Get a 3% yield with this emerging markets play

This global consumer goods giant is stocked with household brand names and expanding aggressively in emerging economies, but remains relatively under the radar.

By StreetAuthority Jul 22, 2013 6:56PM
Grocery shopping (copyright Noel Hendrickson/Getty Images/Getty Images)By Nico Inberg

Trouble is brewing in the Western economies again.

The U.S. economy is growing slowly at best, while the European economy is still contracting. European consumer confidence is still very low, and housing markets are worrisome. The average European is cutting back on expenditures and is saving money rather than spending it.

This means that companies relying on these markets for much or all of their revenue can do little more than cut costs and protect market share.

If you're a large company that wants to grow even larger, you need to be present in the emerging markets. The so-called BRIC countries (Brazil, Russia, India and China) and many other developing economies are growing at a fast clip. They have young, dynamic populations that are working hard and growing wealthier every year.

But rather than risk your money by investing directly in these volatile economies, why not hedge yourself with exposure to developed and emerging-market economies using one investment?

This is one reason I like Anglo-Dutch food and personal-care giant Unilever (UN).

Founded in 1930, Unilever is the world's third-largest consumer goods company (after Procter & Gamble (PG) and Nestle (NSRGY)) and the world's largest maker of ice cream. Unilever has nearly 400 brands in its portfolio of foods, beverages and personal care products. It owns several billion-dollar brands, including Ben & Jerry's, Dove, Lipton and Wish-Bone.

When it comes to taking advantage of both the stability of developed markets and the growth potential of emerging markets, Unilever's management is fully aware of the opportunity.

Sales in developed markets have grown marginally in recent years, with profit margins stabilizing above 14%. In contrast, sales in emerging markets surged 11.4%. Emerging markets already count for 56% of Unilever's total sales, and at the current growth rate, Unilever will be less dependent on the stalling developed markets.

Sales in Asia, the Middle East, Turkey, Africa, Russia and Ukraine have surged by almost 10% a year since 2003 to an annual total of $37 billion. Unilever is expanding its 52% stake in Hindustan Unilever (its India-based operations) to 75% to capitalize on India's fast-growing middle class. Analysts expect Unilever to grow another 6% to 10% this year due to its strong presence in the emerging markets.

Even better, while most investors might be tempted to go with a stock like Procter & Gamble as a play on this thesis, I think Unilever is a better opportunity for investors.

For starters, it isn't as well known to U.S. investors as Procter & Gamble. That puts it under the radar -- exactly where I like my investments. I find that the less well-known an investment is, the better my chances of making market-beating gains before the crowd catches on (provided the idea is good and the company executes, of course).
In comparison, the case is clearly in Unilever's favor. Procter & Gamble's sales grew only 3% last year while Unilever's growth was 10.6%, thanks to its strong presence in the emerging markets. Another reason for preferring Unilever over Procter & Gamble is Unilever's ratio of net debt to EBITDA (earnings before interest, taxes, depreciation and amortization) is only 1.1, which means there is enough room for capital investments and share buybacks.

Also in Unilever's favor is the aggressive growth path that management has introduced. The target is to double sales and increase its social impact while reducing the environmental footprint. Unilever has been chosen as sector leader in the Dow Jones Sustainability Index for the 14th consecutive year. Unilever's price-to-earnings (P/E) ratio is nearly 20 (compared with P&G's 18.4), but its strong growth prospects fully justify this.

Most of Unilever's solid brands have hardly been hit during the financial crisis. Only sales in Europe declined, but that has been more than compensated for by the stormy growth in emerging markets.

One very important factor for Unilever is the cost of raw materials. Palm oil, coffee and sugar are ingredients used in many of its products. Last year, Unilever had to take a one-time charge-off of $2 billion because of higher-than-expected soft commodity prices.

This year, commodity prices have been declining. Most commodities peaked in the summer of 2011 and are still sliding, albeit slowly. Sanford Bernstein analysts estimate that Unilever's core operating profit could rise 30 basis points to 14%. But the price of sugar is coming down, and that is good news for Unilever. Of course, like all food companies, Unilever is continuously hedging the swings in raw materials -- but the trend is down, which should benefit its margins.
Unilever is not a stock you should buy for a quick scalp. It is a defensive investment that provides its shareholders with a nice dividend each year. Unilever's dividend yield is currently 3.4%, but it has grown by 30% since 2009.

Risk to consider: Rising commodity prices could hurt Unilever's profit. Slight price increases could easily be passed on to consumers but bigger movements could be costly.

Action to take: Unilever is growing fast in the emerging markets, and commodity costs are declining. This makes Unilever a great defensive stock to add to your portfolio.
Nico Inberg does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.

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