When I completed my Investment Holdings Reviews in mid-August 2020, mid-April 2021, and early January 2022, the Colgate-Palmolive Company (CL) was not remotely close to being within my top 30 holdings. In essence, I have never viewed CL as being a key holding. Following my CL analysis for the purpose of this guest post, I now explain why I exited my Colgate position after having been a shareholder since September 23, 2015.

Overview

CL manufactures and markets a wide variety of products in the U.S. and around the world in two product segments:

• Oral, Personal and Home Care; and
• Pet Nutrition

Oral, Personal and Home Care products include toothpaste, toothbrushes, mouthwash, bar and liquid hand soaps, shower gels, shampoos, conditioners, deodorants and antiperspirants, skin health products, dishwashing detergents, fabric conditioners, household cleaners and other similar items. CL sells these products primarily to a variety of traditional and eCommerce retailers, wholesalers and distributors worldwide. Pet Nutrition products include specialty pet nutrition products manufactured and marketed by Hill’s Pet Nutrition. The principal customers for Pet Nutrition products are authorized pet supply retailers, veterinarians and eCommerce retailers.

Investors who are unfamiliar with CL may be interested in learning about its 200+ year history. Additional information is also found in Part 1, Item 1 in CL’s FY2021 Form 10-K.

Most investors are undoubtedly familiar with CL branded toothbrushes and toothpaste. Investors, however, may not be aware of several more CL brands. CL’s principal classes of products accounted for the following percentages of worldwide Net sales for the past three years:

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CL is a company which has exhibited virtually no top line growth in over a decade. Revenue (in billions of $ rounded) in FY2012 – FY2021 is 17, 17, 17, 16, 15, 15, 16, 16, 16, and 17.

Operating income and Net income growth have not fared any better over the same period.

• Operating Income (in billions of $ rounded): $3.965, $3.951, $4.113, $3.896, $3.958, $3.710, $3.685, $3.617, $3.875, and $3.901
• Net Income (in billions of $ rounded): $2.472, $2.241, $2.180, $1.384, $2.441, $2.024, $2.400, $2.367, $2.695, and $2.166

When you account for the time value of money, the results reflected above are even worse than at first blush. CL is, essentially, a stagnant company.

On a positive note, CL maintains a ~ 40% worldwide market share in toothpaste. This is more than 2.5 times its next-largest competitor and the low-single-digit share private-label offerings have obtained.

This leading share position extends to many attractive markets such as:

• India – more than 40% toothpaste value share versus the low teens held by local operator Dabur;
• Brazil – ~67% versus less than 7% for Unilever and less than 10% for P&G; and
• China – 27% versus ~13% for P&G.

Financials

Q4 and FY2021 Results

On January 28, 2022, CL released Q4 and FY2021 results (see Form 8-K).

While net sales increased 6.0% and organic sales increased 4.5%, GAAP EPS declined 19% to $2.55 from the prior year’s $3.14. This decline was driven by goodwill and indefinite-lived intangible asset impairment charges in Q4 related to the Filorga skin health business primarily due to the impact of the COVID-19 pandemic on the duty-free, travel retail and pharmacy channels.

Free Cash Flow (FCF)

Generating FCF is not an issue. In FY2012 – FY2021, CL generated Free Cash Flow (in billions of $ rounded) of $2.631, $2.534, $2.541, $2.258, $2.548, $2.501, $2.620, $2.798, $3.309, and $2.758.

FY2022 Outlook

CL’s FY2022 outlook calls for:

• net sales growth of 1% – 4% including a low-single-digit negative impact from foreign exchange;
• organic sales growth within the long-term targeted range of 3% – 5%;
• gross profit margin expansion, increased advertising investment and double-digit EPS growth on a GAAP basis; and
• gross profit margin expansion, increased advertising investment and low to mid-single-digit EPS growth on a non-GAAP basis.

CL expects global macroeconomic, political and market conditions to remain challenging, especially due to COVID-19.

The global marketplace in which CL operates is highly competitive and CL continues to experience heightened competitive activity in certain markets from strong local competitors, from other large multinational companies, some of which have greater resources than CL, and from new entrants into the market in many of CL’s categories. This has resulted in more aggressive product claims and marketing challenges and CL has had to increase promotional spending.

Changes in the policies and practices of CL’s trade customers in key markets, such as inventory de-stocking, fulfillment requirements, limitations on access to shelf space, delisting of CL products and certain environmental, sustainability, supply chain and packaging standards or initiatives also have a negative impact. The retail landscape in many of CL’s markets continues to evolve as a result of the rapid growth of eCommerce, changing consumer preferences (as consumers increasingly shop online and via mobile and social applications) and the increased presence of alternative retail channels, such as subscription services and direct-to-consumer businesses. These trends have been magnified due to COVID-19 in many of geographic regions in which CL operates.

In order to remain competitive, CL plans to continue to invest behind its digital and analytics capabilities and higher growth businesses, such as eCommerce. This rapid growth in eCommerce and the emergence of alternative retail channels have created and may continue to create pricing pressures and/or adversely affect CL’s relationships with key retailers.

CL also recently announced its 2022 Global Productivity Initiative; the majority of the initiative is to be executed in 2022. The program is intended to reallocate resources toward strategic priorities and faster growth businesses, drive operational efficiencies, and the streamlining of the supply chain to reduce structural costs. Implementation of this initiative is projected to result in cumulative pre-tax charges, once all phases are approved and implemented, totaling $0.2B – $0.24B. Annualized pre-tax savings are projected to be in the range of $0.09B – $0.11B.

Another significant challenge is that ~70% of CL’s Net Sales originate in markets outside the U.S.. As a result, CL experiences volatile foreign currency fluctuations.

In FY2021, CL incurred significantly higher raw and packaging material costs. Logistics costs also escalated due to volume and capacity constraints in the shipping and logistics industry and higher eCommerce demand; management expects this difficult cost environment to continue in FY2022.

While CL is taking measures to mitigate the effect of these challenges, management indicates it may become increasingly difficult to implement certain of its mitigation strategies. Future results could, therefore, be adversely affected.

Credit Ratings

A bright spot is CL’s risk profile.

Its current senior domestic unsecured credit ratings are:

• Moody’s: Aa3 since June 2001. The current outlook is stable.
• S&P Global: AA- since May 2001. The current outlook is stable.
• Fitch discontinued its coverage of CL in December 2016.

Moody’s and S&P Global’s ratings are the bottom tier of the high-grade investment-grade category.

These ratings define CL as having a very strong capacity to meet its financial commitments. It differs from the highest-rated obligors only to a small degree.

Dividends and Share Repurchases

Dividend and Dividend Yield

Investors would be wise not to make investment decisions based primarily (solely?) on a company’s dividend yield or on the number of consecutive years in which a company has increased its dividend. It is preferable to invest in a company based on its total potential investment return.

On March 10, 2022, CL declared a $0.47 quarterly dividend payable May 13 to shareholders of record on April 21; this quarterly dividend is ~4.44% higher than the prior $0.45 quarterly dividend. This was the 59th year in a row CL increased the dividend. Unfortunately, the dividend growth rate has slowed over time. It was 4.66% CAGR in the past decade and 2.92% CAGR in the trailing 5-years.

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Source: Portfolio Insight*

The issue with CL’s dividend rests not in the company’s ability to service its dividend; its dividend has stood the test of time with CL being one of the longest dividend paying companies in the US. The issue is that CL’s dividend history includes several years in which the quarterly dividend increase was $0.01 or $0.02 per share. CL’s capital appreciation has been negligible and nominal annual dividend increases do not remotely compensate investors for the negligible long-term capital appreciation.

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Source: Portfolio Insight*

It is highly unlikely CL will amend its dividend policy to reward shareholders with significantly larger annual dividend increases. So….we essentially have a company where capital gains over the past several years are negligible and dividend increases which barely keep up with the rate of inflation in the United States.

Share Repurchases

In FY2012 – FY2021, CL’s average outstanding shares (in millions) was 960, 940, 924, 910, 898, 888, 873, 861, 859, and 848.

On June 18, 2018, CL’s Board authorized the repurchase of common stock having an aggregate purchase price of up to $5B under a new share repurchase program; the repurchase of common stock the under this Program began June 19, 2018. The Board also authorized share repurchases on an ongoing basis to fulfill certain requirements of CL’s compensation and benefit programs.

In FY2021, CL repurchased its common stock at a cost of $1.32B.

I am a strong proponent of share repurchases IF shares are repurchased at attractive valuations. When done properly, a reduction in the number of issued and outstanding shares can result in a significant appreciation in the value of each remaining issued and outstanding share.

I favour share repurchases over dividend distributions because I incur no tax liability until such time as I sell the shares. I must, however, report annually the dividend income from holdings within taxable accounts.

Another drawback with dividend income is that as a Canadian resident I automatically incur a 15% withholding tax on dividends received from US companies.

I stress, however, that I favour share repurchases If done at attractive valuations. When a company overpays to repurchase shares, we then encounter a destruction of shareholder value.

Enter CL….

I encourage investors to access CL’s Form 10-K reports found in the SEC Filings of the Investor section of the company’s website. Search for ‘Issuer Purchases of Equity Securities’ within the FY2020 and FY2021 Form 10-K reports. We see that CL repurchased several million shares at average prices in excess of the current $74.50 share price (as in the high $70s and the $80s) in Q4.

Looking at the Condensed Consolidated Statements of Cash Flows in the Form 10-Q reports, we see that CL does not limit its share repurchases to just the last quarter of the fiscal year; a random review of several Form 10-Q reports reflects quarterly share repurchases. If we look at CL’s stock chart, we see that CL’s share price from mid-2020 to FYE2021 was in excess of the current ~$74.50 share price (March 22, 2002 stock market close share price). This means CL was consistently repurchasing shares for ~1.5 years at prices in excess of the current share price.

Valuation

Price/EPS

CL’s FY2012 – FY2021 diluted PE levels are 20.30, 27.11, 30.35, 24.67, 42.49, 29.13, 24.60, 25.50, 27.32, and 27.18.

CL’s forward adjusted diluted PE ratio estimates based on the current $74.50 share price and earnings estimates derived from the two discount brokerage trading platforms I use are:

• FY2022 – 21 brokers: $3.32 mean and $3.24 – $3.40 range. The valuation using the mean is ~22.4.
• FY2023 – 20 brokers: $3.59 mean and $3.44 – $3.66 range. The valuation using the mean is ~20.8.
• FY2024 – 11 brokers: $3.84 mean and $3.68 – $3.98 range. The valuation using the mean is ~19.4.

Some investors might consider the valuations to be somewhat appealing. There is a reason, however, why these valuations are what they are. An investment in CL is essentially ‘dead money’.

Final Thoughts on Why I Exited My Colgate Position

CL might appeal to some investors because:

• its share price is near a 52 week low;
• it is a Dividend King (50+ years of dividend increases) and a Dividend Aristocrat;
• the current valuation looks attractive; and
• Moody’s and S&P Global assign attractive credit ratings.

I disagree that CL is a good investment and in good conscience can not bring myself to retain any CL exposure since I envision poor total investment returns going forward. In fact, CL has the distinction of being one of my worst performing investments over a multiple year period.

The following reflects just how poorly CL has performed relative to the broad S&P 500 index over the 6.5 year period in which I was a shareholder.

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