Stock Review: Colgate Palmolive (India)

 

Colgate Palmolive (India) surprised markets by posting lower-than-expected results for the December quarter on the last day of January. The stock lost over 6 per cent over three sessions (since January 31), compared to around 2 per cent decline in Sensex. However, it has recovered by two per cent since then. The disappointing results, along with the expected increase in tax rates, have led brokerages to prune their earnings per share (EPS) estimates for Colgate by 8-11 per cent for 201011 and 12-14 per cent for 201112. Given the growth expectations, at Rs 810.50 (PE of over 23 times its 2011-12 estimated EPS), analysts believe the stock is fairly valued.

Q3: Higher ad expenses and taxes, lower profits

For the December quarter, Colgate's net sales growth was largely driven by the 12 per cent growth in volumes (toothpaste 13 per cent and toothbrush 24 per cent), making it the eleventh consecutive quarter of doubledigit volume growth. The fasterthan-industry growth has helped Colgate expand volume market share by 110 bps and 120 bps to 53.4 per cent to 40.9 per cent, respectively, for these products (the January-November 2010 period). In the emerging mouthwash (Plax brand) category, too, its volume share has more than doubled from 6.6 per cent to 17.3 per cent.

The good news, however, ends there. Thanks to a 60 per cent jump in advertising and promotional (A&P) spends, to Rs 120.6 crore (or 21.6 per cent of net sales), Colgate's Ebitda margin contracted 700 basis points to 13.4 per cent — the lowest in nine quarters. The A&P expense was driven by multiple factors. While its oral health campaign in October was a one-off expenditure, Colgate also stepped up branding efforts towards Sensitive, Total and Plax. While A&P spends are usually not secular (and depend on activity levels across categories), analysts say the increase in December quarter is a pre-emptive step to protect market share from major players like P&G (which kicked off its first Oral-B dental campaign recently) and GSK Consumer, who are likely to enter the oral care segment in 2011-12.

Going ahead, while analysts expect A&P expenses to revert to 15-16 per cent levels (of net sales), they believe that rising costs of inputs (which have remained benign so far) could keep profitability under check in 2011-12.

The December quarter also witnessed a spurt in the tax rate to 27 per cent (from 20 per cent in the first half), thereby accelerating the fall in profits. The 5-year tax exemption available to Colgate's Baddi unit has ceased which has reduced the income tax exemption to 30 per cent (of profits) from 100 per cent. The management expects its tax rate to inch up to 29 per cent in 2011-12, compared to 12 per cent in 2009-10 and an estimated 24 per cent in the current financial year.

Valuations

Going ahead, Colgate is expected to maintain its volume growth at around 13 per cent in 2011-12, driven by its rural focus and regular product launches. While its EPS for the current financial year is estimated to decline by 2-4 per cent to about Rs 30, analysts expect it to rise by 12-14 per cent in 2011-12.