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The 3 Biggest Risks Facing Unilever

Wednesday - 11/21/2012, 3:58pm  ET

LONDON -- With its strong clutch of category-leading consumer brands and growing emerging-market presence, Unilever is a business with very definite attractions. A 67 billion pound FTSE 100 constituent, the company earned a pre-tax profit of 6.2 billion pounds on revenues of 47 billion pounds last year.

And with margins like that, no wonder this defensively positioned business is popular with many investors. Better still, with its shares changing hands today at 2,334 pence, the company offers income investors a reasonably tempting forecast dividend yield of 3.4%.

But how safe is that share price? And -- of vital importance to income investors -- how safe is that dividend? In short, how could an investment in Unilever adversely impact investors' wealth?

In this series, I set out to answer just these questions. My starting point: Unilever's latest annual report, where the company's directors are obliged to address the issue of risk.

Risk management
One immediate thing I'm looking for is an acknowledgement that risks do exist and need managing.

The good news? As you'd expect from a business of Unilever's size and caliber, the company has in place a risk-management policy, a system of regular reviews, and a number of high-level committees tasked with monitoring the risks that the business has identified.

But what, precisely, are those risks?

Read the small print, and Unilever identifies no fewer than 13 risks as having a significant potential impact on the company's financial performance. They range from political risks and natural disasters to changing consumer tastes, and from private-label brands to supply chain disruption.

So let's take a look at three of the biggest.

Customer relationships
Unilever operates in one of the world's toughest marketplaces, selling premium branded products to supermarkets such as Tesco, Sainsbury's, and Morrison's. And not only are these supermarkets tough negotiators, capable of delisting brands and shrinking available shelf space, but they are also competitors, too. Competitors? That's right: Competing against almost every Unilever brand is a cheaper supermarket "own label" offering. As the company puts it:

Successful customer relationships are vital to our business and continued growth. Maintaining strong relationships with our customers is necessary for our brands to be well presented to our consumers and available for purchase at all times ... [and] our retail customers frequently compete with us through private label offerings.

Here, Unilever's strength in emerging markets -- where it makes 54% of sales -- helps significantly. As the company points out, it aims to build and maintain trading relationships across a broad spectrum of channels ranging from centrally managed multinational customers through to small traders accessed via distributors in many developing countries.

Also, both brands and customer relationships are focused around areas where Unilever thinks it can add value and build sustainable competitive advantage -- positioning it firmly away from price-led markets and customers and more into ones where its strengths in innovation, sustainability, and other non-price characteristics are valued.

Sustainability
And speaking of sustainability, Unilever has set itself a tough challenge. Sustainability, it recognizes, is important to consumers -- and so it is important to Unilever. But can this importance be reflected without impacting growth and profitability? As the company puts it: "Unilever's vision to double the size of our business while reducing our environmental impact will require more sustainable ways of doing business. This means increasing the positive social benefits of Unilever's activities while reducing our environmental impact."

To me, the risk here is around growing the business. In terms of ensuring sustainability, the company can point to the Unilever Sustainable Living Plan, which sets clear longâ"‘term commitments for environmental impact, underpinned by specific targets in areas such as sustainable sourcing, water availability and usage, waste, and greenhouse gases. These, in turn, are monitored by the Unilever Sustainable Development Group, comprising five external specialists in corporate responsibility and sustainability.

But growing the business and profit at the same time? Beyond an acknowledgement that progress toward the Unilever Sustainable Living Plan is monitored by the Unilever leadership executive team and the board, nothing is said.

Supply chain risk
Unilever is a global business with global supply chains. But what happens to profit and revenue when those supply chains are disrupted? As Unilever puts it: "Our business depends on securing high quality materials, efficient manufacturing, and the timely distribution of products to our customers. Our supply chain network is exposed to potentially adverse events such as physical disruptions, environmental and industrial accidents or bankruptcy of a key supplier which could impact our ability to deliver orders to our customers."

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