I’m not completely convinced by the operating leverage play out in Colgate - RM costs as a % of sales have mostly gone down over time - while total manufacturing cost, is <25% of Gross Profit, so I’m not sure how much room it has to go lower (in order to increase your net profit) given its only 5% of sales. Additionally, with higher crude prices in the last couple quarters, I’m not sure if Colgate will be able to grow EPS in the short term. I think much of the recent margin improvement has been due to lower crude prices, a trend which has stalled. In order for colgate to return to its historical sales/FA ratio, colgate needs to grow sales to that point - for that to happen, it must sell more toothpastes? Given the maturity of the market, it would be dangerously simplistic to assume that revenues will tend to full capacity utilization.
So with no meaning full short term margin improvement, and slow near term EPS growth + moderate growth in the foreseeable future (volume growth can’t be much higher than population growth given penetration is already 75/90%+ in rural/urban areas), I really don’t understand why this stock is worth 40x earnings.
I am also wary of players like Patanjali/Dabur building their distribution networks as the major bottleneck to Patanjali’s growth has been its lack of distribution. If Colpal continues losing market share, a correction in its’ stock price is highly possible, especially with the stock trading at high multiples compared to the overall market and its own history. Even without market share losses, increasing competitive intensity should cap industry wide price increases and keep Colgate EPS muted.
As far as the consumption per capita thesis is concerned, I think it’ll play over several years. Even if its takes only 10 years for 30% of Colgate’s users to brush twice instead of once, it only adds ~2.6% CAGR to your total return, while the high upfront price paid (PE multiple) makes for a bumpy rides if there any potholes on the way up.
For me, Colgate is a short because it seems like the best way to play the FMCG overvaluation thesis due to 1) heightened competitive intensity 2) bullish crude view and 3) high valuations (40x+ trailing earnings) in spite of high penetration. It seems to like the FMCG sector is in a ‘Nifty 50’ like craze that took hold of the US in the 70/80s, and a great way to hedge a correction.
Disc. Short Colgate