Colgate-Palmolive's Q2FY20 results (Neutral) - Stable volume growth but at higher cost…

Q2FY20 result highlights

• Net sales grew by 4.5% yoy to Rs12.13bn (est: Rs11.95bn), EBITDA (including other operating income) fell by 2% yoy to Rs3.23bn (est: Rs3.6bn), PBT fell by 7% yoy to Rs2.78bn (est: 3.17bn) while reported PAT grew by 24% yoy to Rs2.44bn (est: Rs2.65bn); Adj for change in tax rate PAT fell by 7% yoy.
• Domestic sales increased by 5% yoy with a volume growth of 4% yoy (est: 3%).
• Gross margins was flat yoy at 64.5%, despite subdued input costs; but came in 100 bps lower than our estimates likely on account of higher promotional intensity.
• Staff cost increased by 7% yoy, other expenses declined by 1% but advertising expense were up 26.5% yoy (up 250bp yoy to 14.5% as percentage of sales) given the continued investment behind brands and new launches. Resultant EBITDA margins fell by 180bps yoy to 26.4% going back to levels of FY17.
• Other income was flat yoy, depreciation was up 27% yoy.

Key positives: Marginally better than expected volume growth.

Key negatives:  Flat gross margins & much higher ad spends.

Impact on financials: Cut EBITDA/ PBT estimates by 2-3% for FY20/21E.

Valuations & view

Colgate’s volume growth at 4% yoy did not see sequential moderation in 2Q, which is a positive. However, flattish gross margins and sharp increase in advertising spends clearly highlight that growth has come at high cost. While benign input cost & benefit of lower tax rate does provide headroom to invest behind core brands, we believe, higher skew to rural market, relatively weaker Naturals portfolio, high category penetration and high competitive intensity in the category provide limited scope to increase volume growth. We are factoring in 6% volume CAGR over FY19-21 resulting in 8% revenue CAGR, over the same period. Factoring weak margins, we have cut our EBITDA estimates by 2.5% each for FY20/21E, however, lower tax rate has led to EPS increase by 11% each for FY20/21E. Over the last 3months, stock has seen a run up of ~30% and current valuations at 49x/44x FY20/21E, we believe, adequately captures the baked in improvement in volume growth. Maintain neutral with a revised target price of Rs 1,433 (40x FY21E).