VALUATION OF COLGATEPALMOLIVE
Presented by:
Carlos Castro
Alejandro Sabogal
FINANCE 332
Dr. William Trainor
April 25, 2005
Valuation of ColgatePalmolive
I. Introduction.
We chose the ColgatePalmolive Company because it is one of the world's leading consumer products companies with products marketed in over 200 countries and territories throughout the world. Colgate is the second largest US maker of detergents. Among its main competitors, we can find Clorox, Gillette, and Procter and Gamble. The Company manages its business in three product segments: Oral, Personal and Home Care, and Pet Nutrition. Colgate has achieved global leadership in toothpaste, hand dishwashing liquid, liquid hand soap, liquid cleaners and specialty cleaners.
Colgate is a largecap growth company that over the last 25 years has proven to be an attractive investment because of its global performance and its successful financial strategy. The company has increased profitability by reducing costs without inhibiting growth. Consistent innovation and development of new products has allowed it to increase its market share in the developing world. In 2004, approximately 55% of Colgate’s sales derived from its Oral Care division in Asia and Africa. In addition, sales of Pet Nutrition products accounted for 14% of the Company's total worldwide sales in 2004.
In graph No. 1, we can see Colgate’s performance from April 1995 to April 2005 compared to the S&P 500 and one its main competitors, Procter and Gamble.
Graph No. 1. Colgate’s Price History.
Source: www.moneycentral.com
Taking a close look at the graph, we can see that Colgate was highly correlated with the S&P 500 and P&G’s stock between April 1995 and January 2000. From this point, over the next five years Colgate tended to overperform both the S&P 500 and P&G. During the last year, P&G has overperformed Colgate and the S&P 500.
II. P/E and P/Sales Analysis
Table 1 – Historical EPS, P/E, Sales
YEAR

1995

1996

1997

1998

1999

2000

EPS

0.26

0.98

1.14

1.31

1.47

1.7

P/E

65.1

21.1

27.1

31.3

34.5

31.5

Sales (millions)

8,358.20

8,749.00

9,056.70

8,971.60

9,118.20

9357.9

Sales per share

14.33

14.87

15.33

15.33

21.46

16.51

P/Sales per Share

1.23

1.55

2.4

3.03

3.03

3.91

Common Shares Outstanding (millions)

583.4

588.5

590.8

585.4

424.9

566.7

YEAR

2001

2002

2003

2004

2005 (Projected)

Average

EPS

1.89

2.19

2.46

2.33

2.89

1.67

P/E

30

23.5

22.3

21.9

20.60*

29.9

Sales (millions)

9427.8

9294.3

9903.4

10584.2

10837.16

9425.61**

Sales per share

17.11967

17.34011

18.55612

20.09913

20.5795

17.42

P/Sales per Share

3.37

3.02

2.72

2.56

2.7546***

2.68

Common Shares Outstanding (millions)

550.7

536

533.7

526.6

526.59+

546.42

* Estimates by Money central
** 2.39% Sales growth.
*** Price/sales intrinsic growth = 7.6%
+ 2005 Shares outstanding are the same as 2004 since Sales and Sales per share grow at the same rate, 2.39%. (10,837.16/20.57 = 526.59)
Based on the past 10 years, Colgate’s EPS has increased from 0.26 in 1995 to 2.33 in 2004, resulting in 24.2% intrinsic growth. Its sales have shown a moderate growth rate of 2.39%, ranging from $8,358 millions in 1995 to $10,584 millions in 2004. From this, we can estimate the EPS, Sales, and Sales per share for 2005 at 2.89 (2.33*1.242), 10,837 millions (10,584*1.0239) and 20.58 (20.09*1.0239), respectively. We estimated 2005 P/sales to be 2.75 based on a 7.6% intrinsic growth, see table No. 1 above. Finally, we decided to use Money Central’s estimate for 2005 P/E, 20.6.
Colgate’s PE ratio has usually ranged from 21.1 to 34.5, except in 1995 when it reached an unusual 65.1, consistent with its lowest price ($16.9), EPS (0.26) price/sales (1.23), and net profit margin (2.1) for the 10 year period. Colgate’s P/sales per share has ranged from 1.23 to 3.91.
Graph No. 2. P/E and P/Sales
According to the P/E range, Colgate’s value could vary between $60.9 (21.1*2.89) and $99.7 (34.5*2.89), excluding the 1995 P/E in our computation of the maximum price. Based on P/sales, the price could range from $25.31 (1.23*20.58) to $80.47 (3.91*20.58).
Using the projected P/E and EPS for 2005, we can find an estimated price of $59.53 (20.6*2.89). This value is below the P/E floor of $60.9 because money central estimated P/E for 2005 to be 20.6, below the historical minimum of 21.1. Our projected price based on 2005 P/sales and sales per share is $56.59 (2.75*20.58). Therefore, based on these estimates we can conclude Colgate’s price should be somewhere between around $56 and $59. See graph 3, and table No. 2.
Graph No. 3. Price of Colgate' Stock Based on PE Projections
Table 2 – Projected Stock Price using P/E and P/Sales

PE

EPS

Stock Price

P/Sales

Sales/Share

Stock Price

Expected

20,6

2,89

59,534

2,75

20,58

56,59

Minimum

21,1

2,89

60,979

1,23

20,58

25,31

Maximum

34,5

2,89

99,705

3,91

20,58

80,47

Compared to the industry and S&P 500 over the last 5 years only, Colgate’s sales growth has been lower. Its EPS growth rate has been about the industry average, but greater than S&P 500, as shown in table No. 3.
Table 3 – Sales and EPS compared to industry and S&P 500
Growth Rates % Company Industry S&P 500
Sales (5Year Annual Avg.)

2.61

3.29

4.68

EPS (5Year Annual Avg.)

10.71

10.73

2.47

Based on P/E, P/S and P/Cash flow ratio ratios, Colgate seems an attractive stock since its ratios are all below the industry average. CL’s Price/Book value is greater than the industry’s due to Colgate’s total equity decrease over the last 5 years. We will explain this decrease in the next section. See table No. 4.
Table 4 – Price Ratios compared to the industry
Colgate’s net profit margin, 12.9% (5 last year average) has been greater than the industry’s, 8.6%. This may be explained partly by CL’s debt/equity ratio 3.18, which is higher than the industry’s, at 1.20. Finally, Colgate’s Return on equity has been considerably higher than the industry’s, 194.5 and 62.7, respectively (we will discuss CL’s ROE further). On the other hand, its ROA has been relatively close to the industry’s, see table No. 5.
Table 5 – ROE and ROA compared to the industry.
Colgate Industry
Return On Equity (5Year Avg.)

194.5

62.7

Return On Assets (5Year Avg.)

16.7

10.7

III. FUNDAMENTAL ANALYSIS:
Here we will value Colgate based on the FCFE per share and the twostage growth model. We assume in the first stage that Colgate will grow at a fixed rate for 5 years and in the second stage will show an infinite growth at 5%. This last is consistent with the estimated returns investors can expect from the S&P 500, based on “What to expect from your stocks?” by Batchelor, 8/25/04.

Cost of Capital: CAPM: Ri = Rf + Beta(RmRf)
We will use a risk free of 4.32%, actual yield on the 10 year treasury according to Money Central US Treasury Indexes. In addition, we will use the historical average of 5.5% for the risk premium.
Since we found the current Beta for Colgate at only 0.2, we decided to use the market Beta of 1 to make our cost of capital close to 10% (historical required rate of return). Otherwise, our K would be too low and we would violate the Gordon dividend discount model, assuming a K smaller than G.
Rf = 4.32% (from Money Central current US Treasury Indexes)
β =0.2 (from Money Central, company report)
Rm =9.82 (to keep the risk premium at 5.5%)
K = 4.32 + 0.2(9.824.32) = 5.42%
K = 4.32 + 1(9.824.32) = 9.82%

Growth Rate for Colgate
We first calculated G based on Colgate’s ROE and B (Retention ratio). Unfortunately, we encountered a problem here because Colgate’s ROEs during the last five years have been extremely high due to a notorious decrease in total Equity.
According to Colgate’s Balance sheet from 2000 to 2004, this reduction in Shareholder's Equity may be best explained by shareholders’ repurchase of common stock for the period.
Table No. 6 – Shareholder’s equity
Shareholder's Equity

2004

2003

2002

2001

2000

Preferred Stock Equity

274.0

292.9

323.0

341.3

354.1

Common Stock Equity

971.4

594.2

27.3

505.1

1,114.0

Total Equity

1,245.4

887.1

350.3

846.4

1,468.1

Thus, based on the averages of ROE and B = (1payout ratio), we find an intrinsic growth of 95.23%.
Table No. 7 – Calculation of G_{1}

2004

2003

2002

2001

2000

Average

Total Net Income

1,327.10

1,421.30

1,288.30

1,146.60

1,063.80

1,249.42

Payment of Cash Dividends

536.2

506.8

413.4

396.7

382.4

447.10

Dividend Payout

0.404039

0.356575

0.320888

0.345979

0.359466

35.74%

B= (1dividend payout)

0.595961

0.643425

0.679112

0.654021

0.640534

64.26%

ROE

124%

230%

215%

99%

72%

148.21%

G_{1 }= 148.21% * (10.3574) = 95.23%
This growth is not reasonable mainly because of the significant decrease in Colgate’s total equity from 2000 to 2004. Therefore, we decided to use the Analyst’s estimates for the growth of Colgate (7.17% 2005) of 9.2% for the next five years.
We assume that the growth rate after 5 years will be 5%
G_{2 }= 5%

FCFE:
The formula is Net Income + depreciation – Capital expenditure – change in working capital – principal debt repayments + new debt issues.
Note numbers are in millions:
Table No. 8 – FCFE per share


2004

2003

2002

2001

2000

AVERAGE


Net Income

1,327.10

1,421.30

1,288.30

1,146.60

1,063.80

1,249.42

+

Depreciation

327.8

315.5

296.5

336.2

337.8

322.76



Capital expenditure

1,274.70

287.10

358.70

441.00

448.50

562.00



Change in working capital

41.90

28.30

0.50

23.20

21.80

14.42



Principal debt repayments

753.9

804

763.5

595.9

739.4

731.34

+

New debt issues.

1,246.50

229.2

964.5

887.9

925.4

850.70



914.70

903.20

1,427.60

1,357.00

1,117.30

1,143.96


Shares Outstanding

526.6

533.7

536

550.7

566.7

542.74


FCFE per share

1.736992

1.692337

2.663433

2.464137

1.97159

2.11





AVERAGE

2.105698


Therefore, our FCFE for this company is 2.11. We used averages for every component of the formula. As we can see from the table above, Colgate has issued more debt than it has paid over the last five years.

Two Stage growth model:
Here we plugged the numbers obtained above to calculate the intrinsic value of Colgate. We assumed the current growth continues for five more years.
Table No. 9 – Two Stage Growth Model
Pessimistic and optimistic input values were estimated to be 10% more or less than projected. As table No.9 shows, the intrinsic value for Colgate should be around $55 with a range between $37 (pessimistic) and $90 (optimistic). Since the current value of Colgate is $51.38, we consider this price is very close to our valuation. This event does not let us conclude that the stock is undervalued with certainty.
IV. SUMMARY AND CONCLUSIONS:
In summary, we used various techniques to determine a good estimate for Colgate’s price. First, based on our P/E and P/sales analysis, we suggested Colgate’s stock should be worth between $56.5 and $59.5, with a minimum of $25 and a maximum of $99. According to our FCFE analysis the stock should be valued around $55.
Since the current value of Colgate is around $51, we concluded to hold the stock. We first thought the stock was undervalued, but the difference between the intrinsic and the current value is very small, leading us to believe it would be better to wait for the stock to drop somewhere close to the pessimistic value of $37.
However, if the predictions from Money Central’s analysts are accurate, the price should be somewhere around $59.5 (EPS = 2.89 * P/E = 20.6) at the end of 2005, showing a small chance of profit from the current price of $51.38. This assumption is very risky and should not be considered as a serious alternative for a longterm investor. We would only suggest buying this stock if Colgate’s growth prospects were estimated at a much higher rate than the last fiveyear average from table No.3. We would look for a smaller ratio of CL's P/E to its fiveyear growth compared to the industry. 