Stock Review: Colgate-Palmolive

 

Colgate-Palmolive (India) is close to celebrating its platinum jubilee in India, and yet the brand remains as fresh in consumers' minds as when it first entered this market. Its toothpaste brands have captured slightly more than half of the Indian oral care segment. The company no longer relies on toothpaste alone: it now straddles the toothbrush and toothpowder segments as well and comes out tops in both.

So far Colgate has had a successful run. At the national level, it has had to contend only with HUL (Pepsodent) and Dabur (Lal Dantmanjan and Babool). Its other competitors are smaller regional brands. More players though are now seeing serious money in your cavities and are going all out for a piece of the action.

 

Sources of moat

Imagine reaching out to 1.2 crore school-going children (read, prospective customers) every year. Imagine stocking your flagship product in over 45 lakh stores and being present in 1,000 towns all over India.

Finally, imagine engaging 36,000 doctors to recommend your products.
That's what Colgate does every year. Colgate's success, apart from the usual branding story, is one of building an elaborate distribution network — one which few competitors can duplicate easily. As a result, Colgate has captured 53.1 per cent of the Indian toothpaste market — twice more than its closest competitor.

Colgate's moat also comes from the high stickiness of its products. Like the daily newspaper, consumers don't change their preferred brand of toothpaste in a jiffy. That is the nature of this product. Hence, companies enjoying a dominant position in this category have a comfortable advantage over their competitors. In fact, Colgate has created such an effective machine that its average ROE for the last three year stands at nearly 140 per cent (though this figure will moderate in future).

Fortifying its hold. Colgate has extended its stranglehold to other oral care categories as well. In toothbrushes, it has a 40.3 per cent market share — way ahead of its nearest competitor (which has an 18.4 per cent share). In the toothpowder category, it has a 46.4 per cent market share (its closest competitor holds 30.1 per cent).

Colgate's high-decibel advertising, coupled with its unmatched distribution, has kept it ahead of the comcompetition. Within the toothpaste category, Colgate reported annualised volume growth of 14.7 per cent during the last three years — ahead of the industry's 10 per cent. Its toothbrushes saw higher volume growth of 26.6 per cent (annualised) compared to the industry's growth rate of 22.8 per cent.

Colgate's distribution strength. Colgate's market leadership is also owing to the strength of its distribution network. By 2010 its network had reached 94 per cent of rural areas and 97 per cent of urban areas. This depth of coverage is expected to help Colgate be present wherever the opportunity of uptrading comes up.

Rural focus. Colgate's focus on rural areas is now producing results. A full 40 per cent of the company's FY10 revenues came from rural areas. This is up from 35 per cent about five years ago.

 

Growth drivers

Low penetration. Toothpaste has a penetration of only 64 per cent in India. In rural India that number falls even lower to 40 per cent. Look at it another way - about 435 million Indians still do not use toothpaste (though some use toothpowder). For companies like Colgate that is a huge market that remains to be tapped.

Low per capita consumption. Further, at 127 grams, the per capita consumption in India per year is still lower than in many other markets. The Chinese, for instance, use twice as much toothpaste as Indians do, while Americans use four times as much. Simply encouraging people to increase usage by, say, brushing twice a day regularly will set the cash registers ringing for toothpaste companies.

New categories. Tooth-care companies are now chasing new categories like mouthwash. This Rs 100 crore market is dominated by Johnson & Johnson's Listerine with a 70 per cent share. Colgate has increased its volume share in this category from 7.5 per cent in FY10 to 22 per cent in FY11.

New launches. Colgate recently launched its Sensitive Pro-Relief toothpaste which addresses the sensitive-tooth segment. So far only GSK Consumer's Sensodyne was present in this segment. It has also introduced Colgate 360 Sensitive Pro-Relief Toothbrush.

 

What could cause moat to be breached

Toothpaste, as we said, is a product that has high connect with users, and something that they don't change easily. Those competing against Colgate have the option to address new users (like children), non users (persuade the rural population to migrate to toothpowder/toothpaste) or focus on niches (herbal toothpastes like Meswak). Regional players like Neem could maintain their hold through effective marketing.

The P&G threat. Procter & Gamble (P&G) is expected to launch either its Oral B or Crest brand of toothpaste in India. That will likely be the biggest threat to Colgate's predominance in the country. P&G is world's no. two oral care company just behind Colgate. Globally Colgate has managed to beat P&G in the toothpaste segment. It will be interesting to see how market shares change once P&G's toothpaste enters this market.

Current competitors looking for cavities. Domestic competitors like HUL's Pepsodent, Dabur's Babool, Red toothpaste and Meswak have upped the ante. Both are giving Colgate a run for its money in rural areas with their low priced variants. All are now spending more than ever on their brands. The stress is beginning to show. Volume growth for Colgate came in at 10 per cent during Q4FY11 — the lowest in the last 12 quarters. In future, strong rural reach by both HUL and Dabur could possibly slow down Colgate's volume growth.
So far Colgate has managed to fend off all its competitors successfully. Pumped up by higher ad spends, the company has managed not only to maintain its market share but has even increased it steadily. It is advantage Colgate so far.

 

Concerns

Higher advertising costs. Colgate spent 13.4 per cent of its revenues on ad spends during Q4FY11 (20.9 per cent in Q3FY11). That is among the highest in the category. Look at it another way: Colgate currently spends around 70 per cent more on ad spends today than it did five years earlier. Ad spends are expected to remain in the range of 15-16 per cent for Colgate in the immediate term.

Lower margins. High ad spends along with higher packaging costs due to rise in crude prices and other input prices (mint and menthol) impacted EBITDA margin by 287 basis points (bps) y-o-y in Q4FY11; it declined to 24 per cent. On a full-year basis, EBITDA margin for FY11 declined by 138 bps to 20.3 per cent. Margin expansion could continue to be muted on account of higher ad spends.

 

Financials

Over the last five years, the company's revenue has grown at a compounded annual growth rate (CAGR) of 16 per cent while its profit after tax has grown at 30 per cent. It is a debt-free company. Over the last five years, it has clocked a very high average return on equity of 105 per cent.

In Q4FY11, Colgate reported revenue growth of 12.6 per cent y-o-y to Rs 581 crore, largely driven by volume growth in the toothpaste category. Overall volume growth came in at 12 per cent for the quarter. Only toothpowders registered a marginal decline in volumes. All of Colgate's core brands, i.e., Colgate Dental Cream, Active Salt, Max Fresh and Cibaca did well. Earnings took a hit of 0.3 per cent (in Q4FY11) to Rs 114.1 crore on account of a 150 per cent jump in tax rates as the Baddi plant lost its tax benefits. In future, tax benefits will decline from 100 per cent to 30 per cent.

 

Valuation

Currently the stock is trading at a 12-month trailing PE of 32.77, which is higher than its five-year median PE of 26.1. Thus the company is trading at a level that is higher than its own historical levels.

This is not the best of times to accumulate this stock. The annualised earnings growth of the company over the last five years stands at 23.95 per cent. This gives it a price-earnings to growth (PEG) ratio of 1.37, which is rather high. Wait for a market correction before accumulating the stock.