Taazgi ka Dhamaka?

A dreary Ranveer Singh, woken up by the incessant honking below, is in no mood to be trifled with. But once the crystals open, there’s no stopping him or the weary commuters stuck in traffic. The Bollywood actor, busy endorsing Colgate Max Fresh’s cooling crystals, takes the street by the same storm, which the FMCG industry, including Colgate, is trying to stave off from Patanjali Ayurved.

It’s not that Colgate needs any introduction. It has been operating in the country since 1937, offering a range of oral care products. In fact, it is the most widely used toothpaste brand in India, with close to 60% market share.

But the stock has been facing the brunt on Dalal Street of late, correcting 16% in CY16 as against a 2% decline in the Sensex and the BSE FMCG index. Colgate’s slump is the result of its anemic volume growth, which at 1% was the lowest in 10 years. Its topline in the third quarter of FY16 grew a mere 1.9% to Rs.1,006 crore, dragging down the stock to a 52-week low of Rs.791 in the following quarter. Besides, its PAT growth too has been falling from 11% in FY13 to 4% in FY15 as a consequence of a 70% jump in advertising and promotion (A&P) spends.

While the stock has clawed its way back and is trading 6% above the March low, it is still 24% below its all-time high of Rs.1,099 seen in CY15. Not surprisingly then, few analysts are worried, saying the industry is going to become more competitive with the entry of Patanjali. They also warn that consumer preference towards herbal toothpastes can act as a significant threat to behemoth Colgate’s volumes. For instance, analysts at Credit Suisse peg Colgate’s volume growth over the next couple of years at a ‘subdued’ 4%-5%, while observing that a further slowdown is possible if the Patanjali show turns out to be ‘very strong’. 

Fears Overdone
There is no doubt that the volume and topline growth have taken the smiles off Colgate. But is the Patanjali euphoria overdone? For starters, not all numbers are ominous for Colgate. In CY15, the company’s market share in the toothpaste category grew 60 basis points. In the toothbrush category, it was up 140 bps on a year-on-year basis. Moreover, over the past eight years, Colgate’s overall market share has gone up to 54% from 48%, while HUL’s market share is down from 29% to 21%, as per reports. Colgate has also held on to its market share despite lowering A&P spends and opting for price hikes. In the third quarter of FY16, the company reported a 11% year-on-year drop in A&P spending, its second consecutive cut after a 17% year-on-year decline in the second quarter.

There is no doubt that the Patanjali phenomenon, though recent, is affecting the FMCG space. Baba Ramdev, the yoga guru, who promotes the brand, has proclaimed that Patanjali has the potential to upstage big names such as Colgate in a few years. But a section of analysts argue that it won’t be easy for the herbal brand to make deep cuts in Colgate’s market share. Rahul Arora, institutional equities head, Nirmal Bang, says, “Patanjali has managed to create a bit of a splash. But, its gain is not coming at the expense of Colgate. Players such as Dabur, Vicco, HUL, which together account for more than 40% of the market share, are more at risk as they have more verticals to manage."

Although the competition posed by Patanjali is different in that the brand is promoted by a spiritual leader with mass following, Colgate has managed to grow whenever competition has got intense. “They have the ability to come back strongly. This is not the first time that regional or herbal players have done well,” points out Abneesh Roy, associate director at Edelweiss. About 12-13 years back, regional players had a market share of around 13% in toothpastes, which came down drastically to low-single digits. “Small regional players such as Amar and Anchor were wiped out,” adds Roy.

Moreover, analysts feel that Patanjali’s strategy to use the ‘ayurveda’ peg to sell every consumer product may be difficult to sustain in the long run. The initial success of Patanjali came from traditional food items such as ghee and honey, which are perceived to be healthy and are spoken about in religious texts. “They are now trying to go all over the place. Ayurveda doesn’t talk about products such as noodles, chocolates and toothpaste, then what is the selling point? You can’t just price a product lower and expect sales to take off. You need a compelling story to drive the brand,” opines Rajeev Thakkar, CIO at PPFAS Mutual Fund.

Is the worst over?
Analysts feel that the 1% volume growth in the third quarter marks the bottom for the MNC. “We believe that Colgate’s volume growth is at the bottom of the cycle and a rural revival in FY17 will lead to positive surprise on earnings,” analysts at Phillip Capital say.

After two years of deficit rainfall, IMD has forecast above-normal rainfall this year, which should aid rural incomes, and thereby Colgate. Rural segment has been a strong enabler for Colgate and accounts for 37% of its overall revenues. In fact, its dense distribution network in rural India not just gives it an edge over competition but has helped the company build a moat around its business. “Rural areas are more immune to competition and hence provide a more stable market share. Colgate enjoys higher market share in these regions relative to urban markets,” analysts at UBS note in a report.

The rural presence though hasn’t built itself. The company has employed GPS to find gaps in its rural coverage, and to identify villages that could offer new opportunities based on population growth. This move has helped Colgate optimise distribution routes of the vans that physically deliver its products to the villages. “Colgate is working with around 25,000 villages and over 25,000 dentists,” says Arora.  But there’s more potential, feel market experts. “India is an under-penetrated market. People still use twigs and toothpowder. So, as rural incomes go up and urbanisation happens, we can see the benefit coming in for players such as Colgate,” says Atul Kumar, fund manager, equity at Quantum AMC.

UBS analysts too see upside potential. The per capita toothpaste consumption in India is still the lowest among major emerging countries at 122 ml per day, which implies a significant runway for growth, they note, adding that Colgate’s earning estimates are not reflecting this potential. India’s contribution to Colgate’s global growth is also underappreciated. Over the past 10 years, toothpaste volumes in India have delivered a growth of 10% CAGR, compared with 6% in China, and approximately 3% in Latin American countries.

According to Arora, in Brazil, for instance, a Colgate product is consumed three to five times a day on an average. This includes mouthwash, floss and toothpaste. In India, close to 80% of the population brushes just once a day. So, if the usage goes up two to three times, that would lead to a strong volume growth even if hypothetically no new users are added.   

Additionally, some feel it’s not too late for Colgate to jump on to the herbal bandwagon. “Although, Colgate might have missed the bus in herbals, it is not too late. They have the distribution and the brand. Sure, they would need a lot of herbal products to fight Patanjali and Dabur but there is no reason they can’t do it,” says Roy of Edelweiss.

More teeth
The growth potential aside, the Street believes valuations, too, are attractive. The stock is currently trading at 34x, close to its five-year average one-year forward P/E multiple.
“Even as we appreciate the concerns around Patanjali’s success in the oral care segment and bake in additional conservatism in our forecasts for Colgate, we see the current levels as a fairly decent entry point into what we continue to see as a top consumer franchise in the market,” state analysts at Kotak Institutional Equities. The brokerage has recently upgraded its call on the stock to ‘Add’.

The analysts at Kotak expect Colgate to deliver a healthy 12% earnings CAGR over FY16-FY18. “The stock is trading at 8-10% discount (on 1-year forward P/E) to both consumer sector (ex-ITC) and its five-year historical average. All these factors, combined with Colgate’s track record to battle competition — Close-Up in the 80s, Pepsodent in the late 90s, local players such as Balsara, Anchor etc. over 2002-05 and recently P&G — make the recent sharp correction a good opportunity to accumulate a strong franchise,” states the report.

Meanwhile, value investors such as Thakkar are hoping that the Patanjali panic further brings down Colgate’s valuation so it could get them grinning again. While Thakkar is waiting for the stock to correct further to around 25x one-year forward earnings, others like Arora are already seeing value. “I don’t know how many companies after Hindustan Unilever will fetch you 70%-75% return on equity, return on capital employed in India,” he points out.

It seems like the tide is turning for Colgate as its nine-month PAT has recovered 9% to Rs.430 crore. In addition to this, at 2.5-3% dividend yield, the stock too appears attractive.

Seems like a good enough reason to add Colgate to your shopping cart.