Colgate-Palmolive (CL) Equity Research Real Estate – UAE
th
April 19 , 2007
Equity Research Consumer Goods Sept 30th 2009
Initiation of coverage Recommendation relative to:
Consumer Goods
Overweight
Target Price
USD 83.4
CMP USD 73.3
as on 29th Sept. 2009
SYMBOL: PRICE SEPT. 29, 2009):
CL 73.3
RATING:
AA-
TARGET PRICE: MARKET CAP (MM):
38,020.04
SHARES OUT. (MM):
497.19
52-WEEK RANGE:
76.76 - 54.77
AVG. DAILY VOLUME (,000):
3,683
We initiate coverage on Colgate Palmolive (CL) with an overweight recommendation and a fair 12 months price target of USD 83.4. Sound fundamentals, large and growing market share, strong brand loyalty and cost efficiency justify the premium valuation to the company. We expect the company to continue growing strongly given its presence in the highgrowth emerging economies. The company enjoys an industry-best return on capital in the HPC industry, and the strategic changes incorporated by the company are expected to further improve its resource utilization.
Investment Highlights Colgate to continue to register robust organic growth. The high-growth regions—Latin America and Asia—should help the company continue to register mid-to-high single-digit organic revenue growth. About 50% of the company’s revenue is derived from developing and emerging economies where the company commands a dominant market share. These regions are also characterized by low per capita consumption of oral care and hygienic products and entail a significant market expansion possibility. We believe that its geographic presence can enable the company to achieve an EPS growth of 10%, as indicated by the management.
Performance (%)
Absolute
Rel. to sector
4.9% 7.8% 1.2% 54.77 76.76
0% 4% -15%
1m 3m 12m 12m low 12m high 2point
110
S&P 500
CL
100
Margins expected to remain robust. The company has the best margins in the industry with an adjusted ROIC of about 26% in FY08, which is ahead of the industry average of about 23% and much higher than that of its closest competitor P&G’s 10%. The various cost rationalization steps taken by the company are expected to further enhance its returns. The multiyear restructuring programme completed in FY08 along with the ongoing business planning initiatives should help management achieve gross margin of about 60%. Currency fluctuation remains a concern. Colgate derives more than 80% of its revenue from outside the US, which makes it highly susceptible to currency fluctuations. Any significant dollar appreciation can weigh heavily on the company’s revenue growth and margin.
90 80 70 60 50 Sep08
Nov- J an08 09
Mar- M ay09 09
Jul09
Attractive valuation. At the current price, the dividend yield stands at 2.34%. At USD 73.3, the company is trading at 18.7 times its TTM earnings and 17.0 times FY09 earnings. . We place per share fair value at USD 83.4 representing a 13.8% upside potential.
Document
Classification:
Confidential
Contents Investment Highlights Investment Rationale
3
Investment Concerns
5
Business Overview
6
Wide geographic presence
6
Strong Brand and Customer Loyalty
7
Plans promotional spend to improve top-line growth
7
Cost saving initiatives
7
Business Segments
8
Oral, Personal and Home Care
8
Pet Nutrition
9
Geographic Segments
9
North America
10
Latin America
11
Europe/South Pacific
11
Greater Asia/Africa
12
Recent initiatives
13
Financial & Operating Performance and Outlook
14
Topline growth to remain strong led by Oral Care and Pet Care
14
Cost saving initiatives help improve margins
15
Regular dividend payout
15
Valuation-Colgate is attractively valued
17
DCF Valuation
17
P/E Valuation
17
ROIC/WACC Valuation
17
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Page 1
Investment Rationale We initiate coverage on Colgate-Palmolive (CL) with an overweight recommendation and a target price of USD 83.4 based on the weighted average value of DCF, price to earnings (PE) and ROIC/WACC. We believe that Colgate will continue to achieve strong growth and sustain its leadership position in the HPC segment, given its diversified global presence and brand strength, respectively.
Market leader in product category with strong brand loyalty…
Geographically diversified with strong presence in high growth developing and emerging markets….
Wide economic moat strengthens pricing power. The company is the leader in the oral care market with about 50% global share in the oral-care category. It has a strong brand equity and commands considerable pricing power as demonstrated over the last few quarters. During the recent economic slowdown, private labels have not been able to provide any significant challenge to the company. While the competitors have struggled to preserve volumes, the company has achieved organic volume growth despite increasing prices. The price increase, to some extent, helped the company offset the impact of adverse currency movement. Significant portion of revenue from high-growth regions sustains top line organic growth. As the US and other developed countries struggle for growth in the aftermath of the downturn, the company, with its geographic diversity, is better placed than its competitors, who derive most of their revenue from the developed markets. The company derives more than 75% of its revenue from outside the US and about 50% comes from the fastergrowing developing and emerging (D&E) economies. While we anticipate organic growth for the company to be in low single-digits in developed economies, the growth in D&E economies is expected to be in double digits. The D&E markets are characterized by lower penetration of HPC products compared to the developed markets. Also, as income levels increase in line with economic growth, awareness about oral hygiene and personal care will rise. Colgate’s brand equity, combined with tailored packaging and products at multiple price points should continue to drive growth. Chart 1: Revenue (in USD mn) and organic growth in geographical segments 15,000
20%
12,000
16% 12%
9,000
8% 6,000
4%
3,000
0%
0
-4% 2005 2006 2007 Total Oral, Personal and Home Care Total OP&H organic grow th
Source –Company Data, Sutherland Research
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2008
2009E 2010E Pet Nutrition Pet Nutrition organic grow th
Softening of raw material prices to positively impact margins …
Margins likely to improve on softening commodity and raw material prices. The company took a 290 bps hit on gross margin on account of higher raw material prices in Q2FY09 vis-à-vis a 600 bps drop in Q4FY08. However, in the current fiscal year, we are witnessing some softening in raw material prices. As the raw material price environment becomes more benign in 2009-10, the benefits of cheaper input cost after the expiry of existing hedges/long-term contracts would boost the operating margins. Currency stabilization to reduce stress on pricing and allow company to focus on gaining volume. The company has taken a substantial hit on the currency front during the last couple of quarters on account of dollar appreciation. However, as the first green shoots of economic recovery blooms and investors’ risk appetite increases, money flow from the US to other D&E markets is likely to increase, putting pressure on the dollar, which will benefit the company. This will also allow the company to concentrate on gaining volume and market share without resorting to price increases to offset the dollar impact. The company has indicated that it will adopt a strategy of increasing ad-spend to gain market share and is unlikely to raise prices this year. Resilient amidst challenging times. The company has withstood the global slowdown and has come out stronger. While the competitors reported decline in sales in the nine months since October 2008, Colgate increased both volume and market share on account of a strong product portfolio and brand equity.
Cost saving programmes have started reflecting in margin improvements. . .
Productivity enhancing programmes such as “Back to Basics” to improve profitability. The company has completed its multiyear restructuring programme (an integral part of the ‘back to basics’ initiative) in FY08 spending an after tax amount of USD 776 mn. The restructuring is expected to offer an after tax savings of USD 350-375 mn annually. The company has adopted a tactical approach of focusing on rationalizing manufacturing facilities, streamlining procurement and stressing on higher margin brands. The company’s ongoing cost saving initiatives such as ‘Funding the Growth’ (which added 180 bps and 80 bps to Q2FY09 and Q1FY09 gross margins, respectively) and Colgate Business Planning (incremental savings of USD 150 million in 2009) are still contributing to improving profitability. ROIC to improve further with better resource utilization. Colgate has a high asset efficiency ratio and generates the best ROIC among the large US companies in the HPC category. Its adjusted ROIC of about 27.5% is about three times that of P&G. We expect that with increased margins and better resource utilization, the company is likely to further improve returns.
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Investment Concerns
Hardening of the US dollar against other currencies to impact the revenues and margins. . .
Susceptible to currency hit. The company earns more than three fourth of its revenue from outside the US, which makes it highly vulnerable to currency movements. About 82% of the company’s Q2FY09 revenue came from outside the US. In the event of the dollar gaining strength, the company’s revenue and profitability are adversely affected. In Q1FY09 and Q2FY09, while the company’s organic growth was a decent 8% and 6% respectively, it reported negative sales growth of 13% and 11.5%, respectively, on account of the dollar appreciation. Any deterioration in the global recovery may continue to lead to a flight of capital towards the dollar for safety, as witnessed during the economic crisis. Such a scenario will affect Colgate’s revenue and profits adversely. Vulnerable to slowdown in emerging markets. While a significant presence in the D&E markets facilitates higher growth, it also leaves the company susceptible to any slowdown in these markets. However, the strong global crisis headwinds could not significantly affect the company’s revenue.
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Business Overview Wide geographic presence Colgate-Palmolive is a global Home and Personal Care (HPC) company with a dominant share in the global oral care market and a profitable line of pet nutrition business. The company has operations in more than 70 countries and its products are sold in more than 200 countries and territories. The company operates its business through two product segments: Oral, Personal & Home Care segment and Pet Nutrition. Its product range includes toothpastes, shampoos, detergents, shower gels, deodorants and shaving products. Major brands of the company include Colgate, Palmolive, Mennen Speed Stick, Irish Spring, Kolynos, Ajax, Soupline, Suavitel and Fab, as well as Hills Science Diet and Hills Prescription Diet pet foods. The Pet Nutrition segment produces nutrition products for dogs and cats. It owns the specialty pet-food maker Hill's, which sells its products through veterinaries and specialty pet retailers. Colgate products are sold worldwide and about three fourth of its revenue accrue outside the US.
Products sold in more than 200 countries and territories. . .
Chart 2: Business structure
Colgate Colgate-Palmolive Palmolive
Oral Oral Care Care
Personal PersonalCare Care
Colgate ColgateMax MaxFresh Fresh
Soft Soap
Colgate 360
Speed Stick
Colgate Total
Lady LadySpeed SpeedStick Stick
Home Home Care Care
Palmolive Palmolive
Pet Pet Nutrition Nutrition
Hills Science Science Diet
Hills Prescription Diet
Clinical ClinicalStrength Strength
Irish Irish Spring Spring
Source - Company reports
At the beginning of FY06, Colgate modified its geographic reporting structure to "address evolving markets and more closely align countries with similar consumer needs and retail trade structures." As part of this move, Eastern European countries and Russia were transferred to the "Asia" region, while operations in the South Pacific and Australia were transferred to the “Europe/South Pacific� region.
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Strong Brand and Customer Loyalty
Market leader with close to half of global oral-care market share. . .
One of the biggest strength of the company is its strong brand loyalty. At some places, its brand name is synonymous with toothpaste. Colgate's global toothpaste market share strengthened to 44.8% during Q2FY09 with market share gains in many countries including the US, Mexico, Brazil, China, India and Russia. Colgate also strengthened its global leadership in manual toothbrushes, with its global market share of 31.1% year to date, up 60 bps versus year ago.
Plans promotional spend to improve topline growth Colgate intends to push its top-line growth through aggressive advertising and promotion. The company has had a cautious approach in the past few quarters towards advertising spend to conserve cash. However, the management has suggested that the company may increase spending on advertisement and sales promotion to increase brand visibility. Further, the fall in advertisement costs globally may lead to higher promotional activity within the earmarked budget. These steps are expected to further solidify Colgate’s dominant market position.
Cost saving initiatives Several cost saving initiatives launched to enhance profitability. . .
The company has taken various steps to reduce cost and increase profitability. The company completed its multiyear restructuring plan in FY08 which is expected to contribute USD 350 mn-425 mn annually to the cash flow. The company now focuses on high growth and high margin brands in HPC and pet nutrition businesses. This has helped the top-line growth through favorable sales mix.
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Business Segments Business is segregated in two segments; Oral, Personal & Health Care and Pet Nutrition . . .
Colgate-Palmolive derives the majority of its revenue from four core product lines: Oral Care, Personal Care, Home Care and Pet Nutrition. The company markets its products under two distinct business segments: Oral, Personal & Home Care and Pet Nutrition. For operational purpose, the company is organized along different geographic lines. The Oral, Personal and Home Care segment is operated through four geographic segments: North America, Latin America, Europe/South Pacific and Greater Asia/Africa. The company, through Hill’s Pet Nutrition, competes globally in the pet nutrition market. Chart 3: Revenue Break-up (2008) Oral Care 41%
HPC 86%
Pet Nutrition 14%
Home Care 23% Personal Care 22%
Source: Company Annual Report, Sutherland Research
Oral, Personal and Home Care Oral, Personal and Home care dominates the company’s portfolio contributing about 86% to total revenue and about 83% to operating profit as of FY08.
Oral care is the predominant segment deriving about 41% of the total revenue of the company. . .
Oral Care Colgate's Oral Care products include Colgate brand toothpastes, toothbrushes, mouth rinses and dental floss, and pharmaceutical products for dentists and other oral health professionals. Recent product launches in this segment include Colgate Max Fresh, Colgate Luminous, Colgate Total Plus Whitening, Colgate Propolis Whitening and Colgate Sensitive toothpastes, Colgate 360 degree manual toothbrushes, Colgate MicroSonic battery-powered toothbrush and Colgate Smiles line toothbrushes for kids. Colgate is the global market leader in oral care with about 45% market share, followed by P&G at 20%. Oral Care (toothpaste, toothbrush, mouthwash, tooth whitening) remains Colgate’s principal business, contributing about 41% to total revenue. The major reasons behind the company’s increasing global market share over the years are the company’s increased focus on high growth and high margin oral care products and the significant strides made in increasing its volumes and market share in this segment.
Personal Care The Personal Care product range includes shower gels, shampoos, conditioners, deodorants and antiperspirants and liquid hand soaps. Recent product launches include Palmolive Naturals shampoo and conditioner, Irish Spring Micro Clean and Protex Oats bar soaps and Lady Speed Stick 24/7 and Speed Stick 24/7 multiform deodorants. Primary brands in this segment include Irish Spring, Softsoap, Palmolive, Speed Stick, Lady Speed Stick, Crystal Clean, Team Spirit, Afta and Skin Bracer.
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Personal Care constituted about 22% of company’s revenue in FY08. Colgate has tried to grow this segment through acquisitions. The company took a controlling stake in the organic personal care products company, Tom's of Maine in FY06.
Home Care Home Care constituted about 22% of the company’s FY08 revenue. In line with its strategy to prioritize high margin businesses, the company divested its Latin American and Canadian household bleach businesses in FY06 and FY07, respectively, which led to a reduction in sales by 0.5% in both FY07 and FY08, and the home care business by about 2.5% in FY08.
Pet Nutrition Pet Nutrition business is growing at a double digit growth rate. . .
Pet Nutrition contributed about 14% to total revenue in FY08. Pet Nutrition is sold through Hill’s Nutrition in 87 countries. Although a smaller segment, it has registered double digit growth for the past three years. Furthermore, the segment is a high margin business and accounts for a proportionately high 18% of the total operating profit.
Geographic Segments Colgate reports Oral, Personal and Home Care business under four geographies: North America, Latin America, Europe/South Pacific and Greater Asia/Africa. Chart 4: Revenue and Operating Margin break-up for FY08 5
40%
4
30%
3
20%
2 1
10%
0
0% North America
Latin America
Europe/South Pacific
Revenue (in USD bn) Source: Company Annual Report, Sutherland Research
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OPM
Greater Asia/Africa
North America Chart 5: Revenue and Operating Margins
2,900 2,800 2,700 2,600 2,500 2,400 2,300
25% 24% 23% 22% 21% 20% 19% 2005
2006
Revenue (in USD mn)
2007
2008
Operating margin
Source –Company Data, Sutherland Research
North America is the oldest geographic region for the company, contributing about 19% (as of FY08) to the total revenue from the Oral, Personal and Home Care business segment and a similar proportion to the company’s operating profit. Albeit a mature market, the company has been able to achieve mid-tohigh single-digit organic growth in the region for the last four years, led by growth in core brands such as Colgate Total toothpaste and Colgate 360° toothbrush. The company divested its heavy duty laundry detergent business in North America and South East Asia in FY05 and Canadian household bleach business in FY06, which negatively affected the North American sales growth by 3.5% and 1.5% in FY06 and FY07, respectively. The company acquired Tom’s of Maine Inc. in FY06, which allowed it to enter the fast-growing health and specialty trade channel in the US where Tom’s of Maine toothpastes and deodorants were market leaders; the acquisition helped Colgate’s North America revenue inch up 0.5%. New product launches and relaunches have ensured organic growth in the region. . .
Furthermore, Colgate has been able to derive organic growth from this mature market through product introductions and re-launches. After recording negative and flat sales growth in FY03 and FY04, the company bounced back strongly, recording an average organic growth of 6% in the last four financial years and gaining market share. In the US, the company’s market share in the toothpaste category increased 50 bps to 36.9% at the end of Q2FY09, while that in the toothbrushes category grew 480 bps to 32.7% during the same period. The operating profit margin, which fell from 24.4% in 2002 to 21.2% in FY06, improved significantly in FY07 to 24.5% with the company focusing on highmargin businesses, restructuring programs and cost-saving initiatives.
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Latin America Chart 6: Revenue and Operating Margins
5,000
30%
4,000
29%
3,000
28%
2,000
27%
1,000
26%
0
25% 2005
2006
Revenue (in USD mn)
2007
2008
Operating margin
Source –Company Data, Sutherland Research
Latin America contributed 31% to the company’s revenue in the HPC category (about 27% of the company’s net sales in FY08). It represents the largest geographic region for the company in terms of sales. This region has been the prime propeller of the company's revenue growth, clocking high single-digit or double-digit growth over the past decade. In FY08, the organic revenue growth for the region was 16.2%, while operating profit grew by 17.3%. The series of cost rationalization steps taken by company reflects in the company’s growing margins in the region. The operating profit margin for FY08 was 28.9% and the company registered a CAGR growth of 14% in 2003-08. Colgate has almost a monopoly in the oral care market in Latin America with a 78.3% share in the regional toothpaste market. Also, the company has added to its market share in almost every country in the region. The company has registered robust growth in countries such as Brazil, Mexico, Venezuela, Colombia and Argentina. The core brands of the company such as Colgate Total range of toothpastes and Colgate 360° range of toothbrushes have led the growth in the oral care category, while Palmolive bar soaps and Shampoos have led the growth in other categories. In Brazil, Colgate's toothpaste market share reached 70% in Q2FY09, up 120 bps y-y, while its market share in Mexico is in excess of 85%. Colgate leads the manual toothbrush market in Latin America with a 41.4% share, up 260 bps y-y. Its dominant position offers a strong pricing power to the company.
Europe/South Pacific Chart 7: Revenue and Operating Margins
4,000
24%
3,000
23% 22%
2,000
21%
1,000
20%
0
19% 2005
2006
Revenue (in USD mn)
Source –Company Data, Sutherland Research
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2007
2008
Operating margin
Europe is a challenging market for the company with stagnating sales. ..
Europe/South Pacific contributed 27% to the oral care revenue of the company and 23% to the total revenue with operating profit margin of 20.8% in FY08. This region is also matured and poses a challenge for the company to generate volume growth. In FY04, the company acquired GABA Holding AG (GABA), a privately owned European oral care company headquartered in Switzerland to strengthen its European business. The cost of GABA, net of cash, was around USD 730 mn. The company has been struggling to achieve growth in this region although the GABA acquisition helped partially offset the declining sales. In FY08, the company recorded organic growth of 0.9%, which remained negative over the last three quarters ending June 2009. Moreover, with this region facing the maximum brunt of the slowdown, consumer shift towards cheaper private labels have also affected sales negatively. In addition to the revenue stagnation, the company faces declining operating margins in the region. While the other regions have seen an improvement in operating margins, Europe/South Pacific’s margin contracted from 23.1% in FY06 to 20.8% in FY08. Operating profit declined 2.3% in FY08 as the company could not pass on the increased cost to the customers. Western Europe has been specifically challenging for Colgate. The company intends to counter the slide through increased ad-spend and product innovation. The company is following the strategy it followed in the US by building different variants of Colgate Total franchise, which has been continuously driving growth for the company. However, the current situation remains challenging.
Greater Asia/Africa Chart 8: Revenue and Operating Margins
3,000 2,500 2,000 1,500 1,000 500 0
20% 15% 10% 5% 0% 2005
2006
Revenue (in USD mn)
2007
2008
Operating margin
Source –Company Data, Sutherland Research
Greater Asia/ Africa is the second fastest growing region for the company with double digit growth rate. ..
Greater Asia/Africa is the second fastest growing region for the company, recording early double digit organic growth rate over the last two years. The region contributes about 20% to the HPC business and 17% to the company’s total revenue. Oral Care is a significant part of the segment’s business, comprising approximately 66% of sales (FY08). In India and China, two of the biggest markets in the region, its market shares are growing and have reached north of 50% and 30%, respectively. Colgate Total, Colgate Max White toothpastes and Colgate 360° toothbrushes have been leading in terms of volume growth in Oral Care. Although, the region has the lowest operating profit margin at 16.8% (FY08). The margin has continuously expanded since FY05 on account of cost-saving initiatives. The region contributed 12.4% to the total operating profit in FY08.
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The company experiences particularly strong sales growth in Vietnam, Malaysia, India, Thailand and the Middle East. This region includes several rapidly growing D&E markets and will likely be a driver of the company's sales growth in the oral care business along with Latin America.
Recent initiatives The company has initiated several cost saving programmes to improve profit margins. ..
The company has initiated various steps to bolster its leadership position in the personal products industry as well as increase market share. In FY04, the company initiated a broad strategy through FY10 for accelerated earnings growth. The strategy, called “Back to Basics,” intended to strengthen the company’s global leadership position in oral care, while also continuing to pursue growth in pet food and personal care businesses. The company intends to achieve a double-digit EPS growth rate and increase its gross margin to reach 60% by FY10. The restructuring activity helped the company improve margins and consolidate market share. Under this initiative, the company embarked on a four-year restructuring program completed in FY08. Since the inception of this program in December 2004, the company has incurred total pretax cumulative charges of USD 1,069.2 mn. The program helped the company streamline its global supply chain by rationalizing approximately one-third of its manufacturing facilities, closing certain warehousing facilities and centralizing its purchasing and other business support functions. Through this program, Colgate expects annual savings of USD 475 mn-500 mn, all of which should increase future cash flows. The multiyear restructuring program has helped the company further consolidate its market share especially in Latin America and the US. The company now focuses on higher-growth and higher-margin brands. Increasing advertising spends and innovative steps (especially in developing and emerging markets) have facilitated faster growth of company’s products; the company’s high single-digit organic sales growth since FY06 is among the best in the industry. These steps have further strengthened the company’s position in the HPC industry.
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Financial & Operating Performance and Outlook Topline growth to remain strong led by Oral Care and Pet Care Consistent mid to high single digit organic topline growth . . .
Robust performance by Oral and Personal Care division in Latin America (17.2% growth Y-o-Y in FY08) and Greater Asia/Africa (13.8% in FY08) helped Colgate post a double digit revenue growth of 11.2% in FY08. The Pet care division, which contributes 14% to the total revenue, grew at 15.5% in FY08. The company registered a CAGR revenue growth of 9.1% in FY03-FY08. Largely in line with the company’s focus on high-growth and high-margin Oral Care and Personal care products, the contribution of Oral Care in total revenue increased from 34% in FY03 to 41% in FY08 largely due to excellent growth registered both in D&E and some developed markets. At the same time, the contribution from home care fell to 23% in FY08 from 29% in FY03. Chart 9: FY08 Revenue Bridge (USD) 511
320
-46
15,330
Fx
Ac. Dvst
FY08
756 13,789
FY 07
Price
Volume
Source: Company Annual Report, Sutherland Research
Forex effect pulled the company growth into negative region . . .
In the last three quarters ending June 2009, when other companies reported volume contraction due to the global economic crisis, Colgate recorded strong organic growth of 9.2%, 8.0% and 6.0%. However, due to the dollar appreciation, net growth was negative during the period. Oral Care continued to record healthy volume growth, but Pet Care, while recording positive organic growth as the company increased prices, registered an 11.5% volume drop in Q2FY09, which pushed the overall volume growth into the negative zone. With signs of global economy stabilization visible, we expect stabilization on the currency front as well. We also expect that with the renewed focus on promotional activities and freeze on price increase, the company will register good volume growth. We expect Oral Care to sustain its growth, led by accelerated growth rates in Latin America and Greater Asia/Africa, and Pet Nutrition to resume growth with the company adopting various strategies to revive volume growth. We expect the overall sales revenue for FY09 to contract 2% because of the soft first two quarters, but to increase 7% in FY10.
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Cost saving initiatives help improve margins High material prices pulled the margin down . . .
Colgate posted gross margin (adjusted for restructuring expenses) of 56.7% in FY08, 57.3% in FY07 and 56.4% in FY06. While the initiatives taken by the company had positive effects, the unprecedented high material prices raised the input cost which offset the benefits. Nevertheless, the impact of the initiatives was clearly visible in the first two quarters of FY09—the gross margin improved to 57.5% and 58.8%, respectively, even after taking a hit on material prices to the extent of 310 bps and 290 bps, respectively. We believe that as material prices soften and the full effect of the initiatives emerges, the margin will improve even further. While the company has a target gross profit margin of 60% by FY10, we have conservatively estimated gross margin to be 58.8% in FY09 and 59.2% in FY10. Chart 10: Gross Margin Bridge Q2FY09 vis-à -vis Q2FY08 310 bps
58.8%
56.8% 180 bps
Q2FY08
Price
FTG
-290 bps
Material
Q2FY09
Source: Company Annual Report, Sutherland Research
The adjusted SG&A expense for FY08 was 34.8%, down 90 bps from FY07 on restrained advertisement (40 bps) and R&D (10 bps), and other cost-savings programs. In the first two quarters of FY09, SG&A expenses were 33.8% and 34.6%, respectively, from 36.2 in Q1FY08 and 35.8% in Q2FY08. The 140 bps q-q increase in advertisement expense led to a slight increase in SG&A in Q2FY09. The company has indicated that it will increase advertisement expenses to enhance visibility and support new product launches; this additional cost is expected to be funded from savings in other operating expenses and higher gross margin. For FY09, we expect SG&A cost to be about 35% of revenue and advertisement cost to be about 10.8% of revenue. The adjusted operating profit margin and adjusted fully diluted EPS in FY08 was 21.5% at USD 3.84. With the company increasing its margin and controlling its other overheads, we expect the operating profit margin to increase. We expect the company to register a 23.7% operating margin at USD 4.19 fully diluted EPS in FY09.
Regular dividend payout Has increased dividend payout at a CAGR of 14% in 2004-08. . .
Colgate has been consistently rewarding its shareholders with a high dividend payout, which has been ranging from 40% to 45%. Colgate has consistently increased its dividend payout between FY04 and FY08, at a CAGR of 14%. At the current share price, the dividend yield stands at 2.34%.
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Chart 11: Dividend per share (USD) 1.56 1.40 1.25 1.11 0.96
2004
2005
2006
2007
2008
Source: Company Reports, Sutherland Research
Strong Operating Cash flow Has a strong credit rating of AAwhich reduces cost of capital . . .
Colgate has generated strong cash flow from operations, offering support to deliver on debt obligations and take up any opportunity that may arise. Colgate has a AA- debt rating. The strong rating reduces cost of funds for the company and increases shareholders’ return. Colgate had a low debt-to-equity ratio of 0.77 and a net debt/EBITDA of 86% as of FY08, which offers opportunity for the company to raise funds comfortably.
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Valuation-Colgate is attractively valued At the closing market price of USD 73.3, the stock was trading at 16.9 times its FY09 earnings. With Colgate’s market leadership position and significant pricing power, we believe that its stock deserves a premium over its peers. We initiate coverage on Colgate with an overweight rating and a 12 month price target of USD 83.4, which is 13.8% higher than the closing price of 73.3 on 29th September, 2009. We have used a combination of Discounted Cash Flow (DCF), relative valuation matrix of P/E and the ROIC/WACC methodology to value the company. Table 1: Valuation Matrix (Weighted average fair price per share)
Valuation Method
Arrived price
Weight
Discounted Cash Flow
88.8
1/3
Price to Earnings (relative)
82.4
1/3
ROIC/WACC
79.1
1/3
DCF Valuation Based on the discounted future cash flows, we arrived at a price of USD 88.8 per share, based on our projections for the next five years and a long-term growth rate of 1.5%. We arrived at its cost of equity at 8.16% considering a beta of 0.72, market risk premium at 6.76% and risk free rate at 3.29%. The cost of debt has been considered at 4% and tax rate at 35%.
P/E Valuation The average PE for Colgate’s peer set is 16.4. The company is currently trading at 18.64 times its trailing 12 months earnings and 16.9 times its estimated FY09 earnings. Given the strong fundamentals of the company, we offer 25% premium to the company arriving at a valuation of 89.0. The company is currently trading at 18.7 times its trailing twelve months earnings vis-à-vis the previous range of 20 to 44 times trailing results. Looking ahead, the company is trading at 16.9 times FY09 estimated earnings of USD 4.3 a share.
ROIC/WACC Valuation EV/IC is closely related with ROIC/WACC in the consumer staples space. Hence, we have calculated the fair value based on the next five year forecast of Market cap = enterprise value (Invested capital * ROIC/WACC) - net debt - non current liabilities. For Colgate, based on an invested capital of USD 12.8 bn, ROIC of 26.9% by FY13E and a WACC of 7.6%, we calculate fair value at USD 79.1. We offer a 25% premium considering the market leadership position in its product category, strong brand equity and customer loyalty.
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Colgate- Palmolive: Summary of Financials Colgate-Palmolive : Key Ratios Sales Growth (%) EBITDA Growth (%) EPS Growth (%)
2006A 7.4 (2.3) 1.2
2007A 12.7 22.6 30.3
2008A 11.2 13.9 13.9
2009E (2.0) 12.1 13.5
2010E 7.0 12.1 12.8
2011E 6.3 7.2 11.4
2012E 5.9 7.2 8.2
2013E 5.9 6.7 7.6
Gross Margin (%) EBIT Margin (%) EBITDA Margin (%) Tax Rate (%) Net Margin (%)
54.8 18.1 18.3 31.5 12.9
56.2 19.7 19.9 29.6 13.7
56.3 20.2 20.4 32.2 13.4
58.8 23.2 23.3 32.1 14.8
59.2 24.3 24.4 32.1 15.6
59.4 24.5 24.6 32.1 16.3
59.6 24.8 24.9 32.1 16.7
59.8 25.0 25.1 32.1 17.0
1.6 0.7
1.5 0.6
1.4 0.6
0.9 0.5
0.6 0.3
0.2 0.1
14.8 95.9 24.4
17.2 76.0 25.4
19.6 101.8 28.4
21.7 70.2 31.9
22.3 54.8 29.9
22.7 45.5 31.9
22.1 38.6 29.1
Q2-2009
Q3-2009E
Net Debt/ EBITDA Net Debt/ Capital ROA (%) ROE (%) ROIC (%)
N.A. N.A.
N.A. N.A. 21.3 33.7 27.2
Income Statement (Quarterly) in USD mn except per share data
Q1-2008
Q2-2008
Q3-2008
Q4-2008
3,502.8 (1,490.4) 2,012.4
3,744.7 (1,543.8) 2,200.9
3,849.3 (1,562.0) 2,287.3
Q4-2009E
Revenues Cost of goods sold Gross Profit
3,713.0 (1,613.2) 2,099.8
3,964.8 (1,725.0) 2,239.8
3,988.0 (1,751.8) 2,236.2
SG&A Operating Income
934.8 1,159.8
959.9 1,251.2
977.5 1,206.3
900.8 (516.0)
868.6 811.4
904.0 886.8
913.6 883.2
932.0 897.8
Net Interest Income/ (Expense) Other Income/ (Expense) Pretax Income
33.7 5.2 1,126.1
25.4 28.7 1,225.8
22.9 52.4 1,183.4
13.6 16.8 (529.6)
21.2 15.3 790.2
21.5 18.4 865.3
22.0 30.0 861.2
18.1 33.8 879.8
223.5 880.6
247.8 956.6
245.6 937.8
251.0 (817.5)
253.7 507.9
277.8 561.3
276.5 569.8
282.3 582.9
Income Taxes Net Income -GAAP
3,664.6 (1,613.5) 2,051.1
Q1-2009
3,927.0 (1,593.6) 2,333.5
Diluted Shares Outstanding
535
535
535
535
535
535
535
535
EPS (USD) EPS - Diluted (USD)
0.9 0.9
1.0 0.9
1.0 0.9
1.0 0.9
1.0 1.0
1.1 1.1
1.1 1.1
1.2 1.1
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Income Statement (Annual) in USD mn except per share data
2006
2007
2008
2009E
2010E
2011E
2012E
2013E
Revenues Cost of goods sold Gross Profit
12,237.7 5,536.1 6,701.6
13,789.9 6,042.3 7,747.6
15,330.4 6,703.5 8,626.9
15,023.8 6,189.8 8,834.0
16,074.0 6,558.2 9,515.8
17,084.8 6,936.4 10,148.4
18,086.9 7,307.1 10,779.8
19,149.2 7,698.0 11,451.2
SG&A D&A Operating Income
3,034.9 16.3 2,218.0
3,427.3 18.2 2,720.4
3,773.0 18.8 3,101.3
3,618.2 19.5 3,479.3
3,838.9 20.9 3,902.4
4,080.3 22.2 4,181.9
4,301.6 23.5 4,481.5
4,554.2 24.9 4,783.0
EBITDA
2,234.3
2,738.6
3,120.1
3,498.8
3,923.3
4,204.1
4,505.0
4,807.9
Net Interest Income/ (Expense) Other Income/ (Expense) Pretax Income
(158.7) (128.4) 2,059.3
(156.6) (54.2) 2,563.8
(95.6) (103.1) 3,005.7
(82.8) (97.5) 3,396.5
(81.7) (20.9) 3,820.6
(70.1) (22.2) 4,111.9
(30.8) (23.5) 4,450.7
6.8 (24.9) 4,789.8
Income Taxes Net Income -GAAP
648.4 1,319.1
759.1 1,703.6
967.9 1,922.8
1,090.3 2,181.9
1,226.4 2,460.6
1,319.9 2,741.7
1,428.7 2,967.6
1,537.5 3,193.7
550.5
543.7
535.0
535.0
535.0
535.0
535.0
535.0
2.6 2.5
3.3 3.2
3.8 3.7
4.3 4.2
4.9 4.7
5.4 5.2
5.9 5.6
6.3 6.1
Diluted Shares Outstanding EPS EPS - Diluted
Balance Sheet & Cash Flow Data in USD mn except per share data
2006
2007
2008
2009E
2010E
2011E
2012E
2013E
Cash and cash equivalents Accounts receivable Inventories Other current assets Current assets PP&E Total assets
489.5 1,523.2 1,008.4 279.9 3,301.0 2,696.1 9,138.0
428.7 1,680.7 1,171.0 338.1 3,618.5 3,015.2 10,112.0
554.9 1,591.9 1,197.1 366.1 3,710.0 3,119.5 9,979.3
608.1 1,557.4 1,154.2 366.1 3,685.9 3,428.2 10,244.3
1,332.6 1,554.2 1,150.2 366.1 4,403.1 3,743.9 11,256.4
1,903.7 1,635.2 1,226.4 366.1 5,131.4 4,062.4 12,281.0
2,851.4 1,734.5 1,300.9 366.1 6,252.9 4,380.8 13,697.4
3,981.7 1,836.3 1,377.2 366.1 7,561.3 4,699.2 15,299.3
Total debt Total liabilities Shareholder's equity
2,720.4 7,727.1 1,410.9
3,221.9 7,825.8 2,286.2
3,585.3 8,057.2 1,922.1
2,405.6 7,077.4 3,166.9
2,405.6 6,685.6 4,570.8
1,214.0 6,146.0 6,135.0
1,143.4 5,869.2 7,828.1
921.4 5,649.0 9,650.2
Net income (including charges) D&A Change in working capital Other Cash flow from operations
1,353.4 312.4 0.0 192.6 1,821.5
1,737.4 315.7 293.0 (64.4) 2,203.7
1,957.2 328.8 (57.3) 43.8 2,238.3
2,221.9 367.4 (26.0) 0.0 2,621.8
2,505.7 407.6 84.6 0.0 2,904.9
2,792.0 450.3 117.5 0.0 3,163.4
3,022.0 495.5 117.1 0.0 3,423.7
3,252.3 543.4 124.5 0.0 3,699.7
Capex Free cash flow
(476.4) 1,345.1
(583.1) 1,620.6
(683.5) 1,554.8
(676.1) 1,945.8
(723.3) 2,181.5
(768.8) 2,394.6
(813.9) 2,609.8
(861.7) 2,838.0
(620.4) (1,059.0) 1.3
(528.3) (1,754.4) 1.4
(613.4) (1,465.9) 1.6
(676.1) (1,892.6) 1.9
(723.3) (1,457.0) 2.1
(768.8) (1,823.5) 2.3
(813.9) (1,662.1) 2.5
(861.7) (1,707.7) 2.7
Cash flow from investing activities Cash flow from financing activities Dividends (USD)
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2009 Sutherland Global Services Disclaimer
This publication has been prepared on behalf of Sutherland Global Services solely for the information of its clients. It is not investment advice or an offer or solicitation for the purchase or sale of any financial instrument. While reasonable care has been taken to ensure that the information contained herein is not untrue or misleading at the time of publication, Sutherland Global Services makes no representation that it is accurate or complete. The information contained herein is subject to change without notice. Sutherland Global Services and any of its officers, employees, related and discretionary accounts may, have long or short positions or may otherwise be interested in any transactions or investments (including derivatives) referred to in this publication. In addition, Sutherland Global Services may provide banking, insurance or asset management services for, or solicits such business from, any company referred to in this publication. Neither Sutherland Global Services nor any of its officers or employees accepts any liability for any direct or consequential loss arising from any use of this publication or its contents. This publication may not be reproduced, distributed or published by any person for any purpose without the prior express consent of Sutherland Global Services. Any investments referred to herein may involve significant risk, are not necessarily available in all jurisdictions, may be illiquid and may not be suitable for all investors. The value of, or income from, any investments referred to herein may fluctuate and/or be affected by changes in exchange rates. Past performance is not indicative of future results. Investors should make their own investment decisions without relying on this publication and should make their own independent evaluation of the relevance and adequacy of the information contained in this material and make such other investigations as they deem necessary, including obtaining independent financial advice, before participating in any transaction in respect of the securities referred to in this material.
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