Re-rating is unwarranted
Colgate’s 2Q performance was weaker than anticipated. Company has arrested market share decline but that is only half the job. Oral care category growth lags sector growth and hence Colgate needs to gain share to justify re-rating in the stock. We cut EPS by 1-3% and value the co. at 35x on Sep-21 EPS, arriving at a TP of Rs 1,400. Maintain NEUTRAL.
HIGHLIGHTS OF THE QUARTER
* Revenue grew by 4.5% (vs. exp. of 5.5%) driven entirely by volume growth. Volume growth was sluggish given (a) Slowdown in rural (now trailing urban), (b) Absence of share gains despite 27% growth in A&P and (c) Slowmoving category growth (trails FMCG sector by 2-3%). Competitive intensity remains high particularly in LUPs (Rs 10/pack).
* Naturals growth has now tapered to mid-teens from 25- 30% range as it has attained a meaningful share (>25% mix in oral care category). Within naturals, Colgate has gained market share (8.1% in CY18 vs. 6.5-7% in CY17) led by Swarna Vedshakti and re-launch of Colgate Salt. Colgate has recently launched Colgate Charcoal to capitalize on naturals fad.
* Premium segment (4% mix vs. 8% mix earlier) has now returned to growth but is not enough to compensate for moderation in growth in other segments. Co. has relaunched Colgate Total to capitalize on this trend.
* GM were flat as co reinvested benefits from benign commodity inflation into higher promotions. A&P/Other expenses grew by 27/-1% which resulted in 2% de-growth in EBITDA (vs. exp of 7%). New management’s focus is on spending aggressively on A&P (~14% of sales) at the cost of margins to drive market share gains. Lower corp. taxes resulted in 24% growth in APAT to Rs 2.44bn (exp Rs 2.65bn).
Colgate’s market share has largely stabilized but we still don’t see signs of gaining meaningful share anytime soon. As a category leader, Colgate needs to drive category growth at a time when natural’s fad is moderating. New management (Ram Raghavan - MD and Mukul Deoras – India chairman) keeps us interested in the story. Ram began his career as a management trainee with Colgate India in 1997. His recent experience as the head of innovation center at Colgate-Palmolive LATAM is exactly what Colgate India needs i.e. product excitement and diversification. Thereby, we model revenue/EBITDA CAGR of ~9/13% over FY20-22E. We don’t expect a rerating in the stock owing to modest earnings expectation. We maintain NEUTRAL.
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