Third Point recently acquired a significant position in Colgate-Palmolive (CL, Financial). The investment fits several important criteria in the current investment environment. First, the business is defensive and has significant pricing power in inflationary conditions. Second, there is meaningful hidden value in the company’s Hill’s Pet Nutrition business, which we believe would command a premium multiple if separated from Colgate’s consumer assets. Third, there is a favorable industry backdrop in consumer health, with new entrants via spin-offs and potential for consolidation. Finally, the current valuation is attractive both because earnings growth is poised to inflect higher, and because shareholders are paying very little for the optionality around Hill’s or Colgate’s ability to participate in further consolidation in the consumer health sector.
Colgate has a strong portfolio of brands and operates across four categories that should perform well across most economic conditions: oral care, home care, personal care, and pet nutrition. Although Colgate has delivered organic sales growth of 5-6% over the past few years, earnings growth has been disappointing, and the stock has become a perennial underperformer. Foreign exchange headwinds have pressured reported results. Business reinvestment, supply chain disruption, and inflationary pressures have weighed heavily on margins; those headwinds are now reversing. Stepped up investments in demand generation, product innovation, and digital capabilities are starting to pay off. Global supply chain bottlenecks are easing and product availability on the shelf is improving. And, most importantly, raw material, transportation, and wage pressures are stabilizing, and even reversing in some areas, at the same time additional pricing takes effect. Taken together, the stage is set for Colgate to deliver several years of outsized earnings growth, as sales continue to increase, foreign exchange movements are annualized, and margins finally recover.
The star of Colgate’s portfolio over the past few years has unquestionably been the Hill’s Pet Nutrition business. Hill’s is a premium pet food brand that distributes primarily through specialty and veterinarian channels. Its best -known brands are Hill’s Science Diet and Hill’s Prescription Diet. Hill’s has been growing sales organically at 11-12% over the last several years, generates mid/high 20’s operating margins, and is on track to contribute about 20% of Colgate’s sales and profits in 2022. What is even more impressive is that the business has achieved this level of performance despite experiencing supply constraints. To support future growth, the company recently acquired three pet food manufacturing plants from a third party. This strategic move allows the company to bring on additional capacity faster than rivals, take share and thus accelerate growth.
The pet category is one of the most exciting pockets in consumer, and Hill’s is a phenomenal brand with a long runway for growth. We believe that as a stand-alone business, Hill’s could deliver even faster growth and better margins, and would command a premium multiple of 25-30x EPS for an aggregate valuation approaching $20 billion on CY23 numbers. Hill’s is a valuable consumer growth company and hidden gem inside of Colgate’s otherwise defensive product portfolio.
Colgate is an important piece of the consumer health sector, which is currently undergoing unprecedented change. GSK and Pfizer recently separated their consumer health division (now called Haleon) after rebuffing a GBP 50 billion offer for that business from Unilever.
Interestingly, Haleon has a large presence in oral care, with brands like Sensodyne, Parodontax, and Polident. Johnson & Johnson also plans to separate its consumer health business, which includes marquee brands like Listerine, Tylenol, and Neutrogena. Such large transactions should cause further consolidation in the space, which could create some interesting opportunities for Colgate’s assets. Although the Board is fairly long-tenured and not known for making bold moves, we are confident that it will act in the best interests of shareholders if Colgate becomes part of the current M&A minuet in consumer health.
Colgate’s valuation provides a strong margin of safety coupled with significant upside. On our numbers, shares now trade for a low 20x multiple on CY23 EPS. Looking ahead, we see shares compounding at a mid to high teens rate over the next several years just from earnings growth and the nearly 3% dividend. Any strategic actions around Hill’s or the consumer health sector could add materially to our expected return.
From Daniel Loeb (Trades, Portfolio)'s Third Point third-quarter 2022 letter.
