Colgate’s margins shine, but volume concerns can’t be brushed away

Gross and Ebitda margin rose year-on-year by about 630 basis points (bps) and 560 bps, respectively, to 72.2% and 33.6%. Both these metrics reached their “highest-ever level", Nomura Financial Advisory and Securities (India) said.

Key factors that facilitated the expansion of margins in Q3 were a drop in raw material costs and price hikes taken earlier. Plus, to an extent, a favourable base also helped given that the margin had contracted year-on-year in Q3FY23.

Collectively, this meant Ebitda increased by 30% year-on-year to ₹468 crore. This comes at a time when Colgate’s total operating revenue rose by 8% to nearly ₹1,396 crore. Even so, shares of Colgate dropped by close to 4% on Tuesday amid weak broader markets.

The margin shine was dimmed by a dull outlook for volume and perhaps, concerns of margins gains reducing ahead. Revenue growth was driven by price hikes and not volume growth, which is typically more appreciated. Analysts estimate Colgate’s volume to have slightly fallen year-on-year or have grown marginally. The company said its toothpaste segment achie-ved double-digit growth and also saw volume gro-wth. However, growth in the toothbrush segment and exports has disappointed.

Still, everything put together, Colgate’s growth outperformed Hindustan Unilever Ltd’s oral care portfolio, which saw mid-single digit growth in Q3.

Be that as it may, the challenge for Colgate really is that the outlook on meaningful volume growth ahead is weak despite many product innovations. Factors like high penetration, intensifying competition and lower frequency of product usage in the oral care category pose a hurdle for volume growth. Also, there is limited room for further price increases without impacting volume.

“We see an overarching focus on pricing (especially at the premium end, and in case of variants where competition is weak) and margins that could weigh on volume growth and premiumization in the medium term," Kotak Institutional Equities said in a 23 January report.

The analysts note that Colgate has used the inflationary cycle to push disproportionate price increases (even as raw material prices have eased) and expand gross margin by 450-500 bps to about 70%+ (industry leading).

Of course, this means the earnings growth prospects are bright in FY24. Already, for the nine months ended December (9MFY24), Ebitda margin has expanded by 440 bps year-on-year.

Jefferies India has upgraded its FY24-26 earnings-per-share estimate for Colgate by 3-4%, building Q3 beat and, expecting higher margin trajectory ahead. But margin expansion is set to recede ahead, too. Earnings growth should moderate from Q4 (vs 30% EPS growth 9MFY24), as benefit of a raw material inflation impacted low base wanes, said Jefferies analysts. Besides, Nomura notes that Colgate’s royalty (4.9% of sales) is up for renewal in July, which may add pressure if increased. Plus, after a sharp 63% gain in Colgate’s shares in the past one year, valuations are pricey. The stock trades at 47 times FY25 estimated earnings, Bloomberg data shows. 

An uptick in volume is crucial for Colgate to see continued market share improvement and also aid investor sentiment. But given the rally and lack of enough levers for a pick-up in volume growth, significant upsides in the Colgate stock appear few and far between.