Friday, February 18, 2011

Colgate-Palmolive - Part 3

Every stock has its risks and here we talk about Colgate's.

Colgate's biggest risk comes from its competitor - P&G. This company is the nemesis of Colgate, like Jedi vs Sith, Windows vs Mac, Man U vs Liverpool. You get the idea!

P&G has 24% of the oral care market, just a tad smaller than Colgate's 26%. P&G owns Crest - the other big toothpaste brand in US and some other parts of the world (but not in Singapore) and Oral B, the toothbrush specialist.

As we can deduce from our own personal experiences with these brands, P&G probably has a bigger market share in the not-so-profitable toothbrush and other oral products (like floss, denture solution, rinse etc) and a smaller share in toothpaste, where Colgate is really the gorilla here.

Now P&G has been trying to break Colgate's dominance in toothpaste, hence they are been aggressively pricing their products in various important markets. They are really pushing toothpastes of Crest and Oral B into the emerging markets and the biggest market - the US.

This perhaps explained the weakness in Colgate's earnings and stock performance over the past 12 to 18 mths. P&G had some moderate success and Colgate's sales growth in emerging markets indeed slowed in the recent quarters.

With risks in investment thesis, it is also usual practice to come out with mitigating factors, which would help dilute the risks. So for P&G, I guess the mitigating factor would be that the situation would probably be temporary.

This is bcos once P&G reach a optimal market share where it enjoys economies of scale as well as optimal profitability, it doesn't make sense to cut prices to gain volume any further bcos the marginal profit goes down significantly.

Let's rationally thinking about this. In a market where 80% of people uses Colgate (like Brazil or Singapore), there are probably some people who would switch to P&G bcos of price. So we can expect Colgate's share to fall. But after it falls to 60%, ie P&G now has 40% of the market, does it make further sense to throw a ton of money into advertising, sales rebate to get shelve space, and to further price cuts to gain the additional 10%?

Toothpaste is a very personal choice, there would be a group who would never switch from Colgate bcos they like the taste, or the colour or whatever. So it gets harder and harder to get more share.

Of course, P&G also risks Colgate's retaliation. Colgate has lower manufacturing costs bcos of its bigger scale and its first mover advantage. Colgate's local factories are probably built years ago, fully depreciated with more experience staff and sales people. If Colgate embarks on a price war, P&G will lose.

Hence it is likely that P&G would stop cutting prices once it has gained some share and some loyal customers. P&G stands to gain more by maintaining prices, improving margins and just enjoying the organic growth of the market. As the market is growing rapidly, I believe there is room to accomodate 2 players. This means that Colgate would not get to same spectacular growth it enjoyed bcos of P&G's entrance but it's still respectable growth in a great business in the right geographical regions.

As a last note, in a industry where there are only a few players, it make sense to maintain some price discipline such that all the players can make good margins. This is something akin to the Prisoners' Dilemma that we talked about. Both players stand to gain if they cooperate rather than fight.

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