Buy, Sell, or Hold Colgate-Palmolive?

Christopher is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Colgate-Palmolive (NYSE: CL) reported earnings over the last 12-months of $4.94 per share, and paid a dividend of $2.32. At the current share price of around $91, this represents a dividend yield of 2.50%. The company has increased its dividend for 49 years without a break, and shareholders have seen an average increase of 12.7% per year in the dividend over the last five years. Through these years, the average pay out rate is around 47%.

There has, however, been a problem looming on the horizon for a couple of years, and it’s good to see that Colgate is attempting to do something about it before it takes effect.

Through 2011, the price of its raw materials rose by about 12.5%. It was a similar story in 2010. Throughout this time, with the economy in the United States in the doldrums, Colgate stuck with a policy of reducing the prices of its products in order to maintain market share. This policy of eating the increased costs of its raw materials whilst dropping prices to the consumer (at an average of around 2% in each quarter since the summer of 2009) finally lead to a drop of 5% in net income.

Last quarter, for the first time since its price reduction policy was instigated, Colgate raised prices and now continues to do so. It has been raising prices aggressively in Latin America, and now will be raising prices in North America – last quarter by 0.5%. Its weak spot now is Europe, where it expects to have to keep a lid on prices due to the weakness of the consumer market there.

Its revenue increased by 5% on the last quarter from a year earlier, though its costs rose by 9%. Gross profit margin fell by 1.5% over the period to 57.6%.

The difficulty for Colgate with its new policy will be to do just enough to rebuild gross margin without losing market share. To this end Colgate is planning to increase the amount of advertising spend. Colgate sees one of its key challenges this year as the exchange rate of the dollar, though on a currency neutral basis it expects to see double-digit growth in gross diluted earnings per share.

Current estimates for the 12-month target price for Colgate’s shares center around $94.70. On a price to earnings ratio basis, the shares trade in line with other companies in its sector such as Proctor and Gamble (NYSE: PG) at 18.78, and Clorex (NYSE: CLX) at 16.53. It is a similar story when measured on a forward price to earnings ratio. Its dividend is solid and well covered by earnings, though both Proctor and Gamble shares and Clorex shares yield a higher 3.3% and 3.5% respectively.

Shareholders should hope that Colgate’s attempt at building margins work. This could see the dividend increase and further support the shares. Though operating cash flow of $2.93 billion over the year is plenty to pay for its $4.81 billion debt, its debt/ equity ratio of 189 is the highest of the three companies (Proctor and Gamble’s is 51).

The shares have been trading between $86 and $94 since the end of August. I believe shares are likely to do so for some time to come, certainly until the new price raising strategy is embedded successfully. I recommend a hold on this stock.

 


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