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1 Green Flag for Unilever, and 1 Red Flag

Inflation is grabbing headlines today as consumers face rising prices throughout their daily lives. One place inflation is easily noticeable is the grocery store, where products from companies like Unilever (NYSE: UL) line the shelves. Consumer products makers are dealing with their own inflation headwinds and are passing on the financial hit as fast as they can.

Here's how Unilever is faring in this effort and why inflation remains a big problem for the company.

Green flag: Big price increases

Unilever was able to increase prices by a huge 11.2% in the second quarter of 2022. That comes after price increases of 8.3% in the first quarter and 4.9% to close out 2021. It is, without a doubt, moving quickly to forward its rising costs on to consumers. That is exactly what Unilever should be doing right now, and the action is having the desired effect. Notably, in the second quarter, organic sales rose a hefty 8.8%.

Image source: Getty Images.

A possible consequence of this is that consumers often shift to lower-priced products when faced with material price increases. That has, indeed, been the case at Unilever. However, the sales volume declined "only" 2.1% in the second quarter and 1% in the first quarter. The fourth-quarter 2021 price hikes didn't result in a volume decline at all.

So, at this point, Unilever has been fairly successful at pushing through price increases to offset the inflation it is seeing without doing too much damage to its business. As long as Unilever can continue to achieve this type of success, it should be able to muddle through the inflationary hit that it and all other consumer staples companies are experiencing today.

Red flag: Margin squeeze

There is one problem: Inflation is running incredibly hot right now. Thus, the price increases that Unilever is facing are material. So material that it can't pass them all on at one time. That's why there have been multiple rounds of price hikes. But if the company goes back to the well one too many times, the well could run dry. Note how Unilever's volumes decreased over the past three quarters as the price hikes increased. There's a cause and effect that's vital to understand.

Most consumer staples companies try to keep price hikes to a minimum and often wait to pass on costs until they are clearly a permanent or significant factor. That means that Unilever is behind the curve when it comes to inflation. To put a number on it, the company's underlying operating margin fell 1.7 percentage points year over year in the second quarter. Over the first six months of 2022 the underlying profit margin was off by a full two percentage points.

While the material price hikes in the second quarter offset the margin decline, allowing earnings per share to advance 1%, earnings during the first half of the year were still down 4.7%. The company is catching up to the inflation it's seeing in its business, but there's clearly still a gap that it must bridge to bring its margins and profitability back to previous levels.

A delicate dance

On the surface, a rise in prices would seem like a fairly simple thing. But it really isn't. Right now, Unilever is seeing mostly positive results from its efforts to pass rising costs on to consumers, but its margin performance shows that it still needs to do more. The lag is normal, but rapid-fire price hikes driven by today's elevated inflation levels could easily make the already-complicated process of price increases even more difficult.

Shareholders should be pleased with the company's success so far, but they will need to keep a close eye on the operating margin.

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Reuben Gregg Brewer has positions in Unilever. The Motley Fool recommends Unilever. The Motley Fool has a disclosure policy.


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