Colgate-Palmolive (CL, Financial) is one of the world’s largest global producers of detergents, toiletries and other household and pet nutrition products.
The company has some of the most familiar and well-regarded brands in the world including Ajax, Palmolive, Irish Spring, Softsoap, Fabuloso, Mennen, Speed Stick, Science Diet, Hill’s Pet Foods and Colgate. Each of these brands has a dominant position within its respective market. Colgate controls approximately 45% of the worldwide oral care market, 23% of the personal care market, 21% of the home care market and 13% of the total pet nutrition market.
Although revenues have been squeezed over the last two years due to strength of the U.S. dollar, Colgate-Palmolive’s expansion efforts into new international consumer product markets continues to advance as expected and now has a presence in more than 200 countries and territories. About 82% of its revenues are now generated from international sales – with more than 50% of those sales coming from emerging markets.
Financial highlights
As expected, given Colgate-Palmolive’s significant international presence, it produced fairly mediocre financial results after taking into account currency movements. Net sales dropped 5% to $15.2 billion while global unit volumes fell 2%. Excluding divested businesses and the impact of the deconsolidation of the company's Venezuelan operations, unit volume actually increased 1.5% and organic sales grew 4.0%. In Latin America, which makes up 24% of sales (and is the largest region of operations; North America at 21%), unit volume decreased 16.5% with 9.0% higher pricing while foreign exchange was negative 3.0%. Organic sales for Latin America increased 10.5%. From what we can tell, a lot of what is going on with declining sales has to do with the strengthening value of the dollar. Much of the company’s production is done in local markets so currency impacts play their largest role on translation to the financial statements.
That said, with some modest cost reductions and efficiency gains along the distribution channel, Colgate-Palmolive was able to grow its operating margins to 25.3% in 2016 (the highest level in 10 years) and boost its net earnings by over 75% to $2.4 billion. Included in this is a gain on the sale of land in Mexico. A good-sized share buyback further supported per-share earnings growth, and the dividend was raised 3.3%. Sales through 2017 should grow in the low single digits but, of course, will remain sensitive to currency movements. The implementation of additional cost cutting measures, new marketing campaigns aimed at higher-margin personal care items, and new product launches offset by higher input and packaging costs should lead to further gross margin expansion and a modest increase in earnings.
Purchase considerations
Colgate-Palmolive controls some of the best brands in the world, many of which aren’t even recognizable to North American Investors, and most are position leaders in their respective markets. Colgate-Palmolive has a 44% share of the global toothpaste market and 33% share of the manual toothbrush market. Other brands, such as Ajax and Softsoap are number one or two, and it has many other top five brands. The company pursues a “first-to-market” global strategy that has given it a strong foothold in most emerging markets such as China, India, and Latin America.
Colgate-Palmolive is in an amazing position to benefit from the increased acceptance and use of dental care products and other toiletries in these markets. Colgate-Palmolive is also highly liquid, conservatively financed and generates a tonne of cash. The company favors organic growth over acquisition driven growth, which typically results in better returns on reinvested capital. The company rarely slumps and is largely recession proof. It reinvests heavily and achieve profitability through operational efficiencies.
Colgate-Palmolive is a solid defensive play with a good dividend that will benefit from global income growth. Relative to some of its top competitors, such as Procter & Gamble (PG, Financial), Colgate-Palmolive is also a safer, steadier, stock in the consumer necessities market as it is less aggressive about reaching for new sources of growth in sometimes fast-changing markets such as cosmetics. This company is all about being slow and predictable but has a management team that is oriented to generating strong returns for shareholders with little risk.
Fundamentals-based technical valuation
Technical valuation provides a basis for evaluating stocks by analyzing the statistics generated by market activity, such as past prices. Most technical indicators do not measure a stock’s fair value but instead use charts and other tools to predict directional patterns and ranges in stock prices in an attempt to predict the future. In this section, we do precisely that, but we use different types of technical indicators, what we call “Fundamentals-Based Technical Indicators.” That is, while each of the indicators relies on price patterns, price patterns are always viewed in combination with drivers of company fundamentals, such as business sales, earnings, cash flows or book value. Our combined use of historical price and fundamentals data is what separates them from their traditional technical counterparts in which the only thing that really matters is the stock’s past price and/or volume pattern.
Technical indicators
A brief description of each indicator is presented below, with results to follow.
Earnings calibration model: A forecasting method that calibrates the company's forward price trend with the company’s EPS trend using 15 years of quarterly price data. This method assumes that there will be no multiplier expansion or compression. Price is projected forward based on a moving weighted average of the firm's trailing 12-month earnings line calibrated to the last three-year, five-year, 10-year and 15-year periods. The stock's average annual trading range is used to establish upper and lower price bounds. If an investor believes that the firm's earnings multiplier will expand (compress), then they might want to adjust our price estimate upward (downward).
Least squares regression model:Ă‚ A forecasting method built using linear econometrics processes. Price is projected forward based on a linear econometric model built using 15 years of quarterly data. Explanatory variables include sales per share, earnings per share, free cash-flow per share and book value per share. Results are tested for statistical significance and projected forward based on estimates of sales, earnings, free cash-flows and book value.
Correlated time series model:Ă‚ A forecasting method built using various time-series processes, including MA, AR, ARMA, GARCH, GBM and BMMR processes, that model the 15-year quarterly historical correlations between the company's stock price patterns and the company's sales per share, earnings per share, free cash-flow per share and book value per share and then uses these correlations to forecast the company's future stock price pattern. The stock's annual trading range is used to establish upper and lower price bounds.
Neural network model:Ă‚ Price is projected forward based on the results of a proprietary neural network forecasting model. The neural net was developed, trained and tested on the company's financial statements over the last 10 years. Pro forma financial statements are then incorporated into the neural net to generate estimates of the company's stock price two years forward.
1-standard deviation valuation bands:Ă‚ Valuations bands based on 1 standard deviation P/E (TTM) multiple (outliers removed) over the past 10 years applied to (1) trailing 12-months' earnings and (2) the market's earnings estimates for the next two years. A price line that trends within the upper and lower price bounds signals that the stock is approximately fairly valued.
Proprietary valuation bands:Ă‚ A forecasting method that helps identify the market direction of the company's stock giving investors a heads-up as to whether the stock is likely under or overvalued. This method involves the development of three price lines. A market price trend that exceeds the upper price bound is likely to fall in value or trend sideways until it is back within the upper and lower price bounds. At these times, do not expect much from your position. A price line that falls below the lower price bound might be a strong buy. At these times, expect the price line to trend upward until it is back within the upper and lower price bounds. The upper and lower price bounds and target price line are built using a closely held proprietary market based valuation model that simultaneously quantifies the simplicity/complexity of the business' operations, the extent to which the business' future is predictable, the strength of the firm's competitive advantage, the sustainability of the firm's competitive advantage and the financial strength of the firm.
Results
Figure 1 below presents model results with prices forecasted forward two years for our first three models. Figure 2 presents results for our last three models, with a summary of the data presented in Figure 3 below.
Figure 1: Earnings calibration, least squares regression and correlated time series models
Figure 2: Neural network model, 1-standard deviation valuation bands and proprietary valuation bands
Conclusion
The price estimates derived using each of these indicators with upper and lower price bounds are summarized in Figure 3. Average price estimates are compared to the market's estimates in the last three columns.
Figure 3: Valuation targets
Our earnings calibration model indicates a value of $45.53. Colgate-Palmolive's current price trends above the upper price bound of $50.11 and is a bearish signal. Our least squares regression and correlated time series models point to fair valuation with Colgate-Palmolive's stock trending within the lower and upper price bounds of $69.55 to $78.72 and $67.76 to $76.93. The neural network model also points to fair valuation, with Colgate-Palmolive's stock price trending within the lower and upper price bounds of $70.98 and $80.15. Taking an average of all model results, we carry a NEUTRAL rating on Colgate-Palmolive, setting a 12- to 24-month price target of $65.88 and a price range of $58.20 to $73.56. We recommend waiting for a bit of a price dip before taking a position (which will hopefully come soon!), but note that, while close, our estimates and valuation ranges are about 10% lower than the market's consensus estimates. As such, there could be a larger return inherent in a position in Colgate-Palmolive than our analysis suggests, if the market's estimates prove accurate.
As a further cautionary note, competition in Colgate-Palmolive’s primary markets are becoming increasingly intensified, requires greater innovation, and calls for more frequent product launches and advertising campaigns to stay relevant. Further, as we’ve seen over the last decade, Colgate-Palmolive’s heavy reliance on international markets results in heavy currency exposure, and with its growing presence in emerging markets, greater business risk, as is evidenced by the failed expansion into Venezuela (which was largely a currency driven business failure, not a managerial failure).
That said, Colgate-Palmolive is generally a steady stock play. It will never attract massive momentum-based capital inflows from more aggressive investors though, so don’t expect a rapid spike in the stock price any time soon.
Disclosure: We hold no positions in Colgate-Palmolive.
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