Wednesday, September 12, 2012

Keep Smiling with Shares in Colgate Palmolive

The only problem with Colgate-Palmolive $CL is that there isn’t a problem with Colgate-Palmolive. The company has defensive growth prospects and is extremely well run. Its management has successfully innovated and are expanding strongly within the growth markets in the emerging world. It has strong market positioning in most of the leading markets and is leveraging its brand in order to maximise value for its shareholders. Alas, I suspect most of this is already in the price and who likes buying a stock that is fairly priced?

Why Colgate is Outperforming the Sector

Unlike its struggling rival Procter & Gamble $PG Colgate has managed to weather the slowdown quite well. Whilst the former is traditionally understood to try and hold pricing in a downturn and then leverage its powerful brands in the upswing, Colgate has managed to be innovative enough in order to drive sales growth. A better comparison would be with a much smaller rival like Church & Dwight $CHD.

Colgate and Church & Dwight have outperformed thanks to innovation, new product development and a staunch defense of their brands. The difference is that the latter is really a strong player in niche markets and is small enough to be able to shift easily. Colgate is much larger and I think its achievements are even more notable.

The innovation comes in the form of products like Colgate Optic White toothpaste and mouthwash. Having read about this product I was astonished to see it widely available in Hungary recently and I think a visit to a personal care store would help an understanding of why Colgate is doing so well. Simply put, the brand is very strong and seeing a selection of Colgate toothpaste, toothbrushes and mouthwash all displayed together in store brings an immediate appreciation of what the company is doing to leverage its brand strength.

Not Just Good at Oral

It’s not just about Colgate. The other major brand Palmolive is being leveraged through the creation of new fragrances in personal care and dish liquids. I recall looking at McCormick & Company recently and was surprised at how its industrial flavors division was doing. This is largely because food companies are being forced to innovate and introduce new flavors. I think it is the same principle with personal care and the company is continually doing this with Palmolive.

The Numbers?

The latest numbers were excellent. In this environment generating 8% organic growth within personal care products categories is little short of sensational. In addition 4.5% came from volumes whilst pricing accounted for 3.5%. Gross Margins increased 50bp but were actually held back by currency effects. No matter, the company forecast sequential increases in gross margin for the third and fourth quarters. Earnings only increased by 6%, but were up double digits on a currency neutral basis.

What is interesting about the sector is that soft commodity costs do appear to be abating, which means that margins should be able to expand. Of course, this is only part of the story. Companies still need to hold or even expand market share.

Growth Prospects

Geographically there was the usual problem of softness in Europe, but emerging market growth remains strong. The recently acquired Sanex brand is heavily exposed to Europe and Colgate will have its work cut out to generate growth above the flat to low single digit growth that these categories are growing in Europe right now.

A much better prospect will be expanding new products into emerging markets like Latin America and the Far East. For example in toothpaste, Colgate has 72% and 83% market share in Mexico and Brazil respectively. This kind of brand strength should create opportunities for increasing sales of mouth wash and other oral products. Emerging markets contribute about 53% of revenues and a similar amount in earnings for Colgate.

That said, Colgate operates in highly competitive markets with all its product lines and if its competitors have failed to innovate, then discounting and increased promotions will be the name of the game. US growth is slowing and there appeared to be a negative reaction in the US with the pricing increases in the last quarter. Growth prospects are focused around the launch of mouth wash in the US. If there is one thing that we know from this earnings reporting season it is that US consumers are not taking well to price increases in personal care or household products.

The Bottom Line

Colgate is a fine and worthy business, but is it a good investment? Frankly, I would love to own this stock and I did until recently, but I find it difficult to justify paying 21x earnings for a stock expected to generate single digit growth in the next couple of years. It may be relatively stable and secure but no company is without risk and Colgate operates in highly competitive markets. Nor is the yield anything to write home about.

In conclusion, Colgate is an excellent company, but all of this seems to be priced into the shares already. Now if it had a meaningful dip from here...

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