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Colgate: Bending to competition? - Views on News from Equitymaster
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Colgate: Bending to competition?
Jul 25, 2005

Introduction to results
Oral care major Colgate India (Colgate) has announced its results for the first quarter ended June 2005. Declining realisations on account of intensifying competitive pressure has taken a toll on the company’s performance, as it has recorded a lackluster growth in the quarter. Further, a greater than proportionate rise in expenses has led to the margins contracting by 50 basis points.

(Rs m) 1QFY05 1QFY06 Change FY05
Net Sales 2,427 2,583 6.4% 9,642
Expenditure 2,023 2,167 7.1% 7,968
Operating Profit (EBDIT) 403 416 3.1% 1,674
Operating Profit Margin (%) 16.6% 16.1%   17.4%
Other Income 56 106 91.0% 342
Interest 3 2 -33.3% 12
Depreciation 46 26 -43.8% 224
Profit before Tax 411 495 20.5% 1,781
Exytraordinary income/(expense) - (75)   -
Tax 156 140 -10.6% 649
Profit after Tax 254 280 10.1% 1,133
Net profit margin (%) 10.5% 10.8%   11.8%
Effective tax rate (%) 38.0% 28.2%   36.4%
No. of Shares (m) 136.0 136.0   136.0
Diluted earnings per share* (x) 7.5 8.2   8.3
P/E ratio (x)   29.3    
(* annualised)        

What is the company’s business?
The ‘Colgate’ brand is synonymous with oral care in India. The company has successfully created a strong brand image and awareness in the minds of consumers over the last fifty years. Colgate earns around 95% of its revenues from the oral care segment. The company leads the 90,000 TPA oral care market with nearly 50% share. The oral care market has a penetration of only around 42% in India. The company also has a small presence in the personal products category with brands such as Palmolive (soaps, shaving products) and Charmis (face cream).

What has driven performance in 1QFY06?
Revenue show goes on:  The company recorded a paltry growth of 6.4% in topline during the first quarter, inspite of the toothpaste segment growing at a faster rate, indicating that other companies have put pressure on Colgate’s pie. Low priced competition has also been a bane for the oral care major. The company’s soap division continues to be a drag on the balance sheet.

Margins dented:  During the quarter under review, operating margins have dipped by 50 basis points, mainly on account of rise in advertising expenditure from 16% of sales in 1QFY05 to nearly 18% in 1QFY06. Staff costs have also risen during the quarter, adding to the pressure on the margins. However, the company’s cost of goods has declined from 51% of sales to 48% in 1QFY06, and this has seemingly pared the margin decline.

Cost break up
as a % of net sales 1QFY05 1QFY06
Total Cost of goods 51.0% 48.3%
Staff Cost 6.2% 7.8%
Advertising 16.0% 17.7%
Other Expenditure 10.1% 10.1%

‘Extraordinary’ hit on bottomline:  A one time expense of Rs 75 m has hit Colgate’s bottomline during the quarter. Reportedly, this expense was towards provision for diminution in the value of the company’s investments in its wholly owned subsidiary in Nepal, consequent to the discontinuation of toothpaste production at the Nepal facility. Depreciation for the quarter was down 44% YoY mainly due to closure of the Aurangabad plant. However, once Colgate’s toothpaste manufacturing facility at Baddi, Himachal Pradesh becomes fully operational, depreciation will rise further.

Over the past 5 quarters
  1QFY05 2QFY05 3QFY05 4QFY05 1QFY06
Sales growth (YoY) 6.8% 6.5% -5.8% 3.9% 6.4%
Advertising as % of sales 16.0% 14.4% 12.8% 13.6% 17.7%
OPM (%) 16.6% 18.0% 17.0% 17.8% 16.1%
Net profit growth (YoY) 23.0% 16.4% 4.0% -12.1% 10.1%

What to expect?
At the current price of Rs 241, the stock is trading at a price to earnings multiple of 23.6 times our estimated FY07 earnings. Although revenue growth for the quarter has been lacklustre, the same cannot be said for the bottomline as it has been impacted mainly on account of the extraordinary expense. Also, the fact that the company has spent a greater amount towards advertising is indicative of the stiff competition that it is facing in the domestic oral care market.

Though per capita consumption of oral care products in India is poor compared to even other developing nations, we believe that Colgate is essentially a long-term story. In our view, the prospects of the company are still too leveraged on one product, which is facing intense competition. The company is likely to see bottomline expansion over the next year owing to tax benefits and operating leverage but growing the topline will remain a challenge. Colgate is not among our top picks from the FMCG sector. But this could change if the parent decides to make Colgate India as one of its key outsourcing hubs for toothpaste.

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