Is the best of margins behind the company Colgate Palmolive (India) Ltd for oral care products? This is the question that its investors must try to answer, especially after the bright gross margin and Ebitda margin shows that it presented in the December quarter (Q3FY24).
Gross and Ebitda margin increased year-over-year by approximately 630 basis points and 560 bps, respectively, to 72.2% and 33.6%. Both these metrics reached their “highest level,” according to Nomura Financial Advisory and Securities (India).
Key factors that facilitated the expansion of margins in Q3 were a drop in crude costs and prices picked up earlier. Moreover, to some extent, a favorable basis also helped as the margin contracted year-on-year in Q3FY23.
Collectively, this meant that Ebitda increased by 30% year on year to ₹468 crores. This comes at a time when Colgate’s total operating income increased by 8% to nearly ₹1,396 crores.
Despite that, Colgate shares fell more than 4% on Tuesday amid weak broader markets.
The marginal brilliance has dimmed due to a dull outlook on volume. Revenue growth was driven by prices and not volume growth, which is usually more valued. Analysts estimate that Colgate’s volume fell marginally year over year or grew slightly.
The company said its toothpaste segment achieved double-digit growth and also saw volume growth. However, growth in the toothbrush segment and exports were disappointing.
However, all told, Colgate outperformed in growth against Hindustan Unilever Ltd’s oral care portfolio, which saw mid-single-digit growth in Q3 led by Closeup.
Be that as it may, the challenge for Colgate really is that the outlook for significant volume growth going forward is dim despite many product innovations. Factors such as high penetration, intensifying competition and lower frequency of product use in the oral care category present an obstacle to volume growth. There is also limited room for further price increases without affecting volume.
“We see a general focus on pricing (especially at the premium end, and in the case of variants where competition is weak) and margins, which could weigh on volume growth and upside in the medium term,” Kotak Institutional Equities said in a report on 23 January.
The analysts note that Colgate used the inflationary cycle to push disproportionate prices (even as raw material prices declined) and expand gross margin by 450-500 bps to around 70%+ (industry leading).
Of course, this means that the prospects for revenue growth are bright in FY24. Already, for the nine months ended December (9MFY24), Ebitda margin expanded by 440 bps year-on-year.
Jefferies India upgraded its FY24-26 earnings per share estimate for Colgate by 3-4%, expecting a higher margin trajectory going forward. But the margin expansion is also set to recede going forward.
“Earnings growth should however moderate in early Q4 (vs. 30% EPS growth in 9MFY24), as the benefit of raw material inflation impacted a low base decline,” Jefferies analysts said.
In addition, Nomura notes that Colgate’s royalty (about 4.9% of sales) is renewed in July, which may add pressure if increased.
Plus, after a sharp 63% gain in Colgate’s stock, valuations are expensive. The stock trades at nearly 48 times FY25 estimated earnings, according to Bloomberg data.
An increase in volume is crucial for Colgate to see continued market improvement and also help investor sentiment. But given the rally and lack of enough leverage for a pick-up in volume growth, significant upside in Colgate stock seems few and far between.