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In 2013, Gain Big With Blue Chips

Gaurav is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Now that the manufactured drama of the fiscal cliff is done, we can examine how to weather the actual headwinds of 2013. Europe has a genuine growth crisis and the expiration of the payroll tax cut will hurt the pocketbooks of average Americans. In such times it may be necessary to recall that the Darwinian principle is "survival of the fittest" and not "survival of the biggest." When uncertainty is in the air, we all like a safe blue-chip stock that we can park our cash into, but remember that not all blue-chip stocks are born equal. 

So here are the characteristics to look for:

1)  Find a defensive stock with dependable earnings and a well-established brand. A low beta and a long history would definitely count in their favor. 

2)  It should have good cash flow management; they should be able to consistently deliver large dividend yields without overstretching their finances. Also important is that they continually increase the size of the dividends.

3)  The business should be well positioned to (at least) maintain its market share. Although you have accepted temporary setbacks in capital gains, long term growth prospects are still important. 

Considering these parameters, it makes sense to examine two titans of packaged consumer goods: Unilever (NYSE: UL) and Procter and Gamble (NYSE: PG).

Unilever

This multinational uses its collection of popular brand names to sell staple goods across the globe. In fact, the London-based company has 12 brands valued over one billion euros (Axe/Lynx, Knorr, Lipton, Omo, Sunsilk, Dove, Rexona, Blue Band, Lux, Hellmann's, Flora/Becel and Heart brand) and they sell their products in more than 180 countries. Not bad, huh? The charts below demonstrate how resilient this company is against a toxic global economy. After a quick dip at the outset of the Great Recession, sales rebounded forcefully in 2010 and 2011 mostly from increased turnover in emerging markets in Asia and South America.

<img src="/media/images/user_13833/blog_large.png" />

<img src="/media/images/user_14986/unilever-sales_large.png" />

Granted, growth in operating profits from those regions has not managed to keep pace with the growth in sales, but that is because of the higher capital expenditures demanded by expansion. Some of you may be worried that the dividend payout ratio is getting too high and Unilever may have to halt dividend growth or risk mismanaging their cash flow. It's a reasonable concern but not one I happen to share because their free cash flow has fallen from planned, rather than unplanned, costs. Companies like Unilever are able to produce at economies of scale which allows them to outprice smaller rivals, especially during times of economic hardship. So it's only reasonable to expect them reinvest more capital at a time when it will cost them less to do so. Check out the total amounts spent on capital expenditures and acquisitions in the last few years:

<img src="/media/images/user_14986/unilever-dividendsfcf_large.png" />
 

As you can see, since 2009 the percentage of Free Cash Flow used for dividend payments rises in sync with their expansionary spending. If it was primarily volatile commodity prices and input costs that were increasing the payout ratio, then I would be worried. Such unexpected expenses can be troublesome, but Unilever's spending is purely tactical and I have faith in their management. Just this week they finalized the sale of their Skippy Peanut Butter brand to Hormel Foods (NYSE: HRL) for a whopping $700 million. Combine that with a 6.6% underlying sales growth in the first three quarters of 2012 and Unilever's cash will be just fine.

Procter & Gamble

If you looked up "blue chip stock" in the dictionary, I wouldn't be surprised if you found the P&G logo. This is a company that since its incorporation in 1890 has consistently paid a dividend, and has raised that dividend for the last 56 years. Even with a 5-year dividend average that is 35.9% above its peers, they've still managed to keep their payout ratio 5.5% lower than the industry average. Like Unilever, they are a consumer goods company with a stellar lineup of brands, 25 of which sell over $1 billion per year.

<table> <thead> <tr> <td colspan="2"><strong>Beauty and Grooming</strong></td> <td colspan="2"><strong>Household Care</strong></td> </tr> </thead> <tbody> <tr> <td> <p>Always<br />Braun<br />Crest<br />Fusion<br />Gillete<br />Head & Shoulders</p> </td> <td>MACH3<br />Olay<br />Oral-B<br />Pantene<br />SK-II<br />Wella</td> <td>Ace<br />Ariel<br />Bounty<br />Charmin<br />Dawn<br />Downy<br />Duracell<br /> </td> <td>Febreeze<br />Gain<br />Iams<br />Pampers<br />Tide<br />Vicks</td> </tr> </tbody> </table>

I'm a big fan of this company but they have been faltering in recent years. Innovation and higher margins are what used to drive their success (think Swiffer) but there have been no significant breakthroughs of late, and management has been forced to rethink their strategy. North America is still far and away P&G's largest market, so high unemployment and stagnant middle-class wages in the US have pushed consumers towards lower priced substitutes. Just take a look at this to chart:

<img src="/media/images/user_14986/pg-profitability-ratios_large.png" />

 

For each metric, there is a smaller gap now (between P&G's margins and that of their rivals) than there has been for the last 5 years. Obviously that trend is set to continue because of negligible economic growth but clearly P&G's management has gotten wise to it. The board announced their intention to eliminate 5,700 non-manufacturing jobs by June as a cost-saving measure; and a share buyback of at least $4 billion, which could provide a slight bump for the EPS. And although they aren't doing it as fast as Unilever, they are seeing some decent emerging markets growth. 

Recommendations

All things considered, Unilever is better positioned for long term growth than its larger counterpart. While they both fit the first two characteristics we are looking for, P&G's shrinking margins make me doubtful of their long-term prospects. Sure, the buyback and layoffs are encouraging but it doesn't dramatically alter their business model or exposure to slowing US growth. I'm inclined to believe that consumers substitute downwards more easily than they substitute upwards, meaning that losses in their consumer base are not immediately remedied if the US does experience a solid recovery. Don't get me wrong, I'm not saying that P&G is a hard "sell," so if you have been with them for a while and enjoy a juicy dividend, then stay the course. But if you are uncommitted to either and doing a side-by-side analysis; Unilever can provide you growth and steady income, which satisfies all the criteria. So if your footing is unsure in this economic landscape, then hop right on the Unilever bandwagon and enjoy the ride. 


slightlywonkish has no position in any stocks mentioned. The Motley Fool recommends The Procter & Gamble Company and Unilever. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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