Colgate-Palmolive: Squeezing it out

Colgate-Palmolive increases profit despite lower sales

Colgate-Palmolive has done it again. It's surprised the markets with a 22 per cent increase in net profit in FY04. Although a drop in the provision for tax had a big role to play in this, growth in operating profit was also impressive at 12.25 per cent.

Especially so because, in the beginning of FY04, the company had taken an average price cut of about 17 per cent for a number of its oral products.

Volume growth almost made up, as net sales last year was just 0.9 per cent lower. But the lower realisations did hit profitability. Margins before accounting for ad spend (which the company calls operating contribution), fell almost 200 basis points.

Thanks to the drop in prices, however, the company could cut down on advertising and promotions. Cost of advertising fell 380 basis points as a percentage of sales last fiscal.

This was the reason operating profit grew 12.25 per cent despite the marginal fall in sales. Even in FY03, the company had managed to increase operating profit by 22 per cent despite a nine per cent fall in sales. In that period too, the margin increase was largely because of a 240 basis point cut in ad spend.

Sadly, the company has stopped reporting segment results for the oral care and personal care businesses. As a result, it's not possible to figure the performance of the new offerings in the personal care segment under the 'Palmolive Aroma' range.

Based on the stock price prior to the results announcement, the stock was trading at around 14 times trailing earnings and had a dividend yield of over five per cent. No wonder the stock has now corrected sharply upwards. With the company holding on to its market share in oral care, and with the ability to surprise on margin improvement, the stock may not continue to underperform the market going forward.

Besides, the company is setting up a centre at Himachal Pradesh, which will help lower costs thanks to the number of tax benefits available in that region. Some analysts feel that the new centre could also be used as an outsourcing base by the parent company. While this could be a surprise on the upside, the possible entry of P&G's Crest will be negative.

Capital goods manufacturers

With the threat of rising interest rates looming large on the horizon, the capital goods industry is one sector which could offer a hedge of sorts. Since mid-May, the BSE Capital goods index has risen around 12 per cent, well above the rise in the Sensex.

Analysts point to several reasons for the outperformance. For one, there are signs of a reversal in the outlook of key commodity sectors ""-HR prices in the key Chinese market have dropped from their peak of approximately $ 550 a tonne in February - March 2004 to $475 - $ 490 per tonne currently, while that of aluminium have cooled by 10 per cent from their peak to approximately $ 1600 per tonne currently.

The point is, with lower raw material prices, capital goods manufacturers can expect lower costs and higher margins. The other impact of lower commodity prices has been a shift in investor sentiment away from the commodity sectors, with investors looking for new avenues.

The other part of the story is that the capital goods industry can look forward to a sharp rise in demand, thanks to the ubiquitous expansion plans of corporates.

Further, order books of capital goods manufacturers are growing, thanks to a revival in public sector capital expenditure.

For instance Siemens has recently bagged large contracts from the Indian Railways, while Larsen & Toubro has benefited from ONGC stepping up its oil exploration efforts.

Siemens India has an unexecuted order book which amounted to Rs 1962.4 crore as on March 31, 2004, a year-on-year growth of 166 per cent.

L&T's engineering and construction division saw its order backlog grow 24 per cent to Rs 16961 crore for the quarter ended March 2004, while BHEL has an outstanding order book position of around Rs 23650 crore at the end of 31.03.2004, a year-on-year growth of 50 per cent. ABB India booked orders worth Rs 593.5 crore during the first quarter ended March 04, an increase of 56 per cent year-on-year.

The downside for capital goods manufacturers lies in the strained finances of numerous state electricity boards (SEB), which has been made worse by announcements of free power for farmers.

SEBs are a key customer for several capital goods manufacturers, and they face delayed payments from SEB's. However, at current levels, capital goods scrips already factor in this downside.

With contributions from Mobis Philipose and Amriteshwar Mathur