Thursday, February 14, 2013

How Much Upside is Left in Colgate-Palmolive?

Colgate-Palmolive (NYSE: CL) reported another solid set of results recently, with organic sales growing 4%. It’s the sort of stock that investors should be looking at right now because the market has come a long way in a short space of time. As a consequence, it might be a good idea to start looking at some consumer staples in case we see a mini-correction in the main indices. With that said, I think CL is very attractive, but I’m going to take a pass here. It looks fully valued and it has been performing so well (within intensively competitive markets) that investors are entitled to wonder if it can continue.

Colgate Carries on Innovating

The story over the last few years has been how well Colgate has innovated and introduced new brands into new markets. It’s a strong performance because it has squeezed growth in a difficult market; whereas a key rival like Procter & Gamble (NYSE: PG) has failed to exploit the full power of its brands, Colgate has been able to drive growth via new mouthwash, toothpaste and toothbrush products. My take on PG’s difficulties is that its traditional approach to slowdowns (hold pricing, protect the brands but lose a little market share and then reap the rewards of leverage when the economy recovers) has been thwarted thanks to the anemic nature of the recovery in the mass consumer market. However, PG has been changing of late amidst renewed efforts to take back market share.

While the economy has challenged PG, it has played into the hands of Church & Dwight (NYSE: CHD) and its mix of value and recession resistant brands. In fact, CHD has been (alongside CL) the company most capable of generating double digit EPS growth in this environment. If a slow economy has been beneficial to CHD, it is not done much for CL. Its growth has come from internally generated performance and a strengthening presence within emerging markets.

Colgate’s Growth Prospects

A few bullet points on what to expect in the mid to long term future and then some commentary on them:

  • A global restructuring program (costing $1,100-1,250 million in charges) intended to generate $365-435 million annually within four years
  • 1-2% growth in developed markets, 8-9% in emerging markets
  • 6-7% revenue growth for 2013 and 10-11% EPS growth
  • Continued innovation in developed markets
  • Significant new product launches with Hill’s Pet Nutrition (13% of current revenues) will bring back volume growth and contribute positively to margins.

The efficiency program is already in progress, and CL expects $30-40 million in savings this year with charges of $185-220 million. The program reflects a realization of the fact that the developed world is seeing slower growth. The good news is that CL actually increased market share in many key categories in Europe and increased quarterly operating profits by 14% in Europe/South Pacific. Moreover, CL recorded 4% organic growth in North America with some impressive market share gains in such a competitive market place. It’s impressive stuff.

Turning to emerging markets, in Q3 CL recorded 5% organic growth and now 6% in Q4. To be fair, it has been up against some tough quarterly comparisons, but investors need to keep an eye on this metric because it is tracking below the 8-9% that CL would rather have. Furthermore, there are some concerns that the likes of PG are going to be more aggressive within emerging markets and in particular in Brazil. Considering that CL has over 71% market share with toothpaste, there is a lot for rivals to aim at. Similarly, its market share in China was cited as 34%.

Probably the most exciting developments at CL are the new products at Hills which should lead to improved performance going forward. It is a great sector of the economy to be exposed to and offers strong long term growth prospects.

Where Next for Colgate?

The stock certainly isn’t cheap now, and I would argue it is fairly valued for its revenue and earnings growth prospects outlined above. The question is whether it will hit them or not. If so then I think the potential is for Colgate’s share price to ‘do its earnings.’

It will require success with the ongoing product innovation within developed markets and skillful negotiation of the increasing competitive pressures within emerging markets. Alongside this, the guidance contains some assumptions over the restructuring program and success with Hills. The recent history of CL suggests it will achieve these things, but there is little margin for error here and the evaluation doesn’t look compelling.

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