EUR 850.00 For Business Accounts Only

Morningstar | Colgate to Amp Up Brand Spending in 2019 to Withstand Competitive Pressures; Shares Attractive

Lagging top-line performance has plagued consumer products firms the past few years, and Colgate has not been immune. However, we view favorably the firm’s strategic intent to enhance its spending on product innovation (within its core mix, across adjacent categories, and throughout the digital realm) and advertising (which management suggested would increase on an absolute basis and as a percentage of sales in fiscal 2019, likely to a low-double-digit percentage of sales) as a way to ensure Colgate withstands competition longer term. This spending appears to us even more prudent presently, given that Colgate (much like its peer set) is opting to raise prices across its portfolio to offset cost inflation as it relates to commodities and transportation. For Colgate, when higher prices accompany new products aligned with consumer trends, volume degradation has historically persisted.

As a means by which to fund this increased investment, we’re encouraged that Colgate has been working to extract excess costs, targeting $500 million-$575 million in savings by the end of 2019, which equates to around 5% of cost of goods sold and operating expenses excluding depreciation and amortization. But rather than bolster its bottom line, our outlook calls for Colgate to direct around 12% of sales (more than $2 billion annually) to research, development, and marketing, a modest bump relative to the past decade but not too dissimilar from peers.

Overall, we still believe Colgate’s leading brands and entrenched relationships with retailers and professionals (dentists, veterinarians, and dermatologists) should ensure economic profits for the next 20 years. As such, we don’t intend to alter our $70 fair value estimate. With the shares trading at more than a 10% discount to our valuation, we’d suggest investors keep this wide-moat name on their radar.

For the fourth quarter, organic sales ticked up 2%, as a 2.5% bump from higher prices was offset by a 0.5% shortfall in volume. Profitability was hindered by inflated commodity and transportation costs (which ate into gross margins to the tune of 490 basis points, the impact of which was diluted by 290 basis points from the firm’s productivity initiatives) as well as increased brand spending. Adjusted gross margins eroded 100 basis points to 59.4% and adjusted operating margins ticked down 210 basis points to 24.6%. While macro and competitive headwinds are unlikely to subside, we think Colgate can hone its competitive edge, and we continue to forecast 3% average annual sales growth, 60% average gross margins, and operating margins expanding to the high 20s by the end of the next decade (from the mid-20s over the past few years).