a 3%-plus yield.
As for the effects of a general European slowdown on sales, investors could do worse -- Europe recently accounted for 41% and 89%, respectively, of total revenue for big-name companies McDonald's (NYSE: MCD) and First Solar (Nasdaq: FSLR).
For investors who still aren't sold on Unilever, you could hedge currency risk by initiating a short position in either CurrencyShares Euro Trust (NYSE: FXE) or CurrencyShares British Pound Sterling Trust. This move could make even greater sense given euro and/or pound exposure that's likely lurking in existing areas of your portfolio.
Don't get me wrong, I'm not suggesting that investors fancy themselves currency traders. But at a time when dollar parity is a real possibility, a bit of carefully calculated hedging might help you sleep better at night -- and give you the added confidence to take advantage of what is most likely a long-term bargain in Unilever.
