Wednesday, January 26, 2011

Colgate-Palmolive - Part 1

There should always be an investment thesis behind every investment. An investment thesis is a statement to describe in a few words why you bought the stock.

The investment thesis for Colgate would be something like this:

Colgate-Palmolive is the biggest player in the oral care industry with a dominant market share in toothpaste globally. Colgate enjoys the stable growth of the consumer staples sector but has significant exposure to the growing emerging markets (Latam and Asia). Earnings is likely to grow at double digit for the next 3 to 5 years.

After writing the investment thesis, it is usual practice to put down a few positives, risks, valuation, snapshot of the financials and other relevant details.

First let's look at Colgate's geographical breakdown

As you can see, most of Colgate's profits are coming from outside developed markets (US and Europe). There is a segment called Pet Nutrition, although it's probably exposed to developed markets, it's a growing segment with a respectable 15-20% growth. So just roughly calculating, around 65 to 70% of Colgate's business is actually growing fast, ie double digit growth. From there, we can then think of the overall co. blended growth, which would be roughly 8-10% at the topline or revenue level.

At the operating level, margin is at a high 25%. Colgate is a very well-run firm, it's operating margin or OPM has been expanding for the last 7-8 years. However we cannot assume that this would go on indefinitely, maybe 28% would be a peak. There are a few supporting factors:

(a) Emerging markets has higher margins
(b) There is some success launch in high end toothbrushes
(c) Colgate has come up with toothpaste for sensitive teeth, which is grabbing share in developed markets

So, for 8-10% topline growth, with some margin expansion, Colgate can actually grow its earnings at teens for the next few years. In fact, that is exactly what Colgate had achieve for the last 10 or even 15 years, with even lesser topline growth.

Colgate's tremendous but yet stable growth is demonstrated by its dividend track record. Colgate has increased its dividend for the last 47 years! Needless to say, it's one of those admired Dividend Arisocrat and it's just going to keep growing!

Next post, we look in detail at its dominance in oral care!

Monday, January 10, 2011

The Oral Care Industry

Value investors love mundane sectors and what could be more mundane than brushing your teeth? Nobody ever talks about brushing their teeth, how they enjoy it or how they look forward to it every morning. Well basically I think nobody does, that’s why it’s never been talked about.

But as far as investing is concerned, this is one of the best business to be it. We will talk about a few important points:

Everyday Necessity (Consumer Staples)

Well, first of all, everyone brushes teeth at least twice a day right? Toothpaste runs out fast, and people just buy back the same brand without thinking too much. Even if prices were up like 20%, they will still buy it. After all it’s something going into your mouth. If it’s going from $5 to $6, most people wouldn't risk switching to something that doesn’t taste right.

And toothbrushes, they wear out fast too! Not to mention dentists keep recommending that you change yours every 2 months. So it’s a business with growing recurring demand, as long as world population grows.

This is also the beauty of consumer staples. Hence they usually trade at a higher multiple vs other cyclical sectors.

The Industry Structure

The business model may be great but if there are too many competitors, it drives margin down and there is little money to be made. The strange thing about the oral care industry is that globally, there really aren’t that many players. Basically there are only 5, and they control 70% of the world’s market. The top 2 guys alone, Colgate and P&G, controls 45%. So it’s an oligopoly.

When the industry structure is such, the top players have the pricing power and they call the shots and the 3 minor players will follow. Of course they are also cognizant that they can only raise prices to the extent that consumers won’t be put off. If toothpaste becomes $20, I think a lot of alternative brands will appear and most people will switch to them immediately.

However the top players would choose to raise prices just enough to keep people from switching. In fact, given their size, they can lower prices to kill competition when they see fit. That is the power of oligopolies and monopolies.

Well, it’s not so good for the consumers though.

Emerging Market Growth

As with most consumer staples, we can expect steady growth as long as consumption grows. Specifically for oral care, growth rate can actually be high single digit driven by volume increase (as global population increases) and price increase (which should keep in pace with inflation, if not more) over the long run.

It is worth noting that this high single digit growth is also mostly driven by emerging markets. The number actually breaks down to low single digit growth rate for developed markets and teens growth rate for emerging markets.

So having exposure to this industry is basically another way to bet on the growth in the emerging markets. The difference is that you probably pay a fraction of the multiple of the actual consumer staples in emerging markets. (Well the growth rate is also lower bcos the base includes developed markets)

Next, we look at the main player in the market!