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How Risky Is Colgate-Palmolive Company Stock?

By Leo Sun – Mar 25, 2016 at 7:13AM

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The toothpaste and soap maker is generally considered a "safe" consumer staples play, but investors should recognize the risks the company faces.

Colgate-Palmolive (CL 0.76%) is often considered a stable "defensive" consumer staples play for tumultuous times. Over the past 12 months, its stock price has stayed nearly flat and slightly outperformed the S&P 500's 3% decline. However, despite its reputation for being a steady, slow-growth stock, Colgate-Palmolive still faces several significant headwinds.

Let's discuss four such challenges, as mentioned in its most recent 10-K filing, to see just how "risky" this consumer staples stock is.

Image source: Colgate-Palmolive.

1. Foreign exchange impacts
Colgate lists "exposure to foreign currency fluctuations" as one of its top risks, because it sells products in over 200 countries but reports earnings with the strong U.S. dollar. That impact caused Colgate's revenue to fall 7.5% annually to $3.9 billion last quarter, even though global shipments remained flat. "Organic" sales -- which exclude the impact of foreign exchange, acquisitions, and divestments -- rose 5%.

Net income fell 4% annually but posted double-digit growth after excluding currency impacts. A major sore spot is Venezuela, where inflation surged a whopping 141% last year. That currency collapse forced Colgate to change its accounting method for the country, which caused a $1.06 billion writedown last quarter.

Colgate isn't the only consumer staples giant facing currency woes. Procter & Gamble's (PG 0.31%) sales fell 9% annually last quarter, but rose 2% on an organic basis. To deal with currency impacts, P&G "deconsolidated" its Venezuelan operations last year, which enabled it to report the subsidiary's value as an investment instead of a business unit.

2. The four-year plan
At the end of 2012, Colgate commenced its "Global Growth and Efficiency Program" -- a four-year program aimed at ensuring sustained growth in Colgate's unit volume, organic sales, and earnings per share. At the time, Colgate expected the plan to generate annual pre-tax savings of $365 to $435 million by the fourth year.

However, Colgate now warns that the successful implementation of the remainder of the program "presents significant organizational challenges and, in some cases, may require successful negotiations with third parties." Colgate also notes that "financial or strategic difficulties, delays and unexpected costs" and "changes in foreign exchange rates" could cause the company to miss its growth and savings targets. While that doesn't mean the program failed, it indicates that the macro environment was tougher than Colgate had anticipated in 2012.

3. Volatile expenses
Colgate also warns that there is "no guarantee that our ongoing efforts to reduce costs will be successful," and that "volatility in material and other costs could adversely impact our profitability." However, things aren't as bleak as that warning suggests.

Last quarter, Colgate noted that its savings from the four-year plan were "partially offset by higher costs" including higher raw and packaging material costs and exacerbated by unfavorable foreign exchange rates. But despite those challenges, Colgate's gross profit margin still inched up 20 basis points annually to 58.8% last quarter. Total selling, general, and adminstrative expenses also fell 10%, mainly because of a decrease in traditional ad spending and a focus on cheaper in-store promotions.

Image source: Colgate-Palmolive.

4. Acquisitions and divestments
Colgate-Palmolive, P&G, and other consumer staples giants all scoop up smaller brands to fuel sales growth while divesting non-performing brands. But as Colgate warns, some of those acquisitions and divestitures "could adversely impact" its financial results in the future.

Back in 2005, Colgate streamlined its portfolio by selling numerous under-performing brands like Fab and Dynamo. It did so to focus more on its higher-margin oral, personal, and pet care products. During the following decade, Colgate bought "natural" toothpaste maker Tom's of Maine, Sanex personal care, and Myanmar toothpaste maker Laser. It also boosted its stake in Asian and European subsidiaries and divested its lower-margin household bleach businesses in most of Latin America and Canada.

Today, 47% of Colgate's sales comes from oral care products, 20% comes from personal care, 19% comes from home care, and 14% comes from pet nutrition. Therefore, investors shouldn't worry too much about Colgate's acquisitions and divestments backfiring since the company has mainly used those tactics to boost profitability instead of pursuing unfocused sales growth.

So how "risky" is Colgate-Palmolive stock?
I believe most investors have gotten accustomed to the currency headwinds facing consumer staples companies, and that they're willing to use the organic and constant currency growth figures to gauge their long-term growth. Based on those figures, Colgate and P&G are fairly low-risk stocks with decent dividends -- Colgate pays a forward yield of 2.2%, while P&G yields 3.2%.

The only thing that bothers me about Colgate is its valuation. Its trailing P/E of 46 is much higher than P&G's P/E of 28 and the industry average of 25. Its 5-year PEG ratio of 4.4 is also higher than P&G's ratio of 3.7 and the industry average of 2.6. Those ratios indicate that while Colgate stock isn't terribly risky, it still isn't cheap compared to its industry peers.

Leo Sun has no position in any stocks mentioned. The Motley Fool recommends Procter & Gamble. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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