Value sales are down, but volume is up. Improved margins, but less-than-stellar results in Western Europe. What does it all mean, asks James Ball

Unilever's full-year results last week proved almost as divisive as its flagship Marmite brand and provoked equally strong reactions.

Many in the City believe the presentation vindicated CEO Paul Polman's strategy for the business, but others pointed to the dismal top-line figures: full-year sales slipped 1.7% and profits were a hefty 2bn lower year-on-year.

The markets reacted badly to the figures: Unilever's share price tumbled more than 4%, knocking hundreds of millions off the company's value. By contrast, analysts have stuck by Unilever, with several leading brokers releasing "buy" recommendations after the update.

Unilever's results have certainly proven contentious but is it the company's admirers or detractors who are on the money?

A closer look at Unilever's results certainly paints a brighter picture than the gloomy top-line numbers: volumes grew 2.3% over the year and accelerated in the fourth quarter to a solid 5%. Underlying operating margins also improved over the year, up by one percentage point in the fourth quarter and 0.2 percentage points over the year.

The main causes of the profit slump were largely defensible: increased research and development investment, 164m pension deficit funding and an end to one-off boosts to revenue from sell-offs.

Disposals boosted Unilever's 2008 profits by more than 1.25bn, but in 2009 that particular income stream dried up, and it actually became a buyer once more, snapping up haircare company Tigi and Sara Lee among others.

Plenty to offer
Though the results clearly reflect the fact that 2009 was a tough year to do business, Polman had plenty to offer investors, too: improved margins, more investment and solid volume growth. However, he was tightlipped about what the year ahead would bring, other than more of the same.

"We expect continued pressure on consumer spending power and heightened levels of competitive activity in 2010," he said. "We will continue to focus on volume growth as the main driver of long-term value creation, while delivering steady and sustainable year-on-year improvement in operating margin and strong cashflow."

In last year's results, Polman decided not to give the customary market-specific year-on-year guidance, a move that proved unpopular with a few major shareholders. He stuck to this policy again this year a move that was judged by some close to the company as one of the reasons Unilever's shares took a hit on results day.

The other major reason and the company's biggest challenge in the next year was Western Europe. Polman's price-cutting resulted in volume growth of 4.1% in developing markets and 2.5% in the Americas, but in Europe full-year volumes fell 0.1%. Fourth-quarter volume figures were weaker still, down 0.7%, though this was affected by 2009 being a shorter trading year than 2008.

The picture gets worse: underlying European operating margins fell a huge 2.4 percentage points, due to increased advertising and promotional spend. With Western Europe accounting for almost a third of Unilever's sales, Polman's failure to deliver results in this region is worrying investors.

"Europe is fmcg's toughest market at present if you can make it there, you can make it anywhere," says Investec analyst Martin Deboo. "There's no doubt Europe is a relative weak spot for Unilever, and speaking as a fan of Paul Polman, I don't think he's 'made it' until he cracks this region."

Deboo is also keen to point out that one slippery product area could be responsible for making the European picture look even worse than it actually is the spreads market.

Unilever in numbers
Full-year sales fell 1.7% in 2009, to 39.8bn. This decline accelerated towards the year-end fourth-quarter sales fell 4.8% to 9.7bn.

Profits before tax for the full year were 4.9bn, down 30% on last year. Fourth-quarter profits were stronger: down 19% to 1.2bn.

Volume growth was stronger: over the full year, volumes were up 2.3%, accelerating in the fourth quarter to a chunky 5%.

Underlying operating margins improved by 0.2 percentage points for the full year, and by one point in Q4. However, heavy promotional activity drove margins in Western Europe down a huge 2.4 points.
As the manufacturer of market-leading brand Flora, as well as Stork and I Can't Believe It's Not Butter, Unilever is heavily involved in low-fat spreads and over 2009 it proved an incredibly volatile market, churned by the rollercoaster ride of European butter prices, which soared in 2008 before crashing in the latter months of 2009.

Deboo estimates spreads account for about 25% of Unilever's European sales. Given prices fell about 15% over the year, the volatility of spreads could dent European sales by as much as 3% to 4%, he concludes.

Factoring this in to the region's results makes the underlying picture look less gloomy but still far from a walk in the park.

"Spreads are a tricky area for Unilever. As they have a lot of quirky national competitors it's harder to form an effective strategy," Deboo concludes. "Add the fierce battle in laundry with Procter & Gamble and it's clear Europe is not an easy market."

Promotional spend is the favoured tactic in brands' frenetic drive for share in Europe, and when it hurts the bottom line of even a giant such as Unilever, insiders believe smaller, more vulnerable players, could fare even worse.

"Unilever's suffering in Western Europe is largely due to its heavy promotions," says one brand consultant who has worked with the company. "It's proved a very effective strategy to hold share, and it's used by all major manufacturers but it's a difficult drug to get off.

"In time, and in categories where brands are genuinely strong, companies will be able to row back their activity, but even this will likely come at the cost of a short-term sales dip. Ultimately, though, it's still a big-branded world, and these figures don't make me question that for even a second."

Smaller companies without the benefit of fmcg giants' big pockets are more under threat, he warns. Those operating in fresh categories that are still innovation-driven should continue to thrive, but where private label is strong and the big players operate, it may prove almost impossible for all but the biggest to survive.

Polman is clearly redeploying his resources to try and crack Europe. He's reversed an earlier decision to move investment and marketing out of the region, giving funds for a renewed European advertising effort. The company has also invested heavily in innovation on its personal care brands, launching Dove for Men, and is expected to try and capitalise on its recently purchased Tigi brands.

Even Marmite is getting an overhaul, with a new variant set to hit UK shelves next month. The extra-strong Marmite XO will offer fans a more intense Marmite experience.

Polman is hoping the same approach taking his 2009 strategy to drive volume growth further in 2010 will eventually pay off with his shareholders. Just like extra-strong Marmite, it's an approach likely to divide opinion.

Read more
Unilever could quit UK if tax goes up - Polman (11 February 2010)
Unilever warns of a tough year ahead as profits slump by €2bn (6 February 2010)