Here’s Why We Believe Colgate-Palmolive Is Currently Overvalued

Colgate-Palmolive (NYSE:CL) is the undisputed leader in the global oral care market, but is besieged by far bigger rivals in the personal care and home care markets. The competition in these markets is likely to get tougher in the near to medium term due to the strategic direction of Colgate-Palmolive’s bigger rivals, Procter & Gamble (NYSE:PG) and Unilever (NYSE:UL). The company also succumbed to currency headwinds in the previous quarter and allowed its volume growth to turn negative in its biggest geographical market, Latin America. (Read: Colgate-Palmolive’s Volumes Suffer Amidst Heavy Price Hikes in Third Quarter) If this trend continues, Colgate-Palmolive could end up losing volume growth and thus, market share in an increasingly competitive environment. These factors indicate a difficult year ahead for the company, leading to our conservative price estimate vis-à-vis its current market valuation.

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

See our complete analysis for Colgate-Palmolive here

Tough Times Ahead

Colgate-Palmolive has a limited presence in the personal care and home care markets. Its Personal Care market share has fallen from 5.0% in 2011 to 4.5% in 2014. We expect it to continue to decline and fall to a little over 3% by 2022. Similarly, its Home Care market share has declined from 4% in 2011 to 3% in 2014. We expect it to contract to 2% by 2022. This is because not only has Colgate-Palmolive’s discarded its shrewd pricing strategy to protect its margins, it is also set to face tougher competition from P&G and Unilever in the coming years.

Procter & Gamble is currently going through a transformational phase, following which it will be a much more streamlined company with narrower focus areas. It will compete in just 10 product categories, out of which its brands are market leaders in 7 categories and at second position in the remaining 3. The 10 product categories include oral care, personal care and home care, thereby resulting in heavier competition in these segments. (Read: Here’s Why Procter & Gamble Should Not Break Up)

Similarly, Unilever is currently reshaping its product portfolio to give more weightage to its “Prestige” premium line. The company is on an acquisition spree and acquired a number of personal care companies in 2015. ^[1] Although most of Unilever’s acquisition activity is expected to revolve around the personal care segment, the company already has a strong presence in the home care market. Thus, Unilever’s increased presence in the personal care segment combined with its existing strength in the home care market could spell trouble for Colgate-Palmolive.

Colgate-Palmolive has a relatively small presence in the personal care and home care segments compared to Procter & Gamble and Unilever. As a result, the renewed focus of its bigger rivals in these segments is likely to result in much tougher competition for Colgate-Palmolive.

Pricing Strategy to Protect Margins, Not Volumes

Colgate-Palmolive has been battered by currency headwinds in its biggest market by revenue share, Latin America. The company resorted to increasing prices in the region to offset the disastrous impact of adverse currency movements. We hypothesized earlier that too much reliance on price hikes could drive customers away towards cheaper local alternatives (Read: Colgate-Palmolive May be Headed for Trouble in Its Biggest Market), which is exactly what happened in the third quarter. (Read: Colgate-Palmolive’s Volumes Suffer Amidst Heavy Price Hikes in Third Quarter)

The upside of this strategy is that it allows the company to protect its bottom-line. On the other hand, the downside is that sustained price hikes cause customers to switch to cheaper alternatives, leading to loss of market share. Currency headwinds are expected to continue in 2016, and Colgate-Palmolive could lose more market share if it continues to resort to price hikes to offset the impact of the same.

The combination of increased competition and the volume-unfriendly pricing strategy puts Colgate-Palmolive in a precarious position in the near to medium term. While the company’s goal of margin protection and accretion is admirable, it may not hold much meaning if it is unable to expand its revenues. Colgate-Palmolive’s forward PE ratio is 22.48 compared to Procter & Gamble’s 18.84 and Unilever’s 19.30, indicating that Colgate-Palmolive is over-priced relative to its peers. Given that Colgate-Palmolive is expected to underperform vis-a-vis its rivals in the near to medium term, we believe that its higher PE ratio is not justified and its shares are overvalued at the present.

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1. Acquisitions and Disposals, Unilever Investor Relations [↩]