Colgate Earnings: Inflation Eats Away at Margins, but Brand Spending Propels Sales Growth

Wide-moat Colgate’s CL gross margin fell 160 basis points to 56.9%, once again succumbing to higher raw material costs in the first quarter (a 770-basis-point strain), pressures that are unlikely to subside in the near term. Management suggested higher agricultural costs (key ingredients within its Hill’s pet food) would lead to several hundred million dollars in incremental costs this year, even as logistics costs have moderated. Despite this, we surmise Colgate is prudently focused on extracting inefficiencies while surgically raising prices—the combination of which served as a 700-basis-point benefit to gross margin in the quarter (the private-label mix impact from its recent acquisition served as the remaining 90-basis-point drag).

In spite of this angst, we’re encouraged Colgate hasn’t siphoned off brand spending. In this context, advertising was up 14% in the quarter to more than 12% of sales. We see this as supportive of its brand perception at the shelf and its entrenched retail relationships. And we don’t posit Colgate is likely to reverse course. Our forecast calls for it to expend 13% of sales annually, or $2.8 billion, on research, development, and marketing through fiscal 2032. Critically, we believe this spending should serve to prompt consumers to acquiesce to its outsize price increases, which are up 17.5% over the past two years. As evidence, organic sales shot up 10% in the quarter, driven by a 12% step-up in price as volumes were off 2%—a modest retreat when viewed against the pronounced level of pricing Colgate has taken. Its dominant market shares in global and U.S. toothpaste further exemplifies its brand prowess, holding around 40% and 35%, respectively.

When taken together, our $74 fair value estimate should not change outside of a low-single-digit bump for time value, but after a 4% increase on the release, we think investors should await a more attractive risk/return opportunity before building a position.