Colgate-Palmolive’s Volumes Suffer Amidst Heavy Price Hikes in Third Quarter

Leading oral care company Colgate-Palmolive (NYSE:CL) reported a decline in revenues for the fifth consecutive quarter in third quarter results reported on October 30th. ^[1] The fall in revenues can be attributed primarily to the heavy price hikes in Latin America, which is Colgate-Palmolive’s biggest geographical market by revenues (excluding revenues from Hill’s pet nutrition). We had previously suggested that continuation of heavy price hikes in Latin America could push the volume growth in the region into negative territory, which is exactly what happened in the third quarter. (Read: Colgate-Palmolive May be Headed for Trouble in Its Biggest Market) To be fair, the higher prices were implemented to counter a massive 22 percentage points currency drag in Latin America. Colgate-Palmolive’s performance was better on the margins front. The combination of higher prices, restructuring measures and the cost saving program facilitated a slight improvement in the non-GAAP operating margin in the third quarter.

Colgate-Palmolive’s third quarter performance snapshot:

• Revenues declined by 8.9% year on year to $4 billion (5% growth in non-GAAP terms)
• Non-GAAP operating margin improved by 70 basis points year on year to 25.3%
• Non-GAAP diluted EPS contracted by 5% year on year to $0.72

Our price estimate of $61 for Colgate-Palmolive is about 10% lower than its current market price.

See our complete analysis for Colgate-Palmolive here

Preference to Margin Protection Over Volume Growth

Colgate-Palmolive seems to be following in the steps of Procter & Gamble (NYSE:PG) by giving higher preference to protecting its bottom-line, temporarily putting volume growth on the backburner. (Read: A Deeper Look at P&G’s Q1 Results: Focus On The Bottom-Line Is Fine, But At What Cost?) This seems to be the situation at least in Latin America, which is Colgate-Palmolive’s biggest geographical market and accounted for over 30% of its revenues (excluding revenues from Hill’s). The company chose to let volumes fall into negative territory for the first time in recent years, rather than moderating price hikes and bearing the brunt of currency headwinds in the region.

It did pare back prices in North America and Asia despite moderate currency headwinds. Notably, these two were the only regions that achieved positive volume growth in the third quarter. Colgate-Palmolive pulled back on pricing in Europe also, but in this case it was due to the prevailing deflationary conditions in the region. These trends are expected to continue through calendar 2016 and a meaningful revival in volumes is unlikely in the near term.

Cost Saving and Restructuring Programs Boost Margins

Colgate-Palmolive non-GAAP gross margin expanded by 20 basis points year on year in the third quarter and reached 58.8%. Though the improvement was seemingly insignificant, it is commendable that the company achieve it despite a 390 basis points headwind from higher commodity prices. ^[2] The impact of commodity cost inflation was offset by 140 basis points benefit from higher pricing and 270 basis points benefit from the cost saving and restructuring programs.

Additionally, the non-GAAP operating margin benefitted from the lower advertising spending as a percentage of sales. Though the advertising expenditure increased in absolute dollar terms, it declined substantially as a percentage of sales for the sixth consecutive quarter. The lower ratio is due to the higher reliance on digital and in-store promotions, instead of the traditional mediums like television. The company believes that digital advertising and in-store promotional activities and customer engagement have higher return on investments, which is why it is focusing on them. Nevertheless, Colgate-Palmolive has stated that it will continue to balance traditional advertising with digital and in-store promotions, as a result of which the advertising ratio is likely to be higher in 2016. ^[2]

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More Trefis Research

1. Colgate-Palmolive Investor Relations [↩]
2. Colgate-Palmolive Fiscal 2015 Third Quarter Earnings Call Transcript, Seeking Alpha, October 30, 2015 [↩] [↩]