Colgate-Palmolive: Not much to smile about

Given the rising competition and continued margin pressure, valuations do not justify the fundamentals.

The Colgate stock has risen 17 per cent in 2011, as the company has reported strong volume and sales growth consistently for several quarters. However, margins have significantly contracted year on year for the past four quarters ending September, on account of high raw material costs and advertising. This trend, of high sales growth and margin pressure, is may continue, say analysts.

Says Nilesh Gandhi, analyst, Destimoney Securities, “Colgate’s revenues should comfortably grow over the next three years, despite rising competition. But the margins may witness contraction due to high raw material prices, increased promotional activities for launches and increasing competition from other multinationals like Procter & Gamble (P&G), Hindustan Unilever (HUL) and GlaxoSmithKline Consumer.”

Adds Sreekanth PVS, analyst, Angel Broking, “We do not expect any positive surprise in earnings growth. We have modelled in margin contraction due to higher excise duty, higher ad spends (rise in competitive intensity) and lower operating leverage.” Thus, the stock’s outperformance and premium valuation of 27 times 2012-13 estimated earnings may not be sustainable.
 

COMPETITIVE PRESSURES
Rs crore	FY11	FY12E	FY13E
Net sales	2,221.0	2,587.0	2,964.3
% chg	13.1	16.5	14.6
Operating profit	451.0	532.3	621.5
% chg	5.9	18.0	16.8
Net profit	403.0	450.3	518.8
% chg	-4.7	11.7	15.2
EPS	29.6	33.1	38.1
% chg	-4.7	11.7	15.2
E: Estimates                                    Source: Company, analysts’ reports

Advertising vital
Despite a five-six per cent rise in product prices, the operating profit margin declined 550 basis points (bps) in the first half of 2011-12, after having fallen 330 bps in 2010-11. Net profit margin fell 450 bps in the first half of FY12. Besides higher raw material costs, the company spent heavily on advertising (up 310 bps as a percentage of sales in the first half of FY12), partly due to new launches and promotional activities.

It faces stiff competition from companies such as P&G, HUL and GSK Consumer. GSK’s Sensodyne has a market share of 10 per cent in the sensitive toothpaste market, compared with Colgate’s 15.4 per cent. HUL has also become aggressive, through advertising and product launches. And, the shortly expected entry of P&G in the toothpaste market with its global brands, Oral-B and Crest, is a real threat. P&G has already gained six per cent market share (currently 21 per cent) in toothbrushes (Oral-B) over the past two years, while Colgate’s has dropped from around 40 per cent in 2010-11 to 36 per cent in the first half of 2011-12.

Says Amnish Aggarwal, analyst, Motilal Oswal, “The launch of P&G’s Oral-B toothpaste in India will trigger fresh competition. It will have growth and margin implications for the entire oral care segment.” Adds Angel Broking’s Sreekanth, “Competition in the oral care category is set to intensify for all.” Thus, the only way for Colgate to keep its head above water is to keep spending on its brands (mainly premium) through advertising and promotion. This will help maintain volume and sales growth momentum, additionally helped by the shift from toothpowder to toothpaste as penetration increases.

Margin pressure
Margin pressure is inevitable, despite the focus on value added or premium products (Sensitive Pro Relief and Total), where realisations are much higher than core products (Dental Cream, Cibaca and Max Fresh), thanks to competition.

The plan to increase penetration in the rural market would add to the pressure, due to stress on lower price points. Further, the outlook for major raw materials such as menthol, essential oils and packaging is not benign; the raw material index was at an all-time high in the September quarter. Finally, the company’s tax liabilities, which jumped in 2010-11, are expected to rise further, as tax exemptions at its Baddi facility (catering to half the total production) have reduced from 100 per cent to 30 per cent and would completely end by 2014-15.