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Morningstar | Even in Face of Headwinds, Colgate's Sales Sparkle in 1Q; Shares Fairly Valued

We don’t expect any material change to our $70 fair value estimate for Colgate-Palmolive following a solid start to fiscal 2019 that included 3% organic sales growth, reflecting a 2% benefit from higher prices and a 1% contribution from volume gains. While adjusted gross and operating margins eroded 110 basis points and 180 basis points to 59.2% and 23.4%, respectively, we attribute this to pronounced inflationary headwinds combined with a 3% uptick in brand spending, which we view as a prudent means to support the intangible asset that underpins our wide economic moat.

Results through the first three months of the year are tracking in line with our full-year outlook (nearly 1% sales growth and a 70-basis-point degradation in adjusted operating margins to 24.1%). After the stock's mid-single-digit pop following earnings, we now view Colgate as fairly valued. However, we think much attention will continue to center on the sustainability of its top-line trajectory, and we suggest investors keep this name on their radar as we doubt sales will remain on a course due north as the firm works to fend off intense competitive pressures.

From a geographic perspective, North America and Latin America (each more than 20% of sales) were particular bright spots with 3.5% and 6% organic sales gains, respectively. We attribute this to the firm’s strategic agenda to more effectively spend on product innovation (as it relates to core mix, across adjacent categories, and throughout the digital realm) and grease the wheels of its innovation process (to respond in a more timely fashion to evolving consumer preferences). We perceive this investment as even more prudent at present, given that Colgate (much like its peers) is raising prices across its portfolio to offset cost inflation as it relates to commodities and transportation. We think that when higher prices accompany new products aligned with consumer trends, volume degradation has failed to last.

While China remains weak (as evidenced in the 2.5% downdraft in Asia-Pacific underlying sales), partly stemming from retailers' intentional steps to reduce inventory, management’s actions to pivot its mix to more effectively cater to consumers’ desire for premium offerings and bolster e-commerce distribution strike us as prudent for the long-term health of the business. Although growth has been tepid of late, we believe favorable emerging-market demographic and disposable income tailwinds, combined with Colgate’s long tenure operating in these markets and solid intangible assets, should enable the company to realize mid-single-digit annual growth in emerging regions, above the low-single-digit growth we forecast on its home turf.

As a means to support this growth, we continue to expect 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. We think it is Colgate’s leading brands and entrenched relationships with retailers and professionals (dentists, veterinarians, and dermatologists) that should position the firm to generate economic profits for the next 20 years.