Time to book profit in Colgate
Expectations of higher spend on advertising likely to weigh on earnings growth
Expectations of an earnings boost from lower corporation tax rates, and improvement in market share following the appointment of Ram Raghavan as managing director (from August), had kept investor sentiment buoyant in Colgate.
Shares, as a result, had risen nearly 35 per cent during the three-month period ending on October 23. However, concerns over operating margins and market share recovery in its key toothpaste segment after the September quarter (Q2) results indicate that investors should be cautious.
The company announced its Q2 results last Thursday, and its stock has lost 2.6 per cent since, compared to a near 2 per cent gain in the Nifty FMCG (fast-moving consumer goods) index.
While the loss in market share has been testing investors’ patience since a few quarters, margin pressure has compounded its woes. There is little doubt that the focus on regaining market share in the toothpaste segment with higher advertising spend is t he right step. However, the Street is less confident, for now.
While some analysts believe competitive intensity from Patanjali has weakened to a large extent, those at
SBICAP Securities say other large and strong players — such as Hindustan Unilever, Dabur, and Glaxosmithkline Consumer — are very aggressive in the toothpaste category, which makes market share recovery difficult for Colgate despite higher advertising spends.
A few others, too, are sceptical about Colgate’s success in the naturals segment (Swarna Vedshakti).
“Although Colgate shall continue with higher ad spends and trade promotions to gain the lost share, lack of a blockbuster product in the naturals/ayurvedic segment makes it extremely difficult,” said analysts at Prabhudas Lilladher in a Q2 updated report.
Even in Q2, Colgate continued to l ose market share despite a sharp rise in advertising and promotional spend. Analysts at Edelweiss Securities say further l oss in toothpaste market share, in spite of higher promotional and advertising spend, remains a cause for concern.
After l osing
380 basis points
(bps) in market share from June 2016 to June 2019, the figure is estimated to have reduced further by 50 bps in Q2. The company has stopped disclosing market share data.
On the other hand, advertising expenses as a percentage of operating revenue surged by 250 bps year-onyear (YOY) to 14.4 per cent, hurting Ebitda (earnings before interest, tax, depreciation, and amortisation) margin and bottom line in Q2. Colgate witnessed a 178-bp YOY contraction in Ebitda margin in Q2 to 26.4 per cent, its lowest in nine quarters.
Profit before tax was down about 7 per cent YOY to ~278.8 crore. A 24.3 per cent jump in net profit was on account of lower corporation tax rates, and therefore, not comparable. Expectations of higher advertising and promotional expenses, amid subdued demand environment, could weigh on t he company ’s earnings growth. Analysts at Kotak Institutional Equities have trimmed their earnings estimates by 4.8 per cent and 2.4 per cent for 2019-20 and 2020 -21 (FY21), respectively. Overall, investors should avoid taking fresh exposure to the stock until there is a structural improvement in market share with consistent margin performance.
The current stock valuation of around 42x its FY21 estimated earnings is 15 per cent higher than its historical long-term average valuation. At present, close to 60 per cent of 37 analysts polled by Bloomberg have a ‘hold’ or ‘sell’ rating; at least four have downgraded it after the results. Their average one-year target price of ~1,509 is lower than the current price of ~1,535.