The last two years (2015 and 2016) have tested the shareholders of Colgate India. The share price has moved fairly sideways touching a low of 727 Rs and a high of 1099 Rs.The markets have been divided with long term investors holding on to the belief that Colgate will be able to recover and start delivering returns as it has done in the past . On the other hand, there are short sellers who believe increased competition from likes of Patanjali will result in loss of market share and lower profit margins.Adding to the misery, the stock was beaten down with news of Colgate having its  worst quarterly sales growth in 44 quarters (past 11 years) in December 2016.The report takes a look at what the future holds for Colgate shareholders. And if there is enough value for an investor to buy shares to create long term wealth.

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Setting The Table:

 

Before we get down to the valuation of Colgate India, it is important to observe the facts, economy, industry outlook, financials, past performance and competitive advantages. After analysis, each section will form assumptions leading to our valuation.

 

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Key Facts :

 

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1) Colgate is one of the most trusted brands in India.

2) It is one of the largest distribution networks in India.

3) 30% of Colgate India’s demand is from rural areas.

4) Shareholder friendly management which has consistently paid dividends over the past two decades.

5) Management has experience of facing competition in the past and good international product portfolio to up-sell.

6) Colgate is the industry leader with approximately 56% market share in toothpaste segment and 44% market share in tooth brush segment.

7) Low cost producer in the oral care segment compared to competitor due to economies of scale.

Oral Care Market in India:

 

Colgate is the number one player in India when it comes to oral care. Therefore growth of the company depends to a great extent on how the industry grows in the coming years. That being said, India is still quite behind most developed countries when it comes to toothpaste consumption.

toothpaste consumption and oral care market growth in india

India consumes only 127 grams of toothpaste per year per person compared to 255 grams in China and 542 grams in USA .The closest comparison can be drawn with China where the consumption is almost double that of India. The low per capita consumption is mainly attributed to the 3 things namely :

1) Only 57% of the population uses toothpaste in India .

2) Lack of awareness as majority of Indians only brush once a day.

3) Low levels of per capita income.

The toothpaste consumption has a positive correlation to per capita income of India.

 

The Indian Economy :

 

Economy + industry outlook

With the Indian economy slated to grow at 7% till 2020 and 5% post 2020 till 2025 (World bank estimates). One can deduce that as the Indian Economy grows per capita income will rise which in turn should support the growth in per capita toothpaste consumption.Thus there is significant room for oral care players in India to grow as more and more people will switch to using toothpaste as against traditional alternatives. Add to this a population growth of 2% per year on 1.2 billion population base which is set to overtake that of China by 2025.Thus one can assume that as India’s per capita income will grow,with that the toothpaste consumption will also grow.

 

First assumption:

India’s per capita income will grow and will cause the toothpaste consumption to grow as well. Indian Economy will grow at a GDP growth rate of 7% till 2020 and 5% post that till 2025

Second assumption: 

Oral Care market will experience positive growth till 2025 reaching close to 20,000 crores from 7500 crores in 2015

Third assumption:

Toothpaste per capita consumption will reach that of China in next 10 years. Volume growth will be in a range of 3.39%-5.2%

Fourth assumption : 

Growth in the usage of toothpaste and dental products will be in the range of  3-5% YoY till 2025

Monsoon and Rural Growth:

 

The majority of population in India lives in rural areas and are dependent on monsoons. And thus monsoons play a very important role in India’s corporate earnings each year. Colgate being in the FMCG sector is impacted quite a bit by monsoons. In fact Colgate India’s 30% of revenue comes from rural areas.It should also be noted that the lack of awareness for oral hygiene, purchasing power (per capita income) and dependence on monsoon for disposable income is skewed more towards rural areas as compared to urban areas.

Drought Years:

I would expect most of the revenue growth from Colgate to come from rural demand.While considering rural demand,most noteworthy is the fact that the past 2  years F.Y. 2015 and F.Y. 2016 have been drought years. During the period 1871-2015,there have 26 drought years.Thus based on this historical data there is a 18.3% probability of drought in India each year. India has experienced  droughts 5 times in 2 consecutive years  which means a probability of 3.5%. And once three years have consecutively been drought years having a probability of 0.7%. Thus based on the above data , there is a strong probability of 92.3% of good monsoons in F.Y. 2017.

 

Fifth Assumption :

Monsoons in India affect Colgate’s revenue growth

Sixth Assumption :

India will experience at least 2 droughts in next ten years, with a very low probability of 2017 and 2018 being drought years

Competition Intensity :

 

The past 2 years have seen fresh competition with new entrant Patanjali offering Dant Kanti in the natural segment. Other noteworthy competitors are Dabur RED, HUL with Pepsodent and Procter and Gamble with Oral B. Patanjali has managed to corner 4.5%  market share in a short span. Companies in the industry enjoy good pricing power, however some of it has become limited due to low price offerings from Patanjali.

Strategy of Colgate:

 

In times of high competition instead of price wars Colgate always increases its advertising spends to protect its market share. Colgate is very aggressive to protect its intellectual property and brand. As we have seen in the past, when it took legal action to block competitors from using red coloured packaging. Patanjali too has gotten into issues with ASCI over its false claims in advertisements. Colgate has recently introduced Cibaca Vedashakti in response to competition in the natural toothpaste segment.

Because of its strong distribution, low cost production and strong brand; in my view Colgate will be able to maintain a market share, if not improve on it.

 

Seventh Assumption :

Colgate will be able to protect its 57% market share against competitors because of its competitive strengths.

Analysis of Financial Statement :

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Colgate has a very good financial  track record. The company earns a very high return on equity. A high return on equity record signifies the management’s ability to reinvest its earns in profitable ways.

The company has no debt which protects it to a significant extent against interest rate risk. Colgate has had a track record of retaining on an average around 25% of its earnings. The rest is paid back to shareholders in form of dividends.This signifies that the company has been operating as a mature company. However in recent years (especially the last 2 years) it has retained close to 31% and 40% of its earnings respectively. Therefore it seems like that in times of increased competition and poor monsoon (lack of demand) , Colgate is financially stable to deal with this as it has strong cash flows. Colgate operates on a negative working capital and has been able to maintain this for the past decade. Negative working capital is good news as suppliers pay in advance and company has enough cash which can be invested for growth. 

Profit Margins :

 

Another noteworthy trend which emerges from the profit and loss statement is the profit margins. If one looks at the EBIT (Earnings before interest and taxes)

Colgateprofitmargins

The margins have remained fairly stable.Furthermore considering that 2015 and 2016 were both drought years with poor rural demand the margins for Colgate in spite of inflation stands at 18-19% . Hence Colgate has an able management which can maintain profit margins in-spite of tough business conditions.

Revenue :

 

The revenue growth for Colgate has also been mostly stable with a dip in 2015 and 2016.

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It can be observed that in 2015 and 2016 revenue has dropped however profit margin have sustained. Furthermore with respect to revenue it seems sticky with no de-growth happening in spite of drought and increased competition.

While comparing both revenue growth and profit margin we can draw conclusions that the management is focusing on profitable and sustainable growth. Going forward, we can expect Colgate to continue growing its revenue and maintaining profit margin in accordance with various factors i.e : rural demand , Indian economy, monsoons each year and toothpaste consumption (consumer preferences)

Graph-Revenue growth

Reinvestment : 

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A high return on equity means that Colgate has few tangible assets which generate a significant amount of revenue. In order to maintain its current revenue and grow it in the future, the reinvestment in tangible assets is around 9% of its revenue each year. Furthermore, a major asset of Colgate is its brand name which requires a significant amount of advertising monies to be spent each year. To maintain its leadership position and brand name , I feel Colgate will continue to spend 31% of its revenue on advertising to spread awareness and adoption of its products across India. The positive impact of advertising spends, though not immediately, will result in revenue and higher margin over a longer period of time.

Valuation and Conclusion:

 

Almost always as is the case with predicting future earnings , there are many possible outcomes. Therefore a scenario analysis is important. After considering all factors our valuation reflects Average Per Share value of 1,128.29 Rs per share with a company valuation of 30,689 Crores INR.  A range of 845.31 to 1800 Rs per share value was discovered as a result of conducting scenario analysis on our assumptions.

Valuepershare - colgate sensitivity analysis

 

Recommendation :

 

The current market price of 950 Rs as against the valuation of 1,128 per share.Therefore we feel that Colgate is undervalued by 15% which is a margin of safety as an investor. In conclusion – A long term investor can start buying at current levels of 930-950 Rs and keep adding if price goes down in the short run.

Please note that the valuation will be updated each quarter. As also will any news impacting any of the assumptions or factors in Colgate India’s valuation.so STAY TUNED.

 

 

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