Updated on February 19th, 2019 by Josh Arnold
The Dividend Aristocrats are a group of 57 companies in the S&P 500 Index, with 25+ consecutive years of dividend increases.
A select number of Dividend Aristocrats also qualify as Dividend Kings, an even more exclusive group of stocks that have raised their dividends for 50+ consecutive years.
Colgate-Palmolive (CL) is a Dividend Aristocrat, and is also a Dividend King.
Colgate-Palmolive’s long history of dividend increases is due to its strong brands and dominant position across multiple product categories. These time-tested brands have fueled the company’s growth for over 100 years.
Colgate-Palmolive has paid uninterrupted dividends since 1895, and has increased its dividend payments for the past 57 consecutive years.
The one negative aspect of Colgate-Palmolive as a potential investment is the stock valuation. Colgate-Palmolive stock appears to be significantly overvalued today, which could limit its shareholder returns over the next five years.
In this article, we provide a detailed analysis of Colgate-Palmolive’s business model. Before digging in, you may want to examine Colgate-Palmolive’s dividend safety, which we examine below:
Colgate-Palmolive traces its roots all the way back to 1806, making it one of the oldest companies in the US stock market. It was founded by William Colgate, who started a starch, soap, and candle business in New York City.
Today, the company manufactures oral care products like toothpaste, personal care products such as soap, home cleaning products, and pet food.
Source: Investor Presentation
Major brands include Colgate, Palmolive, Hill’s Science Diet, and many more. The core segment is Oral Care, which constitutes nearly half of revenue.
Colgate-Palmolive is a global giant. It sells its products in over 200 countries and territories around the world, and the company generates almost $16 billion in annual sales.
The company has a highly diversified business model, in terms of products as well as geographic markets. Approximately half of the company’s revenue comes from emerging markets, although its reliance upon these markets for growth has waned a bit recently.
This is due to the success of the company’s pet nutrition business, as it continues to take revenue share from other segments. Emerging markets will be a critical growth catalyst for the company moving forward. Colgate-Palmolive has the #1 position in China, with market share above 30%.
However, the company also faces several challenges, including a strong U.S. dollar and cost inflation, which could keep a lid on growth going forward.
Colgate-Palmolive enjoys a world class brand portfolio and very high profit margins. Even after a dip in the company’s profitability recently, it still maintains mid-20% operating margins. There aren’t many manufacturing businesses in the world with that sort of profitability profile.
As mentioned, conditions have tightened as of late, and Colgate-Palmolive has struggled to generate meaningful growth in recent years.
The company’s fourth-quarter earnings report, released on January 25th, highlighted some of the recent struggles the company has had. Total sales were down 2% as organic sales increased 2% and acquisitions added a further 1% to the top line.
However, foreign exchange translation saw revenue fall by 5%, which was more than enough to offset the 0.5% increase in volume and a 2.5% gain in pricing and mix.
The company’s regions turned in varying top line performances. Organic sales increased 0.5% in North America; 1% in Latin America, Europe, and Asia-Pacific; 4% in Africa/Eurasia; and 8% for Hill’s Pet Nutrition.
Despite the difficulties posed by volatile exchange rates, Colgate-Palmolive continues to generate positive organic growth, which indicates the core business is performing well.
The emerging markets are a long-term growth catalyst for Colgate-Palmolive, as global toothpaste use remains relatively low.
Source: Investor Presentation
Colgate-Palmolive has a high market share in regions of the world where toothbrush use is low. This leaves lots of growth potential for Colgate-Palmolive in the years ahead.
However, profitability has been an issue of late, as Q4’s gross margins fell 100bps on an adjusted basis to 59.4%. Management blamed higher raw material and packaging costs, which its competitors have suffered from as well.
Higher pricing as well as productivity savings helped to offset some of this headwind, but it wasn’t enough. The company’s margin issues have been persistent and in Q4, higher logistics and advertising costs sent SG&A costs rising at a time when gross margins declined, which crimped operating margins on both ends.
Indeed, operating margins declined 130bps in Q4 to 23.4%. Colgate-Palmolive’s profitability is certainly not in question, but growth on this front has proven as elusive as revenue growth in recent reporting periods.
In total for 2018, revenue was flat while operating margins were also essentially flat, but a lower tax rate helped drive earnings-per-share 21% higher to $2.75.
Management guided for a low single-digit decline in earnings-per-share for 2019 on flat to slightly higher sales but also higher costs, so our earnings-per-share estimate for 2019 is $2.70. It appears the company’s growth struggles will continue in 2019.
We see Colgate-Palmolive as producing 4% annual earnings-per-share growth on average in the coming years with 2019 coming in weaker than forecast. The company continues to produce low single digit organic revenue gains, but its significant global presence means forex translation continues to be a problem.
Product extensions into premium lines of soap and toothpaste, for instance, should help drive incremental revenue gains in the years to come, and higher pricing should help offset margin-crimping higher raw material costs.
Competitive Advantages & Recession Performance
Colgate-Palmolive has many competitive advantages which have fueled its growth over the past 200 years.
First, it has built a dominant position in its core product categories, most notably in toothpaste.
In toothpaste, Colgate-Palmolive’s market share has risen steadily for many years. Today, it commands a higher market share than the next-three biggest competitors combined.
Source: Investor Presentation
Such high market share allows Colgate-Palmolive to charge higher prices for its premium products, and raise prices over time. Pricing power is a critical competitive advantage for consumer goods stocks.
Another major advantage for Colgate-Palmolive is that products the company sells are necessities of modern life. Consumers need oral, personal, and pet care products irrespective of economic conditions.Colgate-Palmolive enjoys steady demand, which gives the company consistent profitability, even during recessions.
Colgate-Palmolive’s earnings-per-share through the Great Recession are shown below:
- 2007 earnings-per-share of $1.69
- 2008 earnings-per-share of $1.83 (8.3% increase)
- 2009 earnings-per-share of $2.19 (20% increase)
- 2010 earnings-per-share of $2.16 (1.4% decline)
Colgate-Palmolive generated positive earnings growth in 2008 and 2009, during the worst years of the recession. Earnings dipped slightly in 2010, but resumed growing in 2011 and thereafter.
The company’s strong performance from 2007-2010 is a credit to its strong business model and powerful brands. When the next recession strikes, we expect Colgate-Palmolive’s earnings to hold up very well.
Colgate-Palmolive’s dividend is also very safe, which is a topic that we explore in the following video:
Valuation & Expected Returns
Colgate-Palmolive stock has a current price-to-earnings ratio of 24.2. While the stock has certainly had higher valuations than this in the past, it is still elevated.
Given Colgate-Palmolive’s struggles to generate earnings growth in recent years, it does not seem to justify a premium valuation multiple. Our estimate of fair value is 19 times earnings, and shares are well in excess of that today, meaning they are overvalued.
As a result, there is risk of multiple contraction. Should this contraction come to fruition, it would negatively impact shareholder returns. We see a ~5% headwind to total annual returns from the valuation reverting back to fair value over time.
We see total returns of just ~2% annually for shareholders of Colgate-Palmolive as the company’s 2.6% yield and 4% earnings-per-share growth are partially offset by a ~5% headwind from the declining valuation. This makes the company’s prospects unattractive and therefore, we rate the stock a sell.
Colgate-Palmolive’s impressive dividend increase streak certainly counts for something, but the yield isn’t high enough to warrant purchasing the stock since it is trading at a nearly-30% premium to fair value today.
Colgate-Palmolive is a high-quality business, with several category-leading brands. The company has growth potential, through product innovation, its outstanding Hill’s brand, and in emerging markets.
Now might not be the best time to buy shares of Colgate-Palmolive, however, as the stock appears to be meaningfully overvalued. The company needs to prove it can generate higher levels of growth in order to justify its premium valuation.
Colgate-Palmolive does not offer a high yield, or high dividend growth. That said, investors can still count on steady dividend increases each year. The overvaluation of the stock, however, warrants a sell rating.