shades of whiter teeth

Not that exciting.....

Colgate-Palmolive India, a subsidiary of Colgate-Palmolive US, has been operating in India for a long time. All it does is operate an Oral health care business. Not very exciting as it seems for someone who is looking for action and complex matters to solve. Never mind, we can choose to be simple and easy-going just for a while and see what it has to offer for an investor in this business. 

I am looking at its 2012-13 annual report which we can say is dated since two quarters have lapsed already. However, we don't have a regulation that requires a full set of financials from a listed company for its quarterly reporting. That is something that I loathe all the time; we can deal with that another time.

The past 

For any business to see as a potential investment it is quite nice to have a look at what the business looked like many years ago and what it looks like now. That provides some insight on what kind of investments it made in the past, how these were funded and how these performed. 

Over the last ten-year period, Colgate made reinvestment of about Rs.1.10 b in both capex and working capital. Capex was mainly for new plants and expansion of existing plants; plants that make tooth paste, tooth powder, toothbrush and mouthwash. It never used debt; it never raised cash from new issue of shares for a long time. In fact, in 2007 it did something different; it returned a lot of cash back to the shareholders. Implied in this decision was that the company had a lot of excess cash which had no meaningful use; the managers had no new investments in mind; accordingly, Rs.1.2 b cash was returned. The company not only continued to make earnings, but increased it as well: 2007 earnings Rs.1.6 b; 2013 earnings Rs.5 b. Only in 2012 and 2013 (annual report) it made higher capex, and announced new plants in Gujarat and Andra Pradesh. 

The last ten years tell you something: Revenue increased from Rs.9 b in 2004 to Rs.32 b in 2013; operating income increased from Rs.1 b to Rs.6 b. It also had cash of Rs.3.4 b in March 2013. With high operating and net margins, Colgate has been making absurd returns on capital and equity; remember, capital is very little compared to income it is generating. It could be a not-so-exciting business, but it is one heck of a business. It has passed the test of revenue growth and earnings growth on a consistent basis. 

The dividend policy has been straightforward. That boring business does not need much of cash to operate, hence, the payout ratio has been very high. Total dividend payments over last ten years were Rs.21 b.

Additional reward to the shareholders (excluding dividends):

The story so far is good: 

The future

For an analyst, although historical performance is much useful information, it is the expected future performance that matters most. The clues are supplied by the historical information, yet, value of the business is driven by future cash flows and growth. We cannot tell how much the earnings will grow, but, we do know that they will grow at some rate. Then it is easy to drop these expectations into a spreadsheet and come up with a value for such an easy business as Colgate. Nevertheless, I don't want to do this lest I hold any bias created by past performance. 

It is much easier to see how market is valuing this business, though. All I am going to do is: given its current operating income, tax rate, and reinvestment needs, I want to see how much growth market is factoring to give its current market value for equity at about Rs.173 b. This is often a useful exercise to check whether the market's implied indicators are good enough for an investor to make investment decisions. 

Just now....

The following graph shows value of Colgate at different growth rates for the next ten years; the terminal value is set based on stable growth (mature business) assumptions, i.e. sustainable return on capital (I assume that Colgate is capable of generating reasonable level of excess returns until perpetuity), sustainable margins, appropriate level of reinvestment, and cost of capital.

There is caution here as if we mess up mature business assumptions it can upset value, big time. It is useful to remind ourselves that no business, however good it can be, can sustain great performance forever; the limits have to be set at more realistic levels.

As we can see, the market is expecting Colgate's cash flows (after-tax operating profits less reinvestment) to grow at 21.50% for the next 10 years and giving the value of Rs.173 b. Is it possible? Of course, it is. But if it did not, and grew at 15% instead, the value will be Rs.112 b.

The market here represents mainly institutional investors who own about 26% of stock and are the price setters. 

It is for the analyst to pick a growth rate and be comfortable about Colgate achieving it before a decision can be made. 

The concluding thoughts for an analyst are given by Colgate: