Colgate Palmolive

Colgate an outperformer, target Rs 497: Anand Rathi

Anand Rathi is bullish on Colgate Pamolive and has maintained outperformer rating on the stock with target price of Rs 497.

Anand Rathi research report on Colgate Pamolive India

Investment Positives

HUL’s shifting focus away from oral care to help Colgate: HUL's shift of focus from oral care is expected to help Colgate reduce adspend -- from 18% to 11%. The latter would gain market share as no other major competitor in gels and family toothpastes exists. Less competition renders it easy for Colgate to raise selling prices. And concentrate on low-priced toothpastes and toothpowders. Steady revenue growth: Low penetration and per capita consumption of oral care products offer strong medium to long-term growth opportunities. If India achieves half the recommended usage of oral care products in the next ten years, it could result in a 15% volume CAGR. Uptrading of products and the rise in the number of people brushing their teeth twice a day would also help Colgate grow rapidly.

Lower income taxes due to greater production at Baddi: Colgate has expanded capacity at Baddi, to 40,000 tons. So its entire production of toothpastes is expected at Baddi, resulting in lower income tax and savings in excise duty. We expect the effective income tax rate to be around 20% (compared to 26% in earlier years).

Strong FCF generation and generous dividend policy: Capex at Baddi and the VRS at Sewri are almost over. This is expected to result in strong free-cash generation. The company has rewarded shareholders by generous dividends over the years. Declaration of share capital reduction of Rs 9 showed the intention of the management to reward shareholders by returning excess cash. We expect Colgate to maintain such high dividend payouts following strong free-cash generation. At the CMP of Rs 405 and expected dividend for FY09, the stock trades at a dividend yield of 3%. Investment Concerns 􀂾 Rising royalties: With rising in-house production of toothpaste, Colgate is required to pay royalties to its parent company. We expect royalties to rise.

Competition:

Though the threat of competition is low, we do not rule it out. The aggressive launch of variants by Dabur, of Crest by P & G or one last attempt by HUL to gain market share can turn out to be big concerns for Colgate.

Investment Concerns

Reduced investment in oral care may lower growth rates As Colgate and HUL reduce advertising, awareness of oral care products would slow down. Reduced investment in educating people about dental hygiene might hinder industry growth rates.

On the other hand, Colgate, being the market leader, the onus lies on it to expand the category. This might compel it to bear the entire cost of category promotion. Competition Though we do not see competition as a major threat, we do not rule it out. In order to gain market share, Dabur and others (such as Anchor and Ajanta) may introduce products in gels or the family segment. Although not easy, it is possible that Crest would be launched sooner or later. This may create hurdles for Colgate. Also, we do not rule out one last blip by HUL to gain market share.

A business with high growth and a high RoE will attract competition, raising the threat of fresh players in toothpastes. Increase in royalties Colgate is required to pay 5% of net sales as royalty to its parent. However, it is required to pay royalty only on the in-house production. As the in-house production goes up at the Baddi plant royalties are expected to rise. We expect royalties to climb -- from 2.6% of net sales in FY07 to 3% by FY10. As the company still does not manufacture personal-care products, toothpowders and toothbrushes completely, it will not be required to pay royalties on them. In addition, Colgate will not be required to pay royalties on sales of Cibaca, an acquired brand.

Valuation

At the current market price of Rs 405 and FY09 estimates, the stock trades at a P/E and EV/ EBITDA of 17.5x and 12.7x, respectively. As major competitor HUL is expected to shift focus from the oral care segment, Colgate would be helped in a big way. The normalized earnings of Colgate can be much higher than its historical earnings. We expect the growth rates to be more buoyant than historical ones due to supportive macro-economic factors. According to the DCF valuation of Rs 497 and FY09 estimates, the stock trades at a P/E of 21.4x. We initiate coverage on Colgate Palmolive (India), with an OUTPERFORMER rating and a 12-month price target of Rs 497.