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Subdued performance, category challenges persist

Colgate’s Q1FY23 performance was below our expectations. Revenue grew moderately at 2.5% while EBITDA/PAT slipped by 9.1%/6.1%. We estimate ~3% decline in volume. Management alluded, despite slower growth in naturals, it witnessed overall slowdown in the oral care category by ~3-4% as end consumers cut offtake due to inflationary pressure. Management said in Q1 it witnessed sequential inflation of ~7%, though it executed 3% price increases. Gross margin contracted to 66.0% (-293bps) YoY, due to higher COGS (+12.0%). EBITDA lowered by 9.1% to Rs3.4bn due to muted top-line, increase in other expenses (+7.9%), Ad-spends (+1.8%), yet employee cost reduced (-1.3%), resulting in EBITDA margin of 26.6% (-339bps). We reckon though ayurveda/ natural ingredient based toothpastes grew tepid, there is structural shift towards the low price mass segment. We remain cautiously optimistic, as CLGT has sharpened its focus on driving innovation through premium products and investing behind brands with distribution focus. We retain our earnings and maintain Sell with a DCF-based TP of Rs1,534 (implied 32.6x FY24E EPS).

Overall performance was below our estimates; inflationary pressures to persist over Q2

Q1FY23 revenue grew by 2.5% at Rs11.9bn (CentE. Rs12.2bn), we estimate ~2-3% decline in volume. Management said it witnessed slowdown in the oral care category declining by ~2- 3% led by, (1) slower growth in rural markets (2) rising inflation cut consumer spend on oral care products, (3) weak demand for toothbrush category, and (4) drop in exports – now 3% of sales. CLGT saw sequential inflation of ~7%, though company executed 3% price increases. That said, gross margin contracted to 66.0% (-293bps). EBITDA margin cut to 26.6% (-339bps) due to increase in other expenses (+7.9%), Ad-spends (+1.8%), yet employee cost declined (- 1.3%) YoY. Management said elevated inflation to impact Q2 margins.

New products have gained encouraging response; cautiously optimistic

During the quarter company launched Visible White O2 with patented innovation which has been very well appreciated by the customers. Further new category launches such as Palmolive Face-care range and Colgate Strong Teeth & Colgate Vedshakti toothpaste with new formulation have recorded encouraging response. Though CLGT is trying to strengthen portfolio gaps towards premium end, management said structural shift towards the low price mass naturals segment is now stable. However, rising competitive intensity from Dabur (DantRakshak) and HUL (Pepsodent Sensitive) could warrant high ad-spends and weigh on margins. We note, efforts to increasing its rural footprint through ‘project- Muskan’, with focus on improving wholesale channel remains key driver.

What could change our view

We are optimistic on the company’s profitable growth strategy, driven by focus on (1) topline growth, (2) breakthrough innovations, (3) strengthening GTM, and (4) cost reduction targeting efficient supply chain. However, we would be cautious until we see meaningful volume growth across oral care portfolio resulting in market share gains in volume/value beyond 50%.

Valuation and risks

We believe oral care category growth seems to have moderated, despite weak base last year. Though Dabur also confirmed declining trend, yet gained market share. Interestingly with stretched share of wallet witnessed high demand for tooth powder makes us believe category headwind to continue. We are cautiously optimistic and retain our FY23E/ FY24E earnings with Sell recommendation with a DCF-based TP of Rs1,534 (implied 32.6x FY24E EPS). Key risks to our call prolonged weak demand, rising inflation in key RM/PM.

Valuations

We believe oral care category growth seems to have moderated, despite weak base last year. Though Dabur also confirmed declining trend, yet gained market share. Interestingly with stretched share of wallet witnessed high demand for tooth powder makes us believe category headwind to continue. We are cautiously optimistic and retain our FY23E/ FY24E earnings with Sell recommendation with a DCF-based TP of Rs1,534 (implied 32.6x FY24E EPS). Key risks to our call prolonged weak demand, rising inflation in key RM/PM.

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