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Gross margin expansion leads to beat on estimates

* Colgate’s (CLGT) EBITDA and PAT growth for 3QFY21 was ahead of estimates – led by the highest quarterly gross margin in the last 10 years and lower-than-expected depreciation. Meanwhile, sales and volume growth, currently in the mid-single digits, is yet to show signs of approaching an elevated trajectory.

* As highlighted in our note in December, new launches appear promising of late. However, traction on these launches or entry into new categories is needed for the company to grow the topline and earnings above the low- to mid-single-digit CAGRs seen in the past five years.

* In the meantime, a) healthy rural outlook for the next few quarters, especially in light of CLGT seeing 40% sales contribution from rural, b) the promise of traction in new products, and c) inexpensive valuations of 39.1x FY22E and 34.5x FY23E have led us to maintain our Buy rating on the stock.

Better-than-expected sales; significant beat on profitability

* Net sales grew 7.4% YoY to INR12.3b (est. INR12.1b) in 3QFY21. EBITDA increased 17.3% YoY to INR3.7b (est. INR3.6b). PBT was up 24.5% YoY to INR3.3b (est. INR3.1b). Adj. PAT grew 24.7% YoY to INR2.5b (est. INR2.4b).

* Gross margins expanded 410bp YoY to 69.8% (est. 67%) – the highest quarterly gross margin reported in the last 10 years.

* As a percentage of sales, higher staff costs (up 30bp YoY) and higher adspends (up 360bp YoY) were offset by lower other expenses (down 240bp YoY). Thus, EBITDA margins expanded 250bp YoY to 30.1% (est. 29.6%).

* Absolute ad spends were up 38.3% YoY in 3Q.

Highlights from management commentary

* Domestic net sales reported healthy 10.1% growth in 3Q.

* Through higher advertising spends, CLGT continues to invest in its brands and support new product launches.

* The company introduced new categories such as Mouth Spray and Oil Pulling under the Vedshakti franchise.

* CLGT recently launched Asia’s first toothpaste for diabetics, which utilizes Ayurvedic ingredients to help diabetics maintain good oral health.

* The Naturals Toothbrush portfolio was also expanded with the launch of Super Flexi Salt and Zig Zag Turmeric.

* CLGT also launched Colgate Magik, a unique toothbrush that uses augmented reality to enhance children’s experience.

Valuation and view

* Changes to the model have resulted in a 5.4%/5.8%/2.1% increase in FY21/FY22/FY23E EPS, largely led by a gross margin surprise and lower-thanexpected depreciation.

* Inexpensive valuations and the potential benefits of a strong rural presence have led us to maintain our Buy rating on the stock. This is even as we await traction on new products, market share gains, and any announcement related to entry into newer categories – which would elevate topline growth above the 2.6% CAGR levels and earnings growth above the 7.9% CAGR levels of the last five years. With a target multiple of 40x FY23E, we arrive at TP of INR1,810 – a 16% upside to CMP.

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