- Colgate-Palmolive announced global volume growth of 5% year over year with 1.5% price increases with emerging markets leading with 10% growth.
- Currency headwinds continue to be a drag on growth.
- Reiterated 4-5% dollar earnings growth with double digit currency neutral earnings growth in 2014.
- Does Colgate-Palmolive represent value at current prices?
As a dividend growth investor consumer staples companies are great because people need to brush their teeth, clean their house and wash their body whether the economy is in boom or bust mode. It's the consistency in their operations and steady, although sometimes slow growth, that allows them to continue to grow year in and year out and the reason why you can find several consumer staples companies on the list of dividend champions. Earlier this week I updated my valuation on The Procter & Gamble Company (NYSE:PG) (Full Analysis Here) but today I wanted to see how Colgate-Palmolive Company (NYSE:CL) stacks up. Colgate-Palmolive closed trading on Monday, April 28th at $67.86 giving a current yield of 2.12%.
Analysts followed by Yahoo!Finance expect Colgate-Palmolive Company to grow earnings 8.90% per year over the next 5 years and I've assumed they can grow at 7.12% (80% of 8.90%) for the next three years and at 3.50% in perpetuity. Running these numbers through a discounted earnings analysis with a 10% discount rate and summing over 30 years yields a fair value price of $62.01. This means the shares are trading at a 9.4% premium to the discounted earnings analysis.
The Graham Number valuation method was conceived of by Benjamin Graham, the father of value investing, and calculates the maximum price one should pay for a company given the earnings and book value. Colgate-Palmolive earned $2.32 per share over the last twelve months and has a current book value per share of $1.78. The Graham Number is calculated to be $9.64, suggesting that it's overvalued by 604.0%. Since we invest for the future, let's replace the earnings per share with forward looking earnings of $3.00 for FY 2014. Keeping the book value per share the same and re-running the calculation gives a fair value of $10.96. Shares are still overvalued by 519.1%.
Average High Dividend Yield:
Colgate-Palmolive's average high dividend yield for the past 5 years is 2.81% and for the past 10 years is 2.58%. This gives target prices of $51.25 and $55.76, respectively, based on the current annual dividend of $1.44. I'll use the average of $53.51 in my target entry price calculation which would correspond to a yield of 2.70%. Shares are currently trading for a 26.8% premium to the average high dividend yield.
Average Low P/E Ratio:
Colgate-Palmolive's average low P/E ratio for the past 5 years is 17.01 and for the past 10 years is 18.12. This corresponds to a price per share of $51.04 and $54.36, respectively, based off the analyst estimate of $3.00 per share for fiscal year 2014. I'll use the average of the two low P/E ratio models in my target entry price calculation. This gives a low P/E target of 17.57 and a price target of $52.70. Colgate-Palmolive is trading at a 26.8% premium to the low P/E ratio valuation.
Average Low P/S Ratio:
Colgate-Palmolive's average low P/S ratio for the past 5 years is 2.39 and for the past 10 years is 2.34. This corresponds to a price per share of $45.31 and $44.37, respectively, based off the analyst estimate for revenue growth from FY 2013 to FY 2014. 2014 revenue per share is estimated at $18.92 and is calculated from revenue growth but not accounting for potential share buybacks. Currently, Colgate-Palmolive's P/S ratio is 3.48 on a trailing twelve month basis. Once again I'll use the average of the two P/S ratio models, $44.84, in my target entry price calculation. Colgate-Palmolive is trading at a 51.3% premium to this price.
Gordon Growth Model:
The Gordon Growth Model is a quick way to calculate the fair value of a company using the current dividend, the expected dividend growth rate, and your required rate of return or discount rate. Assuming a constant 6.50% dividend growth rate and a discount rate of 9.00%, the GGM valuation method yields a fair price of $57.60. Colgate-Palmolive is currently trading 17.8% premium to this price.
Dividend Discount Model:
For the DDM, I assumed that Colgate-Palmolive will be able to grow dividends for the next five years at the lowest of the 1, 3, 5, 10 year growth rates or 15%. In this case that would be the 1 year growth rate of 6.77%. After that I assumed Family Dollar Stores can continue to raise dividends at 5.41% (80% of 6.77%) for the next three years, and in perpetuity at 5.00%. The dividend growth rates are based off fiscal year payouts and don't necessarily correspond to quarter over quarter increases. To calculate the value I used a discount rate of 9.00%. Based on the DDM, Colgate-Palmolive's is worth $41.69, meaning it's trading at a 62.8% premium to this valuation.
Colgate-Palmolive's trailing P/E is 29.22 and its forward P/E is 20.50. The PE3 based on the average earnings for the last 3 years is 27.40. I like to see the PE3 be less than 15 which Colgate-Palmolive is well over as earnings retreated in FY 2013. Compared to its industry peers Colgate-Palmolive is overvalued versus The Procter & Gamble Company (PG) 22.27, The Clorox Company (NYSE:CLX) 21.50, and Church & Dwight Company (NYSE:CHD) 24.93. Previous comparisons are on a TTM basis. On a forward P/E basis Colgate-Palmolive is overvalued versus PG (18.27), CLX (19.28), and on par with CHD (20.70). Colgate-Palmolive is trading at a 5 year PEG ratio of 2.63 which has shares well overvalued against PG (2.35) and CHD (2.12) and on par with CLX (2.65). A PEG ratio of 1 is generally considered fair value and FDO isn't even close to approaching that level.
Colgate-Palmolive's gross margins for FY 2012 and FY 2013 were 60.4% and 58.6%, respectively, and they have averaged a 60.3% gross profit margin over the last 5 years. The net income margin for the same years were 15.4% and 13.8% with a five year average of 15.0%. Colgate-Palmolive's gross and net profit margins have been very consistent and with little variation which is great to see that in boom and bust times margins are little changed. This allows for better planning on the part of management and consistency in operations. Since each industry is different and allows for different margins, I like to compare the company I'm analyzing to its peer group. Over the TTM, Colgate-Palmolive's gross margin was 58.6% with a net profit margin of 12.9%, Clorox's gross margin was 42.7% with a net profit margin of 10.0%, Procter & Gamble's gross profit margin was 48.8% with a net profit margin of 13.0%, and Church & Dwight had a gross margin of 45.0% with a net profit margin of 12.4%. Colgate-Palmolive is leading the way against its' peers in both gross and second in net profit margin.
Since the end of FY 2003, Colgate-Palmolive has been great at reducing the share count. From FY 2003 to the end of FY 2013, the share count has decreased from 1.178B to 0.940B. That's a total of 18.8% of the shares outstanding since the start and is good for an average annual decrease of 2.1%.
A negative number for the % change value means shares were bought back by the company and a positive value means the shares outstanding increased.
Colgate-Palmolive is a dividend champion with 51 consecutive years of increasing the dividend. The dividend has been increased at a 6.8%, 7.6%, 10.6%, and 11.9% annualized rates over the last 1, 3, 5, and 10 year periods, respectively. Dividend increases are based off fiscal year payouts and don't necessarily correspond to quarter over quarter increases. Colgate-Palmolive is not only a household name, it's also a favorite among dividend growth investors and rightfully so with 51 years of increases.
The payout ratio based off earnings per share has increased over the last 10 years from 41.0% in FY 2004 to 55.9% in FY 2013. Over the last five fiscal years the payout ratio has averaged 47.2%. The general trend has been a higher payout ratio as dividend increases have outpaced earnings per share growth but I still expect solid increases over the intermediate term. Analysts expect 8.90% earnings per share growth over the next five year and adding in 1.5% share count declines could boost the dividend growth rate into double digits and keep a constant payout ratio. Something closer to in line with earnings growth is probably more realistic over the short term to get the payout ratio a little bit lower and have a larger cushion.
I also like to look at the cash flow and the free cash flow payout ratio in order to determine the safety of a dividend. Cash flow is less susceptible to accounting tricks when compared to earnings because after all cash is cash. The free cash flow payout ratio has trended higher along with the traditional payout ratio but has generally been lower over the last five years. Operating cash flow has decreased from $3.277B in FY 2009 to $3.204B in FY 2013. That's an average annual decline of 0.56%. Capital expenditures have been on the rise over that time increasing from $0.575B to $0.670B in the same years for an average annual increase of 3.9%. Flat operating cash flows coupled with increasing capex is not a good combination for free cash flow. Free cash flow, operating cash flow less capital expenditures, has declined from $2.702B in FY 2009 to $2.534B in FY 2013 for an average annual decline of 1.59%. As a dividend growth investor, the sustainability of the dividend is of utmost importance to me, so I also like to calculate the free cash flow after paying the dividend, or FCFaD. The FCFaD obviously has been in decline as free cash flow has declined and the dividend has continued to increase. In FY 2009 FCFaD was $1.721B and in FY 2013 it was $1.152B which is a 9.6% average annual decrease. The FCFaD has essentially been able to cover the share buyback and allow them to be cash flow neutral before accounting for debt issuance/payment. The FCF payout ratio has averaged 42.8% over the last five fiscal years but has risen sharply over that time from 33.4% in FY 2009 to 49.3% in FY 2013. I'll be watching the cash flow situation as new quarterly reports are released to see if progress has been made here.
Revenue and Net Income:
Since the basis of dividend growth is revenue and net income growth, we'll now look at how Colgate-Palmolive has done on that front. Revenue growth since the end of FY 2008 has been fair at best with a 2.6% annual increase; growing from $15.329B to $17.420B. Net Income over the same years has grown at an annualized rate of 4.3% from $1.957B to $2.410B. Since net income has been growing faster than revenue, the net income margin has improved from 12.8% in FY 2008 to 13.8% in FY 2013. Sales will have to increase whether through volume or price increases in order to truly grow the company.
This chart shows the historical high and low prices since FY 2004 and the forecast based on the low, average, and high P/E ratios and the expected EPS values from the discounted earnings calculation above. I have also included a forecast based off a P/E ratio that is 75% of the average low P/E ratio. I like to buy near the 75% low P/E ratio price although this price doesn't usually come around very often. In the case of Colgate-Palmolive, the target low P/E ratio is 17.6 and the 75% low P/E ratio is 13.2. This corresponds to an entry price of $52.70 based off the expected earnings of $3.00 for FY 2014, with a 75% target price of $38.28. Currently Colgate-Palmolive is trading at a $29.58 premium to the 75% low P/E target price and a $15.16 premium to the target low P/E price. FY 2015 price targets are $58.15 for low P/E and $42.24 for 75% low P/E. If you look at the chart the current price line intersects the average P/E line towards the halfway mark of FY 2016 suggesting that it's currently above fair value and that you're paying up for about 2 years of growth at current prices. The current price line intersects the low P/E line towards the middle of FY 2017 so you're paying up for about 4 years of growth at current prices. If actual growth comes in above/below analyst estimates then these numbers are subject to change.
The average of all the valuation models gives a target entry price of $46.09 which means that Colgate-Palmolive is currently trading at a 47.2% premium to the target entry price. I've also calculated it with the highest and lowest valuation methods thrown out. In this case, the Graham Number and discounted earnings valuations are removed and the new average becomes $50.07. Shares are currently trading at a 35.5% premium to this price as well.
Assuming that Colgate-Palmolive grows their earnings and dividends at the rates that I assumed, you're looking at lackluster returns over the next 5 years. In 2018, EPS would be $4.22 and slapping an average P/E of 19.85 gives a price of $83.75. Over the next 5 years you'd also receive $8.80 per share in dividends for a total return of 36.39% which is just a 6.40% annualized rate if you purchase at the current price. Growth in earnings and dividends will be the bulk of your return with very little room for further multiple expansion for the total return investor. If you purchase at the target entry price of $50.07 the 5 year total return jumps to 84.85% or a 13.07% annualized rate.
According to Yahoo!Finance, the 1 year target estimate is $67.71 suggesting that the share price is fairly valued has about 0.2% downside over the next year. Morningstar has Colgate-Palmolive rated as a 2 star stock meaning it's currently above their fair value estimate of $60.00. The fair value price suggests about 11.6% downside from current prices. The following table is from Morningstar and shows the current valuation of Colgate-Palmolive compared to its' industry, the S&P 500, and its' 5 year averages.
Colgate-Palmolive Company is a beast in the oral care product space behind their Colgate brand. They also provide various products in the personal care (deodorant/body wash/soap), home care (Ajax, Palmolive) and a growing pet nutrition line. Each segment as a percent of sales can be seen in the following image from the 2013 annual report.
Colgate-Palmolive is seeking to grow their business on four main fronts. By engaging both consumers and professionals through targeted marketing and collaboration between dental professionals and Colgate to provide health education. They are also continuing to innovate their way to growth. With the major product line being toothpaste you wouldn't think there'd be a lot of new things coming along, but they are beginning to introduce a toothpaste with a "Sugar Acid Neutralizer". A what? Essentially the product directly fights the acids from sugar which lead to cavities. Thirdly, Colgate-Palmolive is working towards achieving a higher efficiency. What's really amazing about running a global business is that one small idea that maybe saves $5 per day at one location doesn't seem like much, but when it's implemented globally the cost savings can be enormous. Their last front is to lead to win. Colgate-Palmolive is leading the charge on creating a more sustainable company that has less impact on the resources they use to make their products.
Overall I think the valuation of Colgate-Palmolive Company is a bit rich at this time. I have a target entry price of $50.07 with an average or "fair" valuation price of $59.72. The price just seems to be too far ahead of itself at this time for me to consider investing capital. Operating and free cash flow needs to increase and with the restructuring that was started in 2012 projected to unlock $275-325M in annual cost savings that would free up more cash flow for growth initiatives. I really like the company and would love to become a part owner but I think there's better opportunities elsewhere in the market.
What do you think about Colgate-Palmolive Company as a dividend growth investment? How do you think the long-term dividend growth prospects are?
A full list of my holdings can be found here.