Colgate-Palmolive (CL) Q4 2017 results were better sequentially with organic sales growth of 2.0%, but it was below expectations due to negative pricing of 1%, its worst price performance since 2004. Margin erosion from pricing deleveraging and higher advertising expenses did not help earnings growth. Management provided its initial 2018 outlook that is only slightly better than consensus, and with the new tax rate providing close to half of the growth. Colgate could be reassessing its growth strategy as it recently acquired 2 small skin care companies. We maintain our price target and position size.
Current Price: $73.53 Price Target: $75
Position Size: 2% TTM Performance: +7%
Thesis Intact. Key takeaways from the quarter:
1. Organic sales a bit better sequentially but still below long term expectations (+3% volume, -1% pricing). The shift of growth coming from volume rather than price is impacting gross margin
a. Up until recently, Colgate was insulated from smaller, more innovative local players, especially in key markets such as India and China. It now needs to raise its advertising spending and lower its prices in order to gain traction again, all while input costs rise. It would not be surprising to hear CL announcing more cost savings initiatives/employee layoffs in the coming quarters similar to peers
b. Segment sales:
i. North America (21% sales): +1% organic sales growth
ii. Latam (25% sales): +2.5% organic sales growth
iii. Europe (16% sales): +4% organic sales growth
iv. Asia Pac (17% sales): +2.5% s organic ales growth
v. Africa/Eurasia (6% sales): -0.5% organic sales growth
vi. Pets (15% sales): +0.5% organic sales growth
c. Adjusted gross margin was 60.4%, a 40bps decline y/y due to higher raw material costs and pricing deleverage. Higher advertising expenses drove most of the 190bps decrease in operating margins, and the cost savings initiative did little to help offset the margin contraction
2. 2018 guidance lackluster
a. Challenging global markets to continue in 2018, with categories up 2-4%, but management did not lower its long-term 4-7% organic growth rate target
b. Sales growth expected to be mid-single-digit, organic sales growth expected to be low to mid-single-digit
c. 50-75bps increase in adjusted gross margin
d. Increase in advertising investments to support new products and base business
e. Low double-digit earnings growth expected, helped in part by tax reform (26-27% tax rate)
f. Colgate could be shifting its strategy to regain growth: CL is not known for actively pursuing M&A, but recently acquired 2 professional skin care companies
3. Valuation: no changes, still a great long-term holding
a. We are maintaining our $75 price target, as 2018 top line growth remains below historical and long-term targets
b. FCF yield 3.8%, dividend yield 2.2%
c. Net debt/EBITDA of 1.2x leaves plenty of room for M&A
The Thesis on Colgate
• High exposure to fast growing emerging markets (36% of Operating Profit from Latin America; 50%+ from EM) so one of the highest growth profiles in Staples
• Defensive Product set (soap and toothpaste). Product line less vulnerable to trade downs due to low private label exposure in the categories
• Strong balance sheet (net debt/ebitda 1.15x) and highest ROIC in the sector
• 2.2% dividend yield