Higher costs likely to put pressure on Colgate-Palmolive's margins

Disruptions on account of the lockdown led to the decline in the performance

The stock of India’s largest toothpaste maker, Colgate, has shed 7 per cent over the last week because of a muted Q1 performance. Over the past year, the stock has risen 18.6 per cent versus a  46 per cent gain for the S&P BSE Sensex, and a 20.4 per cent jump in the BSE FMCG index.
 
While Colgate-Palmolive (India) posted a 12 per cent uptick in the June quarter, helped by double-digit volume growth, it came on a lower base and missed Street expectations. The two-year compound annual growth rate dropped to sub-4 per cent, from 5-6 per cent seen in recent quarters. Disruptions on account of lockdowns led to the below-par performance.
 
Highlighting a multi-year trend, analysts led by Krishnan Sambamoorthy of Motilal Oswal Financial Services say: “It has now been six years since the company reported over 7 per cent sales growth in any year. With the launch of the non-oral care portfolio and investments under the Brush Twice a Day campaign seemingly on the backburner, it is unlikely to return to double-digit growth seen over FY08-15 anytime soon.”
 
Within its segments, though the toothpaste category saw a 5-6 per cent volume growth, the toothbrush segment’s volumes grew 35-40 per cent on a favourable base. The toothbrush segment accounts for 15 per cent of sales.
 
While sales growth disappointed, the margin performance was better than expected. Gross margin was up 300 basis points to 68.9 per cent. This was over 200 basis points higher than Street expectations, led by a better mix, price hikes, and lower-priced inventory. The company increased prices by 3-4 per cent during the quarter. Gross margin has now stayed over the 67.7 per cent mark in each of the last four quarters.
 
The price increase in the quarter, however, did not percolate to the operating margin level; the margin improved 90 basis points to 31 per cent, given higher costs across major cost heads. The key reason, however, remained the 41 per cent YoY increase in advertising spends to 13.8 per cent of sales; a year ago, promotions and advertising were sharply curtailed on account of the national lockdown.

Ashit Desai of Emkay Global Research expects the margin to reduce as input inflation is largely crude-led. The brokerage expects a 100-basis point decline in the operating profit margin in FY22 on higher input inflation and step-up in brand spends.
 
Increased competition is another factor that can force the company to keep ad spends at higher levels and may impact its growth, as well as the margin. The company’s market share in the toothpaste market has dropped from over 57 per cent in CY15 to under 50 per cent now. The decline is largely due to increased competition from herbal players which outperformed the market leader with higher growth. Colgate is perhaps one of the few market leaders which have not gained share during the pandemic.
 
Analysts at Phillip Capital who maintain a “sell” rating believe increased competitive intensity and slowing category growth are key challenges that the management needs to tackle for a meaningful recovery. Some brokerages are on a wait-and-watch mode as they await the results of the company’s strategy of increasing rural consumption, focus on innovation, and raising advertising spends. However, the key is the ability of the company to tap 16-18 per cent growth in the naturals segment (remains a key focus area), which accounts for 35-40 per cent of the market.