Colgate shares don’t reflect full impact of below-par monsoon

Colgate shares don’t reflect full impact of below-par monsoon

With the markets now taking the below-normal monsoon more seriously, a correction was clearly due. In fact, even at current levels, valuations seem stretched at about 24 times expected earnings.

But the markets have been comfortable assigning the stock high-valuation multiples given the company’s ability to grow earnings at healthy double-digit rates.

Also, the company has maintained a high dividend payout rate. This week, the company announced an interim dividend of Rs8 per share, indicating that last year’s high payout of Rs15 a share may be maintained.

Colgate investors have not only enjoyed high dividend receipts in the past, but have also seen high capital appreciation. In the past five years, the stock has risen at a compound annual growth rate of 26.7%, higher than the 25.8% return of the BSE-100 index on the Bombay Stock Exchange (BSE).

For a consumer goods company to beat the broad market is commendable, since the sector has generally been a laggard as far as investor returns go. The main reason Colgate stands apart is that its growth has been on the back of high volume growth.

Graphics by Ahmed Raza Khan / Mint

The company has been able to take advantage of the under-penetration in the toothpaste segment, and a relatively high proportion of its sales now comes from the rural market. Operating profit grew by nearly 60%, thanks to savings on advertising expenses and other expenditure.

But such high growth rates may soon be a thing of the past. With a large number of districts staring at a drought, volume growth will be affected. Back in 2003, the last time the monsoon was below normal, sales had fallen. Back then, rural sales accounted for less than 30% of total sales.

Of late, much of the incremental growth has been coming from rural areas and, hence, an impact on rural sales may derail growth. Rural sales now account for 35% of sales. Earnings estimates for this year may need to be revised, which would mean that the stock would be even more expensive than what current consensus estimates suggest.

Besides, even net profit margins are likely to get affected next year, since the company’s manufacturing unit in a tax haven will lose some amount of tax exemptions. According to an analyst, the effective tax rate may rise to 25%, compared with about 18% currently. As a result, net profit is likely to remain flat at this year’s levels.

While the company has done exceptionally well in the past, near-term challenges and current high valuations could mean that investors would have to settle for a little bit of under-performance for some time.

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