These Scenarios Could Significantly Lift Colgate-Palmolive's Valuation

Colgate-Palmolive is the world's leading manufacturer of oral care products. It reported revenues of $17.3 billion in 2014 and currently has a market capitalization of $62.8 billion. The company derives nearly half of its revenues from its oral care business. Colgate-Palmolive s Personal Care and Home Care segments account for about 20% revenues each, while the rest is made up by the Hill's pet nutrition business.

In 2014, Colgate-Palmolive outperformed its bigger rivals Procter & Gamble, Unilever, and Kimberly-Clark by a significant margin. It achieved organic (non-GAAP) revenue growth rate of 6% year on year, compared to P&G's organic revenue growth rate of 2%, Unilever s 3% and Kimberly-Clark s 4%. Colgate-Palmolive's strong revenue expansion is attributed to its shrewd pricing strategy, which allowed it to raise prices without negatively impacting volumes. (Read: Higher Volumes Help Colgate-Palmolive Beat Currency Troubles in Q4)

Colgate-Palmolive has managed to protect its EBITDA margin despite competitive pricing pressure and commodity cost inflation arising out of currency headwinds. Its ‘Funding the Growth’ cost savings program yielded sufficient savings in 2014 to offset the aforementioned headwinds. The company expects to continue to derive benefits from its ‘Funding the Growth’ program over the next few years.

We have a price estimate of $56 for Colgate-Palmolive, which is about 20% lower than its current market price. In this report, we take a look at the factors which could significantly increase our valuation for Colgate-Palmolive.

See our complete analysis for Colgate-Palmolive here

Higher Than Expected Price Hikes and Cost Savings May Lift Margins (~10% Upside)

So far, Colgate-Palmolive has maintained a fine balance between increasing prices and preserving volume growth. The significant currency headwinds arising out of a strong dollar and weak emerging market currencies made it necessary for Colgate-Palmolive to raise prices considerably in emerging markets in 2014. Consequently, higher pricing contributed 150 basis points to organic revenue growth of 5% in 2014. The company has indicated that it plans to continue the price hikes in emerging markets in order to counter the unfavorable movement of foreign currencies and protect its margins.

We currently believe that Colgate-Palmolive will raise prices in moderation to avoid falling in the same trap as Procter & Gamble , which lost out on volume growth due to higher prices in the last two quarters. (Read: P&G Reports Moderate Q3 Results, Lays Out Future Growth Strategy) However, sustained expected currency headwinds may force Colgate-Palmolive to raise prices (higher than expected) in order to protect its bottom line. It should be noted that in 2014, the moderate increase in prices allowed Colgate-Palmolive to retain volume expansion but failed to protect its operating margin, which declined by 10 basis points year on year. If emerging markets currencies continue to move adversely, Colgate-Palmolive may give preference to protecting its bottom-line over revenue expansion and implement higher-than-expected price hikes.

Further, Colgate-Palmolive expects a relatively benign commodity cost environment in 2015. The impact of lower oil prices is expected to begin trickling in during the first half of the year, which may provide additional cost savings to the company. Its ‘Funding the Growth’ cost saving program is also going strong and yielded cost savings of 280 basis points in 2014. Given this scenario, we currently expect a moderate improvement in EBITDA margin of Colgate-Palmolive's Oral Care, Personal Care, and Home Care divisions (home care includes Surface and Dish Care, and Fabric Care segments) over our review period.

However, if inflation in emerging markets subsides in the medium term and Colgate-Palmolive achieves higher than expected cost savings from its Funding the Growth program, the expansion in its EBITDA margins could be notably higher.

If Colgate-Palmolive's Oral Care division EBITDA margin improve from 24% in 2014 to over 26% and the Personal Care and Home Care divisions EBITDA margin improves from 27% to 31%, over our review period, our valuation for the company will increase by 10%.

Lower Capex Due to Price-Driven Strategy (~10% Upside)

Colgate-Palmolive currently follows a volume-driven revenue growth strategy, as is evident by its organic revenue growth drivers. Its organic revenue growth stood at 5% in 2014, of which volume expansion contributed 3.5 percentage points. In contrast, volumes remained stable in Procter & Gamble's latest third quarter results, while pricing contributed 1 percentage point to its organic revenue growth.

This strategy results in a relatively higher capital expenditure, since the company needs to expand its capacity to keep up pace with volume expansion. Consequently, we currently expect Colgate-Palmolive's Capex as a percentage of EBITDA to increase from 16.5% in 2014 to 17.5% by the end of our review period.

However, as stated earlier, Colgate-Palmolive may opt for a price-driven strategy to counter unrelenting currency headwinds. This may result in a lower volume growth, as consumption is likely to fall in such a macroeconomic paradigm and the company's higher prices may drive away some customers. Therefore, Colgate-Palmolive's need for capacity expansion could be lower than expected, resulting in lower capital expenditure. If Capex as a percentage of EBITDA declines from the current 16.5% to 11.5%, it will result in an uptick of nearly 10% in the company's valuation.

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