Unilevers Financial Strategy - Essay Example

?Evaluate Unilever’s financial strategy Table of Contents Executive Summary 3 Introduction 4 Corporate Life Cycle 4 Sources of fund 6 Modigliani-Miller theorem 8 Dividend Policy 11 Dividend Policy of Unilever 12 Lintners’s Four Stylised Facts 13 Recommendations 14 Reference List 16 Executive Summary In today’s complex and competitive business environment financial strategy applied by the organizations play a major role. In this context, the present report focuses on the evaluation of financial strategy of Unilever. The stage of the organization is firstly decided using the organizational life cycle. The current position of Unilever suggests that it is operating in the matured position and is aiming towards sustainable growth in its business. Then the sources of Finance is analysed using Modigliani-Miller Theorem and it reveals that the debt to equity position of the organization is good and has significant impact on its market value. However, the cash position of the company is not stable and requires attention from the management. The Dividend policy of the organization is healthy and looks at wealth maximization of the shareholders. The managers are concerned about the dividend return and regularly review the dividend policies. Moreover, the economic condition is quite unstable and a sluggish growth is expected. In this regards it is recommended that the organization should give attention towards their cash position and should enhance other activities through which their profitability can be enhanced. The organization is also suggested to maintain healthy debt equity ratio, having higher debt may negatively impact their firm value. Introduction The Unilever Group started their operations in 1885 but was not established until 1930 when the business actually joined forces to create the well established business prior to the start of 20th century. The corporate vision of the organization aims towards helping the people in order to look and feel good and get more out of their life. The organization aims to create a sustainable living place and a better future through their services and brands (Unilever, 2013a). The first priority for the organization is their consumers and then comes the employees, communities and the suppliers. The organization aims to fulfil their responsibilities by serving their customers and make their shareholders eventually rewarded. Financial strategy plays a major role in the sustainability of an organization. Financial strategy is a portfolio that includes corporate strategic plans that involves financing decision and optimum investment that helps in attaining the specified objectives. It is an area of managerial policies that determines the financial and investment decisions, which in turn leads to the wealth maximization of the shareholders (Hill, 2009). This paper focuses on the financial strategy of the organization and provides recommendation on the basis of that. Corporate Life Cycle The Corporate life cycle can be segregated into four stages through which an organization passes. The four stages are introduction, growth, matured and decline. The introduction stage is the point where the organization first places its product and services in the market for the customers. In this stage it starts capturing the market share. The next stage is the growth stage in which the organization with the best quality product or service is at the top of the competition. The sales increases and the organization spend money in building the brand. The demands of the consumers are at the highest point. The third stage is maturity where the organization has maximised their profit and is operating at a stable place in the market. Here the organization decides whether to withdraw their product or services from the market or to bring some innovation in them such that they remain in the market. The main focus is on the sustainability of the business. The last stage is the decline stage. At this stage the organization has already introduced their new products or next generation product. The business occupies most of the market share and has gained a recognition and name for its brand (Quinn and Cameron, 1983; Nazzari and Foroughi, n.d.; Aswathappa, 2008; Jones and Mathew, 2011; Schwarz and Hunter, 2012). If the Unilever brand is considered, then it is seen that the organization is operating at a stable place in the market and has brought innovation in their products. Moreover the organization is targeting towards sustainability of the business. The business model designed by Unilever aims toward delivering sustainable growth of the organization. Sustainability is the integral part of the way in which they conduct their business (Unilever, 2012). Figure 1 Source: (Unilever, 2012) Sources of fund Unilever has a large number of sources of fund such as ordinary shares, internal holding, share-based compensation, shares held by employee share trust, financial liabilities, derivative instruments and other reserves. The key instruments that the treasury department uses are cash and cash equivalent, long-term and short-term borrowings and plain vanilla derivates that include foreign exchange contracts and interest rate swaps. The Group considers the following in their balance sheet as the capital: Total equity that includes retained earnings, non-controlling interest, share premium, share capital and other reserves Current financial liabilities are considered as the short-term debt. Bonds, non-current bank loans and other loans are considered as long-term debt (Unilever, 2012). The capital is managed by the Group in such a way that it safeguards the ability of the firm to optimise the returns of the shareholders through appropriate balance between equity and debt. The capital structure of the Group is based on the judgement of the management related to balancing the elements that meet the strategic as well as the day-to-day needs. The organization considers the proportion of capital to risk and manages the capital structure of the firm in light to the risk characteristics of the underlying assets and the changes in the economic condition. Table 1 Debt Equity ratio 2010 2011 2012 Debt 12486 14662 14635 Equity 14485 14293 15159 Ratio 0.861995 1.025817 0.965433 Source: (Author’s Creation) The debt Equity ratio of Unilever has been compared over the three years, 2010, 2011 and 2012. The above table shows that the organization is highly dependent on equity financing. However, in the year 2011 the debt of the company has increased and is in higher proportion as compared to the equity. The reason for the increased proportion of debt is due to the acquisition of Alber to Culver. In the year 2012, the debt equity ratio is seen to improve (Unilever, 2011). Modigliani-Miller theorem The theorem under its first proposition states that under certain specific assumptions the market value of the firm is not dependent on the debt or equity ratio. The assumptions of the theorem are that the organization will incur no transaction cost, no taxes, no bankruptcy cost, the borrowing rates will be same and no information is revealed in the firm’s financial policy (Villamil, n.d.). If this theorem is applied for evaluation of the sources of fund of Unilever then it can be found that the debt equity position of the firm will have an impact on its market value, which in contrast to the theorem. This is because of the fact that the assumptions made in the theorem does not holds true in case of Unilever. Unilever has incurs significant amount of cost for their transaction and taxes (Shown in figure 3). This implies that the market value of the firm is affected by debt-equity ratio and they need to maintain a lower level of debt as compared to its equity. Figure 2 Source: (Author’s creation) Figure 3: Extract from cash flow Source: (Unilever, 2012) Apart, from debt equity ratio profit, turnover and cash flow of the organization are also an important indicator of the financial strategy of the company. The figures given below clearly shows that the organization has an increasing trend of turnover and profit. The cash flow of the organization is positive but has reduced in the year 2012, this was due to the impact of the changes in the exchange rates. Table 2 Particulars 2010 (€ million) 2011 (€ million) 2012 (€ million) Turnover 44268 46467 51324 Net Profit 4598 4623 4948 Cash and cash Equivalent 1966 2978 2217 Figure 4 Figure 5 Figure 6 Thus, the overall discussion shows that the financial strategy of the organization is financially flexible that aims to accomplish the day-to-day and strategic requirements. Presently the long-term credit rating of the firm is A+/A1 and the short-term credit rating is A1/P1 (Unilever, 2012). They are in a position in which they can access both the debt and equity market, have sufficient flexibility for acquisition, sufficient resilience against economic and financial uncertainty and optimum weighted cost of capital. Therefore, the organization should maintain its debt equity ratio at a lower level since its market value will get affected by that. Dividend Policy Dividend policy of the organization plays an important role in deciding on the returns that they provide to the shareholders. Maximisation of the values of the shareholder is an important objective for every organization. Thus the dividend policy followed by Unilever is an important parameter the will assess its financial strategy. For measuring the efficiency of the organization in dividend payout Lintners’s Four Stylised Facts will be used. Dividend Policy of Unilever The dividend policy framed by Unilever aims to maintain an above average level that increases year after year taking into account the prospective investment commitment, prevailing interest rate and inflation rate in the market. The company promises to pay high dividend payout as long the funds permit. Over a period of seven year, Unilever Indonesia has paid dividend twice a year, a final and an interim dividend. The company announces their interim dividend within our third quarter results that is announced in early November or late October. The final dividend offered by the company is decided with their fourth quarter results, which is put in the annual general meeting for the approval of the shareholders. Unilever has been seen to pay dividends to their shareholders since 1982 (Unilever, 2013b). Table 3: Dividend History Dividend Period Payment Date Dividend Per Share Final 2012 16-Jul-13 334 Interim 2012 20-Dec-12 300 Final 2011 13-Jul-12 296 Interim 2011 15-Dec-11 250 Final 2010 13-Jul-11 344 Interim 2010 15-Dec-10 100 Source: (Unilever, 2013c) Figure 7 Source: (The Financial Times Ltd, 2013) Lintners’s Four Stylised Facts John Linter has conducted a series of interviews on the corporate manager and has found the following dividend policies: The firm should have some targeted dividend payout ratio in the long run. A matures company has stable earning and a high proportion of the earning is paid out. The managers of the organization should focus on the changes in the dividend rather than the absolute value of the dividends. The changes in the dividend should follow a shift towards sustainable long-run earnings. The managers should not be reluctant to make any dividend changes and they are seen to be concerned if they need to cancel an increase in the dividend (Smith, 2004; Zagler, 2010; Ackert and Deaves, 2009). When the above table and figure compared with the Lintners’s Four Stylised Facts, Unilever appears to be sound while framing their dividend policy. It is clear that Unilever has provided dividend every year to its shareholders and with a rising trend. The average dividend yield over 5 years has been 0.04% and the dividend growth rate was 5.32 percent. The dividend payout ratio is 61.42 percent (The Financial Times Ltd, 2013). Reports have suggested that year after year the earnings per share and the dividends per share excluding the growth of extraordinary item have increased by 5.08 percent and 8.00 percent respectively. Moreover, the dividend payout made by the company is noteworthy since very few companies are there in the personal and household product industry that pays dividend to their shareholders. Again when both the dividend per share and earnings per share were measures on an annualised basis, their growth ranked in line with the industry average relative to its peers. Apart from this, they review their policy every year in order to ensure maximization of return to the shareholders. Recommendations The current economic condition is as such that the commodity market is highly volatile and there is significant rise in the cost. Furthermore, the euro crisis and the fiscal cliff have added to the uncertainty and have lower down the confidence of the customers. Therefore, the overall scenario suggests that the developed markets are showing a sluggish growth. Corporate strategy literature and media frequently focus on other aspects of business operations such as marketing, operations, innovation and quality control. The success of most of the large companies depends on the factors like clever marketing strategies, product design, effective manufacturing, product innovation and management procedures. However, the decisions taken by the finance department play a significant role in maximizing shareholders wealth by minimizing cost of capital and making sure that funds are readily available and efficiently used. The overall analysis leads to the conclusion that the financial strategies of Unilever are sound and are aiming towards the growth of the organization. The cash and cash equivalent of the company has shown a downward trend in the year 2012, which indicates that the liquidity position of the organization is not good and it requires immediate concern from the management. Therefore, Unilever should look for measures such that the cash position of the organization improves. At the same time they should maintain healthy debt equity ratio as it may impact their market value. This cash can be used in meeting any unanticipated financial consequence. Moreover, it is also recommended that the organization should focus on their other strategic wings like marketing, product design and operations in order to reduce the cost incurred by them. Reference List Ackert, L.F. and Deaves, R., 2009. Behavioral finance: Psychology, decision-making, and markets: psychology, decision-making, and markets. Connecticut: Cengage Learning. Aswathappa, K., 2008. International business. New Delhi: Tata McGraw-Hill Education. Hill, R.A., 2009. Strategic financial management: Exercises. London: Bookboon Jones, G.R. and Mathew, M., 2011. Organizational theory, design, and change. New Delhi: Pearson Education India. Nazzari, S. and Foroughi, H., n.d. Organization’s Changes Through its Lifecycle: A System Dynamics Approach [online] Available at < http://www.academia.edu/793457/Organizations_Changes_Through_its_Lifecycle_A_System_Dynamics_Approach> [Accessed 30 November 2013]. Quinn, R.E. and Cameron, K., 1983. Organizational life cycles and shifting criteria of effectiveness: Some preliminary evidence. Management Science, 29(1), 33-51. Schwarz, E. and Hunter, J., 2012. Advanced theory and practice in sport marketing. London: Routledge. Smith, A., 2004. The human pedigree. New Delhi: Tata McGraw-Hill Education. The Financial Times Ltd, 2013. Unilever PLC [online] Available at < http://markets.ft.com/research/Markets/Tearsheets/Financials?s=ULVR:LSE> [Accessed 30 November 2013]. Unilever, 2011. Annual Report and Accounts 2011 [pdf] Unilever. Available at < http://www.unilever.com/images/Unilever_AR11_tcm13-282960_tcm13-348380.pdf> [Accessed 30 November 2013]. Unilever, 2012. Annual Report and Accounts 2012 [pdf] Unilever. Available at < http://www.unilever.com/images/ir_Unilever_AR12_tcm13-348376.pdf> [Accessed 30 November 2013]. Unilever, 2013a. History [online] Available at < http://www.unilever.com/aboutus/ourhistory/> [Accessed 30 November 2013]. Unilever, 2013b. Dividends [online] Available at < http://www.unilever.co.id/investorcentre/dividends/> [Accessed 30 November 2013]. Unilever, 2013c. Dividend History Available at < http://www.unilever.co.id/investorcentre/dividends/dividend-history/index.aspx> [Accessed 30 November 2013]. Zagler, M., 2010. International tax coordination: An interdisciplinary perspective on virtues and pitfalls. London: Routledge. Villamil, A.P., n.d. The Modigliani-Miller Theorem [pdf] The New Palgrave Dictionary of Economics. 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