Colgate-Palmolive Co. (CL, Financial) is one of the oldest and largest names in the consumer goods industry. Over the years, it has grown to become a profitable cash cow, but its revenues have flattened with the management's focus on margin expansion. The company has also started to see strong competition and loss of market share in key markets as well as rising operating expenses and foreign exchange risks in emerging markets.
Rising operating expenses
Colgate-Palmolive has struggled to produce organic revenue growth over the last several years and there has been a marginal increase in terms of operating costs. The company generates more than half of its revenues outside the U.S. and the weakness of currencies in emerging markets like India is affecting costs. Inflation in these economies is the reason for rising operating expenses. As a result, management revised its operating margin guidance, which was previously expected to increase by 50 basis points, to a more realistic level.
Strong competition in key markets
The largest emerging markets for Colgate-Palmolive are Brazil, India and China. While the company is a market leader in oral care products in both Brazil and India with over 50% market share, it also owns nearly a third of the Chinese market. The current slowdown in these economies as a result of the trade war and the generally weak economic climate has had an impact on Colgate-Palmolive’s business.
While long-term macroeconomic factors, such as high population growth, work in the company's favor, it has started to see strong local competition in these markets. Not only is there a strong emergence of domestic players, but the improving performance of private labels is resulting in a loss of market share, stagnant revenues and stunted growth.
Solid fundamentals and weak growth
Colgate-Palmolive is a classic example of a company that is focusing on margins after growth has flattened. The company enjoys a healthy 13.97% net margin and a return on assets of 17.24%, outperforming industry peers. However, the cause for concern is the growth numbers. The company's three-year revenue growth is -0.4% and every gain in profitability has been largely due to the efficiency of the management team. Given these factors, the current price-earnings ratio of 25.02 seems fair. The enterprise value-to-revenue ratio of 3.85 seems to be slightly on the higher side.
Colgate-Palmolive's five-year price chart justifies the current price level as we see the total revenue has dropped, which is why the price level is more or less within the same range. The historical price upswings are justified by the dramatic improvement in the margins, but these are also expected to stabilize soon.
The stock has provided a decent dividend yield to investors over the years. The five-year yield-on-cost is 3.42%, which is on the higher side for a consumer goods company. The current yield is 2.62%, which is expected to remain stable in the future.
Conclusion
Colgate-Palmolive is not a bad investment for those who already hold the stock. A decent dividend yield and a management team focused on margin expansion are two very positive aspects of the stock. However, the company is struggling to grow its oral care business despite the rising population and is losing market share in large economies. The rise in material costs due to inflationary pressure is also not a positive sign. From a growth perspective, the stock appears to have very limited upside but can be held for its dividend yield.
Disclosure: No positions.
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