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Colgate-Palmolive in Neutral Zone

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We reiterate our long term Neutral recommendation on global consumer goods dealer, Colgate-Palmolive Company (CL), driven by robust third quarter performance, an impressive guidance, various strategic initiatives as well as a solid financial position. However, we remain on the sidelines in anticipation of currency devaluation in Venezuela that may limit the company’s profitability. The stock also maintains a Zacks #3 Rank that implies a short term Neutral rating.

Despite the tough economic conditions, the company witnessed improved margin performance in third-quarter 2012, riding on the back of funding-the-growth initiatives and higher pricing. Consequently, Colgate-Palmolive’s earnings for the quarter increased 5% from the prior-year period to $1.38 per share. However, earnings remained in line with the Zacks Consensus Estimate. Moreover, on an organic basis, the company’s sales escalated 5% year over year with global volume improving 3%.

Looking ahead, Colgate-Palmolive continued to expect to register double-digit earnings per share growth for fiscal 2012 and gross margin expansion in the range of 75–125 basis points.

The oral, personal and home care dealer commands a market-leading position in these categories. We believe management's continued focus on product innovation, globally recognized brands and broad international presence in both developed and emerging markets provides a platform to the company to take advantage of growth opportunities and thereby augment profitability.

With an aim to improvise unit volume, organic sales and further consolidate its global leadership position, the company recently announced a four-year Global Growth and Efficiency Program or 2012 Restructuring Program. The program is anticipated to save in the band of $365–$435 million annually from the fourth year of the program and will slash its workforce by 8% from the current level of 38,600. Considering the company’s strong brand portfolio along with the healthy financial position and its fundamental capabilities of improving top and bottom line, it can be stated that Colgate-Palmolive will surely achieve its long-term objectives.

Colgate-Palmolive is focusing on acquiring businesses that have the potential to generate higher top-line growth and margin. To work toward this strategy, the company acquired Sanex business and divested its laundry detergent brands in Colombia. Colgate-Palmolive believes that these transactions will contribute 1% earnings growth in fiscal 2012.

Apart from this, the company remains focused on its product innovations to drive top-line growth. The recent alliance with Omron Healthcare will help the company formulate innovative ways for oral care solutions, marking an improvement in the same for consumers around the world. Management remains confident on this partnership with the opinion that Omron’s modern techniques and strong development skills will help boost Colgate Palmolive’s top line while developing a healthy customer-vendor relationship.

Colgate-Palmolive also boasts a strong balance sheet that offers financial flexibility to drive future growth. Further, the company remains committed toward enhancing shareholders return, which is evident from its robust dividend payment history and 50 million shares repurchase program announced in September 2011.

On the flip side, with the possibility of currency devaluation in Venezuela, Colgate’s profitability may suffer as it generates approximately 5% of its total sales from the country. It is strongly believed that due to rising fiscal deficit and pressure on Forex market, Venezuela government may opt for currency devaluation in 2013 after the gubernatorial and local elections. This will help Venezuela to partially reduce its fiscal deficit, but at the cost of high inflationary situation in the economy.

Further, the company remains prone to any change in foreign laws and regulations that could negatively impact operations, foreign consumer preferences, disruptions or delays in shipments, and currency fluctuations. Colgate-Palmolive’s international business accounted for approximately 80% of sales in fiscal 2011.

Similar to any company dealing with consumer products, Colgate-Palmolive also faces intense competition from other well-established players in the consumer goods industry. Rivals such as Church & Dwight Co. Inc. (CHD), The Clorox Company (CLX), Procter & Gamble Co. (PG), etc. continue to combat on the basis of pricing, promotional activities and new product introductions. Failure to compete on any of these lines may hamper Colgate-Palmolive’s market share, resulting in reduced top and bottom lines.

As evident from the above discussions, Colgate-Palmolive seems to be doing well on the earnings, sales, and financial front. However, general industry and competitive challenges keep us on the sidelines.

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