Currency Headwinds Rip Through Colgate-Palmolive Q2 Results

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Colgate Palmolive

Leading oral care company Colgate-Palmolive (NYSE:CL) reported its fiscal 2015 second quarter earnings on July 30th. [1] The company’s revenue and profits were heavily dragged down by significant negative impact of currency movements. Colgate-Palmolive derives a much higher proportion of its revenues from the emerging markets compared to its peers like Procter & Gamble (NYSE:PG) and Unilever (NYSE:UL), which led to the severe currency impact. Colgate-Palmolive raised prices sharply during the quarter to offset the currency headwinds, which led to dampened volume growth. While the company managed to achieve volume growth in all but one of its geographical markets, we believe that further sustained price hikes could have meaningful negative impact on Colgate-Palmolive’s volume growth.

In the second quarter, Colgate-Palmolive’s organic revenue growth of 5.5% year on year was more than offset by a currency impact of 12 percentage points. As a result, its second quarter revenues contracted by 6.5% year on year and fell to $4 billion. [1] Further, higher than expected currency impact inflated material costs heavily, causing a 3.5 percentage points drag on the gross margin. This was partially offset by higher pricing and cost savings from the Funding the Growth program, which restricted the gross margin contraction to 50 basis points compared to the previous year. [2]

Our price estimate of $60 for Colgate-Palmolive is about 10% lower than its current market price.

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See our complete analysis for Colgate-Palmolive here

No Respite from Currency Headwinds

The impact of unfavorable currency movements on Colgate-Palmolive’s revenues seems to be getting worse with each quarter. In fiscal 2014, the company’s revenues faced a currency headwind of 6 percentage points. This increased to 10 percentage points in the first quarter of fiscal 2015, and 12 percentage points in the second quarter. The impact is likely to get worse over the next few quarters as the US dollar remains strong and most other major currencies remain weak.

So far, Colgate-Palmolive had maintained the fine balance required between price hikes and volume growth that is necessary to achieve sustainable organic growth. However, the company faltered a little in the second quarter as it scrambled to raise prices in regions with unusually volatile currencies. For instance, the Africa/Eurasia region led the pack with a 21.5% adverse currency impact, forcing Colgate-Palmolive to raise prices heavily in an attempt to stop the revenue leakage. Similarly, higher pricing contributed as much as 9 percentage points to organic revenue growth in Latin America, as currency headwinds dragged revenues from the region down by 18%. However, the increased pricing resulted in muted volume growth of 0.5% in the region. [1]

However, Europe was an exception to the trend. Due to the deflationary conditions in Europe, Colgate-Palmolive reduced prices in the region despite a negative currency impact of 18 percentage points. The lower pricing helped the company boost volumes by 4.5 percentage points in the region. [1]

Colgate-Palmolive expects the adverse macroeconomic environment to continue in the near term. This includes sluggish consumption in most regions of the world and heavy currency headwinds for US-based companies. In order to stifle the disastrous currency impact, Colgate-Palmolive has planned further price hikes throughout the rest of the year.

The muted second quarter volume growth suggests that the company may already be near the breakeven point between price hikes and volume growth. Thus, we believe that if the planned price hikes are too high, it could severely impede Colgate-Palmolive’s volume growth over the rest of the year.

Cost Savings Wiped Out By Currency Impact

Colgate-Palmolive could generally rely on its Funding the Growth program to provide some respite to the company and bolster its non-GAAP operating margin even in difficult conditions. However, in the second quarter, adverse currency movements had a massive impact on material prices. Consequently, commodity cost inflation dragged down Colgate-Palmolive’s gross margin by 230 basis points. This impact more than wiped out the 170 basis points benefit derived from the Funding the Growth program.

However, management believes that it still has the potential to expand its gross margin by 50 to 100 basis points in fiscal 2015, compared to the previous year. We believe that achieving this target may be possible if Colgate-Palmolive is able to sustain the increasing rate of savings from its Funding the Growth program. For instance, the program yielded a benefit of 170 basis points in the first quarter, which increased to 230 basis points in the second quarter. If Colgate-Palmolive is able to continue this increasing rate of savings, it may be able to achieve its gross margin expansion target.

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Notes:
  1. Colgate-Palmolive Fiscal 2015 Second Quarter SEC Filing [] [] [] []
  2. Colgate-Palmolive Fiscal 2015 Second Quarter Earnings Call Transcript, Seeking Alpha, July 30, 2015 []