At ₹1,405, the stock of Colgate-Palmolive trades at a price-to-earnings of 41 times its trailing 12 month earnings. Not only is this above the FMCG basket’s multiple of around 39 times, it is also well above the stock’s own five-year average of 35 times.

Colgate is the market leader in toothpastes and toothbrushes — segments which are more ‘essential’ in nature account for a small share of customer wallets and are thus more immune to consumer spending cuts. Colgate fought off competitors as well, regaining the market share it lost in 2012. But reclaiming lost territory has come at the price of a fierce promotional push. Other costs are also up, resulting in poor net profit growth even as sales have held up.

The toothpaste market is also almost fully penetrated in urban regions. With a narrow product focus, Colgate lacks other avenues to drive growth, compared with peers that have a larger product portfolio, such as Hindustan Unilever, Dabur India, and Godrej Consumer, which trade at valuations of between 36 to 38 times. The stock thus lacks triggers that can push it much higher from here. Further, other sectors too have now caught the market’s eye. Investors can therefore book profits in the stock.

Market penetration The toothpaste market in the urban region is almost fully penetrated at over 90 per cent. The rural market holds much more promise, being less penetrated at around 63 per cent. But then, Colgate has already been working on widening its rural reach.

Between 2011-12 and 2012-13 alone, the company expanded its rural network by about 25 per cent.

Protecting market share Sales growth for Colgate has been good, holding above 15 per cent for the past several quarters. This has also come from a judicious mix of price rise and volume growth, indicating that the company has good pricing power and demand is holding up.

In the past four quarters, volume growth has been maintained at 9 to 10 per cent. While this is below the company’s 12-13 per cent average growth in the earlier years, this is understandable in the light of the overall slowdown in consumer spending.

Colgate holds 56 per cent of the toothpaste market now, up from the 54 per cent in 2012. These gains have come even as arch rival P&G introduced Oral-B, and HUL and GSK Consumer stepped up thrust on their respective brands, Pepsodent and Sensodyne.

Colgate also improved market share in toothbrushes from 38 per cent in 2012 to 40 per cent now. To defend its market share, it splurged on promotional campaigns. New launches include Visible White, as well as premium ones in Active Salt Healthy White and Max Fresh.

Spending on advertising and promotion has slowly crept higher — from 10 per cent as a proportion of sales in the March 2013 quarter to 13.7 per cent by December. During April-December 2013, ad-spend-to-sales ratio was 13.1 per cent, above the 12 and 11 per cent in the comparable periods in 2012 and 2011.

Margin down Along with forking out more on promotional activities, Colgate saw a rise in other expenses such as freight, even as raw material costs cooled off. As a proportion of sales, other expenses moved up to 25 per cent in the April-December 2013 period against the 22 per cent in the year-ago period.

Higher costs shaved over 2 percentage points off Colgate’s operating margin, which came in at 17 per cent for the nine months to December 2013. The company has routinely clocked operating margin of over 20 per cent in the previous years.

The hit on profits trickled down to the net profit level too, with growth cooling off. Reported profit for the April-December period was up just 9 per cent even as sales grew 16 per cent.

With rivals showing no signs of backing off, Colgate may be obliged to keep ad-spends at higher levels to protect its turf, which will continue to weigh on profit margins. Smaller players such as Dabur are also stepping into the premium category. Further, the potential in the dental care market and Colgate’s strong positioning appear to be built into the stock’s price.

With a small product portfolio in toothpastes, toothbrushes and mouthwash, Colgate also has limited new routes to generate far higher growth, unlike diversified peers.

Correction

The stock recommendation headline for Colgate-Palmolive incorrectly said Buy. The error is regretted.

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