Colgate Palmolive - All foamed out - Ambit

Colgate's EBITDA CAGR of 30% over FY07-12 was supported by gross margin expansion. We do NOT expect further market share gains given the aggression from P&G (Oral-B toothpaste launch next month), GSK Consumer (Sensodyne) and the rumoured entry of ITC in this segment. We also model declining gross margins given limited scope for further consolidation of contract manufacturing and shift towards toothpaste from toothpowder. Rising advert to sales ratio and tax rate will lead to only 8% EPS CAGR over FY13-15, lower than the 24% reported over FY07-12. Current valuations of 38x FY14 EPS do not appear to factor in this approaching growth moderation and rising competitive intensity. We initiate coverage with a SELL stance.

Colgate's leadership presence is supported by: (a) focused initiatives around dentists and rural consumers that are stronger than HUL's; and (b) a broader oral care portfolio allowing premiumisation. We expect significant moderation in EBITDA CAGR from 30% over FY07-12 to 8% over FY13-15 due to:

High competitive intensity: Since oral care is one of the highest gross margin categories (~60%) in the FMCG universe, the competitive intensity has increased substantially with the successful new entry of players like GSK (Sensodyne and Paradontax), proposed launch of Oral-B toothpaste by P&G next month, and rumours of ITC's entry into this segment. Consequently, we expect the A&P spends to sales ratio to increase by ~100bps over FY13-15 and hence be a substantial drag on earnings growth.

Consolidation of contract manufacturing: Replacement of contractual outsourced manufacturing locations with Colgate's in-house manufacturing units over the past decade has led to a gross margin benefit of 13-15 percentage points. However, with the 'purchase of traded goods:sales' ratio declining from 42% in FY02 to 7% in FY12, there is only a limited scope for further consolidation.

Shift from toothpowder to toothpastes: Due to consumers shifting from toothpowder to toothpaste, the contribution of toothpowder to Colgate's overall revenues has declined from 22% in FY01 to 11% in FY12, providing a 200bps benefit to EBITDA margins over the past decade. Once again, we see limited potential for further reduction in this ratio going forward.

Valuation: Colgate's FY14 P/E multiple of 38.1x is at ~45% premium to its historical (FY10-13) average one-year forward trading multiple of 26.4x. Given our expectation of a moderation in earnings growth, as discussed above, we believe this premium is unjustified. Our DCF-based valuation generates a TP of Rs. 1,227/share, 15% downside (implied FY14 P/E of 32.2x).

Source : Equity Bulls

Keywords