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Aarati Krishnan

Diversifying its product portfolio.

VOLUME growth in the toothpaste segment has picked up, after price cuts of 17-20 per cent on the major brands taken earlier this year. But as FMCG majors such as Colgate-Palmolive India (Colgate) embark on a strategy of price reductions to drive long-term growth, earnings and profit margins may slow further in the short term.

Investors can pare exposures in the Colgate stock. At a price-earnings multiple of about 18 times its trailing 12-month earnings, the stock's valuation appears stiff given its sober growth prospects.

Volumes pick up, but not enough

Colgate has closed the nine months ended December 2003 with marginally lower sales, at Rs 810.9 crore. That the sales number has not slumped significantly, despite the price reduction of about 17 per cent on Colgate's flagship brands in the first quarter of 2003, shows that the price cuts have paid off in the form of higher volume offtake. But the marginal decline in sales indicates that volume growth has still not picked up enough to fully compensate for the sacrifices on price.

Sustaining this volume growth on the enlarged base may be challenging. Apart from the fact that Colgate's price cuts have been matched by its closest competitor, Hindustan Lever, the mushrooming tribe of low-priced new entrants to the toothpaste category, may also intensify the battle for shares.

In fact, Colgate has recently taken a fresh round of price cuts on its low priced brands such as Cibaca Top and Herbal, in an effort to ward off such competition.

Personal care — shrouded in mystery

The personal care business, where Colgate has debuted new brands at the premium end — such as the Palmolive Naturals soap range and the Aromatherapy range of shower gels — has the potential to improve Colgate's sales mix and, thus, its profit margins. But the payoffs from this diversification may take some time to materialise.As Colgate has discontinued (from the December 2003 quarter) its earlier practice of providing segmental numbers for its personal care business, it is difficult to gauge if the contribution from this category is on the rise.

Meanwhile, Colgate's reported profit growth of 21 per cent for the nine months ended December 2003, also overstates its sustainable growth rates. For one, a VRS charge of Rs 6.1 crore taken by Colgate in 2002, has depressed earnings for that year, bloating profit growth rates for the nine months ended December 2003. But for this charge, the growth in Colgate's operating profits for the nine-month period would have been at 2.2 per cent and not 7.9 per cent, as reported.

Second, much of the expansion in operating profit has been funded by a cutback in advertising expenses.The strategy of cutting back on adspend and passing on the savings to consumers through price cuts may be a good tactical move. But how this will impact the health of the Colgate brands in the increasingly crowded market place, over the long term, remains to be seen.

Part of the savings from the cutback in adspend has been absorbed by rising procurement costs during the quarter. One positive trigger for Colgate's stock could come from its emergence as a sourcing base for its US-based parent. Colgate's parent has recently indicated that it would be rationalising its manufacturing facilities for cost-savings. And Colgate too has recently announced plans to set up a new toothpaste facility at Himachal Pradesh at Rs 50 crore. But in the absence of any concrete announcements on this score, this is still in the realms of speculation.

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