Colgate (CL): 120 Years of Uninterrupted Dividends

Colgate (CL) has been one of the most successful dividend growth stocks over the last few decades and is one we are watching closely for our Top 20 Dividend Stocks portfolio.

 

Like many other consumer staples businesses, CL benefits from strong brands, dominant market share positions, and financial strength to invest heavily in new product innovation and marketing. The company appears to be very well positioned for long-term earnings growth, and its dividend is one of the best that income investors can find – very few companies can claim uninterrupted dividends since the late 1890s!

 

With that said, the company is facing some macro headwinds today, and the stock’s multiple is relatively high. Let’s take a closer look.

 

Business Overview

CL has been in business for more than 200 years and focuses on four consumer categories – oral care (46% of sales – toothpaste, mouthwash, toothbrushes), personal care (21% – shower gel, body lotion, liquid hand soap, bar soaps), pet nutrition (13% – specialty pet food), and home care (20% – household cleaners, liquid fabric conditioners, hand dishwashing soap).

 

Some of the company’s most well-known brands include Colgate, Palmolive, Protex, Speed Stick, Ajax, Irish Spring, Sanex, Hill’s, and Softsoap.

 

The company’s products are sold in over 220 countries, with about half of sales coming from emerging markets and over 80% of sales coming from outside of the United States. CL has operated in most of its current markets for more than 70 years.

 

Business Analysis

CL has been in business for a long time. William Colgate started a starch, soap, and candle business in New York City in 1806, nearly 210 years ago. The company’s first toothpaste was introduced in jars during the early 1870s and moved into a collapsible tube in 1896.

 

Why does any of this matter? We think one of CL’s competitive advantages is the cumulative knowledgebase it has built up over the company’s lifetime. Over two centuries of R&D, marketing expertise, consumer insights, branding, distribution relationships, and much more have been accumulated.

 

Perhaps equally important, CL has been in key emerging markets for a long time as well. For example, the company entered Mexico in 1925, Brazil in 1927, and India in 1937. This long-lasting presence has certainly helped CL understand these consumers well and tweak its brands and products to meet these consumers’ needs very well.

 

Like we have discussed with Kimberly-Clark and General Mills, shelf space is another major advantage that incumbents have in the consumer staples sector. Retail customers want products that they know will sell and be invested in by the manufacturer in the form of expensive in-store displays, product packaging, and marketing campaigns. Taking a risk on new products from much smaller companies often provides little upside.

 

CL invests heavily to stay ahead of trends in its markets, which are slow-changing to begin with. The company invested $277 million in R&D last year and dropped nearly $1.8 billion on advertising. These investments ensure that the company’s products continue to meet evolving consumer needs and remain in the forefront of their minds as they shop. As seen below, CL has been relentless with its advertising spending, creating strong brands the new entrants will have a very hard time challenging.

 

 

Altogether, CL’s longevity, effective R&D and marketing investments, and high quality management have allowed the company to dominate most of the markets it competes in. CL is #1 in toothpaste (45% global market share; more than 3x greater than its next biggest competitor and up from 35% in 1995; share is highest in many emerging markets – Mexico 81%, Brazil 72%); #2 in mouthwash; #1 in manual toothbrushes; #1 in liquid handsoap, #1 in liquid fabric conditioners; #2 in bar soaps and liquid body cleaning; #2 in hand dishwashing and household cleaners; and #1 in pet food sold through vet clinics.

 

The company’s quality reputation and strong mindshare with consumers have helped it grow sales and profits through price increases. As seen below, CL reported positive pricing changes in nine of the last 10 years:

 

 

We can see CL’s advantages show up in the company’s return on invested capital, which has remained stable and in excess of 30% each year over the last decade. Very few companies have earned such strong returns. Higher returning businesses are able to compound their earnings faster and fuel significant long-term dividend growth.

 

 

From a growth perspective, CL’s track record is remarkable. The company more than quadrupled operating profits over the last 20 years and has consistently reported mid-single digit organic sales growth. Emerging markets are growing 2-3x faster than developed markets, providing a nice tailwind thanks to CL’s geographic mix (51% of sales were in emerging markets last year).

 

In addition to emerging market growth, CL’s investments in new product lines and categories should also drive nice volume growth over the coming years. The company’s 2012 Restructuring Program is expected to deliver $340-$390 million in annual after-tax savings by the end of 2016, allowing CL to reinvest in R&D and marketing to continue driving profitable growth.

 

Key Risks

The consumer staples sector attracts many dividend investors because its pace of change is typically slow and demand for many of its products is consistent even in weaker economic climates. For these reasons, the sector is viewed to have lower fundamental risk.

 

With that said, consumer habits are constantly evolving. For example, many of the packaged food giants are struggling to shift their sales mix and brand perception into healthier natural and organic foods. Some branded product categories also face increased competition from private label brands, which have meaningfully improved in quality and won over more trust from consumers.

 

When companies become very large in size and sometimes overextend their product portfolios, it becomes harder to combat these threats in a timely manner. Procter & Gamble is a prime example.

 

We don’t believe CL faces as many of these risks as some of its peers do. Toothpaste doesn’t really face health concerns, and its evolutions (e.g. extra whitening) are minor compared to many other product categories. CL can also continue leveraging its brand to create any new product variations that come up in many of its markets and plug them into its existing distribution channels to fight off new threats.

 

From a private label risk perspective, most of CL’s products are very personal items that are used daily by consumers, conditioning them to expect certain tastes, scents, and experiences. We believe personal products that are used daily have strong potential to build a more loyal group of consumers that are less willing to try lower priced items on the shelves. CL’s historical pricing power and volume growth give us some confidence in this assumption.

 

During CL’s third quarter 2015 earnings call, management also commented, “At the same time, we’ve seen a decline in private label shares in many of our categories, indicating the consumer’s preference for branded products and respect of our equities.”

 

The company also noted that its market shares are up year-to-date in toothpaste, manual toothbrushes, mouthwash, liquid hand soap, body wash, and fabric conditioners. CL appears to remain in a position of strength today.

 

In addition to changing consumer preferences and private label threat, the big boys sometimes get into market share battles with each other. The result is lower near-term earnings as higher marketing expenses are needed to protect share. For example, in 2004, CL issued a profit warning (its first since 1995) partly as a result of heavy marketing spending necessary to fight off intense global competition and the stock fell by 11%.

 

We should also note that CL’s near-term results can be impacted by temporary macro headwinds. Over 80% of sales are generated outside of the United States, with 50% of revenue recorded in emerging markets. The strong U.S. dollar is denting reported growth, and many emerging markets are in turmoil as a result of slumping commodity prices and unfavorable foreign currency exchange rates. Demand for CL’s products is generally inelastic, but the business could experience some hiccups if these headwinds intensify. We don’t see any impact on CL’s long-term earnings potential and would be buyers on weakness.

 

Let’s take a look at the company’s dividend.

 

Colgate Dividend Analysis

We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend. CL’s long-term dividend and fundamental data charts can all be seen by clicking here and support the following analysis.

 

Dividend Safety Score

Our Safety Score answers the question, “Is the current dividend payment safe?” We look at factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.

 

CL recorded an excellent dividend Safety Score of 95, suggesting its current dividend payment is one of the safest available in the market. The company’s moderate payout ratios, consistent cash flow generation, recession-proof products, and wide moat support the favorable ranking.

 

Over the last 12 months, CL’s dividend has consumed 56% of the company’s “as reported” earnings and 59% of its free cash flow. These payout ratios are very attractive for a stable business like CL and provide plenty of room for continued dividend growth.

 

Looking at longer-term trends in payout ratios can also be helpful to see if growth in earnings per share has kept up with dividend growth. As seen below, CL’s payout ratios have been pretty consistent in the 40-60% range.

 

 

For dividend companies with enough operating history, it’s always a prudent exercise to observe how their businesses performed during the financial crisis. CL managed to grow its sales volume by 0.5% during 2009 while holding pricing flat. Clearly most of CL’s products are needed regardless of how the economy is performing.

 

 

High quality companies are able to generate free cash flow year in and year out. Rising cash flow is important because it supports continued dividend growth without expanding the payout ratio. As seen below, CL has generated very consistent free cash flow in each of the past 10 years.

 

 

While payout ratios, margins, industry cyclicality, free cash flow generation, and business performance during recessionary conditions help give us a better sense of a dividend’s safety, the balance sheet is an extremely important indicator as well.

 

Companies with high amounts of debt, cyclical business operations, and inconsistent cash flow generation could find themselves in a cash crunch if demand unexpectedly weakens and they have overextended themselves. They will always cut the dividend before missing a debt payment, so monitoring cash and debt levels is important.

 

CL’s balance sheet is in good shape, especially considering the stability of its cash flows. As seen below, the company has about $5 per share in debt for every $1 of cash, but its net debt / EBIT ratio is a modest 1.4x. This means that CL’s net debt could be covered with less than 1.5 years of EBIT. Investors shouldn’t lose any sleep worrying about the company’s financial health.

 

 

CL has one of the highest quality dividends an income investor can find. While its dividend yield is relatively low, these are otherwise the perfect candidates for investors living off dividends in retirement to consider.

 

Dividend Growth Score

Our Growth Score answers the question, “How fast is the dividend likely to grow?” It considers many of the same fundamental factors as the Safety Score but places more weight on growth-centric metrics like sales and earnings growth and payout ratios. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.

 

CL’s Growth Score is 55, meaning its dividend’s growth potential ranks a little above average. The company has paid uninterrupted dividends since 1895 and increased its dividend for 52 consecutive years, easily securing its spot on the dividend aristocrats list.

 

As seen below, CL’s dividend growth has been solid over the last 10 years, although the rate of growth has decelerated from 11% to 6% per year. We expect future growth to be at least in the mid-single digits, about in line with expected earnings growth. The company’s sub-60% payout ratios, stable end markets, and strong cash flow generation make it one of the most reliable dividend growers in the market.

 

 

Valuation

CL trades at 22.3x forward earnings and has a dividend yield of 2.3%. Excluding movements in foreign exchange rates, CL’s earnings are growing at a double-digit rate today. To justify its multiple, the company needs to continue executing – there seems to be little margin for error in today’s price.

 

Thinking longer term, we believe the company can grow earnings at a 6-8% annual rate, implying that the stock offers annual total return potential of 8-10% today. However, given the macro headwinds facing the business today, we are a bit leery to jump into the stock at a 22x earnings multiple. A 10% pullback, similar to what happened to the stock in August, would make us much more interested in accumulating a stake.

 

Conclusion

CL is one of our favorite blue chip dividend stocks – uninterrupted dividends since 1895, a portfolio of household brands, resilient products, plenty of opportunities for long-term growth, and dominant market share around the world.

 

Unlike some of its peers, we believe CL has a more compelling case for long-term earnings growth because of its stronghold in fast-growing emerging markets (rising incomes and hygiene standards) and ability to expand into adjacent product categories that leverage its brands and distribution channels (CL focuses on several core products today compared to dozens at P&G). The dividend is also extremely secure and appears to offer 5-8% annual growth potential going forward, easily outpacing inflation.

 

Should conditions in emerging markets continue deteriorating or the U.S. dollar move even higher, we hope a better buying opportunity will present itself. For now, we will continue watching the stock for a more opportunistic entry point.