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High promotions and weak margins impact earnings

* Colgate reported a 9% miss on earnings in Q2 due to lower gross margins amid higher input costs and higher ad spends. Volumes grew ~4% with sales growth of 5% - 2% below our estimates as higher promotional intensity resulted in lower price-led growth.

* Gross margin declined sharply by 230bps qoq due to higher input cost pressure, which is likely to continue. We, hence, reduce margin assumptions, factoring in a 120bps decline in operating margins in FY22. Moderation in ad spends may benefit marginally though.

* Colgate has stepped up its efforts but is yet to see a consistent improvement in growth trends. After few quarters of improvement, growth was slower in Q2. We expect that growth trends improve ahead with the help of innovations and GTM initiatives.

* We reduce FY22-24E earnings by 3-6%. Post the recent correction, valuations at 37x/33x FY23E/FY24E EPS appear reasonable. Retain Buy with a revised TP of Rs1,765 (Rs1,880 earlier), rolling forward to Dec’23E EPS. Rural slowdown remains a risk to estimates.

Volumes up ~4%; sales growth lower due to high promotional intensity:

Colgate’s revenue increased by 5%, with ~4% growth in domestic volumes (5% 2yr revenue CAGR). Promotional intensity was higher on a low base, resulting in lower price-led growth for the quarter. Sequential recovery in volumes has been healthy, with toothbrushes witnessing good growth. Colgate has stepped up its aggression and innovation efforts, with differentiated products (Diabetics toothpaste) and natural range (Vedshakti mouth spray, etc.); however, these steps are yet to drive improvement in growth trends. We expect that the continued focus on innovations and GTM initiatives should improve growth and market share ahead.

Higher input prices dent margins:

Gross margins were down 130bps YoY (150bps below estimates), due to higher input prices and lower pricing growth at consumer end. EBITDA margins declined 220bps to 30% (softer decline of 80bps QoQ) due to lower gross margins and higher employee expenses and ad spends, up 9% and 13%, respectively. Input inflation, led by crude and crude derivatives, remains high. We factor in a 120bps decline in EBITDA margins in FY22.

Valuations appear reasonable post recent correction; maintain Buy:

We reduce earnings estimates by 3-6% for FY22-24, factoring in lower margins due to high inflation. Post the recent correction, valuations at 37x/33x FY23E/FY24E EPS appear reasonable. Maintain Buy with a revised TP of Rs1,765 (Rs1,880 earlier), based on 40x Dec’23E EPS. (vs 40x Sep-23 earlier). Slowdown in rural demand remains a risk to estimates.

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