Colgate-Palmolive: What Recent Results Mean For Long-Term Holders

Aug. 25, 2022 8:01 AM ETColgate-Palmolive Company (CL)3 Comments

Summary

  • In spite of its lacklustre performance, Colgate-Palmolive generated superior risk-adjusted returns in recent years.
  • All eyes are currently on the company's strong quarterly sales growth, which defied expectations.
  • However, long-term investors should remain focused on CL's margins that are temporarily under pressure.

The Shop Happy Hour /Colgate Illustrator Activation

CJ Rivera

Colgate-Palmolive (NYSE:CL) is hardly a business for risk-seeking and short-term oriented investors. While the management has given us a master class in long-term value creation, the share price is also unlikely to make anyone rich quickly. On the contrary, CL is an investment akin for anyone looking for steady value accumulation, superior risk-adjusted returns and a wide moat.

I first covered the company about four years ago when I emphasized the importance of having high and sustainable return on invested capital. My investment thesis has not changed materially since then, although for a period of time I did warn against the company's high valuation.

To put everything said above into perspective, CL has achieved a total return more than 44% since my first article on the company, while the broader equity market returned roughly 57% over the same period.

CL stock total return level
Data by YCharts

For the average retail investor, that would have meant significant underperformance at a time when returns of many high-risk technology names were making the headlines on a daily basis.

If we consider risk, however, things look rather different for Colgate-Palmolive. The company has a beta of below 0.5 and more specifically of 0.42 over the past two years and 0.47 over a 5-year period.

Colgate-Palmolive Beta

Seeking Alpha

Therefore, on a risk-adjusted basis, Colgate-Palmolive has been a far superior investment over the period. Moreover, during the period when I rated the company as a 'Hold' and warned against short to medium term risks, CL did underperform the overall market.

Colgate-Palmolive stock total return
Data by YCharts

The Power Of Strong Global Brands

As inflationary pressures are raging through the economy, consumer staples are at risk of declining volumes and margin pressures. These effects, however, are more pronounced for companies operating in lower valued added segments and those having weaker brands.

In that regard, Colgate-Palmolive brand portfolio is well-positioned with many of the global strongest brands in their respective categories.

Colgate-Palmolive brands

Colgate-Palmolive Investor Presentation

That is why, the company has recently surprised the investment community by reporting one of its strongest quarterly organic sales growth numbers in more than a decade.

Colgate-Palmolive revenue growth

Colgate-Palmolive Investor Presentation

For comparison, Procter & Gamble's (PG) most recent results were still below that number which clearly illustrates the pricing power of Colgate-Palmolive's brands.

Procter & Gamble 2022 results

Procter & Gamble Investor Presentation

Yet another reason why CL's most recent results were so impressive, was that the company achieved that in spite of its high exposure to markets outside of the United States (see below) at a time when the U.S. dollar index reached new highs.

Colgate-Palmolive revenue by segment

Colgate-Palmolive 10-Q SEC Filing

The market has also been fixated on topline growth numbers, as Colgate tends to outperform the Consumer Staples Select Sector SPDR Fund (XLP) during quarters when organic sales growth is at high single digits.

Colgate-Palmolive share price performance

prepared by the author, using data from Seeking Alpha and Colgate-Palmolive Investor Presentation

The impressive topline growth, however, was not a one-off deal as CL increased its full year guidance to 5-7%.

Colgate-Palmolive 2022 guidance

Colgate-Palmolive Investor Presentation

Profitability In The Spotlight

Although sales growth is highly important for large cap consumer staples, which are severely limited in their growth potential, profitability is where long-term investors should be focused.

Colgate-Palmolive has been one of the most profitable businesses in the Home & Personal Care space, both on gross profit and EBITDA basis.

Colgate-Palmolive profitability

prepared by the author, using data from Seeking Alpha

As the graph below clearly illustrates, more profitable businesses have fared far better in past year, when inflationary pressures returned.

Colgate-Palmolive performance versus peers

prepared by the author, using data from Seeking Alpha

Not only are more profitable businesses better positioned to weather the rising commodity prices, but also have much better reinvestment opportunities and stronger competitive advantages. Having said that, gross margins are usually a good starting point since they indicate the price premium achieved by the company's brands.

That is why, on a historical basis, gross margin is a very good indicator of Colgate's price-to-sales multiples.

Colgate-Palmolive valuation versus margins

prepared by the author, using data from SEC Filings and Seeking Alpha

Following the tailwinds during 2020, Colgate's gross margins have quickly fallen back to pre-pandemic levels and are now at one of their lowest levels for the past decade. As we see in the graph below, rising costs of raw materials were the major driving force of this decline.

Colgate-Palmolive gross margin breakdown

prepared by the author, using data from Earnings Transcripts

Although CL's management has done a good job at improving productivity and the strong brands allowed for pricing action, inflationary pressures were far stronger and eventually margins fell. Interestingly, the management seems to have discontinued the practice to report the segmented basis points impact on gross margin since the first quarter of 2022.

Not surprisingly, since then gross margin fell sharply.

Colgate-Palmolive gross margin

prepared by the author, using data from Seeking Alpha

As dire as the recent historical results might seem, Colgate's valuation multiples seem to suggest that this downward trajectory in margins is unlikely to continue. That is why CL's P/S multiple is far higher than it was back in 2012, even though gross margins are roughly in-line (see the graph above).

To understand why that is, we should take a look at the major raw materials used in production of Colgate's products.

The Company is exposed to price volatility related to raw materials used in production, such as essential oils, resins, tropical oils, pulp, tallow, corn, poultry and soybeans.

Source: Colgate-Palmolive 10-K SEC Filing

As prices of all these rose sharply in recent years, major commodities, such as palm oil and soybeans oil, are already back to 2021 levels.

Palm oil prices

FRED

Soybean oil prices

FRED

This does not necessarily mean that pricing pressures will continue to ease, however it is a major relief for Colgate's margins going forward. At the same time, price increases of CL's products are most likely permanent and with that would soon allow the company to regain its profitability provided that supply chain issues do not persist.

Conclusion

Colgate-Palmolive is hardly a company that will make the headlines with spectacular shareholder returns over brief periods of time. Nevertheless, CL continues to quietly generate alpha and deliver superior risk-adjusted returns for those who care not only about returns but also about risk. As inflationary pressures continue to dominate today's narrative around the company, long-term holders should look beyond that and take advantage of any short-term noise.

This article was written by

Vladimir Dimitrov, CFA profile picture
4.13K Followers
Investment strategy for those seeking steady and above-market returns

Vladimir Dimitrov is a former strategy consultant with a professional focus on business and intangible assets valuation. His professional background lies in solving complex business problems through the lens of overall business strategy and various valuation and financial modelling techniques.

Vladimir has also been exploring the concept of value investing and in particular finding companies with sustainable competitive advantages that also trade below their intrinsic value. He supplements his bottom-up approach with a more holistic view of the markets through factor investing techniques.

Vladimir made his first investment in farmland right out of high school in 2007 and consequently started investing through mutual funds at the bottom of the market in 2009. In the years that followed he has been focused on developing his own investment philosophy and has been managing a concentrated equity portfolio since 2016. Vladimir is LSE Alumni and a CFA charterholder . 

All of Vladimir's content published on Seeking Alpha is for informational purposes only and should not be construed as investment advice. Always consult a licensed investment professional before making investment decisions.

Disclosure: I/we have a beneficial long position in the shares of UL either through stock ownership, options, or other derivatives. 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.

Additional disclosure: Please do your own due diligence and consult with your financial advisor, if you have one, before making any investment decisions. The author is not acting in an investment adviser capacity. The author's opinions expressed herein address only select aspects of potential investment in securities of the companies mentioned and cannot be a substitute for comprehensive investment analysis. The author recommends that potential and existing investors conduct thorough investment research of their own, including detailed review of the companies' SEC filings. Any opinions or estimates constitute the author's best judgment as of the date of publication, and are subject to change without notice.

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