Colgate-Palmolive: Stability Amid Volatility

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I first made Colgate-Palmolive (CL) a long idea in March 2018. Since then, the stock is up 12% compared to the S&P 500’s 48% gain. Despite its poor performance, the stock still offers favorable risk/reward to investors, especially amid current market volatility. I think the stock is worth at least $104/share today – up a 35%+.

Colgate stock is bullish over the long term based on the following:

  • The company has a major share in the global toothpaste and manual toothbrush market.
  • Nearly recession-proof flexibility of Colgate’s products
  • Company’s large distribution network
  • Expected long-term growth in the company’s key markets
  • The current price has increased by 35% at the consensus growth rate.
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Figure 1: Long Idea Performance: From the date of publication to 5/10/2022

what is working

Strong Global Brand and Distribution Network Support Revenue Growth: Colgate-Palmolive has a strong brand and a vast distribution network which creates a strong competitive advantage. according to Kantar Brand Footprint SurveyColgate products account for over 60% of all global households, second only to Coca-Cola
As the world’s most chosen brand. Smaller competitors can’t match Colgate’s niche brands, distribution network, and retail shelf space. These advantages have helped the company in 1Q22 . helped its organic sales improve 4% year-over-year (YoY) in the[1],

The company is well positioned to continue its revenue growth through the remainder of 2022. The company’s manufacturing and distribution is back at full capacity, and the company plans to increase advertising spend. Given these developments, Colgate raised the range of its 2022 revenue guidance from 4% to 5% at the midpoint.

Stable Cash Flow in Multiple Market Environments: Colgate’s strong brand, wide distribution network and flexible demand for its products enable the company to generate consistent Free Cash Flow (FCF). No matter the economic environment, oral care, soaps, deodorants and cleaning products are essential to everyday life and exhibit strong demand.

Colgate has generated positive FCF every year since 1998 (oldest data available). Over the past decade, Colgate generated $24.7 billion (38% of market cap) in FCF as per Figure 2. Colgate’s consistent cash flow has made its stock a natural choice for investors looking for stability in the midst of economic uncertainty.

Figure 2: Cumulative Free Cash Flow of Colgate since 2012

Colgate’s Digital Transformation: Colgate is rapidly developing a robust digital channel that will leverage the same manufacturing and distribution benefits that its existing channels enjoy. Colgate’s digital sales grew 27% YoY in 2021 and comprised 13% of total sales. The company’s superior online capabilities better prepare it to compete with the growing number of direct-to-consumer competitors in its end markets.

Colgate is more profitable as compared to competitors: Colgate has the highest invested capital among its peers listed in Figure 3. High invested capital helps the company to deliver better return on capital (ROIC) as compared to the competitors. Colgate’s ROIC of 17% is much higher than its peers’ market-cap weighted average of 12%.

Figure 3: Colgate Vs. Peers: NOPAT Margin, IC Turns and ROIC: TTM

Pet nutrition is a growth driver: Compared to TTM, Colgate’s pet nutrition segment accounted for ~20% of total sales, and since 2016, pet nutrition has grown faster than the rest of the company’s total sales. looking ahead, Grand View Research The global pet food market is projected to grow at a CAGR of 4.4% by 2030.

Plus, extra capacity from Colgate’s newly acquired pet food manufacturing facility Will support Colgate’s continued growth in the Pet Nutrition segment.

Figure 4: As a percentage of total pet nutrition revenue since 2016

Underestimating GAAP earnings: Colgate is more profitable than investors understand. Colgate’s GAAP earnings fell to $2.0 billion TTM in 2020 from $2.7 billion. However, the company’s TTM core income, which measures the business’s normalized operating profit, is $2.6 billion too high. Should GAAP earnings more closely reflect the company’s core earnings in the future, its shares could rise higher on the earnings surprise.

what is not working

Decrease in sales from North America and Europe in 1Q22: Colgate pushed through aggressive price increases to achieve strong 1Q22 organic sales growth in emerging markets, which grew 4.5% YoY in 1Q22. However, the company delayed raising prices in North America and Europe until the end of 1Q22. As a result, organic sales in North America grew just 0.5% and organic sales in Europe fell 3% year-over-year. Management noted in its 1Q22 Earnings Call, that they see “strong sales” from North America and Europe in April. Assuming demand remains strong, the price hike implemented at the end of Q1 will turn profitable in the coming quarters.

Falling Margins: in your current 1Q22 Earnings CallColgate’s management acknowledged, “2022 is shaping up to be a more difficult year than we anticipated with higher-than-expected growth in raw materials, as you’ve seen from others, particularly fats and oils and logistics. ” Notably, the company is experiencing a 60% year-on-year increase in the cost of fats and oils, which are used in each of its product segments. Colgate is also facing higher transportation cost. Freight rates from its manufacturing facilities in Mexico to its distribution facilities in the US are 30% more than in 2021.

Although revenue increased in 1Q21, rising costs impacted the bottom line. Core income fell from $708 million in 1Q21 to $646 million in 1Q22. Rising raw material and transportation costs are eating into the company’s gross margin and Colgate’s net operating profit after tax (NOPAT) margin fell from 19% in 2019 (before the pandemic) to 17% at TTM.

However, in the long term, I expect Colgate to effectively offset the increase in raw material and transportation costs along with the rise in prices. Rising inflation has likely created a more elastic pricing environment for Colgate’s products as its competitors are also forced to adjust their pricing upwards. Most importantly, Colgate’s superior ROIC and operating efficiency position to weather input price inflation and continue to generate better cash flows than competitors.

Development of private label: A long-term challenge facing many consumer product companies is the growth of private label products. Consumers are increasingly accepting of private labels. Long-term shift towards private label products accelerated during the COVID-19 pandemic, which saw nearly 40% US consumer Trying out new brands in the midst of wider supply-chain problems. Many of these consumers continue to stick with private-label products chosen during the pandemic.

However, Colgate is in a better position than most consumer product companies because its private label competition is largely limited to its hand soap and toothbrush markets.

Loss of market share during the pandemic: Although Colgate remains the largest global toothpaste and manual toothbrush provider, the company lost market share during the pandemic. Colgate’s share of global toothpaste market falls 42% From 1Q19. in 39% In 1Q22, while the company’s share in the global manual toothbrush market fell 32% To 31% at the same time.

While its market share has fallen slightly from pre-pandemic levels, Colgate’s share of the global toothpaste and manual toothbrush market has remained unchanged since 1Q21. Additionally, in the US, Colgate’s share of the manual toothbrush market has increased. 42% From 1Q19. in 44% In 1Q22.

Geopolitical Risk: In response to the Russia/Ukraine conflict, Colgate suspended sales of all products in Russia except “health and hygiene products essential for daily use”. In its 1Q22 10-QColgate says its actions in response to the Russia/Ukraine conflict “have had no material impact on our business.” For context, sales to Eurasia accounted for ~2% of total sales in 2021.

While conflict in Ukraine could increase the risk of further conflicts around the world, Colgate’s risk to any single country outside the US is limited. About 70% of the company’s sales in 2021 were generated outside the US in more than 200 countries. The company’s primary geopolitical risk is input cost, which is a risk shared by its competitors.

The stock price for declining profits is

Colgate’s price-to-economic book value (PEBV) ratio is just 0.9, which means the market expects its profits to decline and remain permanently below 10% TTM levels. below, i use My Reverse Discounted Cash Flow (DCF) Model To analyze future growth expectations in cash flow baked into a couple of stock…

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