When CEOs Become Delusional: The Case of Unilever’s Polman

May 16, 2017

When CEOs Become Delusional: The Case of Unilever’s Polman

  • Unilever CEO Polman declared himself more competent than Buffet just because Unilever has outperformed Berkshire in the last 8 years. The funny thing is, Unilever outperformed thanks to Buffett.
  • Not only that, but Berkshire outperformed Unilever on revenue and earnings while at equal valuations, Berkshire would also largely outperform.
  • The 8-year bull market has clearly gotten into some CEOs’ heads. This creates a very dangerous situation for long term shareholder value creation.

Introduction

In an interview with Jim Cramer, I was thunderstruck to hear Unilever’s CEO (NYSE: UL), Paul Polman, tell the world that his returns have been better in the last 8 years than Buffett’s Berkshire Hathaway (NYSE: BRK.A, BRK.B).

Comparing oneself to Buffett is one thing, but Polman putting in out there in the open that he is better than Buffett—the 4th richest guy on the planet—requires an amazing track record, one that goes beyond one economic cycle and that is clearly above Buffett’s. If he doesn’t have such a track record we can call him delusional without any worry. In today’s article, we’ll see whether Mr. Polman is right as we’ll compare the performances and discuss the danger long term shareholders incur from bad and delusional management.

Few understand that a rising tide lifts all boats. An 8-year-old bull market with interest rates close to zero can easily get to one’s head, especially if you’re a CEO of a multinational company and you think that you are the reason for the excellent performance, but all CEOs should really thank the Yellens and Draghis of this world first, and only then brag about their skills in public.

Polman vs. Buffett

Polman has been UL’s CEO since January 2009, so let’s compare UL’s and BRK’s stock performances since then.

The first thing I did when I heard Polman’s statement was to check if he really outperformed Buffett. I was really surprised to see that he actually hadn’t.


Figure 1: UL’s stock (134%) has underperformed both the S&P 500 (189%), and BRK (173%) since January 2009. Source: Nasdaq.

For the sake of fairness, we should add UL’s dividend to the stock performance and reinvest the dividend into the company. When doing that, UL has outperformed BRK as $100,000 invested in UL in 2009, when Polman became CEO, would now be worth $331,037. Polman is completely right, $100,000 invested in BRK would on the same day, the 1st of January 2009, would now only be $272,867. Thus, Polman is far better than Buffet as he outperformed him by 17.5 percentage points in an 8-year long bull market.

The funny thing is that UL outperformed BRK thanks to Buffett. The Kraft Heinz Company (NASDAQ: KHC), partly owned by BRK, offered $50 per share to buy UL when UL was trading at $42. Since then, UL’s stock has appreciated as the company is pursuing other options.


Figure 2: UL’s stock price increased thanks to Buffett. Source: Nasdaq.

Without Buffett’s offer, using a stock price of $42 for UL, $100,000 invested in UL in 2009 would now be worth $257,855, or $15,000 less than had that $100,000 been invested in BRK. So Polman should thank Buffett for the improved performance and not go around telling the world how he is better than Buffett.

Additionally, the wise investor knows that stock performance isn’t really an indication of managerial quality, especially in a market that just goes up and in an economy where many have a vague memory of what a recession really looks like. What we have to look at is how much shareholder value Polman has created and compare it to what Buffett has done.

Buffett’s favorite measure of performance is, of course, book value because it isn’t under the influence of market vagaries and short term stock boosts coming from buybacks.

Comparing book values shows that Buffett clearly outperformed as UL’s book value per share practically hasn’t moved since 2009 while BRK’s has more than doubled.


Figure 3: Book value BRK, UL, and UL with dividends. Source: Morningstar.

For the sake of fairness, I have added a line above where I’ve kept UL’s dividends. In that case, Polman outperformed Buffett again as UL’s book value would have increased from $4.58 in January 2009 to the current $15.32.

Now, you’re probably wondering what I’m smoking (I live in the Netherlands but I don’t use any drugs, don’t worry) because Polman is right in his statement as he has both outperformed Buffett by market value and by book value. Well, let me show you how things are a bit different below the surface and that what UL’s CEO is thinking is extremely dangerous.

First, UL’s 2008 revenue, when Polman took over, was €40 billion while BRK’s was $107 billion. For 2016, UL’s revenue was €52.7 billion, representing an increase of 30% in 8 years. BRK’s revenue has increased to $236 billion which represents an increase of 120%.

Similarly, UL’s net income for 2008 was €5.02 billion and is now €5.1 billion, representing an increase of 1.5%, while BRK’s was $4.9 billion in 2008 and is now $22.5 billion. Given BRK’s volatile earnings, I’ll use the 2008 net income of $13.2 billion to calculate the increase, i.e. 70%.

So, if you’re a shareholder, what kind of manager would you prefer? One that increases revenues by 120%, or one that increases revenues by 30%? One that increases net income by 70%, or one that increases it by 1.5% in 8 years? One that measures their quality by looking at the stock price, or one that measures their quality by how much real value they have created for the shareholder?

Further, let me make a few important points. UL’s price earnings (P/E) ratio is 26.3, while BRK’s is 17.86. At the same valuation, the initial market outperformance would be on Buffet’s side as $100,000 invested in BRK in 2009 would now be worth $402,331 compared to UL’s $331,037 with all dividends reinvested.

UL’s dividend payout ratio is around 70% for a dividend yield of 2.95%. If BRK payed out 70% of earnings in the form of dividends, its dividend per share would be $9,599 giving you a dividend yield of 3.9%. At an equal yield of 2.95%, BRK’s share would be worth $325,389. The $100,000 invested in BRK in 2009 would then be $362,105, thus again beating UL’s investment return. This again shows how stupid it is to use stock prices to measure managerial quality.

In addition to the above market valuation metric differences, UL increased total liabilities from €28.3 billion to the current €40 billion. As the 41% increase in liabilities hasn’t improved earnings at all and revenue growth of 30% in 8 years can be mostly attributed to inflation and the 30% appreciation of the dollar, I wonder how anyone can call UL’s management competent. Well, nobody really is calling them competent, so they have to do it themselves.

The above is a clear indication of how delusional Polman is as he thinks he is the reason for UL’s stock outperformance. Further, UL’s P/E ratio in 2009 was 19 while now is 26.3. A return to a P/E ratio of 19 would result in a share price of $38.12 which is a 28% decline compared to current prices. Going back to the $100,000 initial investment, it would decline to $234,034, which again means UL is underperforming BRK.

Conclusion

I can imagine Buffett sitting in his office last Friday evening watching CNBC and breathing a sigh of relief for not squandering his money on a costly acquisition with bad management. As he often likes to say, when he has too much money, he is more prone to make stupid investments. Hopefully his next acquisition attempt will be much wiser than UL.

On the other hand, and another indication of Polman’s incompetence, is the fact that Buffett’s partner, 3G’s Jorge Paolo Leman, was after UL through Kraft Heinz because he is known for buying poorly run companies and exponentially increasing their efficiency through cost cutting and synergies. Given that Polman increased UL’s net income by a whopping 1.5% in 8 years, I would conclude that the only reason why Polman and other UL managers were against the acquisition is for their own salaries and benefits.

The moral of the story is BRK’s shareholders are better off without UL, while UL’s shareholders would be better off without Polman. I urge UL’s board of directors to, if they don’t want to sell the company to Buffett, at least fire Polman because he hasn’t really improved anything in the last 9 years while the stock performance is just the result of a bull market. The options for UL are to sell themselves to Buffett or to hire someone like 3G’s Paolo Leman who knows how to improve efficiency and grow shareholder value.

As a thank you note from UL’s shareholders, I would be happy with $16,000. This is Polman’s salary for half a day of work as his yearly compensation is around $9 million, and I spent just about an evening writing this article. They can contact Investiv for the payment details, hopefully the management is competent enough to do that.

On Corporate Management

A clear thing that I see in the corporate world is that the management is seldom questioned if the company is profitable. If the company loses money, then the CEO is at risk while if the company remains profitable, it doesn’t really matter whether the management is improving things or not.

UL is a clear example of a behemoth that isn’t growing and would be much better off with new management. I feel bad for UL’s shareholders as their returns could have been much higher if the management had been focused on improving and growing the business and not just on where the stock price was going.