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Unilever: Analysis on Royalties

The date of 12-12-12 (December 12th, 2012) might mean good luck for some people, but not for investors who hold the shares of Unilever Indonesia (UNVR). On that day, the stock suddenly dropped from 25,950 to 23,150 positions. A day later, the decline continues to position 20,350, so overall, UNVR had tumbled 27.5% in just two days. It was a very great decline, given that UNVR was not a penny stock, but the third largest company on the Indonesia Stock Exchange (IDX) in terms of market cap (before the drop, now it is the eighth largest, after Bank BRI/BRI). Bloomberg called the decline as the worst for stock in the last twelve years.

The decline wasn’t without cause. On December 12, the company announced an affiliation deal with its parent company, Unilever BV (UBV), a company from the Netherlands. In such deal, UNVR plans to increase royalties on trademarks, licensing of technology, and management services to the UBV, from the previous 3.5% of the total turnover (revenue) per year, to 5.0% in the year 2013, and will increase to maximum of 8.0% in 2015.

Because UNVR will pay a higher royalty to its parent company, then could be conclude that the net income of the company would be reduced, because the cost of royalty will increase. That's why some analysts then gave negative recommendations to the UNVR, and as a result its stocks fell. In its own disclosure, the management of UNVR did not explain the benefits of the plan for the company, but that UNVR would have opportunity to market some new products that would be developed by the UBV in the future, so that the business portfolio will be more diversified. Of course, most analysts do not think that it is a strong  reason to justify this affiliate transactions, and more assumes that the transaction is a form of profit transfer from UNVR to its parent company in the Netherlands.

Products of Unilever

So the big question, what is the impact of the increase in royalty payments to the financial performance of the company in the future? Okay, let's check.

In Nine Months 2012 (9M12), UNVR pay royalties amounting to Rp690 billion, or equivalent to 3.4% of the company's revenue of Rp20.3 trillion. However, noted that UNVR have to pay 3.5% of royalties from the company's revenue to the UBV, beyond revenue from related parties. In 9M12, the revenue from related parties was Rp915 billion (equivalent to 4.5% of total revenue), so the revenue from third parties was Rp19.4 trillion, so the royalty is Rp690 billion (3.5% from Rp19.4 trillion, or to be exact 3.55%. The excess amount is a service fee).

Back to the revenue of UNVR. In the last four years (2007 - 2001), the company's revenue continuing to increase by an average growth of 17.0% per annum. Assume that in the future, UNVR revenue will increase by an equal amount, and 4.5% of revenue comes from related parties. So, here are UNVR projected revenue, and revenue after related parties, from the full-year 2012 to 2015. Figures are in billions of rupiah.

Year
2012
2013
2014
2015
Revenue
27,125
31,736
37,131
43,444
Revenue after Related Parties
25,905
30,308
35,460
41,489

Then, remember that the royalties paid by UNVR to the UBV will rise gradually, from 3.5% in 2012, to 5.0% in 2013, 6.5% in 2014, and 8.0% in 2015 (note that the rate of 8.0% for 2015 is the maximum rate, so that the realization could be lower, but let us just use the number). Therefore, here is the amount of royalties, until the year 2015:

Year
2012
2013
2014
2015
Royalties (after enhancement)
907
1,515
2,305
3,319

Meanwhile, if the royalties remained at the level of 3.5%, then the following is the amount of royalties:

Year
2012
2013
2014
2015
Royalties (before enhancement)
907
1,061
1,241
1,452

Thus, here is the additional value of royalties, after the deal of enhancement

Year
2012
2013
2014
2015
Royalties (after increase)
907
1,515
2,305
3,319
Royalties (before increase)
907
1,061
1,241
1,452
Difference
0
455
1,064
1,867

In conclusion, the amount of additional costs that must be paid by UNVR due to the increase in royalties is likely Rp455 billion in 2013, Rp1.1 trillion in 2014, and Rp1.9 trillion in 2015.

Okay, now we are going to the projection of operating profit and net profit. In the last five years, the operating profit margin (OPM) of UNVR hasalways maintained at the level of 22.5%, so the following is the projected operating income of UNVR until 2015.

Year
2012
2013
2014
2015
Operating Profit
6,103
7,141
8,355
9,775

The above projection is if the royalties remains at the level of 3.5%. Meanwhile, if the royalties are rising gradually, as already mentioned above, the operating profit would be reduceby the additional costs due to increased royalties. And here are the results.

Year
2012
2013
2014
2015
Operating Profit (before added royalties)
6,103
7,141
8,355
9,775
Added royalties
0
455
1,064
1,867
Operating Profit (after added royalties)
6,103
6,686
7,291
7,908

Finally, the income tax rate to be paid by UNVR is about 25% of the profit before tax (or in this case operating profit, as UNVR almost have no non-operating expenses or income other than taxes). Thus, here is the projected net income of UNVR if the royalties were not raised, compared with the projection if royalties increased.

Year
2012
2013
2014
2015
Net Profit (before added royalties)
4,577
5,355
6,266
7,331
Net Profit (after added royalties)
4,577
5,015
5,468
5,931
Difference
0
341
798
1,400

So, from the last table above, it seems quite clear that after the royalties enhancement, then the potential net profit of UNVR in 2013 would be reduced approximately Rp341 billion, and the reduction will increase to approximately Rp1.4 trillion in 2015. As a result, the projected CAGRof net profit of UNVR will also fall from 17.0% (if it is assumed that the CAGR for net profit is the same to CAGR of revenu) to only 9.0%. When viewed from here, then the downgrade of UNVR by some analysts is reasonable. If the royalty increase was only from 3.5% to 5.0%, the effect may not be too pronounced. But unfortunately, the increase was 8.0%.

However, as you can see above, UNVR would still have a good net profit growth, although more slow than the previous projection. I said good, because the projected growth of 9.0% would achieved when UNVR is routinely pay dividends amounting to 100% of its net profit each year. Yup, the fact is that UNVR is a mature company without any business development plan, and yet it's still growing. And if you consider that theCAGR of net profit of UNVR during 2007 - 2011 has had reached 28.4% instead of 17.0%, then the growth in net income UNVR in the period 2012 to 2015 could be higher than 9.0% which mentioned earlier.

About the stock, considering that UNVR is very, very good company with ROE reaches 90 - 100% almost every year, then the stock is still good for investmentonly at the lower price as the projected growth of the company is now limited. If earlier the stock is worth valued at PERabove 30 times, which means 20,000 or more, then now the ideal entry position for UNVR is about 16,000, which reflects the PER of 25 times.

In conclusion, possibly there will be further corrections after, because usually when a stock is freefall like this, then it needs time to recover. In the near future, UNVR probably would go up because of a technical rebound, but the trend is likely down. And if you later have found its bottom (perhaps in the range of 16,000’s which mentioned earlier), then slowly but sure UNVR will rise again.

So for you who have not held this stock before, it is actually a very good chance, just wait for the ideal price to enter. Because if you remember, the stock of Perusahaan Gas Negara (PGAS) had once a sudden drop from 4,000 to 3,200 in just two days, and then he continued to tumble until stuck at 2,200. But now? PGAS is solid at the position of 4,500's, or had gained more than 100%. Just info, PGAS is also a company with excellent fundamentals, although not as good as UNVR.

And since UNVR is a bluchip stock with very good liquidity, then you may use some large funds.

PT Unilever Indonesia, Tbk
Rating of Performance in 9M12: S
Rating of Stock in 20,350: BBB


Original article was written at December 18, 2012

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