CL - Colgate-Palmolive: Nothing To Smile About

Summary

• Colgate-Palmolive continues to show modest growth, but this is entirely driven by pricing, with volumes under continued pressure.
• This composition of growth weighs on margins as adjusted earnings have been stuck around the $3 per share mark for a while.
• Given the continued disappointments in terms of execution and still demanding valuations, I fail to see the appeal here.

Shares of Colgate-Palmolive ( CL ) have seen a setback as the fourth quarter earnings report did not live up to heightening expectations in recent weeks.

In October, I concluded that no smiles were seen yet, even as Colgate has seen stable topline sales growth in recent times, with the business being hurt by inflationary pressures as well. Despite this observation, for essentially a boring consumer staple stock, valuations were a bit too demanding to be attracted to the shares, at the time trading at $71 per share, the same levels as they do trade today.

A Recap

When I looked at Colgate in October, I went back to the summer of 2019 when I last covered Colgate following its $1.7 billion purchase of Laboratoires Filorga Cosmetiques, an expensive skin care deal that gave the company greater exposure to Asia and personal care.

Despite a hefty price tag, the pro forma revenue contribution was only pegged around a percent based on a $15.5 billion revenue run rate, as Colgate posed steep earnings of $2.4 billion, equal to $2.75 per share. Pro forma net debt of $7.5 billion worked down to a less than 2 times leverage with $4.2 billion in EBITDA reported.

At the time a $74 stock, with earnings power seen around $3 per share, valuations were not cheap at 25 times earnings. That said, long-term secular growth trends and moderate leverage created a roadmap for long-term shareholder value creation.

What happened has been a period of stagnation, as shares have largely traded in a $70-80 range ever since, quite a tight range given the volatility seen in the world in the meantime on various fronts. In the meantime, the company has grown sales to $17.4 billion in 2021, with adjusted earnings having risen to $3.21 per share that year, on the back of organic growth and a gradual decrease in the outstanding share base. Despite some small buybacks, the company has been able to reduce net debt to $6.4 billion, reducing leverage ratios a bit further as EBITDA had improved to $4.4 billion.

The company originally guided for modest sales and earnings growth in 2022, as first quarter sales growth of 1.5% was held back by the strong dollar, with adjusted earnings down six cents to $0.74 per share.

While second quarter sales rose 5.5% in reported terms, earnings were down another eight cents to $0.72 per share, as net debt inched up to $7.0 billion, while EBITDA fell to a run rate of around $4.0 billion. Leverage ratios would rise further towards 2 times as Colgate announced a $700 million deal to grow its Hill's Pet nutrition business, further growing dry pet food production capacity.

With earnings trending around $3 per share, a 23-24 times earnings multiple was demanding given the softer performance (certainly as of late) as the earnings yield had to compete with much higher risk-free rates as well. I saw no reason to alter a modest long position that I have held for years, the performance over the past few years has been a bit too soft.

Recovery And Back

Since looking at Colgate, this summer shares have crept higher from $70 to $80 by year's end, now having sold off to $71 per share again after the latest quarter results were a bit too soft.

Third quarter sales rose 1.0%, amidst intensifying currency headwinds, as adjusted earnings were down seven cents to $0.74 per share. The 1% reported sales growth was driven by 7% organic growth, offset by strong currency headwinds, as the composition of growth was very disappointing. Prices rose by more than 11%, offset by a more than 4% decrease in volumes. This shows that the internal components of growth have been very weak, explaining a modest increase in reported sales growth, accompanied by lower profits.

Fourth quarter sales were up 5% on a reported basis amidst 8.5% organic sales growth as pricing remained strong, but organic volume declines fell 2.5%, limiting the fall in adjusted earnings per share to two pennies, with adjusted earnings posting a $0.77 per share. This resulted in earnings for the year coming in at $2.97 per share.

For 2023, based on prevailing spot rates, the company guided for 2-5% sales growth. This looks a bit soft, given that the dollar has recently given up some gains, with sales growth entirely explained by organic sales growth. The company guides for a similar low- to mid-single digit increase in earnings per share, creating quite a non-eventful set-up for the coming years. This is a bit disappointing given the acquisition announced this summer, continued inflation, and recent weakening of the dollar.

Net debt is reported at $7.8 billion which combined with an EBITDA number just in excess of $4 billion helped leverage continue to come in below 2 times.

And Now?

The reality is that 2022 has been a tough year, with earnings having come in around $3 per share mark for many years in a row now despite a modest pace of share buybacks and occasional bolt-on M&A. While 2022 was a very tough year for obvious reasons, I am not that impressed with the outlook for 2023 given the impact of inflation, softer dollar, and bolt-on dealmaking. This implies some continued soft performance, something which quite frankly has been going on for some time now.

Moreover, the volume declines are quite serious as inflation and pricing actions are the only reason for growth, while the internal composition of growth creates continued pressure on margins, that is continued volume declines.

This creates a tougher long-term set-up, even though the truly long-term demographic outlook for the business looks reasonable. Given all these developments, I understand why investors act disappointed (again) as Colgate's track record in recent years simply has not been too convincing as it is really on management to deliver here.

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