UNILEVER NIGERIA PLC. Vetiva Research 08 September Q2 10 Earnings Release. Closing up unimpressively. Fair Value Range N17.50 N21.

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1 Vetiva Research 08 September 2010 Q2 10 Earnings Release Closing up unimpressively We cut our fair value estimate of Unilever plc s equity by 16% reflecting our negative outlook for FY 10 performance where we see snowballing cost profile dipping earnings by 27% and turnover growth holding back to mid-single digit (vs. 19% in 2009FY). We maintain our Reduce rating on the stock with a fair value estimate of N YTD, the counter has performed strongly (33% up) and we recognize market s tradition of placing valuation premium on conglomerates. That notwithstanding, we believe current pricing is overstretched (Unilever trailing P/E of 28x relative to Market P/E of 16x) and stress that the deceleration in growth and unabated margin pressure do not lend support for the huge valuation premium it currently enjoys; thus we see risk to the downside. Growth slows despite aggressive brand investment: Unilever continues to invest massively in product development and brand promotion to solidify her strong market presence amid growing competition in personal care and food products markets. Management remains steadfast on its strategy of product portfolio optimization in the Home and Personal Care strategic business unit which drives about 57% of turnover. Though turnover growth has lost its double-digit steam over the past 2 quarters on the back of credit squeeze and challenges with key distributors, Unilever s products dominate their respective markets continually making up large portion of consumer spend on household staples. Import dependency on the rise; margin pressured by high bought-in cost: On the average, Unilever imports about 48% of its input needs, with the resultant exposure to volatile commodity price and FX movement. This exposure has almost doubled over the past 4 years as the company relies on the global purchasing power of the Unilever Group to source for key inputs. The strategy has not however fed through margin positively in recent times as underlying margin still looks quite vulnerable despite slowdown in sales which implies earnings are much more at risk for 2010FY. H1 performance tells the story: H1 performance was rather modest at top line level with turnover at N22.77billion (+7.9% y-o-y) while operating profit dipped steeply by 35.77% to N2.70billion. According to the management, the growth in turnover was partly supported by 2% hike in prices which further underscores our view that volume growth has been foiled relative to Margin contraction was compounded by huge A&P spends on newly launched products, which we think might pay off in the coming year. Key Headlines Q2'10 Q2'09 Chg 2010F Q2 as % NGNbn % NGNbn of 2010F Turnover PBT Tax PAT PBT Margin 11.2% 16.6% 10.3% Analyst Ahmed Razaq a.razaq@vetiva.com Stock Data Fair Value Range N17.50 N21.68 Symbol: NSE Bloomberg Reuters: UNILEVER CONGL. INDEX NSE ASI 1-Sep 1-Dec 1-Mar 1-Jun Source: NSE, Vetiva Research Vetiva Capital Management Limited Plot 266B Kofo Abayomi Street Victoria Island Lagos, Nigeria Tel: Fax: research@vetiva.com UNILEVER UNILEVER.NL UNILEVE.LG Current Price (N): Trailing EPS (N): 0.87 Trailing P/E (x): P/E (x): Shares Outstanding (mn): 3,783 Market Cap (N bn): Wk High (N): Wk Low (N): Share Price Performance 30 Days (%): Days (%): weeks (%): Ownership Structure: Unilever Overseas Hold. BV (%): Others (%): week share price performance Source: Company fillings, Vetiva Research Please see the last 2 pages for important disclosure and analyst certification 1

2 Highlights of H1 Performance Turnover losing double-digit growth steam: Unilever s halfyearly growth in turnover has been impressive over the past 3 years with a record level of more-than doubling its half-yearly sales in four years from N10.2billion in H1 06 to N22.8billion in the just concluded H1 10. This growth feat has been fueled by the joint impact of strong consumer spend on the back of buoyant GDP per capita, capacity expansion and supply chain rationalization by Unilever. However, over the past 6-9 months, turnover growth has been condensed to midsingle digit rate due to headwinds in product distribution as key distributors face challenges accessing credit to fund their working capital positions. Hence, H1 10 turnover managed a 7.88% y-o-y growth though there was commendable improvement in Q2 (April June). Fig 1: Half-yearly turnover over the past 4 years H1 H2 H1 H2 H1 H2 H1 H2 H1 H2 F Source: Unilever, Vetiva Research Our concerns with respect to slowing turnover growth is amplified even more by Management s disclosure that turnover growth in H1 was partly buoyed by an average of 2% hike in prices, which was arguably the next feasible option to lessen the negative impact of swelling cost on profitability. While Unilever has traditionally enjoyed inflation pass-through to consumers in form of price increases without material demand relapse due to the basic necessity nature of its product portfolio, rising inventory levels (which rose by 33% in H1 10) and moderating sales volume partly caused by weak purchasing power are key flashpoints to our view that there are difficulties to growing sales volumes. We observed that Unilever had some challenges in July this year with its key distributors. We anticipate that those limitations to accessing sales inventory will be reflected in the Q3 performance figures, further influencing lower turnover outlook for Q3 and then on the cumulative full year picture. 2

3 Market leadership unchallenged across niches: Despite a slowdown in consumer spending and tight credit environment which impaired the sales growth in the past year, Unilever continues to invest in a robust brand strategy, with significant advertising spend, in a bid to further entrench its market presence. Product portfolio optimization has been on the front burner with continuous product innovation and retail market penetration. In the detergent market, additional market share has been captured with the launch of Sunlight and the re-launch of OMO through robust advert and promotional campaigns. In the Oral care market, where Unilever has an estimated market share of 80%, Close Up has been performing quite impressively with innovative variants to fend-off and stay ahead of the competition. For the Savoury category, the rollout of new variants for Knorr and the increasing push of the new Blue Band formulation in a sizable package with affordable price points have helped support Unilever s market share. That said, we look out to the possibility of product cannibalization which in our view could distort Unilever s growth equation if the intensity of products substitutability increases and product uniqueness becomes lost. Margin pressures subsist; recovery expected in 2011: Despite a 2% hike in product prices to salvage margin, increasing advert and promotional spend combined with rising input cost have rendered Unilever margins vulnerable for the 2010 financial year. Significant saving has been achieved on finance cost which reduced by 77% over the past year following the 2009 deleveraging of its US$20million loan which infused some FX risk to earnings. Operating margin in H1 10 perched at 11.9%, a level last seen in 2008 and represents some 400bps below 2009FY level. Baring additional uptake of more expensive domestic borrowing, we do not anticipate further pressure on margins from finance cost. However, we do not expect margin to recover strongly before 2011 given the on-going investment on brand development, which we expect to start yielding gains next year. Fig 2: Operating margin trending down; recovery expected in % 15.0% 15.9% 15.4% 12.0% 11.9% 10.0% 10.0% 7.5% 5.0% 2007A 2008A 2009A H1' F 2011F Source: Unilever, Vetiva Research 3

4 Earnings descend by 37% on weak margin: The weak margin we have stressed above, driven largely by unfavourable input cost and significant marketing expenses, have fed through earnings negatively compounded by the not-too-impressive turnover growth. Unilever recorded a H1 10 PAT level of N1.68billion, representing 37% y-o-y decline. The steeper decline at post-tax earnings was compounded by higher effective tax charge of 35% vs. 28% a year ago. The falling trend in earnings is also reflected at PBT level though less strongly at 27.39%. Half year earnings stands at 45kobo per share translating to an annualized EPS of 90kobo (vs. 2009Aof N1.08). Fig 3: Operating margin trending down; recovery expected in H1 H2 H1 H2 H1 H2 H1 H2 F Source: Unilever, Vetiva Research 4

5 Outlook and forecast revision Weak 2010FY on low demand and distribution challenges: The outlook for Unilever s FY 10 Turnover is not very encouraging as we do not see it making up for the weak turnover growth performance in H1 10. Though private sector credit is beginning to show green shoots of recovery in Q2 and we expect H2 10 to be a better half-year in terms of lending resumption, expected gain on turnover growth from this front is likely to be partially offset by the challenges Unilever faced with key distributors in July this year. However a plus for turnover expectations is the seasonality usually experienced in the festive ember months, and for which we expect to see some support in H2 10 coupled with the 2% increase in average product pricing. In summary, we forecast a turnover of N44.48billion for 2010FY representing y-o-y growth of 6%. We expect double-digit growth to resume in 2011 as the full impact of brand investment begins to yield fruits and consumer purchasing power gains some strength on the back of 7% GDP growth forecast. Fig 4: Private sector credit (Ntrn) and growth (RHS) Fig 5: Unilever turnover performance and forecast Credit Annualised growth 80.0% 70.0% 60.0% 50.0% 40.0% 30.0% 20.0% 10.0% 0.0% -10.0% % 0 Q1'08 Q2'08 Q3'08 Q4'08 Q1'09 Q2'09 Q3'09 Q4'09 Q1'10 Q2' A 2007A 2008A 2009A 2010F 2011F 2012F Source: CBN, Vetiva Research Margins to remain stumpy in H2 10; recovery expected in 2011: With 2010FY taking in the full impact of the huge brand investment, though which we view as a long-term call on value generation, we expect 2010FY margin to be low compared to recent years. Our weak expectation is further compounded by rising input cost though we do not see FX risk as being strong at this moment. We forecast operating margin of 10.0% in FY 10 (vs. 15.9% in 2009). More importantly, H2 has traditionally contributed less to margin (as against higher contribution to turnover). Our best bet on this contrasting scenario is the strong appeal and high demand of low margin products in the second half of the year which is replete with festivities. We do not expect significant deviation from that trend. However, we expect operating margin to rebound strongly to 15%-plus range in 2011 on ward. We think our expectation is well anchored as we do not see the scenario of huge brand investment replicating in post-2010 period, at least not immediately. We also think the retail strategy will be margin-supportive post Source: Vetiva Research 5

6 Changes to estimates: Our expectation on earnings for 2010 follows our broad view that Unilever will close 2010 unimpressively. Based on our sales growth and margin assumptions, we forecast 2010 PBT and PAT of N4.37billion and N2.97billion respectively. Our forecast implies y-o-y decline of 22.8% and 27.4% in that order. We however expect a strong rebound of 29.5% earnings growth in 2011 driven largely by resumption in double-digit sales growth, powerful base effect and efficiency gains. We believe that the long-term prospect of Unilever is strong given its market dominance and continued investment in capacity addition to meet up with rising demand. The table below gives a summary of the changes to our forecast. 2010E 2011E Items in N billion New Old % Chg New Old % Chg Turnover EBIT EBITDA PBT Tax PAT EPS DPS P/E Dividend Yield 3.2% 5.1% 5.7% 6.5% Valuation Current price suggests valuation richness: After reviewing our forecast downward, we cut our fair value estimate of Unilever to N19.52 (from N23.54) with a fair value range of N17.50 N Current price of N24.00 implies a downside potential of 14.07% (on total return basis); hence, we retain our Reduce rating on the stock. The stock currently trades at a 2010 P/E of 31.13x and 2010 EV/EBITDA multiple of 16.25x. These multiples are 28% premium to what our valuation suggests is fundamentally fair and represents significant premium to peer average (see the next page). Our fair value estimate is DCF-based and represents a 50-50% weighting scheme on DDM and FCFF approach. WACC estimate of 14.26% is driven by risk free rate of 9%, beta of 1.08, equity risk premium of 5% and an equity oriented capital structure as Unilever Nigeria, much like its peers, have no material long-term debt profile or target. Over the long-term, we expect Unilever s growth to track the broader economy; hence our 5% terminal growth assumption. Key risks to our valuation include the likelihood of protracted margin pressure beyond 2010 which could result if input cost continues to increase and promotional expenses are kept elevated. We see this scenario playing out if competitive pressure mounts stronger than we have assumed. On the upside, stronger margin contribution from retail strategy could imply higher value accretion than we have modeled. Source: Vetiva Research 6

7 Valuation multiples Most expanded multiple in the consumer space: On the average, Unilever s valuation multiples are trading at significant premia to peer averages. The shares currently trades at 2010E EV/EBITDA multiple of 16.25x representing some 62% premium to the average in our consumer space. We would have been quite comfortable if the value credentials of Unilever are equally above-peer average. The valuation table below gives these comparable figures. Valuation multiples: Unilever vs. peers Valuation multiples Year End 2010E P/E 2010E EV/EBITDA 2010E P/Sales 2010E Div Yield 2010E EBITDA Margin PZ Cussons (1) May 16.96x 8.61x 0.97x 2.63% 11.21% NESTLE December 19.76x 11.36x 2.96x 4.30% 27.30% CADBURY (2) December 55.40x 15.95x 2.87x 0.00% 16.90% UACN December 19.61x 6.44x 1.26x 3.11% 18.67% UNILEVER December 31.08x 16.25x 1.96x 3.19% 12.00% Average 21.85x 10.67x 1.96x 3.31% 16.90% Average (EX Unilever) 18.78x 8.80x 2.07x 3.35% 17.79% 1. PZ Cussons has a May financial year end and as such it multiples are based on May 2011 forecast. 2. Our average P/E multiple computation is exclusive of Cadbury Source: Vetiva Research estimate 7

8 Appendix: Unilever Nigeria Plc s financials and forecasts Income Statement (N'Mill) 2006A 2007A 2008A 2009A 2010F 2011F 2012F Turnover 25,554 33,991 37,377 44,481 47,150 53,280 60,206 Cost of Sales -18,422-22,578-24,361-27,092-30,648-32,501-36,726 Gross Profit 7,132 11,413 13,017 17,389 16,503 20,779 23,480 Dist & Admin Exp. -7,496-8,860-8,545-10,328-10,845-11,508-12,944 EBITDA 425 3,411 5,243 7,750 5,658 9,271 10,536 EBIT ,553 4,472 7,061 4,707 8,197 9,322 PBT (before EI) -1,331 2,013 4,145 6,225 4,373 7,795 8,840 EI PBT -1,331 2,013 4,145 5,661 4,373 7,795 8,840 Taxation ,548-1,567-1,399-2,494-2,829 PAT ,297 2,597 4,094 2,974 5,301 6,012 Balance Sheet (N'Mill) 2006A 2007A 2008A 2009A 2010F 2011F 2012F Fixed assets 7,772 8,641 9,056 9,975 11,316 12,787 14,449 Inventories 5,332 5,083 4,632 4,927 4,632 5,002 5,352 Trade receivables 2,748 3,463 4,369 3,495 4,019 4,212 4,414 Other receivables 1, ,206 1,751 2,122 2,398 2,709 Rec. from related coys ,522 1,553 1,328 1, Cash and bank balances 1,657 1,562 2,706 1,981 2,080 2,184 2,293 Total Assets 10,850 11,712 14,436 13,706 14,180 14,931 15,739 Liabilities Trade payables 1,365 2,365 3,711 2,255 2,030 1,827 1,644 Due to related companies 2,070 1,069 1,553 1,928 1,966 2,006 2,046 Other payables 2,647 4,271 4,353 4,448 4,977 5,411 5,893 Unclaimed dividends Current income tax ,005 1,769 1,427 2,544 2,886 Bank overdraft 5,516 4,036 2,615 1,500 1,650 1,815 1,997 Deferred income tax ,290 1,148 1,240 1,339 1,446 Retirement benefits obligation 1,945 1,833 1,778 1,927 1,965 2,004 2,044 Total liabilities 14,669 15,322 16,811 15,479 15,860 17,671 18,826 Capital and Reserves Share capital 1,892 1,892 1,892 1,892 1,892 1,892 1,892 Share premium Revaluation reserves Retained earnings 1,779 2,856 4,507 6,028 7,462 7,872 9,188 Shareholders' Equity 3,953 5,031 6,682 8,203 9,636 10,047 11,363 8

9 Key financial ratios and forecasts Growth Rates F 2011F 2012F Turnover growth 17% -23% 33% 10% 19% 6% 13% 13% Growth in EBITDA -6% -90% 702% 54% 48% -27% 64% 14% Growth in EBIT -6% -110% -802% 75% 58% -33% 74% 14% Growth in PBT -17% -146% -251% 106% 50% -30% 78% 13% Growth in PAT -16% -138% -230% 141% 58% -27% 78% 13% Profitability F 2011F 2012F Return on Equity 46% -17% 24% 44% 55% 33% 54% 56% Return on Assets 11% -4% 6% 12% 17% 12% 20% 21% Margins F 2011F 2012F EBITDA/Sales 13% 2% 10% 14% 17% 12% 17% 18% EBIT/Sales 11% -1% 8% 12% 16% 10% 15% 15% Pretax Income/Sales 9% -5% 6% 11% 14% 9% 15% 15% Net Profit Margin 7% -3% 3% 7% 9% 6% 10% 10% Asset utilization F 2011F 2012F Sales to cash (x) Inventory Turnover (x) Asset Turnover (x) Fixed Assets (%) 31% 42% 42% 39% 42% 44% 46% 48% Liquidity Ratios F 2011F 2012F Cash ratio Current ratio Interest coverage (x) Days in inventory Days in accounts payable Days in receivables Cash Conversion Cycle

10 INVESTMENT RECOMMENDATIONS Vetiva uses a 5-tier recommendation system for stocks under coverage: Buy, Accumulate, Neutral, Reduce and Sell. Buy/Overweight +25% expected absolute price performance Accumulate +10% to +25% expected absolute price performance Neutral/Hold +/-10% range expected absolute price performance Reduce -10% to -20% expected absolute price performance Sell/Underweight -20% expected absolute price performance Definition of Ratings Buy/Overweight recommendation refers to stocks that are highly undervalued but with strong fundamentals and where potential return in excess of or equal to 20% is expected to be realized between the current price and analysts target price. Accumulate recommendation refers to stocks that are undervalued but with good fundamentals and where potential return of between 10% and 20% is expected to be realized between the current price and analysts target price. Neutral/Hold recommendation refers to stocks that are correctly valued with little upside or downside where potential return of between +/- 10% is expected to be realized between current price and analysts target price. Reduce recommendation refers to stocks that are overvalued but with good or weakening fundamentals and where potential return of between -10% and -20% is expected to be realized between current price and analysts target price. Sell/Underweight recommendation refers to stocks that are highly overvalued but with weak fundamentals and where potential return in excess of or equal to - 20% is expected to be realized between current price and analysts target price. 10

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