Market Share Gains May Not Save Colgate-Palmolive’s Q4 Results from Currency Headwinds

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Colgate Palmolive

Oral care leader Colgate-Palmolive (NYSE: CL) is slated to report its fourth quarter and full year earnings on January 29th. The company’s performance in the third quarter was battered by currency headwinds, which wiped out volume growth derived from market share gains. Given that approximately 80% of its revenues originate from outside the U.S., including more than half from emerging markets, [1] the trend is expected to carry into the fourth quarter also. Consensus estimates for Colgate-Palmolive’s full year revenues stand at $17.3 billion, marginally lower than 2013 revenues of $17.4 billion.

The impact of adverse currency movements tricked down to the bottom line also, although the company has been able to offset it by curtailing advertising investments. Non-GAAP operating profit, which excludes restructuring costs, was $3.1 billion in the first nine months of 2014, which is an expansion of 2% compared to the same period previous year. However, additional restructuring costs of approximately $25 million are expected in the fourth quarter, [2] which will further drag down GAAP operating profit and therefore, GAAP EPS.

See our complete analysis of Colgate-Palmolive here

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Market Share Gains May Not Be Enough to Offset Currency Headwinds

Colgate-Palmolive has been steadily gaining market share in nearly all its major segments. It achieved volume growth of 3% in the first nine months of 2014, led by strong volume growth in its primary oral care business. The company increased its market share in the toothpaste, manual toothbrush and mouthwash categories in nearly all major regions, which helped it weather currency headwinds of 450 basis points on revenue.

It is worth noting that Colgate-Palmolive achieved the aforementioned volume growth despite slowing consumption in key emerging markets like China and Brazil. This is because, unlike competitors like Procter & Gamble (NYSE: PG), whose products are targeted at the premium segment, most of Colgate-Palmolive’s products are targeted at the mass category. Consequently, the lower prices drive demand even during a sluggish economic environment.

However, the company has admitted that the ongoing adverse foreign exchange movements are likely to take a toll on its fourth quarter revenues. [3] The likelihood of Colgate-Palmolive’s bleak short term prospect is underscored by the poor fourth quarter performance of its key competitor in emerging markets, Unilever (NYSE: UL). Like Colgate-Palmolive, Unilever derives more than half of its revenues from emerging markets, most of which are currently facing weakened home currencies against the US dollar. In Unilever’s case, currency headwinds depressed revenue growth by as much as 4.6 percentage points (Read: Unilever’s Revenues Decline in 2014 on Emerging Markets Slowdown, Profits Jump on Cost Savings). Colgate-Palmolive is expected to face a similar level of headwinds in the fourth quarter.

Price Growth and Cost Savings May Stabilize Margins

The impact of adverse foreign currency movements was also felt on margins during the first nine months of 2014. The strengthened dollar resulted in higher raw material and packaging material prices outside of the U.S., which accounts for 80% of the company’s revenues. Colgate-Palmolive was able to partially offset such commodity cost inflation by higher selling prices and cost savings, as a result of which non-GAAP gross margin remained flat at 59% during the nine months compared to the same period previous year. Non-GAAP operating margin, after adjusting for Venezuela and the 2012 restructuring costs, appreciated by over 50 basis points year-on-year.

The stable non-GAAP gross margin and improvement in non-GAAP operating margin were primarily a result of sustained pricing growth and cost savings resulting from the Funding the Growth program. The company achieved pricing growth was 1.5% in each of the three quarters, which boosted gross margin by 60 basis points. Funding the Growth initiatives improved gross margin by 180 basis points, while savings from the 2012 Restructuring program provided another 20 basis points improvement.

Continued successful implementation of the above measures may allow Colgate-Palmolive to protect its bottom line from currency headwinds. The company has also stated that over it plans to further reinvigorate margins by prioritizing investments in higher margin businesses, specifically the Oral Care, Personal Care and Pet Nutrition divisions. [1]

Acquisitions and Divestitures: Conspicuously Absent

So far, Colgate-Palmolive seems to have chosen to not follow the ongoing trend of shedding non-core businesses in the personal care industry (Read: Personal Care Companies Shed Weight in 2014). P&G leads this trend with its strategy of shedding as many as 100 of its non-core brands, including its pet nutrition business. Similarly, Unilever is gradually stepping away from its foods business, while Kimberly-Clark (NYSE: KMB) has spun off its healthcare business into a separate company.

Unlike its competitors, Colgate-Palmolive has not indicated any intention of divesting its non-core pet nutrition business. To the contrary, when revenue growth from this segment fell to 2% in 2012 and 2013, the company enforced measures to revive the business. The measures seem to have paid off and the company was able to turn around the segment in the second quarter of 2014, achieving a year-on-year growth of 5.5%.

However, it is worth noting that each of its key competitors is following similar tactics to boost top line growth in the face of consumption slowdown. In contrast, Colgate-Palmolive has so far not provided any broad strategy for dealing with the faltering growth. Thus, investors will look to the fourth quarter earnings reports to gain an idea of the company’s strategy for countering slowing growth and increasing competition.

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Notes:
  1. Colgate-Palmolive Q3 2014 SEC Filings [] []
  2. Colgate-Palmolive SEC Filings, October 2014 []
  3. Colgate-Palmolive Q3 2014 Earnings Call Transcript, Seeking Alpha, October 24, 2014 []