Colgate-Palmolive: Great Company, Little Appeal At Current Elevated Prices

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 |  About: Colgate-Palmolive Co. (CL)
by: The Value Investor

Summary

Colgate-Palmolive reported in line to slightly weaker than anticipated results on Thursday.

As solid organic sales growth is offset by adverse currency effects.

Despite incremental improvements anticipated in future earnings, shares remain expensive in my eyes.

Investors in Colgate-Palmolive (NYSE:CL) were not too pleased with the company's second quarter earnings report. While earnings were in line, revenues fell short due to adverse currency headwinds in the company's largest Latin American business.

As earnings were reported on the worst trading day so far this year for the market, shares fell by 4% in the wake of the results. Despite a 10% correction from highs set around $70 earlier in July, shares offer little appeal in my eyes, given the very generous price-earnings multiple being attached to the shares.

Second Quarter Highlights

Colgate-Palmolive posted second quarter sales of $4.35 billion, up a paltry 0.1% compared to last year. Analysts were looking for sales to increase towards $4.41 billion.

Despite the essentially flat revenue base, Colgate managed to report net earnings growth of 10.9% to $622 million. Thanks to modest share repurchases, Colgate managed to increase earnings per share by seven cents to $0.67 per share.

Included in the results was a $0.06 per share, or $54 million after-tax charge, associated with the 2012 restructuring program and costs related to the sale of land in Mexico. Adjusted for this earnings came in at $0.73 per share which was in line with consensus estimates.

Looking Into The Numbers

Colgate's overall revenues were flattish, yet there have been some regional divergences. Overall adverse foreign exchange rates had a big impact on the business, reducing sales by 4%. This was offset by a 1.5% increase in pricing and a 2.5% improvement in volumes.

Major weakness was seen in Latin America as sales fell to $1.23 billion, down 4.0% compared to last year. Solid 3% volume growth and 5% increase in pricing was offset by a rather shocking 12% adverse impact of foreign exchange rates.

This was offset by growth in Europe and the Southern Pacific as sales were up by 5.9% to $873 million. In this region, foreign exchange rate movements had a 4% positive impact driven by the strong Euro, while volumes were up by 4.5%, partially offset by a 2.5% reduction in pricing.

Overall revenue trends in Northern America, Asia and the Africa/Eurasia region were rather flat. The pet nutrition business posted a modest 2% sales growth to $560 million. While overall organic growth rates came in at 4.0% for the quarter, it was notably the emerging markets which was the driver behind growth, posting a 6.5% increase in organic sales.

Despite the lack of overall sales growth, Colgate managed to expand its margins a little further. Gross margins rose by 30 basis points to 58.6% of sales. Higher pricing and cost control was partially offset by higher packaging and material costs.

Strong cost control as witnessed by declining selling, general and administrative expenses allowed for a 170 basis point increase in operating earnings to 22.5% of sales. A 180 basis points drop in effective tax rates to 31.9% has been even more helpful to net earnings.

Valuation

At the end of the quarter, Colgate reported having $1.16 billion in cash and equivalents. Total debt of $6.06 billion results in a net debt position of about $4.9 billion.

With 926 million diluted shares outstanding, Colgate's equity is valued at nearly $59 billion with shares trading at $63.50 per share. On a trailing basis, Colgate-Palmolive has now posted sales of $17.5 billion on which it reported net earnings of $2.2 billion. This values equity in the business at 3.4 times annual revenues and 26-27 times annual earnings.

A History Of Strong Brands, And Solid Growth

Colgate dominates the market segments in which it is active. The company reported having a market share of 44.4% in the global market for toothpaste, which is simply astonishing. It furthermore reports a 33.5% market share in the market for manual toothbrushes. On top of these leadings segments, the company is expanding in mouthwash, with the market share of 17.2% increasing by 80 basis points versus last year.

Over the past decade, revenues have increased by about two-thirds, growing at a rate of little over 5% per annum. Earnings have grown by a similar margin over time, although reported earnings have been stagnant since 2009 or so. Investors have seen greater returns as the company has repurchased about 15-20% of its outstanding share base over this time period, adding to earnings per share growth.

Final Takeaway

Colgate's margins are very impressive, yet after-tax margins of about 12-13% reported currently are below their peak of 14-15% as reported a few years ago. Even then the 26-27 times earnings multiple seems a bit steep in my eyes.

This is as margin expansion opportunities are limited to 2-3% points in my eyes as organic sales growth of 4% is already very healthy. Of course the company has massively expanded its margins, sales and market share over the past decade, yet I wonder what can be the incremental drivers going forwards. In the base case scenario I foresee modest market share gains and a growing world population to cater, but nothing spectacular else.

The 2012-2016 efficiency program, which should improve after-tax earnings by $275-$325 million in 2016, should drive earnings growth in the coming two years, but even then shares remain expensive if the company will be able post earnings of about $2.5 billion going forwards.

As such shares offer little appeal while the 2.3% dividend yield is fair, but not excessive. The dominant market position, focus on innovation, technology and emerging markets will most likely result in years of steady organic growth. This makes Colgate a great company, but not my preferred investment alternative due to the full current valuation as argued above.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.