Failed Unilever bid a relief for income investors

Results season for the consumer branded goods sector was eclipsed to a large extent by Kraft Heinz's recent aborted takeover attempt of Unilever. This brief flirtation by Kraft Heinz prompted us to a thought experiment in what the British stockmarket would lose if Unilever ceased to be a listed company.

Unilever offers a fairly unique combination of characteristics to UK investors. It is the global number two player in homecare (after P&G), the number three player in beauty and personal care (after P&G and L'Oréal) and the number six player in food. It is also a highly diversified business both by category and geography.

We see Unilever as a low-ticket, repeat purchase business model with economic resilience and pricing power. It is also a business model generating high, compounding returns on invested capital and converting its earnings consistently to cash. This is all supported by a strong balance sheet.

Unique emerging market footprint

Unilever has an unrivalled, impossible-to-replicate footprint in emerging markets. The company has been in India since the 1880s for instance, and Brazil and Indonesia since the 1930s - Unilever's distribution network in Indonesia is bigger than the Indonesian post office.

And Unilever has delivered for income investors. Long-term dividend growth, has averaged more than 10% over the last 50 years. And despite the current low inflation environment the company continues to grow its dividend at +6% per annum; and has a starting dividend yield of more than 3%.

As such, we greeted the news that talks had been terminated with no disappointment. It would be a great shame to permanently lose such a high-quality dividend stream from both the UK market and Evenlode's investable universe. Following this failed takeover approach, Unilever's management has subsequently announced improved profit margin guidance for 2017 and a strategic review to "accelerate delivery of value", the results of which will be announced in April.

Tightening cost measures

This tightening of the bootstrings is a positive development in many ways for shareholders - there are undoubtedly efficiency improvements and portfolio rationalisation opportunities available to Unilever management in the near term.

But Unilever's relatively low margins (compared to peers) are also the side effect of significant, consistent investment in its brand development and global footprint. We appreciate this long-termist culture that has built up in Unilever (which still to some degree echoes William and James Lever's mindset from the company's origins at Port Sunlight in the late 19th century).

Long-termism is a valuable asset for the patient shareholder, but not something that is easy to measure on a spreadsheet. As Einstein once said, "not everything in the world can be counted, and not everything that can be counted counts".

Quality, resilience, value

Elsewhere in the income universe, there have been some good recent updates from Page Group, Burberry, Victrex, WS Atkins and Paypoint. All of the these continue to generate healthy free cash flow and have net cash balance sheets, despite having faced very mixed end markets over the last year or two.

This bodes well for future dividends, and several of these companies (Victrex, Page Group and Paypoint) also have policies to pay special dividends from time to time when cash positions begin to pile up.

The wider economic and market outlook remains by no means straightforward. Structural deflationary pressures remain significant, with global debt levels still very high. Despite this, we are encouraged by the progress portfolio holdings have made, and we continue to strike an appropriate balance in the Evenlode portfolio between quality, resilience and value as 2017 progresses.

Hugh Yarrow is lead fund manager of the Evenlode Income fund.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.