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Summary of Unilever Indonesia (UNVR IJ) Analysis

Core Content

Unilever Indonesia Tbk (UNVR IJ) is a leading consumer goods company in Indonesia, operating in the home and personal care, as well as food and beverages segments. The company is headquartered in Jakarta and has a significant market presence, with 85% ownership by Unilever NV. Despite its strong position in the fast-moving consumer goods (FMCG) sector, the stock is currently being recommended for a SELL due to high valuations and multiple challenges to its financial performance and growth prospects.

Key Financial Metrics

Main Challenges

1. Currency Exposure and Margins

• 60% of COGS is denominated in USD, while revenues are in IDR.
• Margins are sensitive to IDR/USD cross rate, with significant declines when the rate exceeds 10,000.
• IDR weakening in 2013 and 2014 is expected to further pressure margins.

2. Royalty Fee Hike

• Royalty fees to Unilever NV increased significantly in Dec 2012.
• The new structure is higher than industry standards, wiping out an estimated 15% of FY15F profit.
• This hike reduces the likelihood of a privatisation buyout by the parent company, a key reason for holding the stock.

3. Dividend Payout vs. Capex

• 100% dividend payout has been a key feature, but operating cash flow is no longer sufficient to support both dividend and capex.
• Capex spending has increased since 2010, mainly due to imported equipment.
• By FY15F, net gearing is expected to reach 33%, marking a shift from a debt-free balance sheet.

4. Competition and Pricing Power

• Unilever's products are typically 10-30% more expensive than competitors.
• Market share in key categories like shampoo, oral care, and fabric cleaning has been eroded.
• Price increases are unlikely in the short term due to competition and limited pricing power.

Valuation and Investment Outlook

• Unilever Indonesia is one of the most expensive consumer stocks in the ASEAN region.
• PER premium is at an all-time high, with a forward EPS growth of only 7%.
• The target price of IDR22,350 is based on a 30x FY14F PER, which is 50% higher than the average for Indonesian consumer stocks.
• The key risk to the SELL recommendation is a privatisation buyout by Unilever NV, which could offset the valuation concerns.

Performance and Earnings Projections

• Margins are expected to decline due to the combination of cost pressures and limited pricing power.
• Gross margin contraction is projected to be around 130bps if the IDR weakens by 5% from the base case.
• Net profit is expected to contract by 15% by FY15F due to the royalty fee increase.

Key Risks and Outlook

• High valuations with limited upside potential.
• Currency volatility (IDR/USD) could significantly impact profitability.
• Royalty fee structure is likely to remain unchanged for at least 8 years, leading to permanent cost increases.
• Dividend sustainability is questionable without increasing debt.
• Corporate governance perception has been negatively impacted by the royalty fee change.
• Market share erosion in key categories could further pressure performance.

Conclusion

Unilever Indonesia is currently overvalued relative to its earnings growth and industry peers. The combination of currency exposure, increased royalty costs, and eroding market share suggests that the company may face margin compression and reduced profitability in the coming years. The SELL recommendation is based on the expectation of a de-rating over the next 12 months. Investors are advised to SELL into strength as the stock's high valuation leaves little room for error.