RealMoney Silver - Brush Up on Colgate's Prospects

Brush Up on Colgate's Prospects
By Bill Trent
RealMoney.com Contributor
4/1/2008 1:24 PM EDT

Colgate-Palmolive (CL) has outperformed the S&P 500 by more than 26 percentage points over the last 52 weeks. This was partly because of the non-discretionary nature of its product lines, which investors believe will perform relatively better in a weak economy. Recession or no, I believe there are good reasons to buy Colgate here.

With 75% of its sales sourced outside the U.S., Colgate is about as immune to a U.S. slowdown as a company can be. Even if global economic growth comes to a halt, Colgate's relatively inexpensive yet necessary products should fare reasonably well.

In 2004, Colgate launched a four-year restructuring program that remains scheduled for completion this year. Restructuring charges have been a drag on earnings for the last three years (though the Street has largely looked past this). Once the restructuring is completed, management believes, the annual after-tax benefits will amount to $325 million to $350 million, most of which will increase cash flow.

Consensus earnings estimates have been steadily marching up at a time when overall earnings estimates are headed the other direction. Although the same could be said for a number of other soap and cosmetics manufacturers, including Avon (AVP) , Alberto Culver (ACV) and Church & Dwight (CHD) , there are also competitors -- most notably Procter & Gamble (PG) -- whose estimates are falling, if only slightly.

Furthermore, the quality of Colgate's earnings is superior to that of its peers. The accrual ratio measures the difference between earnings on a cash basis and those reported using accounting estimates. In Colgate's case, the difference is only 4%. Alberto's is 12%, Estee Lauder's (EL) is 15%, Avon's is 16%, and Clorox (CLX) has a whopping 35% difference between its cash and accounting earnings.

On a free cash flow basis, Colgate is yielding a bit better than 4%, which isn't the most spectacular yield, but it's nice given Colgate's defensive nature. Although Procter & Gamble (4.9%), Church & Dwight (5.7%) and Clorox (7.2%) all have more attractive free cash flow yields, Colgate's superior earnings momentum and quality provide a counterbalance to that, in my opinion. Furthermore, Colgate's cash flow is set to improve because of the completion of the restructuring program.

What's more, most of that cash flow has been returned to shareholders. From nearly $1.7 billion in free cash flow, Colgate paid more than $2 billion in dividends and share buybacks. Reduced cash holdings and the proceeds from stock option exercise allowed the company to reduce debt somewhat, despite the aggressive share buyback. Net of the shares issued as a result of option exercise, the company reduced its share count by 3.5 million, a bit less than 1% of the total outstanding.

Downside from current stock levels seems fairly limited. Colgate's earnings are expected to reach $3.81 this year and $4.27 next year, assuming that no further positive revisions are in the cards. The lowest trailing P/E ratio over the last five years has been 18 times, so even if valuations sink to those levels, the company could grow into its current share price.

Better yet, if the stock can maintain its current P/E ratio, it could reach $100 in the next 12 to 18 months, for a 28% gain from current levels.

It doesn't quite amount to one of Cramer's $80-to-$120 plays, but in today's market environment, slow and steady may well win the race.