COLGATE PALMOLIVE Sweet aftertaste

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1 RESULT UPDATE COLGATE PALMOLIVE Sweet aftertaste India Equity Research Consumer Goods Colgate Palmolive s (Colgate) Q2FY12 revenue surged (19% Y o Y; marginally ahead of our estimate) on back of 13% Y o Y volume growth; its core Oral Care category grew 20% Y o Y. COGS pressure eased, leading to marginal dip in gross margin; EBITDA margin contracted significantly (342bps Y o Y) owing to high A&P spends. One off cost of ~INR 100 mn due to closing of the Hyderabad toothpowder facility led to flat PAT growth (marginally ahead of our estimate). Maintain HOLD. Robust volumes spur sales; closure of Hyderabad facility dents margin Colgate reported robust sales spurt of 19% Y o Y to INR 6.5 bn on back of 13% Y o Y volume surge. Easing COGS pressure (up only 36bps Y o Y) led to healthy gross margin of 61%. However, heavy A&P spending (up 306bps Y o Y) dragged down EBITDA margin to 19.4% (down 342bps). One off cost (~INR 100 mn) due to closing of the Hyderabad factory was incurred primarily in the form of VRS compensation of INR 82.2 mn. This led to flat growth in PAT (INR 997 mn). Adjusted PBT stood at INR 1,395 mn, up 8.3% Y o Y (against reported PBT of INR 1,289 mn). Tax rate dipped 59bps Y o Y to 22.7%; we expect the full year tax rate to be 23 24%. Mouthwash currying favour; innovation to help sustain market edge Colgate lost marginal volume market share in toothpaste (40bps) and toothbrush (370bps) categories from 53% and 40% in May 2010 June 2011, respectively. This market share loss looks surprising as Colgate s oral care category grew 20% Y o Y (vis àvis Dabur s 6% growth and double digit growth for HUL). During the same period, mouthwash category s volume share jumped 240bps from 24.0% to 26.4% on back of new launches Colgate Plax Mouthwash finding favour with customers. To counter competitive intensity (Unilever and GSK Consumer enjoy strong market shares in gel and sensitive segments, respectively) and sustain its iron grip in core business, Colgate continued to focus on innovation and launched Colgate 360 surround toothbrush. Outlook and valuations: Fairly valued; maintain HOLD We continue to like Colgate s continued focus on innovation, market stronghold and building brand equity. At CMP, the stock is trading at 32.1x and 27.3x FY12E and FY13E, respectively, and the valuation looks fair. We maintain HOLD/SU. Financials (INR mn) Year to March Q2FY12 Q2FY11 % Chg Q1FY12 % Chg FY11 FY12E Net revenues 6,572 5, , ,206 25,692 EBITDA 1,308 1, ,356 (3.5) 5,270 5,680 Core profit 997 1,003 (0.6) 1,004 (0.8) 4,026 4,247 Diluted EPS (INR) (0.6) 7.4 (0.8) Diluted P/E (x) EV/EBITDA (x) ROAE (%) EDELWEISS 4D RATINGS Absolute Rating Rating Relative to Sector Risk Rating Relative to Sector Sector Relative to Market HOLD Underperformer Medium Equalweight MARKET DATA (R: COLG.BO, B: CLGT IN) CMP : INR 1,002 Target Price : INR week range (INR) : 1,057 / 716 Share in issue (mn) : M cap (INR bn/usd mn) : 136 / 2,796 Avg. Daily Vol.BSE/NSE( 000) : SHARE HOLDING PATTERN (%) Others 22.3% FIIs 19.4% MFs, FIs & Banks 7.3% * Promoters pledged shares (% of share in issue) PRICE PERFORMANCE (%) Stock Nifty : NIL EW Consumer Goods Index 1 month months 1.5 (2.3) months 16.6 (10.5) 19.0 Abneesh Roy abneesh.roy@edelcap.com Harsh Mehta harsh.mehta@edelcap.com October 31, 2011 Promoters* 51.0% Edelweiss Research is also available on Bloomberg EDEL <GO>, Thomson First Call, Reuters and Factset. Edelweiss Securities Limited

2 Consumer Goods One off pressurises margins With effect from September 29, 2011, Colgate discontinued its toothpowder manufacturing operations at Hyderabad factory. This led to INR 1,056 mn costs in Q2FY12 primarily in the form of VRS compensation of INR 82.2 mn; rest reflected in depreciation and other expenses. The company stated that this shutdown will not impact toothpowder segment performance as its current capacity is sufficient to meet demand. Treading innovation path to garner market share To counter 370bps market share loss in the toothbrush segment from 40% in May 2010 June 2011 to 36.3% in October 2010 September 2011 Colgate is treading the innovation path with the launch of Colgate 360 surround toothbrush across the country priced at INR 75. The toothbrush is equipped with a unique head that is packed with special cleaning features surround bristles that simultaneously clean both sides of teeth and reach down to the gum line, a wraparound cleaner, and cheek & tongue cleaner, to provide a whole mouth clean experience and 3x germ removal action. Playing well on trust factor Colgate was ranked as India s Most Trusted Brand in Brand Equity Annual Survey We believe the company s dominant position is a clear reflection of why companies like P&G and ITC are reluctant to enter the toothpaste market. Chart 1: Gross margin steady due to COGS pressure easing Q1FY09 Q2FY09 Q3FY09 Q4FY09 (%) Q1FY10 Q2FY10 Q3FY10 Q4FY10 Q1FY11 Q2FY11 Q3FY11 Q4FY11 Q1FY12 Q2FY12 Gross margin Source: Company, Edelweiss research 2 Edelweiss Securities Limited

3 Colgate Palmolive Chart 2: A&P costs continue to balloon (%) Q1FY09 Q2FY09 Q3FY09 Q4FY09 Q1FY10 Q2FY10 Q3FY10 Q4FY10 Q1FY11 Q2FY11 Q3FY11 Q4FY11 Q1FY12 Q2FY12 A&P spends Source: Company, Edelweiss research Chart 3: Higher A&P drag down EBITDA margin Q1FY09 Q2FY09 Q3FY09 Q4FY09 Q1FY10 Q2FY10 (%) Q3FY10 Q4FY10 Q1FY11 Q2FY11 Q3FY11 Q4FY11 Q1FY12 Q2FY12 EBITDA margin Source: Company, Edelweiss research 3 Edelweiss Securities Limited

4 Consumer Goods Table 1: Balance Sheet As on 30th September 2011 (INR mn) Q2FY12 Q2FY11 Sources of funds Share capital Reserves and surplus 4,441 3,804 Shreholders fund 4,577 3,940 Loan funds 1 1 Total sources of funds 4,578 3,941 Uses of funds Fixed assets 2,762 2,537 Investments Deffered tax asset (net) Inventories 1,658 1,119 Sundry debtors Cash and bank balances 4,212 3,489 Interest accrued on investments/ deposits Loans and advances 1, Total current assets 7,659 5,997 Current liabilities 5,246 4,451 Provisions 1, Total current liabilities and provisions 6,432 5,122 Net current assets 1, Total uses of funds 4,578 3,941 Source: Company, Edelweiss research 4 Edelweiss Securities Limited

5 Colgate Palmolive Financial snapshot (INR mn) Year to March Q2FY12 Q2FY11 % change Q1FY12 % change FY11 FY12E FY13E Net sales 6,572 5, , ,206 25,692 29,639 Other operating income Total revenue 6,755 5, , ,969 26,452 30,548 Cost of goods sold 2,637 2, , ,720 10,302 11,826 Gross profit 4,119 3, , ,249 16,150 18,722 Staff cost ,932 2,184 2,519 Adv. & sales promotions 1, ,493 4,239 4,816 Other expenditure 1, ,554 4,046 4,668 Total exp. (excl. COGS) 2,811 2, , ,979 10,469 12,004 EBITDA 1,308 1, ,356 (3.5) 5,270 5,680 6,718 Dep., amortisation and imp EBIT 1,202 1,213 (0.9) 1,268 (5.2) 4,927 5,288 6,289 Other income (21.0) EBIT including other income 1,297 1, ,387 (6.5) 5,232 5,614 6,679 Interest expense PBT 1,289 1, ,381 (6.7) 5,199 5,589 6,654 Provision for taxation (22.4) 1,174 1,341 1,663 Reported Net profit 997 1,003 (0.6) 1,004 (0.8) 4,026 4,247 4,990 Equity capital (FV INR 1) No. of shares (mn) EPS (INR) as % of net sales COGS Staff costs Adv. & sales promotions Other expenditure EBITDA EBIT EBIT incl. other income PBT Net profit Tax rate Edelweiss Securities Limited

6 Consumer Goods Company Description Colgate is India s biggest oral care products company with more than 90% of its sales coming from this product category. The company has products across variants and price points in toothpaste, toothpowder, and toothbrushes, and is the leader in each of these categories. Investment Theme The company s leadership position in oral care has been strengthened by its continued market share gains. However, we believe further share gains are difficult as competition intensifies. Higher competition will induce Colgate to increase its brand spends, which could cap its margins. Also, fiscal tax benefits from its Baddi unit have come off in FY11, leading to a higher tax rate. Recent run up in its share price makes Colgate s valuation reasonable with the upside capped. Intense competition could put pressure on the company s already modest earnings growth, leading to a de rating of the stock. Key Risks Buoyant urban and rural demand, leading to continued volume growth and market share gain, could sustain earnings growth of the company. Lack of concerted attack by competition will not dent Colgate s base significantly. Colgate may continue to dominate if it intensifies its marketing campaign and competition wanes. Sharp correction in input prices or continued appreciation of the INR could reduce cost of imported chemicals that are priced on import parity basis. 6 Edelweiss Securities Limited

7 Colgate Financial Statements Income statement (INR mn) Net revenue 16,948 19,625 22,206 25,692 29,639 Other operating income Total operating income 17,708 20,352 22,969 26,452 30,548 Materials costs 7,413 7,768 8,720 10,302 11,826 Gross profit 10,295 12,584 14,249 16,150 18,722 Employee costs 1,434 1,591 1,932 2,184 2,519 Other expenses 2,768 3,014 3,554 4,046 4,668 Advertisement & sales costs 2,717 2,994 3,493 4,239 4,816 EBITDA 3,376 4,985 5,270 5,680 6,718 Depreciation & Amortization EBIT 3,147 4,609 4,927 5,288 6,289 Other income EBIT incl. other income 3,464 4,863 5,232 5,614 6,679 Interest expenses Profit before tax 3,453 4,848 5,199 5,589 6,654 Provision for tax ,174 1,341 1,663 Core profit 2,902 4,232 4,026 4,247 4,990 Profit after minority interest 2,902 4,232 4,026 4,247 4,990 Basic shares outstanding (mn) Basic EPS (INR) Diluted equity shares (mn) Diluted EPS (INR) CEPS (INR) Dividend per share (INR) Dividend payout (%) Common size metrics as % of net revenues Materials costs Employee expenses Advertising & sales costs Other expenses Depreciation Interest expenditure EBITDA margins EBIT margins Net profit margins Growth ratios (%) Revenues EBITDA PBT Net profit (4.9) EPS (4.9) Edelweiss Securities Limited

8 FMCG Balance sheet (INR mn) As on 31st March FY09 FY10 FY11 FY12E FY13E Equity capital Reserves & surplus 2,027 3,125 3,705 4,384 5,183 Shareholders funds 2,163 3,261 3,841 4,520 5,319 Unsecured loans Borrowings Deferred tax liability (177) (179) (168) (168) (168) Sources of funds 2,033 3,128 3,673 4,352 5,151 Gross block 4,253 5,345 5,798 6,268 6,918 Depreciation 2,513 2,876 3,248 3,640 4,069 Net block 1,739 2,469 2,550 2,628 2,850 Capital work in progress Investments Inventories 824 1,106 1,537 1,522 1,747 Sundry debtors Cash and equivalents 2,511 3,476 3,956 5,256 6,355 Loans and advances 1,930 1,222 1,122 1,122 1,122 Total current assets 5,377 5,901 7,044 8,197 9,560 Sundry creditors and others 3,945 4,267 4,739 5,290 6,076 Provisions 1,568 1,248 1,693 1,693 1,693 Total current liabilities & provisions 5,513 5,515 6,432 6,984 7,769 Net current assets (136) ,214 1,791 Uses of funds 2,033 3,128 3,673 4,352 5,151 Book value per share (INR) Free cash flow (INR mn) Net profit 2,902 4,232 4,026 4,247 4,990 Add : Non cash charge Depreciation Others Gross cash flow 3,143 4,623 4,401 4,665 5,444 Less: Changes in WC (389) (53) 291 (698) (522) Operating cash flow 3,531 4,677 4,110 5,363 5,966 Less: Capex 55 1, Free cash flow 3,476 3,584 3,657 4,893 5,316 Cash flow metrics Operating cash flow 3,194 3,974 3,854 5,363 5,966 Investing cash flow (145) (470) (650) Financing cash flow (2,551) (3,375) (3,230) (3,593) (4,217) Net cash flow 1, ,300 1,099 Capex (55) (1,093) (453) (470) (650) Dividends paid (2,391) (3,182) (3,489) (3,568) (4,192) 8 Edelweiss Securities Limited

9 Colgate Profitability & efficiency ratios ROAE (%) ROACE (%) Inventory day Debtors days Payable days Cash conversion cycle (days) (75) (78) (67) (67) (67) Current ratio Operating ratios Total asset turnover Fixed asset turnover Equity turnover Du pont analysis NP margin (%) Total assets turnover Leverage multiplier ROAE (%) Valuation parameters Diluted EPS (INR) Y o Y growth (%) (4.9) CEPS (INR) Diluted PE (x) Price/BV (x) EV/Sales (x) EV/EBITDA (x) Dividend yield (%) Edelweiss Securities Limited

10 RATING & INTERPRETATION Company Absolute reco Relative reco Relative risk Company Absolute reco Relative reco Relative Risk Asian Paints BUY SP M Colgate HOLD SU M Dabur BUY SO M Emami BUY SO H Godrej Consumer BUY SO H Hindustan Unilever BUY SO L ITC BUY SO L Marico BUY SP M Nestle Ltd HOLD SU L United Spirits BUY SP H ABSOLUTE RATING Ratings Expected absolute returns over 12 months Buy More than 15% Hold Between 15% and - 5% Reduce Less than -5% RELATIVE RETURNS RATING Ratings Sector Outperformer (SO) Sector Performer (SP) Criteria Stock return > 1.25 x Sector return Stock return > 0.75 x Sector return Stock return < 1.25 x Sector return Sector Underperformer (SU) Stock return < 0.75 x Sector return Sector return is market cap weighted average return for the coverage universe within the sector RELATIVE RISK RATING Ratings Low (L) Medium (M) High (H) Criteria Bottom 1/3rd percentile in the sector Middle 1/3rd percentile in the sector Top 1/3rd percentile in the sector Risk ratings are based on Edelweiss risk model SECTOR RATING Ratings Overweight (OW) Equalweight (EW) Criteria Sector return > 1.25 x Nifty return Sector return > 0.75 x Nifty return Sector return < 1.25 x Nifty return Underweight (UW) Sector return < 0.75 x Nifty return 10 Edelweiss Securities Limited

11 Colgate Edelweiss Securities Limited, Edelweiss House, off C.S.T. Road, Kalina, Mumbai Board: (91 22) , Vikas Khemani Head Institutional Equities Nischal Maheshwari Head Research Coverage group(s) of stocks by primary analyst(s): Consumer Goods Asian Paints, Colgate, Dabur, Godrej Consumer, Emami, Hindustan Unilever, ITC, Marico, Nestle Ltd, United Spirits Recent Research Date Company Title Price (INR) Recos 14 Oct 11 Hindustan Lever Diving in with Dove; EdelFlash 327 Buy 13 Sep 11 Godrej Consumer Products International business takes centerstage; Visit Note 428 Buy 17 Aug 11 Godrej Consumer Products Many more HITs to come; Visit Note 417 Buy Distribution of Ratings / Market Cap Edelweiss Research Coverage Universe Buy Hold Reduce Total Rating Interpretation Rating Expected to Rating Distribution* * 3 stocks under review > 50bn Between 10bn and 50 bn < 10bn Market Cap (INR) Buy Hold Reduce appreciate more than 15% over a 12 month period appreciate up to 15% over a 12 month period depreciate more than 5% over a 12 month period Access the entire repository of Edelweiss Research on This document has been prepared by Edelweiss Securities Limited (Edelweiss). 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