Unilever is almost an obligatory holding for many dividend growth investors. That’s no surprise because the company’s consumer products (including brands such as Dove, Flora and Magnum) are well suited to a world in which a growing number of people are willing and able to buy those products.
That tailwind of growing consumerism has enabled the company to grow its dividend every year for more than 40 years. That’s quite some achievement.
However, since the financial crisis growth has slowed and while the dividend went up in 2014 by about 6%, that was in Euros (the dividend is declared in Euros). In GBP terms the dividend fell slightly.
So is this the end of the road for dividend growth or can Unilever keep on growing, ultimately fulfilling its strategic goal of doubling in size relative to 2009?
Rapid dividend growth may not be sustainable
Let’s get some context by looking at Unilever’s revenue, earnings and dividend growth over the last decade (in GBP rather than EUR):
As I just mentioned the company’s goal is to double its size relative to 2009. Exactly what “size” means is up for debate but for me, a fair definition would be for Unilever to:
- Grow revenues from £35 billion to £70 billion
- Grow earnings per share from 120p to 240p
- Grow dividends per share from 70p to around 140p
Those are lofty goals for a company that already has a market cap of more than £80 billion. Let’s see how it’s done so far in the 5 years since 2009, when it announced the goal to 2014. The company has:
- Grown revenues from £35 billion to £38 billion (6% gain)
- Grown earnings per share from 120p to 121p (1% gain)
- Grown dividends per share from 70p to 90p (29% gain)
Of the three, only dividends seem to be on track for a 100% gain and that’s a problem. Without sufficient growth of revenues and earnings, dividend growth cannot be sustained.
Across the entire period in the chart above, Unilever grew its dividend at the lofty rate of 8.5% a year. That’s great news for defensive and dividend investors, but it only managed to grow revenues and earnings at a barely inflation-beating 4% a year and 2.5% a year respectively.
Either Unilever is going to have to find some major revenue and earnings growth that it hasn’t been able to find before, or it’s going to have to cut its dividend growth rate in half.
With slower dividend growth, valuation and yield become more important
If Unilever’s future dividend growth can only match the growth of its revenues and earnings, which have grown at less than 4% a year over the last decade, how will investors fair?
In the long-term total returns equal dividend growth plus dividend yield, so with an assumed future dividend growth rate of 4% and a current yield of 3.2% (with the shares at 2,850p) investors could reasonably expect a return of about 7% a year.
Of course in reality nobody knows what the future will bring, and things may work out much better or worse than that, but I would say 7% a year is a reasonable estimate of future returns for these shares.
Unfortunately, that is no more than the expected long-term return of the UK market. In other words, at their current price, Unilever shares may be no better than an investment in the FTSE 100 (where the yield is closer to 3.5%).
Buy, hold or sell?
Personally, I’m targeting a return of at least 10% a year which means that at the moment Unilever’s shares are just not attractive enough. So I don’t own Unilever, but if I did I’d sell it and reinvest the proceeds into something that was growing faster, yielding more or both.
For me to buy Unilever shares I’d either need to see the company step up its overall growth rate closer to 7% a year (primarily by increasing its revenue and earnings growth rate) or I’d need to see the dividend yield closer to 5%.
For the yield to reach 5% the share price would need to drop to about 1,800p, which is a fall of some 35% from where it is today. At that price, I’d probably be a buyer.
A 35% fall may sound like a lot but it’s where the shares were until early 2011, and the company has not grown significantly since then.
Of course, a 5% yield from a company like Unilever, beloved of dividend investors, is unlikely. But in reality that just means it would require a good dose of bad news in order to get there.