Fitch Ratings has affirmed Unilever PLC's Long-Term Issuer Default Rating (IDR) and senior unsecured ratings at 'A'.

The Outlook on the Long-Term IDR is Stable. A full list of rating actions is provided below.

The 'A' ratings reflect Unilever's strong business profile, as one of the largest and most diversified consumer goods and food companies (FMCG) globally, and our confidence that despite expected profit contraction in 2022 due to rising costs, the company should be able to return to profit growth from 2023. A phased pass-through of higher costs, together with improving cost-structure flexibility afforded by cost-saving plans, should support this profit recovery.

The affirmation incorporates our expectation that an increase in funds from operations (FFO) net leverage above the 3.3x negative rating sensitivity in 2021-2022, and a drop in its free cash flow (FCF) margin in 2022, are temporary and should return to levels that are commensurate with the ratings in 2023. The ratings also reflect Unilever's record of adherence to a clearly formulated financial policy, with a net debt/EBITDA target of 2x, corresponding to FFO net leverage of 3.1x, which is commensurate with the 'A' rating.

Key Rating Drivers

Cost Inflation Pressures Performance: We expect Unilever's profits to suffer in 2022 from cost inflation, which the company can only gradually pass on to consumers to avoid exacerbating a contraction in volumes sold. Unilever consumers are experiencing the effects of eroding spending power to varying degrees, with those in the US being more resilient to those in emerging markets, to which the company has a high exposure, more vulnerable. Moreover, we expect certain discretionary non-food products sold by Unilever to have higher elasticity to price increases.

Profit Recovery Likely in 2023: Since 4Q21 Unilever has gradually seen input price increases as benefits from its previous commodity hedging wane. We assume its EBITDA in 2022 to shrink 5%-6%, including the effect of divested assets that is partly compensated by newly acquired businesses. The company should be able to gradually pass on price increases, due to its portfolio including a number of non-premium, lower-price point products, and to return EBITDA to 2021's levels. However, the recovery of EBITDA margin will take longer, to around 20% of 2021's levels only by 2025.

Portfolio Rebalancing M&A: Since 2017, Unilever has sold a number of businesses affected by stagnating or declining revenue (margarines in 2018 and tea to be sold in 2H22 being the largest ones) and allocated those resources mostly to acquiring businesses with better prospects. Overall it has rotated a portion of its portfolio accounting for around 17% of sales. The company has focused its acquisitions on high-growth functional nutrition and prestige beauty mainly through small, promising businesses.

Potential Organic Growth in 2023: Organic growth for Unilever only started to turn around partly in 2021 and remains modest with 2022 growth largely driven by passing on cost inflation to customers. It remains to be seen if Unilever will be able to turn around the quality of its portfolio and achieve its targeted organic revenue growth of 3%-5% in 2023-2024. Some acquisitions have not lived up to expectations such as the disappointing performance of Dollar Shave Club, acquired in 2016 for USD1 billion.

Cash Flows Temporarily Flat: Historically Unilever has generated steady FCF of EUR1 billion-EUR1.5 billion. However, given the expected contraction of EBITDA and a number of one-off disbursements for cost-saving initiatives (around EUR0.8 billion) in 2022 beyond the company's ordinary level of 1% of sales, we expect FCF to reduce to close to neutral in the year.

Closely Followed Leverage Target: We believe Unilever can maintain its targeted net debt/ EBITDA of around 2.0x by being flexible with M&A activity and share buybacks. This corresponds to our calculation of 2.9x-3.1x FFO net leverage and is within our 2.5x-3.3x range for Unilever's 'A' rating. Management have communicated - following the failed attempt to buy GSK's consumer healthcare business Haleon - that the company will not pursue other large-scale M&A and remains committed to an 'A' rating.

Share Buyback Pushes Leverage Higher: We do not rule out a continuation of share buybacks in 2024, which are one of the capital-allocation tools Unilever uses to keep leverage around its target. While it has maintained net debt/EBITDA below 2.0x since 2017, this increased to 2.2x in 2021 due to a EUR3 billion share buyback programme. A further EUR3 billion buyback is planned over 2022-2023. Therefore, due to expected lower FFO and FCF we forecast FFO net leverage to remain high in 2022 at 3.5x, leaving no rating headroom. However, an improvement in FFO in 2023 should help reduce leverage to below 3.3x, thus supporting our Stable Outlook.

Leading Global FMCG Company: Unilever's business profile corresponds to the lower 'AA' or upper 'A' rating categories, reflecting the company's strong market position as one of the world's largest FMCG groups with a portfolio of well-known global and local brands. Fitch expects Unilever's continuous innovation and digitalisation to help maintain its resilient performance against intense competition and macroeconomic uncertainties and keep sales growth at least in line with the market's.

Strong Diversification: Unilever's ratings benefit from the company's superior diversification across FMCG product categories, price points and regions. The company operates across all continents in foods and refreshment (38% of 2021 sales), home care (20%) and beauty and personal care (42%). It also maintains a wider footprint in high-growth emerging markets than its peers (2021: 58% of sales) with the resulting exposure to currency fluctuations largely mitigated by the geographic diversity of its markets.

Derivation Summary

Fitch applies its Consumer Products Ratings Navigator to assess Unilever's rating and comparison with peers. However, Unilever's product categories are less cyclical, which allow a more stable revenue profile than those of other Fitch-rated consumer companies selling semi-durable home furnishing products, toys, and appliances, etc. Together with a stronger and more diversified business profile, this allows Unilever to tolerate higher leverage at its rating than the medians in our Consumer Products Ratings Navigator. Therefore, we use less conservative leverage medians from the Packaged Food Ratings Navigator to determine Unilever's credit profile.

Unilever is one of the world's largest FMCG companies with a portfolio of well-known global and local brands and strong footprint across high-growth emerging markets. However, a mildly weaker business profile than Nestle SA (A+/Stable) justifies the one-notch rating differential for Unilever, despite our expectation that over 2023-2024 the two companies will trend towards broadly similar FFO-based net leverage of around 3.0x.

Due to its larger scale, stronger diversification and lower leverage, Unilever is rated higher than both Mondelez International, Inc., another large packaged food company, and Diageo plc (A-/Stable), the global leading international alcoholic beverage producer.

No Country Ceiling, parent-subsidiary linkage or operating environment aspects apply to Unilever's ratings.

Key Assumptions

Organic revenue growth at around 7% in 2022, driven by a 9% price increase and low single-digit volume contraction, followed by an average growth of 3.5% to 2026

Fitch-adjusted EBITDA margin to decline to 17.3% 2022, driven by input cost inflation, before gradually returning to 19.4% in 2024

Capex of EUR1.6 billion-EUR1.7 billion (3% of sales) in 2022-2026

Bolt-on M&A of EUR1.5 billion a year to 2026

Divestment of tea business in 2022 with EUR4.5 billion proceeds

Restructuring costs at EUR1.4 billion in 2022, with EUR0.6 billion (1% of sales) included in Fitch-calculated EBITDA and EUR0.8 billion (all charges exceeding 1% of sales) in items before FFO. Total restructuring costs expected at 1% of sales to 2026 and included in EBITDA

Annual share buyback disbursements of EUR1.5 billion per annum

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

Maintenance of a diversified business portfolio and steady operating performance with mid-single-digit organic sales growth and maintenance of solid EBITDA margin at around 20%

Introduction of a more conservative financial policy, leading to a sustained reduction in FFO net leverage to below 2.5x

FCF margin consistently above 3.5%

Net debt/EBITDA sustainably below 2.0x

Factors that could, individually or collectively, lead to negative rating action/downgrade:

Significant slowdown in organic sales growth relative to major peers'

FFO net leverage at 3.3x on a sustained basis

FCF margin consistently below 2%

Net debt/EBITDA above 2.5x on a sustained basis

Best/Worst Case Rating Scenario

International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

Liquidity and Debt Structure

Strong Liquidity: At end-2021, Unilever's liquidity was strong as short-term debt of EUR6.8 billion was more than covered by Fitch-adjusted cash and cash equivalents of EUR3.9 billion, an undrawn committed USD8 billion of credit facilities and additional bilateral revolving facilities of EUR1.5 billion.

Although the term of both these facilities is 364 days, we include the USD8 billion credit facilities in the liquidity ratio calculation as they benefit from a 364-day term out option and are renewed annually.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg

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