Colgate-Palmolive: Improving Outlook and Reasonable Valuation (NYSE: CL)

investment thesis

Colgate-Palmolive Company (NYSE: NYSE:CL) Revenue growth should benefit from higher prices and a return to volume growth due to moderation.Additionally, increased advertising spend and promotional offers should also help the company gain market share and generate sales Growth moves forward. This should also help offset near-term headwinds from lower consumer trade in an inflationary environment. Good consumer demand for its oral care and Hill’s pet nutrition businesses should help sustain revenue in the medium to long term.

On the margin front, while inflationary headwinds remain, the company should be able to offset them through price increases, volume leverage, and improved efficiencies. Additionally, lower SG&A expenses as a percentage of sales and mitigating foreign exchange headwinds should also aid profit growth. Therefore, I believe the overall outlook for the company’s fundamentals is improving.Additionally, the company trades below its historical average The forward dividend yield is as high as 2.61%. Combined with improving fundamentals, the company is a buy. Therefore, I am upgrading my rating.

Revenue Analysis and Outlook

In my previous article, I discussed the company’s mixed outlook due to the negative impact of the Fabuloso all-purpose cleaner product recall on sales growth. Additionally, slightly higher than historical valuations also keep me on the sidelines. The company has since reported earnings for the first and second quarters of 2023. While the company’s Q1 2023 earnings saw similar dynamics, as I expected, the forward outlook for Q2 2023 earnings took a positive turn. With the stock trading below where it was at the time of my last article, I considered taking a deeper look at the fundamentals.

In the second quarter, the company’s sales growth benefited from increased advertising activity and higher prices. Additionally, synergies from the recently acquired Red Collar pet food business also contributed to sales growth. This was partially offset by lower volumes driven by strict comparisons to the prior year quarter and reduced promotional activity. Overall, revenue increased 7.5% year over year to $4.8 billion. Excluding a 1.5 percentage point gain from the acquisition of the pet food business and a 2 percentage point unfavorable impact from foreign exchange, organic sales increased 8% year over year. Organic sales growth reflected an 11-point gain from higher prices and a 3-point volume decline.

Going forward, I believe the company should be able to continue to deliver organic sales growth as it continues to benefit from rising prices. Additionally, volume growth should also begin to recover in the second half of 2023 due to increased advertising activity, increased promotions, and easing of comparisons. Additionally, good strength and market share gains in Hill’s Pet Foods business should help the company sustain sales growth in the coming years.

The company has raised prices significantly over the past two years to offset the negative impact of inflation. This benefits the company’s organic sales growth. The company is raising prices further in the first half of 2023 and plans further price increases in select markets where inflation continues to be high. I expect the carryover impact of higher prices and additional pricing into the first half of 2023 to continue to support organic sales growth.

In addition, sales volume comparisons are slowing down in the second half of this year. The company’s volume comparisons became about 500 basis points easier from the second quarter to the third quarter. This should be a good driver for a recovery in volume growth and aid comparable sales growth.

Additionally, the company has increased advertising activity over the past few quarters to support price increases and increase consumer awareness over the past few quarters. In the second quarter alone, the company’s advertising investment increased by more than 20% year-on-year, and advertising accounted for 12.5% ​​of sales, much higher than the level before the epidemic. This has helped the company build market share in top categories such as toothpaste, sunscreen and Hill’s Pet Nutrition. The company also plans to continue ramping up advertising in the second half of the year. This should help the company restore sales levels by increasing market share and brand loyalty and preventing a decline in consumer trade.

In addition, the company plans to increase promotional activities to drive sales. In the first half of this year, the company eliminated promotional offers to offset the cost of inflation. This had a negative impact on volume growth in the second quarter as the promotional gap with peers widened. However, going forward, the company plans to gradually increase promotions to make up for the volume it lost to peers due to reduced promotions in previous quarters. This should also support a recovery in volume growth and aid sales growth in the second half of the year.

Additionally, the company’s oral care business is growing market share in both developed and emerging markets. This is due to the company’s increased innovation at different price tiers, especially in the whitening category. The company is aggressively launching high-quality, value-for-money products at entry price points ($4-$6) to attract consumers into the whitening category and drive them to upgrade to premium products (>$25 once they become accustomed to the category and require greater efficacy ). This improved demand for oral care products in the company’s top eight markets, resulting in 180 basis points of market share growth year-to-date in 2023. I expect further innovation and higher advertising will support the category’s growth in other sectors and markets around the world. Helps gain further market share in the future. This should help sales growth.

Finally, Hill’s pet nutrition division is also facing good consumer demand. This is due to an increase in pet adoptions during the pandemic and now post-pandemic, these new pet owners are in need of nutritious pet food and pet hygiene-related products. This helps the company’s Hill’s pet nutrition business. However, last year the company faced capacity constraints to meet this demand, resulting in a loss of market share. To address this issue, the company acquired the Red Collar pet food business in September 2022, which will help it gain additional production capacity and meet consumer demand. Additionally, the company plans to add a pet food plant in Tongannock, Kansas, by the end of the third quarter. This will further increase distribution to better meet current demand and boost business sales.

Therefore, management’s execution in recent quarters provides some visibility to a volume recovery in the coming quarters, and I believe the above tailwinds should help the company sustain business growth in the second half of 2023 and beyond.

Profit Analysis and Outlook

In the second quarter of 2023, the company continued to face raw material cost inflation, resulting in a year-over-year decline of 540 basis points. In addition, start-up costs related to additional pet food facilities and lower-margin private label sales related to the Red Collar business also impacted margins, which declined 70 basis points year over year.

However, the company was able to offset this through price increases, which increased gross margin by 450 basis points year-over-year, and cost-saving initiatives, which increased gross margin by 240 basis points year-over-year. This resulted in gross profit margin increasing 80 basis points year-over-year to 57.8%. Adjusted operating margin declined due to lower SG&A as a percentage of sales due to moderation in logistics costs and operating leverage despite higher advertising spending. This resulted in a 60 basis point year-over-year increase in adjusted operating margin to 20.6%.

Going forward, I believe the company should be able to continue to grow profits. As discussed in the revenue analysis, the company raised prices in the first half of 2023 and has plans for further price increases in select regions where inflation is very high. These incremental price increases, along with the carry-forward impact of price increases in the first half of 2023, will also contribute to the company’s margin growth. Additionally, the company’s margins should also benefit from improved volume leverage as volume growth resumes in the second half.

Furthermore, while agricultural raw material inflation is expected to remain high year-on-year, overall inflation should have less of a drag on corporate profit margins due to slowing logistics costs. This should alleviate some inflationary pressures on margins going forward. Management expects foreign currency headwinds to also ease in the second half, supporting margin expansion. In addition, the company’s newly acquired pet food production capacity through the acquisition of the Red Collar pet food business already had some private label production before the acquisition, with lower profit margins. The company has gradually reduced this volume mix after the acquisition and expects private label sales to disappear completely in the second half of the year. This should lead to a favorable volume mix and help profit growth. Finally, I also expect that the opening of a new pet food plant in Tonganoxic, Kansas, in the second half of the year will improve operating efficiency through improved utilization, which will also help profit growth. Therefore, I am optimistic about the company’s future profit growth prospects.

Valuation and conclusion

Colgate currently trades at 23.22 times the fiscal 2023 consensus EPS forecast, or $3.17, and 21.33 times the fiscal 2024 consensus EPS forecast, or $3.45. This is lower than the 5-year historical average P/E ratio of 24.51x. The company’s forward dividend yield is also decent at 2.61%. I believe the company has good growth prospects, benefiting from higher prices, resumption of volume growth, increased investment in advertising, improved efficiencies, and a favorable cost structure.

While lower consumer trade in an inflationary environment is a concern in the near term, I believe the company should be able to weather the storm and continue to do so thanks to management’s efforts to maintain top and bottom lines amid uncertain macroeconomic conditions. Achieve revenue and profit growth. With visibility of a recovery in sales, the company’s overall fundamentals appear to be improving. This, coupled with lower than historical valuations, leads me to upgrade my rating to Buy.