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Continued weak sales growth, unsustainable margins

Downgrade to Neutral

* Colgate-Palmolive (CLGT)’s weak sales growth trend has persisted in recent quarters, including 4QFY21 – the two-year average sales growth stands at 5–6%. It has now been six years since the company reported over 7% sales growth for any year. With (a) the launch of its Non-Oral Care portfolio and (b) investments under the ‘Brush Twice a Day’ campaign seemingly on the backburner, it is unlikely to return to the double-digit sales growth seen over FY08–15 anytime soon.

* Notably, certain factors that led to the positive margin surprise in 4QFY21 and the full-year FY21 – resulting in all-time high EBITDA margins – are not sustainable. These include (a) higher priced (and higher margin) SKUs gaining prominence in FY21 on account of customers showing a preference for larger packs, (b) slower sales in the low-margin toothbrush category – as the product is more discretionary than toothpaste, (c) lower-than-expected advertising spends in 4QFY21 and the full-year FY21, and (d) intensifying cost pressure due to crude-led RM inflation.

* While there is no material change in our FY22E EPS, we reduce our FY23E EPS forecasts by ~6% due to weak sales trends and lower margins. With a weak topline and earnings growth likely to sustain going forward, the valuation at 37.6x FY23E EPS appears fair. Downgrade to Neutral.

Sales in-line; margin beat on lower ad spends

* CLGT is likely to have posted domestic volume growth of 16% YoY in 4QFY21 (est. 17%).

* Net sales grew 19.8% YoY to INR12.8b (in line with estimates) in 4QFY21. EBITDA was up 60.4% YoY to INR4.2b (est. INR3.9b). PBT grew 62.7% YoY to INR3.8b (est. INR3.4b). Adj. PAT grew 54.1% YoY to INR3.1b (est. INR2.6b). The two-year sales / EBITDA / adj. PAT CAGR came in at 5.5%/16.6%/25.4%.

* Gross margins expanded 300bp YoY to 67.7% (in line with estimates).

* As a percentage of sales, lower staff costs (down 130bp YoY), ad spends (down 290bp YoY), and other expenses (down 110bp YoY) led to EBITDA margin expansion of 830bp YoY to 32.9% (est. 30.6%) – this is the all-time high quarterly EBITDA margin.

* Absolute ad spends were down 4.3% YoY and 24.9% sequentially during the quarter.

* FY21 sales/EBITDA/adj. PAT grew 7%/25.6%/26.8% to INR48.4b/INR15.1b/INR10.4b.

Highlights from management commentary

* Market share was higher in modern trade and e-commerce; the management did not comment on overall market share, except that it remains at robust levels.

* As a proportion of Oral Care category sales, Naturals and Family remain at 38– 39% and 32–33%, respectively, while the share of the Freshness (gel) segment increased over the past year.

* The ‘Bright Smiles, Bright Futures’ school campaign went digital in FY21 (and, hence, cheaper) as schools were closed. Going forward, the campaign would have both digital and physical aspects.

* Good traction is seen in Vedshakti’s mouth spray and oil pulling lines, with the former seeing ~30% repeat purchases despite being a new category

Valuation and view

* The cornerstones of our earlier optimism on improved topline growth in CLGT were (a) new launches in Oral Care, (b) a potentially higher play in Naturals (38– 39% of the category where CLGT was significantly under-indexed), (c) new launches in Non-Oral Care (~only 2% of sales currently v/s around half the sales for the parent) – leveraging on CLGT’s extensive distribution reach and implementation of the Brush Twice a Day campaign.

* These initiatives could have not only led to the recouping of lost market share of ~600bp over the last 6–7 years but also boosted overall sales growth. CLGT also had significant underutilized capacity, as a result of which healthy topline growth would have resulted in even stronger earnings growth. However, the company has either disappointed on these aspects or significantly postponed the same, contrary to our earlier assumptions.

* While there is no material change in our FY22E EPS, we reduce our FY23E EPS forecasts by ~6%, weighed by weak sales trends and lower margins. With weak topline and earnings growth likely to sustain going forward, the valuation at 37.6x FY23E EPS appears fair. We assign a value of 40x FY23E to arrive at our TP of INR1,700/share. Downgrade to Neutral.

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