Impressive Results if You Brush Aside Currency Issues

By Chad Henage - August 6, 2012 | Tickers: CL, KMB, PG | 0 Comments

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I honestly believe that many investors, when they look at an earnings report, look at revenues and EPS growth and that's it. However, if you don't take the time to go behind the headlines, it's very easy to miss impressive growth being hidden by short-term issues. This appears to be the case at Colgate-Palmolive (NYSE: CL). In the company's most recent earnings report, many of their divisions would have reported significantly better results if it weren't for currency fluctuations. Since these fluctuations can both hurt and help a company, investors would do well to ignore the short-term issues and focus on sales volumes instead.

Colgate-Palmolive operates in an extremely competitive environment. The company's oral care, personal hygiene, and home care divisions compete with multiple multibillion dollar conglomerates. This industry is home to names such as Procter & Gamble (NYSE: PG) and Kimberly-Clark (NYSE: KMB), and the company faces tremendous private label competition as well. Even with formidable competition, Colgate-Palmolive was able to turn in some impressive results considering the current economic conditions internationally. Since the company gets about 80% of its earnings from overseas, international currency fluctuations tremendously affect the company's results.

While overall net sales increased just 1.96%, and EPS increased just 3.17%, these numbers don't really tell the whole story. For instance, in the company's North American division, sales were up 2% on a volume decline of 0.5%. A small sales increase can also hide more significant volume growth. This played out in the company's largest markets of Latin America and the Europe and South Pacific division. In Latin America, sales were up 3%, but volume actually grew 6.5%. In the Europe and South Pacific market, the huge negative effect of currency fluctuations caused a 1% sales decline, even though volume growth was impressive at 9.5%. In similar fashion, in the Asia and Africa markets sales grew 5%, but volume growth was up 7.5%. The only division that had challenges in both line items was the Pet Nutrition unit, which showed sales down 1% on a volume decline of 3%. Since volume growth is a more accurate depiction of demand, you can see that Colgate-Palmolive actually had impressive results though the headline numbers don't look that good. Looking at the company's competition, investors should be aware that Colgate, Procter & Gamble, and Kimberly-Clark have some significant differences, though they might all look like attractive investment options.

One way that investors can measure these three companies is, by looking at the very basic financial measure of gross margin. In the same industry, the company with the greatest gross margin either has pricing power or is operating more efficiently than their competition. In addition, investors should look for companies that show an improvement in gross margin over time. Take a look at the comparison of the three companies and you'll see how each is faring:

Colgate-Palmolive has been able to improve its gross margin while its primary competitors have seen margin compression. One of the factors that has led to margin compression has been private-label competition. I've written before, that Procter & Gamble in particular has a hard challenge to compete with private label brands. Over the last few years, many consumers have tried out store brands to save money over the name brands that companies like Procter & Gamble and Kimberly-Clark offer. Though the economy is slowly improving, many of these customers have found the store brands are similar enough that they will not likely switch. Another difference between the three companies that might not be initially apparent is the affordability of their dividends.

The free cash flow payout ratio is really what separates Colgate-Palmolive from Kimberly-Clark. Colgate-Palmolive's payout ratio was just under 45% in the most recent quarter. Compare this to Kimberly-Clark's payout ratio, which has steadily risen from 37.45% in 2009 to over 85% today. While it's true that Kimberly-Clark pays a higher yield, a similar yield can be found at Procter & Gamble with just a 51% payout ratio. As you can see, while the three companies look similar on the surface, there are actually multiple differences. With Colgate-Palmolive offering a respectable 2.3% yield and growing at a similar rate to its two primary competitors, at first the lesser yield looks like a disadvantage. However, the company's higher gross margin, better free cash flow, and lower payout ratio are the differentiating factors. While the market has priced the stock accordingly at just over 20 times full year 2012 earnings, Colgate-Palmolive is leading the way in the personal care industry. Investors should use this research as their starting point to decide if they should brush up on this personal-care giant.

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