The Market Is Smiling on Colgate-Palmolive, but Should You?
Colgate-Palmolive (CL) - Get Report possesses strong brands, high returns on invested capital, and a history of revenue growth with margin expansion. This has cumulated in an uninterrupted dividend since 1895 and increases over the last 50-plus years which qualifies it as a Dividend King.
But at over 20-times earnings, it is tough to argue that the stock is cheap, but should long term dividend growth investors still pay attention?
Business Overview
Colgate has been in business for more than 200 years and focuses on four consumer categories- oral care (46% of sales -- toothpaste, mouthwash, toothbrushes), personal care (21% -- shower gel, body lotion, liquid hand soap, bar soaps), pet nutrition (13% -- specialty pet food), and home care (20% -- household cleaners, liquid fabric conditioners, hand dishwashing soap). Some of the company's most well-known brands include Colgate, Palmolive, Protex, Speed Stick, Ajax, Irish Spring, Sanex, Hill's, and Softsoap.
The company's products are sold in over 220 countries, with about half of sales coming from emerging markets and over 80% of sales coming from outside of the United States. Colgate has operated in most of its current markets for more than 70 years.
There are many characteristics that have allowed Colgate to earn high returns on invested capital over a multi decade period. The company's brands, advertising strategy, research and development investment, and distribution capabilities give us confidence that these historical returns are likely to persist into the future which puts Colgate on the short list for inclusion in our Top 20 Dividend Stock Portfolio. However in determining what price we should pay for the business, we need to investigate how long the company can keep up its historical mid-to-high single digit growth rate.
Revenue Growth Analysis
From 1995 to 2015 Colgate has grown revenue at a 3.4% compound annual growth rate (CAGR) and it would be even higher were it not for the effects of currency translation over the past couple of years (was an 11%-plus hit to the top line in 2015 alone).
The revenue growth has been driven by global population growth, growing consumption per capita of their products, and product extensions with subsequent pricing increases. An important factor to consider when investing in any business is the cyclicality of the revenue. Companies highly exposed to commodity markets, product cycles, and fads can see profits erode and cuts to their dividend during tough times.
In the case of Colgate, we don't have to worry about any of these issues, but rather need to determine if the historical growth drivers can be relied upon on a go forward basis.
The UN forecasts the global population to grow at a 0.8% CAGR from 2015 to 2050 and for roughly half of the growth to come from only nine countries. Colgate has been operating in many of these markets for well over 70 years and has well established infrastructure, marketing, and sales teams which makes them poised to continue to grow with the natural population growth. This single growth driver should allow for low-single digit top-line growth.
Country |
Current Population (Millions) |
Population Increase by 2050 Forecast (Millions) |
Population CAGR |
|---|---|---|---|
India | 1,311 | 394 | 0.8% |
Nigeria | 182 | 217 | 2.3% |
Pakistan | 189 | 121 | 1.4% |
Dem. Republic of Congo | 77 | 118 | 2.7% |
Ethiopia | 99 | 89 | 1.8% |
United Republic of Tanzania | 53 | 84 | 2.8% |
US | 322 | 67 | 0.5% |
Indonesia | 258 | 63 | 0.6% |
Uganda | 39 | 63 | 2.8% |
World | 7,349 | 2,376 | 0.8% |
Source: The Department of Economic and Social Affairs of the United Nations
Even though global population growth appears to be a solid growth driver going forward, the continued increase in per capita consumption of toothpaste and their other products appears to be the trend driving a large portion of the future growth for the company. As the chart below clearly depicts, individuals spend more and more of their income on toothpaste (and I would surmise other health and hygiene products) as they become more wealthy.
This mega trend should continue to benefit Colgate for decades to come and some basic math can show us the potential impact. If India's population started consuming toothpaste on the same magnitude as in the U.S., that would represent a 4-times increase in consumption per capita. For Nigeria, the same arithmetic yields an over 8-times increase in consumption per capita. While oral care, which includes toothpaste, on makes up about 46% of Colgate's overall sales, its other products should experience an increase in consumption per capital as the world becomes wealthier as well.
Country |
Toothpaste consumption per capita (grams per person) |
Increase in consumption per capita needed to be equal to US consumption per capita |
|---|---|---|
Nigeria | 68 | 8.25x |
India | 137 | 4.09x |
China | 277 | 2.02x |
Russia | 362 | 1.55x |
Mexico | 520 | 1.07x |
UK | 543 | 1.03x |
US | 561 | 1x |
Brazil | 622 | 0.9x |
Source: Company Presentations
Also, it is important to note that the counties that are projected to have the greatest increase in population over the coming years are some of the same countries that currently have the lowest consumption per capita of toothpaste.
The last major growth driver for the Colgate is product extensions. Historically the company has been able to do a great job with creating new products, at different price points, that fit specific consumer demands. For instance, when most people think of toothpaste, they think of just plain old toothpaste that satisfies most needs. However over the years, Colgate has introduced a plethora of different options for consumers covering everything from whitening formulas to products specific to sensitive teeth.
The company has not only innovated around toothpaste, but has created toothbrushes with anti bacterial bristles and even specialty pet food for weight loss in its pet nutrition segment. Importantly, all of these different products represent opportunities to raise prices and grow volume for the company. While I've only highlighted a few examples, it goes without saying that this innovation is consistent across its entire portfolio of products.
Looking down the income statement beyond revenue, we can see that historically the business has been able to generate increases in operating income (more than 6.8% CAGR from 1995 to 2015) in excess of revenue growth (more than 3.4% CAGR from 1995 to 2015). This dynamic is important because it allows the business to generate cash flow growth and thus dividend growth in excess of simple top line revenue growth. This allows the business to compound at an accelerated rate as it gains more scale and makes us consider it for our Top 20 Dividend Stocks Portfolio.
Dividend Analysis
Colgate has an excellent dividend history and future dividend outlook characterized by a Safety Score of 98 and a Growth Score of 50. However, it appears that the current yield at 2.1% is a little below average with a Yield Score of just 41.
Despite the relatively low current yield, Colgate has a long runway ahead for additional dividend increases and is set to continue its streak of 50-plus straight years of dividend increases. This is a dividend payer that could have a very high yield on cost someday if purchased prudently.
Conclusion
Colgate clearly has a great business given that the historical revenue growth, margin structure, and ROIC profile are some of the best in class. Importantly, the future looks very bright as the historical growth drivers of the business appear intact and Colgate looks poised to generate revenue growth for decades to come from a growing global population, increase in per capita spend on hygiene products, and product extensions.
Just as critical as the aforementioned forecasted top line growth, it appears that the incremental return on capital should be consistent going forward as well. This should allow intrinsic value to compound at a double digit rate.
Buying the shares at over 20-times earnings today hardly looks like a bargain in the short term and current valuation does appear to incorporate much of the growth and business quality aspects, but over time, measured in decades and not quarters, the value of the business should rise and the shares should follow suit accordingly regardless of the multiple the market ascribes to the business.
With these dynamics intact, we will keep a close watch on this Dividend King and wait for an opportunity to add it to our Top 20 Dividend Stock Portfolio.
This article is commentary by an independent contributor. At the time of publication, the author was long Colgate.