Colgate Palmolive. Charged up to ride the demand recovery! Source: Company Data; PL Research

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1 Charged up to ride the demand recovery! September 30, 2015 Amnish Aggarwal Gaurav Jogani Rating Accumulate Price Rs942 Target Price Rs1,052 Implied Upside 11.7% Sensex 25,779 Nifty 7,843 (Prices as on September 29, 2015) Trading data Market Cap. (Rs bn) Shares o/s (m) M Avg. Daily value (Rs m) Major shareholders Promoters 51.00% Foreign 17.29% Domestic Inst. 8.47% Public & Other 23.24% Stock Performance (%) 1M 6M 12M Absolute (3.3) (5.8) 13.1 Relative (0.9) How we differ from Consensus EPS (Rs) PL Cons. % Diff Price Performance (RIC: COLG.BO, BB: CLGT IN) (Rs) 1,200 1, Sep 14 Nov 14 Source: Bloomberg Jan 15 Mar 15 May 15 Jul 15 Sep 15 Colgate Palmolive remains a strong play on the recovery in oral care market in India due to 1) strong brand presence 2) steady increase in distribution and 4) rising innovation gap over the competition. Although CLGT is suffering from low growth phase due to poor demand, we expect volume growth to recover from 4.5% in FY16E to 8.5% by FY18E. CLGT has been able to thwart successful entry of P&G in Indian market by aggressive advertising, increased focus on market development and innovation. CLGT has launched value added variants in Colgate Total, Sensitive, Simply White and Active Salt. It has also launched Maximum cavity protection with Sugar acid neutralizer and Active Salt Neem and Colgate Total with Charcoal, having natural ingredients. We believe that the strong brand and product investments during the downturn will enable steady increase in market share during the recovery. CLGT has more than doubled its gross block to Rs14.2bn and is looking at investments of Rs1 1.5bn/annum to increase capacities at Sanand for toothpaste and Sri City for toothbrushes. We believe higher capacity utilizations and benefits of scale will lower costs and increase margins in toothbrush business. CLGT is unlikely to focus on emerging segments like Liquid Detergents, Fabric Conditioners, Deo s, Hand and Body wash and surface cleaners, which form an important part of parent s global portfolio. Moreover entry into these categories might be prohibitive after a few years, given strong focus of HUL, P&G, Reckitt and domestic players. We believe that lack of diversification can hamper growth in the long term given 92% penetration of toothpaste in urban and 74% in rural India. We estimate 10% PAT growth for CLGT in FY16 and 18% CAGR over FY16 18 as the impact of higher excise, depreciation and taxes is absorbed in FY16. We expect premium valuations to sustain given ROE, ROCE and dividend payout of ~70%. We value the stock at 35xSept 17 EPS and arrive at target price of Rs1027, a 7.7% upside. Retain Accumulate Key financials (Y/e March) E 2017E Revenues (Rs m) 35,782 39,819 42,560 48,363 Growth (%) EBITDA (Rs m) 6,634 8,222 9,753 11,424 PAT (Rs m) 4,843 5,590 6,283 7,377 EPS (Rs) Growth (%) (2.5) 15.4 (43.8) 17.4 Net DPS (Rs) *EPS growth for FY16 is 9.7% excluding the impact of bonus issue (1:1) Profitability & Valuation E 2017E EBITDA margin (%) RoE (%) RoCE (%) EV / sales (x) EV / EBITDA (x) PE (x) P / BV (x) Net dividend yield (%) Source: Company Data; PL Research Company Update Prabhudas Lilladher Pvt. Ltd. and/or its associates (the 'Firm') does and/or seeks to do business with companies covered in its research reports. As a result investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of the report. Investors should consider this report as only a single factor in making their investment decision. Please refer to important disclosures and disclaimers at the end of the report

2 Volume growth to pick up Gradually Volume growth expected to pickup gradually; Toothpaste industry de grew in volumes by 6% during 2QFY15 mainly due to decline in urban consumption even as rural demand was flattish. Industry volumes have recovered gradually, however it will take industry 4 6 quarters to reach earlier volume growth of 6 7%. CLGT has been growing ahead of the market and grew toothpaste volumes by 5% in FY15 and 3% in 1QFY16. Volume growth is expected to sustain slow recovery in the near term. CLGT is aiming 1 2% higher volume growth than the industry average. Exhibit 1: Volume growth has made a new low at 3% (%) 2QFY11 4QFY11 2QFY12 4QFY12 2QFY13 4QFY13 2QFY14 4QFY14 2QFY15 4QFY15 3 Exhibit 2: Expect gradual recovery to set in from H2FY15 Toothpaste Volume Gr. (%) FY11 FY12 FY13 FY14 FY15 FY16E FY17E FY18E Colgate confident of increasing share, P&G likely to stage a comeback in toothpaste: Competitive intensity in the toothpaste segment has come of the highs as the extent of promotions has come to more normative levels from the highs seen during the launch of Oral B by P&G. Oral B has not been a big success as P&G s market share has dropped to just around 0.5%. Oral B has failed to make much mark due to select launch, supply chain issues, brand related issues (use of all rounder) and above all aggressive response by Colgate and other incumbents. However we note that P&G is second largest toothpaste player in USA with formidable product range. Although near term focus of P&G seems to be Shampoos and other established segments, expect P&G to increase focus on toothpaste segment after a while. September 30,

3 CLGT s oral care focus enables steady increase in market share Colgate s toothpaste share has increased 350bps in the past three years and toothbrush share has increased by 300bps. Colgate continues to gain share across segments led by innovations and increasing distribution. Colgate s market share gain has mainly come at the expense of HUL which has lost share from 24% to 20.5% in the same period. Colgate seems confident of growing ahead of market with steady increase in market share from current levels of 58% led by distribution, market development and innovations; we note that Colgate has 70 80% toothpaste market share in some of the Latin American countries. Exhibit 3: CLGT gained 110bps Toothpaste volume share in 12 months Exhibit 4: CLGT gained 120bps Toothbrush market share in 12 months Toothpaste Volume Share (%) Jan May 09 Jan Sept 09 Jan Nov 09 Jan Dec 09 Jan March 10 Jan May 10 Jan Sept10 Jan Nov10 Apr March 11 Jan June 11 Jan Sept 11 Dec10 Nov11 Jan April12 Jan June 12 Jan Sept 12 Jan Dec 12 Jan Apr 13 Jan June 13 Jan Sep 13 Jan Dec 13 Jan Apr 14 Jan June 14 Jan Sep 14 Jan Dec 14 Jan Apr 15 Jan June 15 Toothbrush Volume Share (%) Jan Dec Jan Apr Jan June Jan Sep Jan Dec Jan Apr Jan June Jan Sep Jan Dec Jan Apr Jan June 15 Colgate s innovation has increased gap with the competition Toothpaste segment is witnessing increased focus on brand building and innovations by the industry. HUL has launched Pepsodent clove and salt and Diamond attraction in the past couple of years. Dabur is sustaining its focus on Dabur Red and Meswak. We note that players like Himalaya and Patanjali which have products positioned on herbal platform are also improving their distribution and visibility in the toothpaste segment. CLGT has significantly upped its innovation levels in the past couple of years. Colgate has launched Sugar Acid Neutralizer, a breakthrough innovation globally. Colgate Active salt has been extended to Active Salt white and Active Salt with Neem variants. Colgate Total franchisee has been strengthened with Total Pro Gum care, Total Advanced Whitening and Total Charcoal Deep Clean Toothpastes. Colgate Sensitive has seen extensions into Sensitive Pro relief and Sensitive Pro relief Enamel repair. Toothbrush segment has seen launch of Slimsoft charcoal in the premium segment and Zig Zag charcoal in the mass segment. We note that innovation levels of CLGT are far ahead of the competition and have considerably increased gap with the competition. We believe that the company would be able to sustain above market average growth rates in the coming periods. September 30,

4 Exhibit 5: Colgate s innovations have increased gap with competition and enabled Premiumisation of portfolio Rs112 Rs112 Rs50 Rs130 Rs108 Rs50 Rs110 Rs102 Rs102 Rs48 Rs100 Rs87 Colgate Total (140gm) Active Salt (100gm) Sensitive (80gm) Visible White (100gm) CLGT has seen increase in ad spend from 15 16% over FY09 13 to 19.4% of sales in FY14 as Colgate did aggressive advertising and sales promotion activity ahead of launch of Oral B. We note that while advertising spend had increased by 100bps from 11.5% in FY13 to 12.5% in FY14, major increase of 260bps was recorded in sales promotion expense from 4.4% to 7% of sales. We expect Colgate to sustain adspend of ~11% of sales due to its aggressive new product and variants launch. Sales promotions however are expected to come down gradually; we expect 80bps decline in total advertising and sales promotion costs from 18.1% to 17.3% of sales. However we note that adspend would remain significantly higher than the band of 15 16% in which Colgate used to operate in the past. Exhibit 6: Adspend has inverse correlation with margins Exhibit 7: Higher promotions have jacked up the advertising expense FY08 Ad pro % to Sales EBITDA Margin (%) FY FY FY FY FY FY FY FY16E 17.5 FY17E 17.3 FY18E Adspend (Total) Advertising Sales promotions FY11 FY12 FY13 FY14 FY15 FY16E FY17E FY18E September 30,

5 Colgate to retain oral care focus; could be a drag in the long term Colgate Palmolive drives 96% of sales in India from oral care, although it has some presence in other personal care products. It has Palmolive Shower gel, Handwash and shaving cream and Charmis all purpose cream in the personal care segment and Axion dish washing paste in the household care segment. Colgate had launched Toilet soaps (Palmolive, Protex), Shampoo (Palmolive Optima), Dish washing paste (Axion) etc in mid nineties but exited soaps and shampoos later. Colgate was amongst the first to launch liquid hand wash and shower gel, however it has not been able to scale it up given rising competition from players like HUL, Reckitt Benkiser, ITC and increased focus on developing the oral care business in India. Exhibit 8: Colgate India drives 96% of sales from Oral care Home and Personal care 4% Oral Care 96% Exhibit 9: Oral care is just 40% of global sales of Colgate Personal Care 23% Pet Nutrition 13% Home Care 24% Oral Care 40% Colgate has achieved 15% CAGR in sales and 17% in PAT over the past decade and should be aiming at similar levels in the medium term. However it is unlikely to enter other home and personal care segments. Colgate globally has presence in Hand Wash, Body wash, Bar Soaps, Deo s, Dishwashing Liquids, surface cleaners, Liquid detergents, fabric conditioners etc under brand names like Palmolive, Ajax, Speed Stick, Suavitel etc. We note that players like HUL, P&G, ITC and Reckitt are investing in development of categories like fabric conditioners, hand and body wash, Deo s and surface cleaners, which are a part of global portfolio of Colgate. Although these categories are highly competitive today and require investment, the cost of entry will be prohibitive in these categories after a few years once these grow in size. September 30,

6 Exhibit 10: Rural penetration has nearly doubled in the past decade Urban Rural We note that toothpaste penetration is 92% in urban India and 74% in rural India; per capita consumption is 136gm, nearly 50% of the levels in China. We believe that medium term outlook on Colgate is intact; however failure to incubate non oral care segments might hurt Colgate in the long term. Benefits of high capex to accrue with a lag: Colgate gearing up for next leg of growth in oral care. It has doubled its gross block from Rs6.8bn in FY12 to more than Rs14.2bn in FY15. It has set up Greenfield toothpaste manufacturing facility at Sanand with a capacity of tones. CLGT has set up its first toothbrush facility at Sri City (Andhra Pradesh) with a capacity of 200mn brushes. We expect Colgate to incur a capex of Rs1.5bn each for coming couple of years. Toothpaste production will gradually be replaced from its Baddi facility which has gone out of excise duty as well as corporate tax exemption, incremental demand will be increasingly met from Sanand facility which is likely to witness increase in capacity to tones. Toothbrush facility is expected to achieve rated capacity by middle of next year and would cater to around 35 40% of its requirements. Colgate is expected to gradually increase capacity to mn toothbrushes in the coming years. Increased capacity and higher utilisation will provide economies of scale and margin expansion over the coming 2 3 years. FY16 PAT growth muted due to higher excise, tax rate Colgate s Baddi unit has gone out of excise and corporate tax exemption in FY16, Baddi unit accounted for nearly 50% of toothpaste production of the company. Colgate is expected to have a 450bps increase in excise duty in FY16 and another 40bps in FY17. This along with mid single digit volume growth will limit the sales growth to 6.9%. 120bps expansion in gross margins will enable 180bps higher EBIDTA margins and 16% EBIDTA growth. 260bps higher tax rate will curtail PAT growth to 10% in FY16. We expect PAT growth to average at 18.6% over FY16 18 enabled by pickup in volume growth and lower increase in depreciation and tax. September 30,

7 Exhibit 11: Expiry of Baddi exemption will increase both excise and tax rates Excise% Tax Rate FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16E FY17E FY18E Exhibit 12: Lower dividend payout and higher capex has impacted ROE RoE (%) Payout (%) FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16E FY17E FY18E Exhibit 13: Estimate 240bps EBITDA margin expansion over FY14 16 Exhibit 14: Sales growth and PAT growth will bounce back post FY16 Gross margin (%) EBITDA Margin (%) Sales Growth % (LHS) PAT Growth % (RHS) FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15E FY16E FY17E FY10 FY FY12 FY13 FY FY15 FY16 FY17 FY September 30,

8 Income Statement (Rs m) Net Revenue 35,782 39,819 42,560 48,363 Raw Material Expenses 14,020 14,677 15,190 17,411 Gross Profit 21,761 25,142 27,370 30,952 Employee Cost 2,118 2,589 2,805 3,121 Other Expenses 13,010 14,331 14,812 16,408 EBITDA 6,634 8,222 9,753 11,424 Depr. & Amortization ,010 1,153 Net Interest Other Income Profit before Tax 6,636 7,804 9,105 10,849 Total Tax 1,793 2,214 2,823 3,472 Profit after Tax 4,843 5,590 6,283 7,377 Ex Od items / Min. Int. 1, Adj. PAT 4,843 5,590 6,283 7,377 Avg. Shares O/S (m) EPS (Rs.) Cash Flow Abstract (Rs m) C/F from Operations 5,557 6,582 7,514 9,260 C/F from Investing (3,475) (2,898) (1,468) (1,500) C/F from Financing (3,809) (3,991) (4,185) (5,067) Inc. / Dec. in Cash (1,727) (308) 1,861 2,693 Opening Cash 4,739 3,012 2,704 4,653 Closing Cash 3,012 2,704 4,565 7,346 FCFF 2, ,053 7,579 FCFE 2, ,053 7,579 Key Financial Metrics Growth Revenue (%) EBITDA (%) PAT (%) (2.5) EPS (%) (2.5) 15.4 (43.8) 17.4 Profitability EBITDA Margin (%) PAT Margin (%) RoCE (%) RoE (%) Balance Sheet Net Debt : Equity (0.5) (0.3) (0.5) (0.6) Net Wrkng Cap. (days) (65) (59) (57) (54) Valuation PER (x) P / B (x) EV / EBITDA (x) EV / Sales (x) Earnings Quality Eff. Tax Rate Other Inc / PBT Eff. Depr. Rate (%) FCFE / PAT Balance Sheet Abstract (Rs m) Shareholder's Funds 5,999 7,703 9,889 12,187 Total Debt Other Liabilities Total Liabilities 5,999 7,703 9,889 12,187 Net Fixed Assets 6,974 11,751 9,756 10,103 Goodwill Investments Net Current Assets (1,525) (1,800) (199) 1,683 Cash & Equivalents 3,012 2,615 4,653 7,334 Other Current Assets 4,399 4,876 4,884 5,416 Current Liabilities 8,936 9,290 9,736 11,067 Other Assets 178 (26) Total Assets 5,999 10,226 9,889 12,187 Quarterly Financials (Rs m) Y/e March Q2FY15 Q3FY15 Q4FY15 Q1FY16 Net Revenue 10,005 9,960 10,285 10,102 EBITDA 1,865 1,946 2,475 2,018 % of revenue Depr. & Amortization Net Interest Other Income Profit before Tax 1,787 1,840 2,342 1,853 Total Tax Profit after Tax 1,296 1,309 1,636 1,227 Adj. PAT 1,296 1,309 1,636 1,227 Key Operating Metrics Volume Growth % Toothpaste market Share (Vol) Tax rate % Gross margin % Ad Spends as % of sales September 30,

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