Colgate Palmolive Co. (CL)




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Colgate Palmolive Co. (CL)

Oral Care Personal Products Home Care Pet Nutrition


June 30th, 2007


I. Selection of the firm
Selection of Colgate Palmolive was prompted by the need to find a solid, consistently earning, staple type company. Selection was initiated on the following criteria:
Beta between 0 and 1

ROE > 50%

Profit Margins > 10%
II. The Firm and its Market
II. 1. Company Profile

2006 marked the 200 year anniversary of the founding of the company. The company operates through two segments, Oral, Personal, and Home Care; and Pet Nutrition.



Oral Products – 38% of Business Sales

Oral Products includes four lines of toothpastes including Colgate Total and Colgate Simply White. Colgate also produces three lines of extremely popular toothbrushes including the Colgate 360 and Colgate Motion. As of 2004, Colgate is the Global market share leader in toothbrushes. Children’s products include rights to Sponge Bob Square Pants, Dora the Explorer, and Barbie.

In addition, Colgate produces full lines of both Over the Counter and From the Dentist lines of teeth whitening, Fluoride, and Sensitivity treatments.

Recommendation:

SELL



Pricing:

Closing Price

2/6/07


$64.85

52 Week High

$69.00

52 Week Low

$58.01


Profitability and Effectiveness:

ROA

16.8%

ROE

135.1%

Profit Margin

12.0%

Operating Margin

18.2%



Market Data:

Market Cap

$33.43 Billion

EPS

$2.76

P/E

23.7

Beta

0.85


Equity Limit Prices:

Stop Loss Price

$60.50


Sector: Consumer Goods

Industry: Personal & Household Goods


Shallu Garg

SGarg@mizzou.edu


Personal Care Products – 23% of Sales

The Company produces full lines of deodorants including Speed Stick for Men and Lady Speed Stick for Women. Their lines of body wash include the Softsoap name and liquid hand soaps by the same name. Bar soap is sold under the Irish Spring name and other toiletries for men include the Colgate shave cream products.



Home Care Products – 26% of Sales

Dishwashing products include the Palmolive and Ajax brands for hand dishwashing, machine washing, antibacterial, and oxy cleaning treatments. Household cleaners include Murphy soap and the full Ajax line of home cleaners. Colgate Palmolive also produces a full line of Fabric Conditioners under the Suavitel Liquid Fabric Conditioner name.



Pet Nutrition – 13% of Sales

Colgate Palmolive also owns Hill’s Pet Nutrition under the trademarks Science Diet and Prescription Diet. This company is separate from the other business segments and produces quality prescription grade pet food in 87 countries. Hill’s products are rated by consumer reports to be of the highest quality available on the market.


Distribution and Brands

The company offers its products to the retail and wholesale customers, distributors, veterinarians, and specialty pet retailers in North America, Latin America, Europe, Asia, and Africa. It offers its products primarily under the trademarks Colgate, Palmolive, Kolynos, Sorriso, Elmex, Mennen, Protex, Softsoap, Irish Spring, Ajax, Axion, Soupline, Suavitel, Hill’s Science Diet, and Hill’s Prescription Diet. Colgate-Palmolive was founded in 1806 and is headquartered in New York City.


II. 2. Competitors

Proctor & Gamble

P&G competes with Colgate Palmolive in a number of product categories and in many of the same distribution channels. Products that directly compete with Colgate Palmolive include: Olay, Crest, Oral-B, Iams, and Gillette. P&G offers a wide variety of other products and while this strategy is successful for them, Colgate Palmolive benefits from a more specialized and focused strategy on a few core products.


Church & Dwight

CHD offers a variety of products that also directly compete with Colgate Palmolive. Its consumer products include baking soda-based products, refrigerator and freezer deodorizer, scratchless cleaner and deodorizer for kitchen surfaces and cooking appliances, bath additive, dentifrice, cat litter deodorizer, and swimming pool pH stabilizer. The company also provides personal care products, such as lotions, creams, waxes, home pregnancy and ovulation test kits, antiperspirant, toothpastes, and battery-operated toothbrushes.


Clorox

CLX is an example of a company that produces products which compete primarily with just a few of Colgate’s products. Clorox generally represents a market share threat in the Home Care products category.


Other Competitors include Alberto Culver, Unilever, Avon, CCA Industries, and more.

DIRECT COMPETITOR COMPARISON

 
















CL

CHD

CLX

PG

Industry

Market Cap:

33.43B

3.01B

9.324B

193.218B

286.97M



















Qtrly Rev Growth (yoy):

7.4%

17.10%

5.20%

27.00%

8.50%

Revenue (ttm):

12.58B

1.85B

4.70B

72.21B

363.40M

Gross Margin (ttm):

55.2%

38.48%

42.46%

51.77%

56.08%

EBITDA (ttm):

2.73B

321.34M

1.08B

17.78B

124.36M

Oper Margins (ttm):

18.2%

13.98%

17.15%

20.52%

6.30%

Net Income (ttm):

1.51B

131.24M

447.00M

9.20B

-75.30K

EPS (ttm):

2.76

1.958

2.918

2.690

N/A

P/E (ttm):

23.7

23.59

22.75

24.01

32.60

PEG (5 yr expected):

1.9

1.78

1.97

1.70

1.73

P/S (ttm):

2.7

1.57

2.15

2.86

1.41



















CHD = Church & Dwight Co. Inc.

CLX = Clorox Co.

PG = Procter & Gamble Co.

Industry = Personal Products

From this table, you can see that CL has strong Operating Margins and Gross Margins. They also have a strong Profit Margin.


Current Events

Colgate released their first quarter earnings on April 30, announcing excellent worldwide sales and unit volume growth. Much of the growth is attributable to a double-digit increase in advertising spending contributing to a 14% rise in revenue, which is an all-time record level. Colgate realized gains on the sale of their household bleach business to Canada and are reaping the benefits of recently purchased Tom’s of Maine, who brings in over $50 million in revenues every year. The firm has enjoyed a prosperous run in its Latin American markets where it generates almost 25% of total sales and 40% of total operating profits although political instability in the region or a disruption to exchange rates could quickly spell trouble.


Sales growth has been stronger over the past five years than over the past 10 years increasing about 6.2% annually since 2002. Over the next five years, we expect sales growth to just over 5% annually. Colgate will probably miss its 2008 gross margin target of 60%, but it now expects to reach this level by 2010. Earnings before interest and taxes are 13 times interest expense, which we think is a safe coverage ratio.
III. Risks and Potential Problems1
Foreign Operations

Colgate operates on a global basis, with approximately 74% of net sales coming from operations outside the U.S. While geographic diversity helps to reduce the Company’s exposure to risks in any one country or part of the world, it also means that they are subject to the full range of risks associated with significant international operations, including, but not limited to:



  • Exchange Rate Risk, which may reduce the U.S. dollar value of revenue they receive from non-U.S. markets or increase the labor and supply costs in those markets,

  • Political or economic instability or changing macroeconomic conditions in major foreign markets, and

  • Changes in foreign or domestic legal and regulatory requirements resulting in the imposition of new or more onerous trade restrictions, tariffs, embargoes, or other government controls.


Competition

They face vigorous competition around the world, including from other large, multinational consumer product companies, some of which have greater resources than Colgate. They face this competition in several aspects of their business, including, but not limited to:



  • the pricing of products,

  • promotional activities,

  • advertising, and

  • new product introductions.


Strength of Buyers

CL’s products are sold in a highly competitive global marketplace, which is experiencing increased trade concentration and a growing presence of large-format retailers and discounters. With the growing trend toward retail trade consolidation, especially in developed markets such as the U.S. and Europe, they are increasingly dependent on key retailers, and some of these retailers, including large-format retailers, may have greater bargaining strength than Colgate’s selling agents. They may use this leverage to demand higher trade discounts, allowances or slotting fees, which could lead to reduced sales or profitability. Colgate may also be negatively affected by changes in the policies of retail trade customers, such as inventory de-stocking, limitations on access to shelf space, delisting of CL products and other conditions. In addition, private label brands sold by retail trade chains, which are typically sold at lower prices, are a source of competition for certain of Colgate’s product lines.


Strength of Suppliers and Input costs

Raw and packaging material commodities such as resins, tallow, corn and soybeans are subject to wide price variations. Increases in the costs of these commodities and other costs, such as energy costs, may adversely affect profit margins if Colgate is unable to pass along any higher costs in the form of price increases or otherwise achieve cost efficiencies in manufacturing and distribution. In addition, the move to global suppliers, to achieve cost reductions and simplify business, has resulted in an increasing dependence on key suppliers. For certain materials, new suppliers may have to be qualified under industry and government standards, which can require additional investment and take additional time.


Level of Success of 2004 Restructuring Program

In December 2004, Colgate Palmolive commenced the 2004 Restructuring Program, a four-year restructuring and business-building program to enhance global leadership position in core businesses. This program presents significant organizational challenges and in many cases will require successful negotiations with third parties, including labor organizations and business partners who may provide manufacturing or administrative services. It is not assured that:



  • the 2004 Restructuring Program will be implemented in accordance with the planned timetable,

  • the actual charges incurred will not exceed the estimated charges, or

  • the full extent of the expected savings will be realized

A failure to implement the 2004 Restructuring Program in accordance with expectations could adversely affect profitability.
Success of Acquisitions

From time to time, Colgate make strategic acquisitions, such as the June 2004 acquisition of GABA, a European oral care company, and the 84% acquisition of Tom’s of Maine in March of 2006 for $100 million. Acquisitions have inherent risks, including, but not limited to, whether they can:



  • Successfully integrate the acquired business,

  • Achieve projected synergies and performance targets, and

  • Retain key personnel


IV. Valuation

Model One:

The following was used in last year’s report to use the dividend discount model. The dividend discount model can be used in valuing CL where:


.
DPS = Colgate Palmolive has a YTD dividend of $1.28
KS = RF + Beta (Market Risk Premium)

  • Beta provided by finance.yahoo.com – 0.83

Ks = 4.50% + 0.83* (5.5%) = 9.065%


g = Because the stable model assumes a growth rate equal to the long-term nominal growth of the economy, we will use a growth rate of 7% (3% inflation + 4% GDP growth). GDP growth of 4% is a conservative assumption.


Dividend growth rate of 10 year for Colgate is 10.5% per Morningstar.com.
Substituting dividend growth rate of 10.5%, we obtain the value of the stock as follows:

Value of stock = DPS(1) = 1.28*1.105 =$68.49


Ks – g 0.09065 – 0.07

If the assumptions of the model are to be trusted, then this stock is only slightly undervalued.




Model Two:


Warren Buffett Way Owners' Earnings Discount Model




assuming discount rate (k) of

8.75%







Owner Earnings in 2006:




Net Income

$ 1,353,400,000.00

Depreciation

$ 328,700,000.00

Amortization

$ -

Capital Expenditures

$ (476,400,000.00)

Owner Earnings

$ 1,205,700,000.00







Prior Year Owner Earnings

$ 1,205,700,000.0

First Stage Growth Rate (add)

9.7%

Owner Earnings

$ 1,322,652,900.0

Discounted Value per annum

$ 1,322,652,900.0







Sum of present value of owner earnings

$13,758,767,530.1







Residual Value




Owner Earnings in year 10

$ 3,043,025,114.5

Second Stage Growth Rate (g) (add)

2.00%

Owner Earnings in year 11

$ 3,103,885,616.8

Capitalization rate (k-g)

6.75%

Value at end of year 10

$ 45,983,490,618.52







Present Value of Residual

$19,875,098,026.22

Intrinsic Value of Company

$33,633,865,556.36








Shares outstanding assuming dilution

511490000

Intrinsic Value per share

$65.76

My discount rate was found the same way as with the discount model. I used analysts’ growth estimate of 9.7% courtesy of Morningstar.com and chose a conservative 2nd stage growth rate. According to the Owners’ Earnings valuation, this stock is neither undervalued nor overvalued.



Price Target Summary

Courtesy WSJ

Mean Target

$73.93

Median Target

$75.00

High Target

$79.00

Low Target

$67.00

Number of Estimates

15



This graph is from WSJ and it points out that Colgate’s closest competitor PG (Procter and Gamble) has been outperforming it over the past year.

Technical Analysis:

The following charts have been provided by finance.yahoo.com:




CL - Default Style



From this analysis, you can see that CL has been below the S&P for the majority of the time.
Recommendation:
Based on the two valuations done above, this stock is either only slightly overvalued or just right at the exact value. Given that we would like to have some stocks in the consumer goods segment and that PG has significantly done well in the past compared to CL, I would recommend selling these stocks and purchasing an equivalent amount of Procter and Gamble shares.
PG has been rated as a five star by Morningstar.com and after evaluating its stock price, the stock comes significantly undervalued as the fair market value is calculated at $77.00 by Morningstar.com. PG has worked through integrating Gillette over the past 18 months but with the two companies almost completely merged, the fair value estimate of this company has raised significantly.
Below is Warren Buffet Way Owners’ Earnings Discount Model. The intrinsic value for PG comes at $78.90 thereby making it significantly undervalued.


Warren Buffett Way Owners' Earnings Discount Model for PG (Procter and Gamble)




assuming discount rate (k) of

8.75%







Owner Earnings in 2006:




Net Income

$ 8,684,000,000.00

Depreciation

$ 2,627,000,000.00

Amortization

$ -

Capital Expenditures

$ (2,667,000,000.00)

Owner Earnings

$ 8,644,000,000.00







Prior Year Owner Earnings

$ 8,644,000,000.0

First Stage Growth Rate (add)

10.1%

Owner Earnings

$ 9,517,044,000.0

Discounted Value per annum

$9,517,044,000.0







Sum of present value of owner earnings

$100,666,730,256.7







Residual Value




Owner Earnings in year 10

$ 22,624,966,661.3

Second Stage Growth Rate (g) (add)

2.00%

Owner Earnings in year 11

$ 23,077,465,994.5

Capitalization rate (k-g)

6.75%

Value at end of year 10

$ 341,888,385,103.70







Present Value of Residual

$147,771,843,254.19

Intrinsic Value of Company

$248,438,573,510.84








Shares outstanding assuming dilution

3148920000

Intrinsic Value per share

$78.90

Based on the Dividend Discount Model:


Ks = 4.50% + 0.88* (5%) = 8.9%
Value of stock = DPS(1) = 1.24*1.11 =$72.44

Ks – g 0.089 – 0.07


Currently the price CL is selling for is $64.85. Hence 300 shares of CL would provide us with $19,455 which can use to purchase share of PG (Procter and Gamble) at $61.19. Hence we can purchase 320 stocks of PG at $19,580.80.



V. Appendices
2004 Restructuring Program2

In December 2004, the Company commenced a four-year restructuring and business-building program to enhance the Company’s global leadership position in its core businesses (the 2004 Restructuring Program). As part of the 2004 Restructuring Program, the Company anticipates streamlining its global supply chain through the rationalization of approximately one-third of its manufacturing facilities and the closure of certain warehousing facilities and also plans to centralize its purchasing and other business support functions. Business-building initiatives include enhancing and reallocating resources with an increase and upgrade in the sales, marketing and new product organizations in high-potential developing and other key markets, and the consolidation of these organizations in certain mature markets. The 2004 Restructuring Program is expected to result in approximately a 12% workforce reduction.


The cost of implementing the 2004 Restructuring Program is estimated to result in cumulative pretax charges, once all phases are approved and implemented, totaling between $750 and $900 ($550 and $650 aftertax). The estimated cost in 2006 is $300-$350 ($225-$250 aftertax). Savings are projected to be in the range of $325-$400 ($250-$300 aftertax) annually by the fourth year of the program. Over the course of the four-year 2004 Restructuring Program, it is estimated that approximately 50%-60% of the charges will result in cash expenditures. While the Company’s initial estimates remain unchanged, charges and savings may vary in a given year. Management’s estimates of the cost and savings associated with the 2004 Restructuring Program are forward-looking statements and are subject to revision over time.



3

4



Valuation Ratios

 

Company

Industry

P/E Ratio (TTM)

23.7

22.9

Price to Sales (TTM)

2.7

2.6

Price to Book (MRQ)

27.7

8.8

Price to Cash Flow (TTM)

17.4

18.2

Price to Free Cash Flow (TTM)

23.8

25.1

Dividend Yield

2.0

1.80



Profitability Analysis


 

Company

Industry

Return on Equity

135.1

29.6

Return on Assets

16.8

9.1

Fixed Asset Turns

4.8

5.6

Inventory Turnover

5.5

4.8

Revenue Per Employee

343.7K

555.6K

Gross Margin %

55.2%

52.8%

Operating Margin %

18.2%

19.2%

Net Margin %

12.0%

13.0%



Financial Strength


 

Company

Industry

Quick Ratio (MRQ)

0.91

0.54

Current Ratio (MRQ)

1.31

0.99

LT Debt to Equity (MRQ)

2.60

0.70

Total Debt to Equity (MRQ)

2.60

0.87

Interest Coverage (TTM)

13.61

11.34


Cash Flow Statement

PERIOD ENDING

31-Dec-06

31-Dec-05

31-Dec-04

Net Income

1,353,400  

1,351,400  

1,327,100  




Operating Activities, Cash Flows Provided By or Used In

Depreciation

328,700  

329,300  

327,800  

Adjustments To Net Income

215,800  

(5,500)

69,300  

Changes In Accounts Receivables

(116,000)

(24,100)

(5,600)

Changes In Liabilities

149,900  

193,800  

109,400  

Changes In Inventories

(118,500)

(46,800)

(76,100)

Changes In Other Operating Activities

8,200  

(13,700)

2,400  




Total Cash Flow From Operating Activities

1,821,500  

1,784,400  

1,754,300  




Investing Activities, Cash Flows Provided By or Used In

Capital Expenditures

(476,400)

(389,200)

(348,100)

Investments

(1,200)

(10,000)

19,600  

Other Cashflows from Investing Activities

(142,800)

178,500  

(761,900)




Total Cash Flows From Investing Activities

(620,400)

(220,700)

(1,090,400)




Financing Activities, Cash Flows Provided By or Used In

Dividends Paid

(677,800)

(607,200)

(536,200)

Sale Purchase of Stock

(520,300)

(749,100)

(567,500)

Net Borrowings

139,100  

(168,100)

492,600  

Other Cash Flows from Financing Activities

-  

-  

-  




Total Cash Flows From Financing Activities

(1,059,000)

(1,524,400)

(611,100)

Effect Of Exchange Rate Changes

6,700  

(18,200)

1,500  




Change In Cash and Cash Equivalents

$148,800  

$21,100  

$54,300


Income Statement

PERIOD ENDING

31-Dec-06

31-Dec-05

31-Dec-04




Total Revenue

12,237,700  

11,396,900  

10,584,200  




Cost of Revenue

5,536,100  

5,191,900  

4,747,200  










Gross Profit

6,701,600  

6,205,000  

5,837,000  













Operating Expenses







Research Development

-  

-  

-  







Selling General and Administrative

4,355,200  

3,920,800  

3,624,600  







Non Recurring

106,600  

-  

-  







Others

16,300  

-  

-  













Total Operating Expenses

-  

-  

-  
















Operating Income or Loss

2,223,500  

2,284,200  

2,212,400  













Income from Continuing Operations







Total Other Income/Expenses Net

(1,000)

(7,400)

(86,300)







Earnings Before Interest And Taxes

2,168,400  

2,221,500  

2,126,100  







Interest Expense

166,600  

142,500  

123,700  







Income Before Tax

2,001,800  

2,079,000  

2,002,400  







Income Tax Expense

648,400  

727,600  

675,300  







Minority Interest

(57,500)

(55,300)

-  













Net Income From Continuing Ops

1,353,400  

1,351,400  

1,327,100  













Non-recurring Events







Discontinued Operations

-  

-  

-  







Extraordinary Items

-  

-  

-  







Effect Of Accounting Changes

-  

-  

-  







Other Items

-  

-  

-  
















Net Income

1,353,400  

1,351,400  

1,327,100  




Preferred Stock And Other Adjustments

-  

-  

-  










Net Income Applicable To Common Shares

$1,353,400  

$1,351,400  

$1,327,100







1 http://investor.colgate.com/edgar.cfm?formchoose=10-K,10-K/A,10-K405

2/24/06 10K Annual Report, Page 8/159



2 http://investor.colgate.com/edgar.cfm?formchoose=10-K,10-K/A,10-K405

2/24/06 10K Annual Report, page 19/159



3 http://investor.colgate.com/financial_info.cfm

4 http://investor.colgate.com/financial_info.cfm


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