Can Colgate Bring Shine To Investor Portfolio

Colgate-Palmolive is the leader in oral care market with products like toothpaste, tooth powder, toothbrush and mouth wash etc. Company was incorporated in the year 1937. In mid 80s the company introduced toothbrush in the market. The company also provides a range of personal care products under the `Palmolive' brand name. Recently, company is focusing on premium toothpaste products like herbal, sensitivity, charcoal and salt.

Size of India dental care market 
Toothpaste is highly penetrated product in India with market size of INR 9,000 - 10,000cr. Besides Toothpaste, toothbrush is also decent market size of INR 3,000 – 3,500 cr. Besides these two products there is small market for tooth powder, mouthwash and other dental care. Though the toothpaste is highly penetrated product, we still can see low single digit growth in market as the frequency of brushing is expected to go up in India. Pre Covid, Colgate ad campaign focused on raising awareness of benefits of brushing twice a day. In their FY21 results concall, company has mentioned that they will bring this back in focus again.
Within toothpaste, segments like herbal and sensitivity (which cater to customer with acute tooth problem) are growth at healthy double digit but that market size is small. These segments are expected to grow at higher rate for medium - long term as awareness goes up and customers find comfort in paying premium price for better product. Colgate has launched toothpaste for diabetic patients in India, addressing high sugar level creating gum problem.

Colgate loss of market share due to Patanjali
Let touch directly to the Colgate pain point. 
Colgate market share has dropped from 57% in 2015 have stabilized to 50% in 2020/21. This is due to emergence of Patanjali who has eaten market share from all incumbents.
 

Patanjali started to get stronger from FY15 onwards. From 3% market share in FY16, as per media reports Patanjali has achieved double digit market share by end of FY21. In last few years, Patanjali group has become very strong in terms of size and scale. Their subsidiary Ruchi Soya itself is 15000cr revenue and overall group revenue can be in the range of 25 – 30,000 which is only after HUL in the Indian FMCG space. If company of that scale want to gain market share and compete on prices, investor taking caution stand is understood. Patanjali is continuously growing its distribution reach / expanding footprint we need to keep an eye on market share and see how it evolve. Positive thing to note is Colgate market share has stabilized at 50% and there was small improvement in market share as well recently.

Colgate growth projection given competitive landscape
Now, Lets look at positive things which are happening at Colgate and why we are evaluating Colgate for investment. Colgate revenue has grown 7% for FY21, and similar trend is continued in first two quarter of FY22, this is higher than 4-5% company has grown in FY17-20
Besides that, EBITDA profile of the company has improved significantly in FY22. For last 5-6 quarters company has posted more than 30% as EBITDA margin. This is near 3-4% higher than 26-27% they use to do in earlier years.
Even when we look at analyst reports. Consensus estimates remain that Colgate revenue/profit is expected to grow at 8-9% for next few years. Colgate remain very high ROE business consistently delivering over 60% return ratios and since company doesn’t need high capital either on capex or working capital, profit into cash will remain high, which will be returned to shareholder as dividend.

What’s unique about Colgate margin

This is very high margin business in FMCG. Normally FMCG (even likes of HUL and Nestle) will be EBITDA margin of 24-25% while Colgate makes much higher margin of 30% plus. Interesting point is other FMCG HUL/Nestle will make EBITDA margin of 24-25% and they have ad spend of 8% of revenue in contrast to that Colgate makes ad spend of 14% and then make EBITDA margin of 30%. There is great cushion in protecting margin profile of the Colgate. All this is because of very low cost of raw material cost in making toothpaste/toothbrush, Gross margin is near 65%.
 

What is valuation construct on Colgate: PE + Div yld
Since this is growing dividend and cash flow rich company, it should be valued at PE ratio. For last 5 yrs it has traded at PE ratio of 46x of trailing 12months EPS. While going through management commentary and analyst forecast, it seems revenue and profits will grow at approx. 8% for next few years. De-constructing this 8% growth forecast in revenue, I believe, volume growth will be minimal, may be 1-2% this will be driven by more people adopting brushing twice a day, 3-4% will come from value mix changes, and 2-3% kind of inflation.
Currently, the valuation has de-rated, it is trading less than 40x of trailing EPS compared to Avg of 46x for last 5yrs. If we assume there will be no re-rating back to avg of 46x, then stock should deliver 8% return on growth of EPS + 2-2.5% dividend yield. So, a moderate 10% return in case there is no re-rating back to normalization. 
Colgate multiple has moved from 46x to 40x as it has lost market share, as we discussed earlier due to competition from Patanjali. Now for last 1-1.5yrs, market share has stabilized at 50%, if company is able to maintain the market share from here, I believe there can be small re-rating from current multiple.

Indian biz valuation vs MNC parent

General view in market is MNC companies are valued at way too high premium in India. So, I was having a look at few MNC companies in India, how they are valued in India compared to their parents overseas. I took HUL and Nestle to compare with Colgate. For eg, Colgate profit will grow at 8% for next 3yrs which will be 90% higher than Parent profit growth, while premium in terms of PE ratio and cash flow for 2yr/3yr fwd is in the range of 60-70%. While comparing same for Nestle and unilever profit growth is expected to be 110-120% while the premium which is paid for valuation will be higher than 200%. It seems market is giving lower premium to Colgate as compared to its growth rate.

Where Colgate can sit in someone portfolio?
Normal tendency of everyone will be if the normalized return without any re-rating will be 10% then should one consider such investment in equity portfolio as normally one would like to have 15-16% return on long term for equity investment. Colgate is special situation in FMCG universe. There is hardly any disruption in toothpaste segment apart from Patanjali in last many years.
While constructing portfolio, one will keep aside for high growth / moderate growth equity and debt. Allocation in stock like Colgate will bring down beta of the portfolio and volatility as a cost for sacrificing return. And mind it as we said earlier, If Colgate can maintain or gain slight market share from here, stock can re-rate above 40x multiple.
One thing can be observed in last few quarters in Colgate is domestic guys are selling. DIIs stake is down from 11% to 7%, a reduction of 400bips which is absorbed by FIIs, whose stake has moved from 15% to 19%. May be this is also pinned from fact that DIIs found 10% return as unattractive while same with low beta is considered fine for FIIs who come with v low cost of capital. 

To conclude Colgate makes sense for investors looking for moderate return with low volatility.