Unilever PLC Intrinsic Value Review

It has been quite some time since I last discussed Unilever PLC (UL). I originally added shares of UL to the Fat Pitch Financials Port back on September 21, 2004. Adjusting for a stock split (9:5), my cost basis for this stock was $18.66.

Yesterday, UL closed the day at $27.66.  According to Marketocracy statistics, UL has been my highest returning stock in my model portfolio, returning 73.20% since inception. Given this appreciation in price, it is time for me to reassess the value of Unilever PLC shares.

The first thing I do when revisiting the value of one of my stocks is to review the latest annual report. The last annual report filed by Unilever PLC was the 2005 fiscal year. The annual report typically provides several years of historical financial information. However, the Unilever annual report only has two years worth of financial data.  Thankfully, Unilever provides a file (pdf) on their site that provides tables of historical financial statements going back to 2001.

In addition to looking at the historical financial statements, I also read the latest third quarter financial report for 2006. One drawback to looking at the third quarter report is that the statement of cash flows is reported for the trailing 9-months.  However, most financial models require annual or trailing twelve month data.

A bit of mental effort is required to figure out how to go from trailing 9-month to trailing 12-month figures.  First, you take the most recent trailing 9-month net operating cash flows from the third quarter report. In the case of Unilever, that is €3,112 million for Q3-2006. In order to make this a twelve month figure, we need to add in the fourth quarter net operating cash flows from 2005.  The problem is that Unilever (and most other companies) does not report cash flows for just one quarter. Cash flows are typically reported on a cumulative basis. I’m not sure why that is the case, but I just know that it makes my calculations more complicated.  To get the fourth quarter of 2005 net operating cash flows, I first take the annual 2005 net operating cash flows of €4,353 million and then I subtract the third quarter trailing 9-month net operating cash flows of €2,804 million and I get €1,549 million. Adding this back to the current trailing 9-month net operating cash flows from the 2006 third quarter report, I get €4,661 million.

I repeated the same process to calculate the trailing 12-month capital expenditures and I came up with €964 million. Now that I have both the trailing 12-month net operating cash flows and capital expenditures, I can just subtract out the 12-month trailing capital expenditures to get the past twelve months of free cash flows. If did the math right, the free cash flows for the trailing past twelve month are €3,697 million.

Over the past four years, free cash flows have been bouncing up and down. There was no clear trend, so I am not comfortable using my usual straight line regression analysis. In addition, due to a stock split and restructuring it is rather difficult to analyze the historical financial data.  Instead, I’m going to use the Gordon Growth Model to estimate the present value of future free cash flows based on current cash flows.

For this valuation, I am using a 10% discount rate, which is the same rate as I’ve been recently using for other stock valuations given how low interest and inflation have been. I intentionally avoid using a discount rate below 10% in order to build in a further margin of safety.

I next take a look at Unilever’s growth rates.  It appears to fall within a 4 to 6 percent range. I decided to run the valuation model using a 5% growth rate for free cash flows. A 5% rate of growth is consistent with the most current rate of growth in the 2006 third quarter trailing nine month net profit from continuing operations versus the previous year’s nine month net profit from continuing operations. Recent sales growth is also in alignment with this growth estimate, coming in at 4.8% this past quarter. The 5% growth rate is also slightly below analyst estimates of a 6.4% growth over the next five years.

Plugging these numbers into the Gordon Growth Model, I estimate that the present value of future free cash flows to be €73,940 million.  To determine the value of common stock equity, I add in cash and cash equivalents of €1,440 million. Then I subtracted current and long-term debt of €10,760 million. I also factored out €412 million worth of minority interests. The result is an intrinsic stock value estimate of €51.885 billion €64.208 billion.

The next step in calculating the intrinsic value per share can be a bit tricky for dual class stocks and for ADRs.  Thankfully, Unilever has made this a bit easier to do recently as a result of the Unilever PLC ADR stock split/restructuring and they have provided most of the detail for us in their shareholder FAQ. Now one share of the UL ADRs are equivalent to one share of Unilever PLC.  In addition, the Unilever PLC shares are now equivalent to the Unilever NV shares. Unilever provides financial data that combines the operations of both Unilever PLC and Unilever NV. Many of the online financial data sources do not fully take this into account, and therefore using tools like my Fat Pitch Finder Spreadsheet often produce erroneous results. After carefully walking through these details, I determined that the total intrinsic stock value I calculated before needs to be divided by 2,968 million shares.

The calculated per share value is €21.63. I then convert that into U.S. dollars by using the most recent exchange rate of 1.29 U.S. dollars per Euro. That is equal to $27.91. Therefore, my intrinsic value estimate for UL is also $27.91. That is real close to the February 5th closing price of $27.66.

Given the stock is trading close to its intrinsic value and the company is still in the middle of their global growth program called “One Unilever” I will continue to hold on to my shares in the Fat Pitch Model Portfolio. One take home from this exercise is that care should be taken in estimating the value of ADRs and other stocks with complicated share class structures. I actually think some of the share price gains in UL have come from the simplification of the relationship between the ADRs and the PLC versus NV shares. I think this has helped the market better assess the value of Unilever.

Full Disclosure: I own share of Unilever PLC ADRs.