RBC Capital downgrades Unilever to ‘underperform’, slashes price target

The bank said Unilever "hasn't the wherewithal" to boost volume performance sufficiently to achieve its 2% growth aspiration given its lack of market dominance, significant non-focus brands and markets (25%/15% of sales respectively), a less benign gross margin environment and record/intention of significantly lower capital investment than the competition.

It said the valuation is pushing towards best-in-class level which it thinks is unjustified, while risk/ reward is weighted to the downside.

"There is no single reason for this downgrade," RBC said. "Rather, we believe that investors' perception of Unilever has shifted from laggard to best-in-class on the back of a revived senior management team, a couple of good quarters benefiting from very strong gross margin bounce-back (just as at P&G), well-received rhetoric around operational strategy and the decision to offload the ice cream business.

"We have no problem with any of this, but think that the shares' 32% outperformance versus the MSCI European consumer staples sector in 2024 was excessive."

RBC said Unilever's portfolio is solid rather than spectacular. "It's the market leader in its business, but to a much lesser extent than Nestlé, for example," it said.

It also said that volume growth has averaged less than 1% per year since 2014 and RBC doesn’t expect that getting rid of the ice cream segment will do much to boost that.

"In our view the 2% aspiration is a big ask," RBC said.

"Nor do we expect emerging markets to close the gap," it added, noting that emerging market participation has barely moved over the last decade despite superior "organic" growth, a victim of EM currency depreciation.

RBC said the company’s focus on 30 Power Brands and 24 key markets makes sense as far as it goes, but despite management's protestations, it worries that the remaining 25%/15% of sales (comprising about 370 brands or 100 OneUnilever markets) risk being neglected and dragging down the whole.

The bank also pointed out that brand investment has increased sharply, but said it can't extrapolate that with confidence.

"Unilever has benefited from a benign gross margin environment and arguably could/should have invested more," it said.

RBC said it thinks that Unilever has significantly under-invested in capex over the long term and believes that a prolonged increase is needed if Unilever is to have any chance of hitting its 2% volume growth goal.

"The consequent decline in depreciation (-140bps since 2020) as well as much higher restructuring costs than peers (ignored in 'underlying' profits) materially diminish Unilever's earnings quality in our view," the bank added.