Colgate-Palmolive's Q1FY20 results (Neutral) - Volumes remain weak, accounting change drives EBITDA beat

Q1FY20 result highlights

• Net sales increased by 4.1% yoy to Rs10.76bn (est: Rs10.85bn), EBITDA (incl op income) increased by 6% yoy to Rs2.99bn (est: Rs2.87bn), Adjusting for one-off gain of Rs341m in base quarter, PAT increased by 5% yoy to Rs1.69bn (est: Rs1.67bn).
• Domestic rev. grew by 6% yoy led by volume growth of 4% yoy (est: 5%) but poor exports led to overall rev. growth coming in at 4.1% yoy.
• Despite higher base, gross margins was flat yoy at 65.6% (est:64.7%) led by benign input cost and price hikes. Staff cost increased by 11% yoy and advertising expense were up 5% yoy (up 20bp yoy to 14.1%).
• Other expenses declined by 3% yoy, largely due to IND AS 116 implementation. Reported EBITDA margins improved by 60bps yoy to 27.6%. Adj for IND AS 116 impact (as per our estimate), EBITDA growth is likely to be ~4% yoy with a margin decline of ~10bp yoy.
• However, with corresponding increase in depreciation (up 27% yoy) & interest expense, the overall impact is neutral at PBT level. Other income increased by 66% yoy but still adj. PAT was up 5% yoy because of higher tax rate yoy (at 35.7%, up 210bp yoy).
• Management said that current quarter saw a moderation in demand impacted by lower than expected growth in the rural markets but this trend is temporary and it expects a pickup in coming quarters.

Key positives: Better than expected gross margins

Key negatives:  Lower volume growth

Valuations & view

On first reading, there appears to be a good 60bps yoy improvement in Colgate’s EBITDA margin in Q1FY20 but it is entirely led by change in accounting norms (IND AS 116), even as the impact of this change is neutral at the PBT level. Volume growth of 4% yoy was largely in line and we are factoring in 6% volume CAGR over FY19-21 resulting in 8% revenue CAGR over the same period. Given the high competitive intensity and high penetration in oral care, we believe revenue growth upsides are capped. To factor in a benign input cost scenario, we are factoring gross margin expansion of 70bps over FY19-21E and EBITDA margin improvement of 130bps (also a function of IND AS 116) and any further expansion looks unlikely. This would drive earnings CAGR of 11.7% over FY19-21E and valuations at 42x/37x FY20E/21E EPS, appears fair given Colgate’s single category salience. Maintain Neutral.