Colgate-Palmolive Company Tapping Massive Growth in Asian Markets

Tuesday 22nd, March 2016


Colgate-Palmolive Company (NYSE:CL) recently expressed enthusiasm about its opportunities in Asia, and management said that the company is planning to reenter Indonesia, the world’s fourth most populous country with a population of approximately 255 million. The worldwide population is expected to reach 8.4 billion by 2030, and in Asia, the population is expected to reach 4.9 billion, a 14% increase over its current estimated levels. So what is Colgate’s potential market share in Asia, and how will it affect revenue and earnings for the company? Let’s find out.

Xerago comment: Colgate-Palmolive presents a fascinating example of a CPG company focussed almost single-mindedly on just one major product category, oral care. As a multi-national company, Colgate has shown a remarkable ability to defend its turf very effectively over the course of nearly a 140 years against similar or bigger sized competitors. To be able to do so both in its home market of the US and numerous other countries all around the world is a huge achievement.

Colgate has followed a remarkably prescient strategy of selling the concept of oral care consistently over the decades. In the early part of the 20th century, the company was the first to hand out free samples of its products to school children in the US to encourage sound oral care practices.

In Asian countries like India where native/traditional oral care practices such as dental powders or the use of neem twigs were prevalent, the company spent time and money promoting its toothpastes and tooth powder as more modern and efficient alternatives. In getting customers to switch to its brand, the company has displayed remarkable patience and resilience.

A billion tubes of toothpaste
According to the 2015 annual report, net sales in Asia of approximately $2.5 billion represented just over 15% of the company’s top line. As of 2014, Colgate-Palmolive held an approximate 86% market share in the oral care (toothpaste) business in Asia.

Given these numbers, the current Asian per capita spend on Colgate-Palmolive products is approximately $0.58. If the population increases to 4.9 billion, and if Colgate merely holds its market share, then this will translate to roughly $2.85 billion in Asian net sales for the company, a $350 million increase over 2015 levels. Note that the company will also benefit from inflation, which isn’t factored in here, as a tube of toothpaste in 1965 cost just $0.55 but retails for around $3 today.

Xerago comment: Despite its formidable market share in most major Asian markets, there is still plenty of opportunity available. In India, Colgate has over half the market but that is in a country where just half the population is estimated to use new, modern methods of oral care. China presents another huge opportunity where Colgate currently has just about a fifth of the market.

A bigger challenge though may come from specialist/niche products that appeal to select audiences. For instance, India’s Patanjali Ayurveda has rattled Colgate in recent months by taking away market share with its toothpaste formulations based on traditional Ayurvedic principles.

For a single-category company like Colgate, the challenge lies in both looking ahead as well as keeping an eye on its competitors who’re trying to catch up. The company has done this by re-formulating products to appeal to local preferences. For instance, it has recently launched charcoal-tipped toothbrushes to cater to a well-known indigenous oral care tradition.

While the company could theoretically tap niche markets by formulating products based on local ingredients, it has so far refrained from doing so. In doing so, it is betting that a new generation of young customers will prefer contemporary solutions to oral care rather than traditional ones.

Colgate has also succeeded in building a formidable distribution chain extending down to the smallest villages. The company’s India website estimates that its products are sold through nearly 5 million retail outlets. This ought to give it a significant barrier to entry against rival brands.

Furthermore, if the company can maintain its margins, which stand at a trailing 12-month figure of 58.6% and 8.6% for gross and net, respectively, it should realize an additional $30 million in net income. Based on outstanding shares of 910 million, this will translate into approximately $0.03 per share, or 2% earnings growth. That might not sound like much, but keep in mind the company has repurchased approximately 15.5% of its outstanding shares since 2006, and its board authorized a $5 billion buyback program in February 2015. These repurchases will further boost earnings for the consumer products company.

A spring of scaled margins
For company margins, it is important to note that, in addition to a valuable portfolio of brands, including Colgate, Palmolive, and Irish Spring, the economic moat of the company is also defined by its low-cost operating structure. The trailing 12-month gross margin for Colgate is 58.6%, compared to an industry average of 51.8%, and its operating margin is 25.1%, far above the industry average of 20.2%. These margins are facilitated by large economies of scale that allow the company to maintain lower unit costs, and management is diligent about keeping them in line. As a result, it is likely these margins will stay in place or improve over the coming years.

Current Asian headwinds
Although these population growth numbers sound promising, the Asian market is not without its own headwinds. In Colgate-Palmolive’s most recent quarterly report, net sales in Asia declined 5%. This underperformance was due largely to foreign exchange headwinds, which are intense, as characterized by CEO Ian Cook at the 2016 CAGNY conference:

Perhaps the most significant headwind in 2015 was foreign exchange. I don’t recall in my time with the company seeing on an annual basis foreign exchange headwinds of nearly 12%, and of course you know well that hits you directly from a translation point of view, but it also impacts you from a transaction point of view in terms of material cost headwinds that you have to deal with.

The good news surrounding the decrease in Asian sales dollars is that unit volume increased by 2.5% in Asia, and once adjusted for foreign translation, sales actually grew 2% for the quarter.

Don’t forget to add toothpaste to the shopping list
Colgate-Palmolive is eyeing the future of its Asian market, and management sees that it is pock-marked with waves of beneficial population growth. As these numbers come to bear on the company’s results, shareholders will benefit if the company can maintain its margins and market share. The toothpaste maker comes complete with a solid moat of brands, economies of scale, and broad global reach with more than 80% of sales generated outside North America. This moat has effectuated solid results over the past decade in the form of consistent earnings that have grown at a 10-year average rate of 3.47%, a return on equity that has averaged an unheard-of 126%, and a sound balance sheet with long-term debt that could be retired in under five years using 2015 net income.

Xerago comment: For most American CPG companies, growth has increasingly begun to accrue from the Asian and Lat-Am markets. With most product categories reaching saturation levels in the US and Europe, the compulsions of growth dictate looking outward to foreign markets.

Colgate has so far displayed a remarkable ability to dominate its product category. One point in the company’s favour is that it operates in a category which is a household staple. It is largely a recession-proof product. Another less-considered aspect is that its peers such as P&G and Unilever have a huge portfolio of brands across product categories. Brands such as Crest and Close-Up could have so easily dominated the product category if they had chosen to, but probably never will. Corporate attention and resources are allotted to the bigger brands in the portfolio. P&G and Unilever’s loss is Colgate’s gain!

Although the stock is not priced for value with a trailing 12-month price-to-earnings ratio of 25, future opportunities make this is a company that investors should consider for their shopping list.

Adam Brownlee has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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