Colgate-Palmolive Is Still Expensive, Yet Closer To An Entry Point

Apr. 30, 2022 10:00 AM ETColgate-Palmolive Company (CL)6 Comments4 Likes
Khen Elazar profile picture
Khen Elazar
8.02K Followers

Summary

  • Colgate-Palmolive is a dividend king that raised its annual dividend for 59 years in a row.
  • Colgate-Palmolive has been elusive, as I never added it to my portfolio due to its valuation.
  • The higher volatility across the markets may serve as an opportunity to buy Colgate-Palmolive.

Colgate-Palmolive To Cut Staff By 12 Percent

Justin Sullivan/Getty Images News

Introduction

As a dividend growth investor, I am always looking for additional opportunities in my portfolio. Sometimes I scan for new positions, while other times I add to my existing positions. The stock market is very volatile lately, opening an opportunity to find high-quality companies at a cheaper valuation when compared to their average valuation.

One of the most elusive companies I have faced was Colgate-Palmolive (NYSE:CL). I have been considering this stock for my dividend growth portfolio for more than five years now, and it has almost evaded due to a high valuation that did not fit the company's growth profile, and I preferred other peers and sectors. Following the market decline, I will revisit the company.

I will analyze the company using my methodology for analyzing dividend growth stocks. I am using the same methodology to make it easier for me to compare analyzed stocks. I will look into the company's fundamentals, valuation, growth opportunities, and risks. I will then try to determine if it's a good investment.

According to Seeking Alpha's company overview, Colgate-Palmolive Company manufactures and sells consumer products worldwide. The company operates through two segments, "Oral, Personal, and Home Care", and "Pet Nutrition". The Oral, Personal, and Home Care segment markets and sells its products under various brands, which include Colgate and Palmolive. The Pet Nutrition segment offers pet nutrition products for everyday nutritional needs under the Hill's Science Diet brand, and a range of therapeutic products to manage disease conditions in dogs and cats.

Colgate-Palmolive logo.svg

Wikipedia

Fundamentals

The sales of Colgate-Palmolive have stagnated over the last decade. The company managed to grow its total revenues by only 2% in 10 years. However, this is partially due to the company repositioning its portfolio. The company divested brands that didn't perform well and invested and acquired other brands like the Hello Oral Care brand. Going forward, the consensus of analysts, as seen on Seeking Alpha, expects Colgate-Palmolive to keep growing sales at an annual rate of ~3% in the medium term.

Chart
Data by YCharts

The company's EPS (earnings per share) has also stagnated as the graph below shows. When taking into account non-GAAP metrics, the growth is still very weak with a 20% increase over the last decade, which equates to less than 2% annually. However, the company has been reshaping its portfolio, investing in its pet nutrition brands while divesting others to position itself better for growth. Going forward, the consensus of analysts, as seen on Seeking Alpha, expects Colgate-Palmolive to keep growing EPS at an annual rate of ~5.5% in the medium term.

Chart
Data by YCharts

The company is not only a dividend aristocrat with over 25 years of dividend increases, but it is a dividend king with 59 years of increasing dividend payments. The company's entry yield is 2.36%, and the dividend is safe with a payout ratio of 78% when using GAAP earnings, and 56% when using non-GAAP earnings. It leaves the company with little room for payout ratio expansion, thus the company is expected to grow its dividend by slightly less than its EPS growth so it can lower its payout ratio.

Chart
Data by YCharts

In addition to dividends, which are the primary way to return capital to shareholders, companies also use buybacks to return additional capital. Colgate-Palmolive has been buying back its shares and reduced the number of shares outstanding by 11% over the last decade. I believe that buybacks are beneficial when the company grows, yet I believe that in the case of Colgate-Palmolive, the management should focus this excess capital on growth as the company struggles with that over the past decade.

Chart
Data by YCharts

Valuation

Shares of Colgate-Palmolive are not cheap by any means. The current forward P/E (price to earnings) ratio is almost 24, and that's after the 5% decline following the earnings release. The company is trading for 24 times the forecasted earnings for 2022, and while it's cheaper than it was just twelve months ago, it still seems expensive when taking into account 5.5% forecasted annual growth.

Chart
Data by YCharts

The graph below from Fastgraphs emphasizes that Colgate-Palmolive is still expensive. The company doesn't only trade for a high valuation, it also trades for a valuation that is higher than its average valuation. Over the last two decades, the average P/E was 22 compared to the current 24. The forecasted growth rate is in line with the average 6% growth rate in the past twenty years.

Fastgraphs analysis

Fastgraphs

To conclude, Colgate-Palmolive struggled to grow over the last decade. The company made several tactical shifts, shedding some brands and investing in others. The dividend is growing, and there are some modest buybacks, but I believe that this is not enough to justify the current valuation, which seems high when taking into account the growth rate and the average valuation.

Opportunities

The first short-term opportunity is the fact that Colgate-Palmolive is as close as you can get to a recession-proof stock. During the 2008 financial crisis, sales for Colgate-Palmolive declined by less than 3% showing remarkable resilience. This challenging environment with inflation and higher rates may lead to another recession, and the company has proved that it will keep selling its products at almost the same pace.

In addition, the company has long-term growth prospects. First, the company is growing at a decent pace in Latin America. In the first quarter of 2022, while Europe suffered from a 9% decline, and the U.S only showed 0.5% growth, Latin America showed strong 5.5% growth. The company is expanding its reach and market share in this continent with a special focus on Brazil which is the largest market in the continent.

Another growth opportunity is the company's pet nutrition segment. In Q1, this segment has shown 11% growth, which was twice as much as the following segment achieved (Latin America with 5.5%). Sales of pet nutrition products were showing strong growth everywhere besides Australia where the company dealt with supply chain challenges. This segment was also responsible for more than $200M in operating income, and it is a major future catalyst.

Risks

The first risk is the competition as the company doesn't possess significant or unique patents. The company sells consumer staples and basic products that are needed daily. Therefore, the barrier to entry is very low, and it is competing both with other branded products as well as with private labels and products focusing mainly on price.

The second risk is inflation. This risk is materializing right now, and indeed inflationary pressures are pushing the company's expenses up. In the company's Q1 reports, the company suffered from an increase in the cost of goods pushing the gross profit lower, and an increase in the marketing budget as the company has to work harder to sell its products at higher prices.

The company lacks the needed margin of safety to be a safe investment in the short term. The company is trading for a valuation that makes me uncomfortable as every miss or guidance change may send the shares significantly lower. When the business environment shifts again, we should expect investors to flock back to growth stocks, and with so little margin of safety, and shares trading above the average valuation, Colgate is risky.

Conclusions

Colgate-Palmolive is growing very slowly at the moment. For a decade we have seen extremely limited growth, yet there are signs of improvement, and the company has several growth opportunities. However, while there are no significant risks to the company's business, and it has a long track record of dealing with recessions and inflation, the valuation seems too high.

The current valuation makes very little sense to me, and I understand why the valuation has declined over the last year. Even if the company manages to grow earnings by 6% annually as expected, I believe that 20 is the suitable P/E for its shares thanks to its strong brands. Therefore, I believe that shares should be considered when the price is around $65.

This article was written by

Khen Elazar profile picture
8.02K Followers
Hi everyone, my name is Khen Elazar and I am 30 years old. I am investing in the stock market since I was 17 years old. I did it with the help and guidance of my Father who is an investment adviser. I used to invest in value and growth stocks, and in Israeli junk bonds. Over the past several years, I have been investing mainly in dividend growth stocks. I also enjoy reading and study new subjects. I am a political junkie and Sport enthusiast, mainly soccer and NBA.
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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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