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We are reverting to a Neutral recommendation from Underperform on fast moving consumer goods giant Unilever PLC (UL - Analyst Report) due to decent third quarter 2013 results.

Why Neutral?

On Oct 25, Unilever reported decent third quarter 2013 sales and recorded organic (excluding the impact of acquisitions and disposals) sales growth of 3.2%. The increase was driven by volume and pricing gains of 1.9% and 1.3%, respectively. Increased investment in innovation and expansion of brands in new markets contributed to the growth.

Though underlying sales in the developed markets declined in the quarter due to global macroeconomic headwinds, the rate of decline moderated from the year-ago quarter. However, the company’s underlying sales increased only 5.9% (in local currency) in the emerging markets compared to 10.3% growth recorded in the second quarter of 2013.

The company generates a substantial portion of its revenues from the emerging markets. Hence, a slowdown in sales in this region in the recent past resulted in a soft top line. Continued weakness in Brazil, Russia, India and China as well as weaker exchange rates, particularly in Brazil, India, South Africa, Argentina and Indonesia, hit the company’s sales in the emerging markets in the quarter.

Of late, Unilever has been divesting its business to focus its resources on the core food portfolio. Recently, the company sold some of its hair care brands to an international hair care company – Strength of Nature. In early-Oct 2013, Unilever sold its Wish-Bone salad dressing business to food company Pinnacle Foods Inc (PF - Snapshot Report) for $575 million, while in Jan 2013 the company sold its Skippy peanut butter business to Austin, Minn.-based producer of branded food and meat, Hormel Foods Corporation (HRL - Analyst Report) for $700 million in cash. In Aug 2012, ConAgra Foods Inc. (CAG - Analyst Report) bought its Bertolli and P.F. Chang's frozen meals brands for $265 million.

However, a decline in spread sales volume and an uncertain macro-economic environment are denting Unilever's profits. The company has been posting weak sales in its spreads business since the last few quarters. The company also closed its spreads manufacturing plant in Atlanta in Jun 2013 due to a sluggish spreads business. In addition, the developed markets are nearing saturation and therefore experiencing sluggish growth. The company also expects slowdown in the emerging markets to continue for a few more years. Moreover, the debt crisis in Europe, commodity cost headwinds and unfavorable foreign currency translations remain a significant overhang. Unilever has a Zacks Rank #3 (Hold).

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