MANAGEMENT MEET

INSTITUTIONAL SECURITIES
INDIA RESEARCH

Colgate Palmolive
Armed to the teeth!
17 December 2012 BSE Sensex: 19317 Sector: Consumer goods

UPGRADE TO OUTPERFORMER
We met Paul Alton, EVP & CFO, Colgate, for a business update. Key takeaways: Sustained business momentum: Colgates oral care business has not been adversely affected by a 6-7% rise in product prices in the past three quarters and continues to post double digit volume growth. Premiumisation is the emerging trend in the oral care business; Colgates premium portfolio (8-10% of revenues) is growing at over 2x the base business. As oral care is still primarily a mass business (vs other personal care categories with 20%+ premium segment) there is significant scope to premiumise; Colgate stands to benefit most from the trend as it is at the helm of this space. Input costs have stabilized after sharply increasing in the past few quarters. With price increases coming into effect and the rupee stabilizing, gross margins should sequentially improve from 58.7% in 1HFY13. Competition from incumbents (HUL and Dabur) and new entrants (GSK) notwithstanding, the management believes it can build on its current market share given a wide portfolio, focused communication and continued launches of new variants in oral care.

Stock data CMP (Rs) Mkt Cap (Rsbn/USDbn) Target Price (Rs) Change in TP (%) Potential from CMP (%) Earnings change (%) FY13E FY14E Bloomberg code 1-yr high/low (Rs) 6-mth avg. daily volumes (m) 6-mth avg. daily traded value (Rsm/US$m) Shares outstanding (m) Free float (%) Promoter holding (%) 111.3 / 2.04 136.0 49.0 51.0 CLGT IN 1482/932 0.09 1,387 188.6 / 3.5 1530 27% +10

Dominance in a relatively inelastic category, benefits of premiumisation, and focus on innovation make Colgate one of the more attractive plays in our coverage universe. HULs higher share of voice has not translated into share of market which is testament to Colgates strong brand equity.We believe concerns over valuations are overdone as Colgates multiples (at 30xFY14 EPS) are in line with those of other MNC consumer companies and, given strong business fundamentals vis-a-vis peers, are justified. Moreover, GlaxoSmithKline's recent open offer to buy back shares of its India consumer healthcare business at a 30% premium to CMP indicates that all consumer MNC names will remain highly pegged. Upgrade to Outperformer, with a higher target price of Rs1530 (Rs1237 earlier). Key financials
As on 31 March
Net sales (Rs m) Adj. net profit (Rs m) Shares in issue (m) Adj. EPS (Rs) % change PE (x) Price/ Book (x) EV/ EBITDA (x) RoE (%)

Price performance relative and absolute

145 130 115 100 85 Dec-11 Colgate-Palmolive (India) Sensex

FY10
20,173 4,213 136 31.0 46.9 44.9 58.0 38.8 155.4

FY11
22,861 4,026 136 29.6 (4.4) 47.0 49.3 35.9 113.4 134.4

FY12
26,932 4,465 136 32.8 10.9 42.4 43.4 32.1 109.0 131.6

FY13E
32,008 5,310 136 39.0 18.9 35.6 38.4 26.1 114.4 143.1

FY14E
37,045 6,115 136 45.0 15.1 30.9 33.3 22.2 115.3 147.5

Feb-12

Apr-12

Jun-12

Aug-12

Oct-12

Dec-12

(%)

3-mth
11.5 4.6

6-mth
19.5 15.8

1-yr
33.3 21.6

Colgate-Palmolive BSE Sensex

RoCE (%) 159.8 Source: Company, IDFC Securities Research

Nikhil Vora nikhil.vora@idfc.com 91-22-6622 2567

Harit Kapoor harit.kapoor@idfc.com 91-22-6622 2649 For Private Circulation only. Important disclosures appear at the back of this report

SEBI Registration Nos.: INB23 12914 37, INF23 12914 37, INB01 12914 33, INF01 12914 33.

Double-digit volume growth despite continued price increases

In spite of continued price increases in the last six quarters as well as some signs of a slowdown in consumer categories, Colgate continues to witness strong double-digit volume growth momentum in its core oral category with no real signs of moderation on the ground. The management believes that the relatively inelastic demand of this segment, consumers converting from toothpowder (which continues to decline as a category) to toothpaste and Indians being one of the lowest per capita consumers of toothpaste in the world are contributing to the steady growth momentum of this business. Volume growth (%) remains steady
(%) 18 14 9 5 Volume growth

Increasing per capita consumption represents a huge opportunity

600 Per Capita Consumption (gms) 542

450 304 300 244 138 255

150
Q1FY10 Q2FY10 Q3FY10 Q4FY10 Q1FY11 Q2FY11 Q3FY11 Q4FY11 Q1FY12 Q2FY12 Q3FY12 Q4FY12 Q1FY13 Q2FY13
0

0 India Philippines China Malaysia USA

Source: Company, IDFC Securities Research

Biggest beneficiary of increasing premiumisation of oral care

As has been the trend in other personal care categories in the past couple of years, oral care is now witnessing the emergence of a premium segment in toothpaste (8-10% of segment revenues, vs 20% of hair, skin and personal wash), one that is growing at over 25% annually. This segment comprises the multi-benefit category (Colgate Total) and the sensitive teeth category (Colgate Sensitive, Pro Relief). With the premium segment still small in the overall oral care mix and growing at 2x the category growth rate, we believe a huge premiumisation opportunity exists that will aid growth and margin expansion for the industry in the next few years. With Colgate having the most complete portfolio and a dominant ~54% share of the industry, it would be the biggest beneficiary of the shift.

Launches of new variants to supplement base portfolio

The management believes a key reason for Colgates success is that it offers an oral care portfolio that spans subcategories and price points. The company continues to invest adequately in its base Colgate Dental Cream (CDC) business. At the same time, it has consistently launched new variants across its oral care segments (one toothbrush launch each quarter, premium toothpaste launches, etc) and plans to do so in the coming quarters as well to supplement the steady growth rates in its base portfolio. We believe Colgate will remain the primary innovator in this space ahead of competition.

2 |DECEMBER 2012

IDFC SECURITIES

A host of extensions launched in the last one year

Product Launch
Colgate Total Advance Whitening Colgate Max Fresh Ice Colgate 360 Battery Colgate Max Fresh Colgate Super Shine Colgate 360 Sonic Power Colgate ZigZag Anti-Germ Colgate Barbie Colgate Spiderman Colgate Plax Fresh Tea Palmolive Aroma and Thermal Spa Company, IDFC Securities Research

Segment
Toothpaste Toothpaste Toothbrush Toothbrush Toothbrush Toothbrush Toothbrush Kids Toothbrush Kids Toothbrush Mouthwash Body wash

Market share on the rise despite sustained competitive intensity

Colgate has increased market share in its core toothpaste segment by ~700bp to 54.3% in six years to end-September 2012. This is an impressive feat given the company was already the clear market leader and went on to increase dominance. This was managed in spite of stiff competition from incumbents as well as entry of new players. Competitive intensity continues to be high with HUL expanding its product offerings and increasing share of voice and players like GSK Consumer and Dabur looking to increase share. However, what works for Colgate is its complete oral care portfolio and steady communication vis--vis other multi-category players. Market share has moved up 300bp in the last 3 years the gap vis-a-vis competition continues to widen
(%) 60 Colgate HUL Dabur Others

45

30

15

0 Q2FY10 Q3FY10 Q4FY10 Q1FY11 Q2FY11 Q3FY11 Q4FY11 Q1FY12 Q2FY12 Q3FY12 Q4FY12 Q1FY13
Industry, IDFC Securities Research

Input costs stabilising; benefits of operating leverage kicking in

Continued inflation in key inputs like essential oils, flavours and packaging material as also depreciation of the Indian rupee led to a gross margin contraction of 100bp to 58.7% in 1HFY13. These factors led to a 6-7% increase in prices in the year thus far; the last increase (~2%) happened in November. With input costs and the rupee stabilizing and the full effect price increases poised to come through, the management expects gross margins to recover by 4QFY13. Further, benefits of operating leverage (partly due to higher pricing mix in sales) on overheads will also boost margins. However, the biggest margin driver in the long term will be premiumisation, with the premium portfolio only 8-10% of sales now growing at nearly 2x that of the base business.

3 |DECEMBER 2012

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Gross margins hit by cost inflation and rupee depreciation

65.0 Gross Margin (%)

EBITDA margins continue to expand yoy

27.0 EBITDA Margin (%)

62.5

24.0

60.0

21.0

57.5

18.0

Q2FY11

Q3FY11

Q4FY11

Q1FY12

Q2FY12

Q3FY12

Q4FY12

Q1FY13

Q2FY11

Q3FY11

Q4FY11

Q1FY12

Q2FY12

Q3FY12

Q4FY12

Q1FY13

Company, IDFC Securities Research

Pragmatic strategy for non-oral care

The non-oral care segment accounts for less than 4% of Colgates overall sales. The management recognizes the fact that the personal care segment is extremely competitive, and has no plans to invest in this business disproportionately as growth is expected to be in line or marginally ahead of its oral care business. The focus will be on premium products in the Palmolive portfolio with the primary channel of distribution being modern trade. We like the companys strategy and believe capabilities in non-oral personal care cannot match those of incumbents and, hence, a cautious growth strategy is the right approach. The management is clear that it will not sacrifice business profitability to expand the non-oral care business. Non-oral care mix likely to be in low single digits in the future
Non Oral care 3.5%

Q2FY13

Oral Care 96.5%

Company, IDFC Securities Research

Strong business fundamentals outweigh valuation concerns; Outperformer

Colgate has retained its leadership position and has also consistently increased its market dominance, defying, in the process, both increasing competition and the observed phenomenon of a dilution in dominance over time. The next leg of growth for the company will be driven by premiumisation. This will not only help maintain the mid-teen revenue growth rate but also boost margins. Oral care, still being largely a mass to mid-premium category (90% of industry), offers an opportunity that Colgate is best placed to capitalize on. Besides, base-business growth will be driven by higher penetration and increasing per capita consumption. Dominance in the sticky and inelastic category of oral care, increasing benefits of premiumisation, and focus on continued innovation make Colgate one of the more attractive plays in our coverage universe. We believe concerns over valuations are overdone as Colgates multiples (at 30x FY14 earnings) are in line with those of MNC consumer names and, given strong business fundamentals vis-avis peers, are justified. Moreover, GlaxoSmithKline's recent open offer to buy back shares of its India consumer healthcare business at a 30% premium to CMP indicates that all consumer MNC names will remain highly pegged. We upgrade Colgate to Outperformer, with a revised target price of Rs1,530.

4 |DECEMBER 2012

IDFC SECURITIES

Q2FY13

55.0

15.0

Comparative Valuations
CMP Rs
Colgate HUL Nestle GSK Consumer* 1,387 518 4,800 3,753

Mcap Rs mn
188,635 1,118,083 468,577 157,315

EPS (Rs)
39.0 15.3 114.7 104.7 44.6 17.2 136.7 121.8

PE (x)
35.6 33.9 41.8 35.8 31.1 30.1 35.1 30.8

EV/EBITDA (x)
26.1 30.3 26.2 26.5 22.2 25.3 21.7 22.9

ROE (%)
106.6 76.7 72.8 34.4 99.2 62.5 64.1 33.9

ROCE (%) FY13E

128.3 60.9 54.9 32.1

FY13E FY14E FY13E FY14E FY13E FY14E FY13E FY14E

FY14E
124.9 66.1 54.2 30.6

5 |DECEMBER 2012

IDFC SECURITIES

Income statement
Year to 31 Mar (Rs m)
Net sales % growth Operating expenses EBITDA % change Other income Net interest Depreciation Pre-tax profit Current tax Profit after tax Net profit after non-recurring items % change 4,213 46.9 4,026 -4.4 4,465 10.9 5,310 18.9 6,115 15.1

Key ratios
FY10
20,173 15.5 15,392 4,781 46.4 209 212 374 4,829 615 4,213

FY11
22,861 13.3 17,715 5,146 7.6 111 285 343 5,200 1,174 4,026

FY12
26,932 17.8 21,147 5,785 12.4 92 400 393 5,884 1,419 4,465

FY13E
32,008 18.8 24,879 7,129 23.2 101 455 485 7,200 1,889 5,310

FY14E
37,045 15.7 28,647 8,398 17.8 116 524 575 8,463 2,349 6,115

Year to 31 Mar
EBITDA margin (%) EBIT margin (%) PAT margin (%) RoE (%) RoCE (%) Gearing (x)

FY10
23.7 21.8 20.9 155.4 159.8 0.0

FY11
22.5 21.0 17.6 113.4 134.4 0.0

FY12 FY13E FY14E

21.5 20.0 16.6 109.0 131.6 0.0 22.3 20.8 16.6 114.4 143.1 0.0 22.7 21.1 16.5 115.3 147.5 0.0

Valuations
Year to 31 Mar
Reported EPS (Rs) Adj. EPS (Rs) PE (x) Price/ Book (x) EV/ Net sales (x) EV/ EBITDA (x) EV/ CE (x)

FY10
31.0 31.0 44.9 58.0 9.2 38.8 56.1

FY11
29.6 29.6 47.0 49.3 8.1 35.9 48.1

FY12 FY13E FY14E

32.8 32.8 42.4 43.4 6.9 32.1 42.7 39.0 39.0 35.6 38.4 5.8 26.1 37.8 45.0 45.0 30.9 33.3 5.0 22.2 32.8

Balance sheet
As on 31 Mar (Rs m)
Paid-up capital Reserves & surplus Total shareholders' equity Total current liabilities Total debt Total liabilities Total equity & liabilities Net fixed assets Investments Total current assets Deferred tax assets Other non-current assets Working capital Total assets

FY10
136 3,125 3,261 5,521 46 5,567 8,828 2,531 108 6,009 179 0 488 8,828

FY11
136 3,705 3,841 6,499 1 6,500 10,340 2,633 109 7,430 168 0 931 10,340

FY12 FY13E
136 4,218 4,354 6,942 0 6,942 11,296 3,238 110 7,827 121 0 885 11,296 136 4,793 4,929 7,659 0 7,659 12,587 4,056 600 7,681 250 0 22 12,587

FY14E
136 5,541 5,677 8,768 0 8,768 14,445 4,978 600
Q3FY11 Q4FY11 Q1FY12 Q2FY12 Q3FY12 Q4FY12 Q1FY13

Revenue growth trend

8,000 6,000 4,000 2,000 0 Net sales (Rs m - LHS) Net Sales Growth (% - RHS) 24 18 12 6 0

250 0 (152) 14,445

Shareholding pattern
Public & Others 20.7% Foreign 21.1%

Cash flow statement

Year to 31 Mar (Rs m)
Pre-tax profit Depreciation Chg in Working capital Total tax paid Ext ord. Items & others Operating cash inflow Capital expenditure Free cash flow (a+b) Chg in investments Debt raised/ (repaid) Dividend (incl. tax) Misc Net chg in cash

FY10
4,829 374 799 (615) (358) 5,028 (1,119) 3,909 173 (1) (3,073) (43) 964

FY11
5,200 343 881 (1,174) (671) 4,579 (444) 4,135 (177) (45) (3,543) 107 476

FY12
5,884 393 (1,214) (1,419) 490 4,133 (999) 3,135 (84) (1) (3,951) 47 (853)

FY13E
7,200 485 (27) (1,889) 189 5,958 (1,303) 4,654 (4,733) (132) (210)

FY14E
8,463 575 138 (2,349) 210 7,038 (1,497) 5,541 (5,364) (3) 175
Promoters 51.0%

Institutions 6.0%
Non Promoter Corporate Holding 1.2%

As of September 2012

6 |DECEMBER 2012

IDFC SECURITIES

Q2FY13

8,616

Analyst
Shirish Rane Nikhil Vora Prakash Joshi Nitin Agarwal Hitesh Shah, CFA Bhoomika Nair Pramod Kumar Ashish Shah Mohit Kumar, CFA Probal Sen Swati Nangalia Abhishek Gupta Saumil Mehta Harit Kapoor Vineet Chandak Nikhil Salvi Dharmesh R Bhatt, CMT Dharmendra Sahu

Sector/Industry/Coverage
Co-Head of Research; Construction, Power, Cement Co-Head of Research; Strategy, FMCG, Media, Retail, Education, Mid-caps Oil & Gas, Metals, Mining Pharmaceuticals, Real Estate, Agri-inputs IT Services & Telecom Logistics, Engineering Automobiles, Auto ancillaries Construction, Power Construction, Power Oil & Gas Media, Alcoholic beverages, Education, Exchanges, Mid-caps Telecom, IT services Metals, Mining FMCG, Retail, Paints, Mid-caps Real Estate, Pharmaceuticals, Agri-inputs Strategy, Mid-caps Technical Analyst Database Analyst

E-mail
shirish.rane@idfc.com nikhil.vora@idfc.com prakash.joshi@idfc.com nitin.agarwal@idfc.com hitesh.shah@idfc.com bhoomika.nair@idfc.com pramod.kumar@idfc.com ashish.shah@idfc.com mohit.kumar@idfc.com probal.sen@idfc.com swati.nangalia@idfc.com abhishek.gupta@idfc.com saumil.mehta@idfc.com harit.kapoor@idfc.com vineet.chandak@idfc.com nikhil.salvi@idfc.com dharmesh.bhatt@idfc.com dharmendra.sahu@idfc.com

Tel.+91-22-6622 2600
91-22-662 22575 91-22-662 22567 91-22-662 22564 91-22-662 22568 91-22-662 22565 91-22-662 22561 91-22-662 22562 91-22-662 22560 91-22-662 22573 91-22-662 22569 91-22-662 22576 91-22-662 22661 91-22-662 22578 91-22-662 22649 91-22-662 22579 91-22-662 22566 91-22-662 22534 91-22-662 22580

Equity Sales/Dealing
Tapasije Mishra Paresh Shah Vishal Purohit Rajesh Makharia Kalpesh Parekh Varun Saboo Samir Gilani Dipesh Shah Mukesh Chaturvedi Viren Sompura Rajashekhar Hiremath

Designation
Group CEO MD, Dealing Head of Sales Director, Sales Director, Sales AVP, Sales Head of Derivatives Director, Derivatives SVP, Sales trading SVP, Sales trading VP, Sales trading

E-mail

Tel.+91-22-6622 2500
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IDFC Securities US
Ravilochan Pola Sanjay Panicker

Designation
CEO Director
Disclaimer

E-mail
ravilochan.pola@idfc.com sanjay.panicker@idfc.com

Telephone
001 646 756 5865 001 212 829 4353

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