COLGATE PALMOLIVE Volumes recover; market share gains monitorable

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1 RESULT UPDATE COLGATE PALMOLIVE Volumes recover; market share gains monitorable India Equity Research Consumer Goods Colgate Palmolive s (Colgate) Q4FY18 revenue growth of 5.2% YoY came in-line, whereas EBITDA/adj. PAT growth of 25.9%/40.6% YoY surpassed estimates. Domestic volume growth remained positive for the second successive quarter, partly on weak base of -3% and increasing focus on Naturals portfolio. Though volumes recouped, Colgate lost 170bps YoY and 30bps QoQ market share (MS) in toothpaste category marred by heightened competitive intensity. Nonetheless, we maintain that while market share loss has largely bottomed out, it would improve gradually (refer: Naturals to stem market share loss). Renewed vigor Palmolive range of personal care would be key monitorable. Maintain HOLD. Volumes spurt; margin jump led by lower other expenses Volume growth at 4% YoY, albeit on low base, was encouraging. This was led by normalisation of trade channel and fast growing naturals portfolio (Swarna Vedshakti & Cibaca s Vedshakti. Colgate s other brands, Colgate Dental Cream and re-launched Max Fresh, continue to do well. However, the company continued to lose MS in toothpaste (down 170bps to 53.4%, fell for eight quarters in a row) and toothbrush (down 260bps to 44.8%) on FY18 basis. Gross margin, at 65.7%, hit multi-quarter high, on soft raw material cost. EBITDA margin jumped 462bps YoY, aided by 75bps and 44bps YoY savings in ad spends and other opex, respectively. GST, Naturals innovation to drive market share and volumes Though Colgate has been losing MS, we believe it is set to rebound owing to: (i) rising focus on herbal-based products at competitive prices launched Swarna Vedshakti in the South and Cibaca Vedshakti in North with focus on taking it pan India; and (ii) higher GST rate (raised to 12% from 5% for herbal toothpaste players) provides Colgate a level playing field with other herbal players. Outlook and valuation: Gradual improvement seen; maintain HOLD We believe Colgate s innovation funnel and brand investments will persist, which should help arrest share loss, but increasing competitive intensity would be a monitorable. Revenues from the new product range under the Palmolive brand would be an added kicker. At CMP, the stock is trading at 36.6x FY20E EPS. We retain our PE multiple of 38x on FY20E to arrive at TP of INR1,254. Maintain HOLD/SP. Financials Edelweiss Research is also available on Bloomberg EDEL <GO>, Thomson First Call, Reuters and Factset. (INR mn) Year to March Q4FY18 Q4FY17 % change Q3FY18 % change FY18 FY19E FY20E Revenues 10,917 10, , ,880 45,867 51,148 EBITDA 3,075 2, , ,124 12,319 14,016 Adjusted Profit 2,004 1, , ,850 7,831 8,975 Dil. EPS (INR) 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 Edelweiss Securities Limited Performer Medium Underweight MARKET DATA (R: COLG.BO, B: CLGT IN) CMP : INR 1,208 Target Price : INR 1, week range (INR) : 1,231 / 975 Share in issue (mn) : M cap (INR bn/usd mn) : 332 / 4,715 Avg. Daily Vol.BSE/NSE( 000) : SHARE HOLDING PATTERN (%) Current Q3FY18 Q2FY18 Promoters * MF's, FI's & BK s FII's Others * Promoters pledged shares (% of share in issue) PRICE PERFORMANCE (%) Stock Nifty : NIL EW Consumer Goods Index 1 month months months Abneesh Roy abneesh.roy@edelweissfin.com Alok Shah alok.shah@edelweissfin.com May 21, 2018

2 Consumer Goods Table 1: Trends at a glance (%) Overall domestic Toothpaste Ad & promotions volume growth volume growth Gross margin EBITDA margin Tax rate spends Q4FY NA Q1FY NA Q2FY NA Q3FY NA Q4FY NA Q1FY Q2FY Q3FY Q4FY Q1FY Q2FY Q3FY Q4FY Q1FY Q2FY Q3FY Q4FY Q1FY Q2FY Q3FY17 (12.0) (12.0) Q4FY17 (3.0) (4.0) Q1FY18 (5.0) (5.0) Q2FY18 (0.9) (0.9) Q3FY Q4FY Source: Company, Edelweiss research Table 2: Toothpaste and Toothbrush segments market shares Period Toothpaste Toothbrush market share (%) Change (bps) market share (%) Change (bps) Q1FY NA 42.7 NA Q2FY NA 43.3 NA Q3FY NA 43.8 NA Q4FY NA 46.2 NA Q1FY (200) Q2FY (190) Q3FY (190) Q4FY (60) Q1FY (160) 45.0 (180) Q2FY (170) 45.5 (110) Q3FY (170) 45.1 (190) Q4FY (170) 44.8 (260) Source: Company, Edelweiss research 2 Edelweiss Securities Limited

3 Colgate Q4FY18 conference call Key takeaways Overall demand, new launches & competition Domestic volume growth, at 4% YoY, was driven by good growth in both toothpaste and toothbrush segments. Post GST, the company has not taken price hikes. Going forward, if required it will take some price hikes. In FY19, toothpaste category is expected to grow at ~6% YoY and Colgate aspires to at least grow at that rate. This would be done on taking products pan India, increase reach, improve direct coverage and having better presence on the e-commerce platform. Naturals, as a category, comprises ~21% of overall toothpaste category. Naturals portfolio has seen some slowdown in growth rates. Swarna Vedshakti enjoys ~1% MS. With the success that Colgate has seen, it will now take it to pan India levels. Cibaca Vedshakti may not be able to travel down South, but Swarna Vedshakti can travel North and gain share too. Rural is growing slightly ahead of urban in toothpaste category. Held MS in CDC, improved MS in Max Fresh. Naturals growth rate has been ~10% YoY It is not witnessing MS loss. Company is looking at volume growth of ~6% for FY19. Competitive intensity remains high in Naturals segment. The company s focus remains firmly on building equity of its brands and delivering innovation by tapping local insights and leveraging trends based on consumer needs. It maintained leadership position in both the toothpaste and toothbrush categories in FY17-18, with volume MS for the year at 53.4% and 44.8%, respectively. Company s key launches in FY18: o o o Colgate Swarna Vedshakti: A premium toothpaste launched in Naturals category. It has met with strong consumer response in the geographies where it has been launched. Colgate Neo Toothbrush: An aesthetically designed toothbrush available in six different colour combinations. New Xtra Fresh Colgate Maxfresh: It has been relaunched with intense coolness and super freshness. Toothpaste In the past three quarters, toothpaste market has started seeing reduction in growth rates. Colgate s toothbrush category is 3x ahead of its closest competitor. Success of Swarna Vedshakti has been very good. Till now only in South, but will now take it to the North. Innovations would be ~4% of toothpaste revenues and should get into double digit. Mouth rinse has seen strong growth. 3 Edelweiss Securities Limited

4 Consumer Goods Margins On absolute basis, ad spends would remain at same levels. Going forward, will spend a lot towards communication of Naturals toothpaste. Ad spends would be towards Naturals segment, Max Fresh and base business. Now that Swarna Vedshakti is being expanded pan India, spends on digital would also increase. Distribution The company has been expanding distribution and availability number of vans in rural is up 3x from 2012 to Plans to increase direct coverage by 20-25%. Other items Believe company has reached steady state in capex. With this coupled with healthy free cash flow generation, the company believes it will easily have higher dividend payout this year. Capex guidance of INR1,500-2,000mn for FY19 and FY20. Inventory is down since excise component is no longer there now. Outlook and valuations: Gradual improvement seen; maintain HOLD Amidst tepid macros, Colgate has been clocking slower sales growth and further dented by heightened competition from herbal players. The company had lost market share in toothpaste from 57.4% in CY15 to 53.4% in Q4FY18 (most likely impacted by herbal players who posted strong growth). However, it maintained share in core brands even as it witnessed loss of share in premium brands. Overall, Colgate has upped its ante by not only increasing its ad spends, but also increasing new launches in the herbal (segment clocked fastest growth in toothpaste category). Going forward as well, the company plans to launch new products in the natural segment and /or expand reach of existing natural segment products. Cibaca Vedshakti is gaining good traction at the mass end in the North where it has been launched, which we believe will aid growth momentum. We also envisage Colgate s competitively priced premium herbal product, Swarna Vedshakt to gain good traction. Now, with Swarna Vedshakti extended pan-india post its successful launch in South, Colgate s overall volume growth should see a leg up. We estimate sales growth to pick up in FY19 on favourable base and government initiatives. With ~250mn consumers currently still not using toothpastes and merely <20% urban users brushing twice daily, toothpaste segment has strong longterm growth potential. An added lever for Colgate is introduction of new products under Palmolive brand which anyways has strong brand recall. We believe Colgate s innovation funnel and brand investments will persist, which should help arrest share loss, even as increasing competitive intensity will be a monitorable. Revenue driver from new product range under Palmolive brand will be an added kicker. At CMP, the stock is trading at 36.6x FY20E EPS. We retain our 38x PE multiple on FY20E to arrive at TP of INR1,254. Maintain HOLD/SP. 4 Edelweiss Securities Limited

5 Q4FY12 Q1FY13 Q2FY13 Q3FY13 Q4FY13 Q1FY14 Q2FY14 Q3FY14 Q4FY14 Q1FY15 Q2FY15 Q3FY15 Q4FY15 Q1FY16 Q2FY16 Q3FY16 Q4FY16 Q1FY17 Q2FY17 Q3FY17 Q4FY17 Q1FY18 Q2FY18 Q3FY18 Q4FY18 (%) Q4FY12 Q1FY13 Q2FY13 Q3FY13 Q4FY13 Q1FY14 Q2FY14 Q3FY14 Q4FY14 Q1FY15 Q2FY15 Q3FY15 Q4FY15 Q1FY16 Q2FY16 Q3FY16 Q4FY16 Q1FY17 Q2FY17 Q3FY17 Q4FY17 Q1FY18 Q2FY18 Q3FY18 Q4FY18 (%) Q4FY12 Q1FY13 Q2FY13 Q3FY13 Q4FY13 Q1FY14 Q2FY14 Q3FY14 Q4FY14 Q1FY15 Q2FY15 Q3FY15 Q4FY15 Q1FY16 Q2FY16 Q3FY16 Q4FY16 Q1FY17 Q2FY17 Q3FY17 Q4FY17 Q1FY18 Q2FY18 Q3FY18 Q4FY18 (%) Colgate Chart 1: Toothpaste volume growth (2.0) (8.0) (14.0) Chart 2: Gross margin Chart 3: EBITDA margin Source: Company, Edelweiss research 5 Edelweiss Securities Limited

6 May-13 Nov-13 May-14 Nov-14 May-15 Nov-15 May-16 Nov-16 May-17 Nov-17 May-18 (INR) Q4FY12 Q1FY13 Q2FY13 Q3FY13 Q4FY13 Q1FY14 Q2FY14 Q3FY14 Q4FY14 Q1FY15 Q2FY15 Q3FY15 Q4FY15 Q1FY16 Q2FY16 Q3FY16 Q4FY16 Q1FY17 Q2FY17 Q3FY17 Q4FY17 Q1FY18 Q2FY18 Q3FY18 Q4FY18 (%) Consumer Goods Chart 4: Tax rate Chart 5: One-year forward PE band 1,300 1, x 40x 35x 30x 25x Source: Company, Edelweiss research 6 Edelweiss Securities Limited

7 Colgate Financial snapshot (INR mn) Year to March Q4FY18 Q4FY17 % change Q3FY18 % change FY18 FY19E FY20E Net revenues 10,851 10, , ,594 45,458 50,692 Other operating income Total operating Income 10,917 10, , ,880 45,867 51,148 Staff costs (0.6) ,059 3,273 3,599 Cost of goods sold 3,750 3,877 (3.3) 3, ,901 16,274 18,072 Gross profit 7,167 6, , ,979 29,593 33,076 Other expenses 1,898 1, ,954 (2.9) 7,528 8,273 9,124 Advertisement expenses 1,436 1,443 (0.5) 1, ,268 5,728 6,336 Total exp. (excl. cogs) 4,092 4, , ,855 17,274 19,060 EBITDA 3,075 2, , ,124 12,319 14,016 Depreciation ,565 1,340 1,577 EBIT 2,670 2, , ,559 10,979 12,439 Interest Other income (6.2) Profit before tax 2,639 2, , ,947 11,515 13,199 Provision for taxes (0.7) 812 (7.6) 3,097 3,685 4,224 Exceptionals (117) Reported net profit 1,888 1, , ,850 7,831 8,975 Adjusted Profit 2,004 1, , ,850 7,831 8,975 Equity capital Diluted shares (mn) Adjusted Diluted EPS Diluted P/E (x) EV/EBITDA (x) ROAE (%) COGS Employee cost Other expenditure Advertisement expenses EBITDA PBT Reported net profit Tax rate Edelweiss Securities Limited

8 Consumer Goods Company Description Colgate is India s biggest oral care products company with ~ 97% of its sales coming from this product category. The company has products across variants and price points in toothpaste, white toothpowder and toothbrushes, and is the leader in each of these categories. Investment Theme The company is market leader in oral care category with 53.4% market share in toothpaste category and enjoys strong brand equity, built over the years through high investment on creating consumer awareness and brand recall. Volume growth would also remain robust riding rise in both penetration and per capita consumption. Also, new categories like sensitive toothpaste and mouthwash will further enhance growth and premiumisation. However, higher competition will induce Colgate to increase its brand spends, which could cap its margins. Key Risks Risks arise from down trading by consumers due to slowdown in rural wage growth and reduced MSP crop prices. Continued depreciation of the INR could increase cost of imported chemicals. Increase in competitive intensity from new entrants. 8 Edelweiss Securities Limited

9 Colgate Financial Statements Key Assumptions Macro GDP(Y-o-Y %) Inflation (Avg) Repo rate (exit rate) USD/INR (Avg) Company Volume growth (2.0) Pricing change EBITDA margin assumpn Staff costs (% of rev) COGS as % of sales A&P as % of sales Financial assumptions EBITDA margin Tax rate (%) Debtor days Inventory days Payable days Cash conversion cycle (60) (71) (60) (60) Capex (INR mn) 2,332 1,863 2,414 3,000 Dep. (% gross block) Dividend payout Yield on cash Income statement (INR mn) Net revenue 39,515 41,594 45,458 50,692 Other Operating Income Total operating income 39,818 41,880 45,867 51,148 Materials costs 14,763 14,901 16,274 18,072 Gross profit 25,055 26,979 29,593 33,076 Employee costs 2,885 3,059 3,273 3,599 Ad. & sales costs 5,117 5,268 5,728 6,336 Other Expenses 7,604 7,528 8,273 9,124 EBITDA 9,449 11,124 12,319 14,016 Depreciation 1,332 1,565 1,340 1,577 EBIT 8,116 9,559 10,979 12,439 Add: Other income Profit Before Tax 8,514 9,947 11,515 13,199 Less: Provision for Tax 2,740 3,097 3,685 4,224 Reported Profit 5,774 6,850 7,831 8,975 Adjusted Profit 5,774 6,850 7,831 8,975 Shares o /s (mn) Adjusted Basic EPS Diluted shares o/s (mn) Adjusted Diluted EPS Adjusted Cash EPS Dividend per share (DPS) Dividend Payout Ratio(%) Common size metrics Materials costs Staff costs Ad. & sales costs Other expenses EBITDA margins EBIT margins Net Profit margins Growth ratios (%) Revenues EBITDA PBT Adjusted Profit (5.7) EPS (5.7) Edelweiss Securities Limited

10 Consumer Goods Balance sheet (INR mn) As on 31st March FY17 FY18 FY19E FY20E Share capital Reserves & Surplus 12,466 14,974 18,092 20,046 Shareholders' funds 12,738 15,246 18,364 20,318 Long Term Liabilities Def. Tax Liability (net) Sources of funds 13,264 15,792 18,910 20,864 Gross Block 13,517 15,460 18,460 21,460 Net Block 11,081 11,459 13,119 14,542 Capital work in progress 1,666 1,586 1,000 1,000 Total Fixed Assets 12,747 13,045 14,119 15,542 Non current investments Cash and Equivalents 2,943 4,562 6,591 7,321 Inventories 2,926 2,267 2,898 3,218 Sundry Debtors 1,299 2,010 1,268 1,414 Loans & Advances Other Current Assets 2,352 2,507 2,507 2,507 Current Assets (ex cash) 7,232 7,721 7,609 8,075 Trade payable 6,012 6,145 6,019 6,684 Other Current Liab 3,958 3,702 3,702 3,702 Total Current Liab 9,970 9,846 9,721 10,386 Net Curr Assets-ex cash (2,738) (2,126) (2,112) (2,310) Uses of funds 13,264 15,792 18,910 20,864 BVPS (INR) Free cash flow (INR mn) Reported Profit 5,774 6,850 7,831 8,975 Add : Non cash charge 1,305 1,725 1,312 1,974 Add: Depreciation 1,332 1,565 1,340 1,577 Others (28) 159 (28) 398 Less: Changes in WC (14) 199 Operating cash flow 6,880 8,495 9,156 10,751 Less: Capex 2,332 1,863 2,414 3,000 Free Cash Flow 4,548 6,632 6,742 7,751 Cash flow metrics Operating cash flow 6,880 8,495 9,156 10,751 Financing cash flow (3,405) (7,833) (4,712) (7,021) Investing cash flow (3,422) (1,863) (2,414) (3,000) Net cash Flow 53 (1,200) 2, Capex (2,332) (1,863) (2,414) (3,000) Dividend paid (3,274) (7,833) (4,712) (7,021) Profitability and efficiency ratios ROACE (%) ROAE (%) Inventory Days Debtors Days Payable Days Cash Conversion Cycle (57) (60) (71) (60) Current Ratio Operating ratios Total Asset Turnover Fixed Asset Turnover Equity Turnover Valuation parameters Adj. Diluted EPS (INR) Y-o-Y growth (%) (5.7) Adjusted Cash EPS (INR) Diluted P/E (x) P/B (x) EV / Sales (x) EV / EBITDA (x) Dividend Yield (%) Edelweiss Securities Limited

11 Colgate Additional Data Directors Data Vinod Nambiar Chairman R.A. Shah Vice Chairman P.K. Ghosh Deputy Chairman I. Bachaalani Managing Director V.S. Mehta Non-executive Director J.K. Setna Non-executive Director Dr. I. Shahani Non-executive Director M.S Jacob Whole-time Director & CFO Shyamala Gopinath Non-executive Director M Chandrasekar Whole-time Director Auditors - Price Waterhouse - Chartered Accountants *as per last annual report Top 10 holdings Perc. Holding Perc. Holding Life Insurance Corp Of India 5.91 Arisaig Partners Asia Pte 2.76 Commowealth bank of Australia 2.23 Sbi Funds Management 2.18 Vangaurd Group 0.85 Morgan Stanley 0.62 Jp Morgan Chase & Co 0.54 Lombard Odier 0.42 Icici Prudential Asset Management 0.37 Wasatch Advisors 0.33 *as per last available data Bulk Deals Data Acquired / Seller B/S Qty Traded Price No Data Available *in last one year Insider Trades Reporting Data Acquired / Seller B/S Qty Traded No Data Available *in last one year 11 Edelweiss Securities Limited

12 RATING & INTERPRETATION Company Absolute reco Relative reco Relative risk Company Absolute reco Relative reco Relative Risk Asian Paints BUY SO M Bajaj Corp HOLD SU H Berger Paints BUY SO L Britannia Industries BUY SO L Colgate HOLD SP M Dabur BUY SO M Emami BUY SP H GlaxoSmithKline Consumer HOLD SU M Healthcare Godrej Consumer BUY SO H Hindustan Unilever HOLD SP L ITC HOLD SP M Marico BUY SP M Nestle Ltd HOLD SP L Pidilite Industries BUY SO M 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 12 Edelweiss Securities Limited

13 May-17 Jun-17 Jul-17 Aug-17 Sep-17 Oct-17 Nov-17 Dec-17 Jan-18 Feb-18 Mar-18 Apr-18 May-18 (INR) Colgate Edelweiss Securities Limited, Edelweiss House, off C.S.T. Road, Kalina, Mumbai Board: (91-22) , Aditya Narain Head of Research Coverage group(s) of stocks by primary analyst(s): Consumer Goods Asian Paints, Bajaj Corp, Berger Paints, Britannia Industries, Colgate, Dabur, Future Consumer, Godrej Consumer, Emami, Hindustan Unilever, ITC, Marico, Nestle Ltd, Pidilite Industries, GlaxoSmithKline Consumer Healthcare, United Spirits Recent Research Date Company Title Price (INR) Recos 16-May-18 ITC Margins shine; recovery in cigarette volumes underway; Result Update 286 Hold 14-May May-18 Hindustan Unilever Bellwether rules unperturbed; Result Update Nestle India Behemoth exhibits its might; Result Update 1504 Hold 8982 Hold Distribution of Ratings / Market Cap Edelweiss Research Coverage Universe Buy Hold Reduce Total Rating Interpretation Rating Expected to Rating Distribution* * 1stocks 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 One year price chart 1,300 1,220 1,140 1, Colgate 13 Edelweiss Securities Limited

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