Colgate-Palmolive - Part 4

Finally, we have here a quick cheatsheet of Colgate's financials.

Basically, it's a company earning USD 4bn on a revenue base of USD 16bn every year and we can expect this to grow maybe 13-15% for the next few years. This growth factors in all we have talked about, including P&G's entrance, GDP growth etc.

Toothpaste is a business that doesn't need a lot of capex, so basically free cash flow is used to pay shareholders. It's free cash flow is about USD 2.4bn, and the FCF yield is 6%.

The interesting part about Colgate's financials would be its balance sheet. Some would argue that it's not exactly great. Debt at USD 3.4bn is greater than its equity of USD 2.8bn. So isn't this risky?

My take is that the management has basically optimized the balance sheet to the hilt. Why is the equity so low? If you notice, equity at USD 2.8bn is the same as a single year's net profit.

This implies that the co. has been paying back equity to its investors. Bcos the business doesn't need money to grow. Whatever excess money made is paid back to shareholders. Although dividend is 3%, Free cashflow yield is actually 6%, I am guessing that the other 3% is used to buy back shares.

And the debt of USD 3.4bn can be easily paid back in less than 2 yrs, using its free cashflow.

However, having analyzed all these, I must admit Colgate is not cheap. PE is 13x two years out, while growth is also roughly 13%. Looking at other measures, EV/EBITDA is a good 10x. This stock is simply trading at its intrinsic value.

The bet here is that the intrinsic value will grow over time. From its track record, it doubles every 8 years or so. Given its current outlook, with growth from emerging markets and some margin improvement, it might take a little shorter than that.

So buy Colgate-Palmolive, get that 3% dividend and see it double to 6% in 6 years and double again to 12% in 12 years! That's a Dividend Aristocrat for you.

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.

Colgate-Palmolive - Part 2

Colgate is very big in toothpaste. This is something that is well-known but yet underrated. When I tell people Darlie also belongs to Colgate, most people are pleasantly surprised.

But what really surprised me was when I went down to my local supermarket and saw that the toothpaste segment basically sells just these 2 brands. I mean, Colgate and Darlie dominate the shelves! There are a few tubes of Sensodyne (by GSK), which is now competing with Colgate's own Sensitive Relief Pro. And there is kids' toothpaste. That's it. The rest is all Colgate.

Here's Colgate's market share in some of the world's biggest markets.

Australia 69%
Brazil 67%
Chile 33%
China 33%
Mexico 80%
Russia 33%
Singapore 80% (my personal guess)
UK 47%
US 35%

Isn't this co. amazing? This firm basically dictate what human beings should use when they brush their teeth.

Why can Colgate exert such dominance?

1. Distribution

Colgate is obviously very strong here, it is already distributing toothpaste in the most remote part of the world when people are talking about BRICs. Next time you visit some of our neighbours like Myanmar or Cambodia, take note of the brand of toothpaste they use!

2. Taste

Again, I think people simply don't like new tastes when brushing their teeth, hence they will keep buying the same brand unless prices are raised by 300% or something.

3. Brand

This is something we talked about countless times. When asked to think about toothpaste, what comes to mind? Colgate's mindshare simply dominates.

So there is little threat that things will change in the next few years. Colgate will continue to dominate the markets and grow. Given its high market share in a few regions, it's OPM is also exceptionally high in these regions, at 30% or more. So as these region gets bigger we can expect marginal improvement in the firm's overall blended OPM. But not much, maybe from 25% to 28% or so, over a few years.

Next post - Risks!

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!

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!