Colgate-Palmolive

Colgate's organic sales increased 2.4% in the second quarter, driven by 1.6% higher prices and 0.8% growth in volumes (1.2% excluding the private-label pet business exit). Adjusted gross margin expanded 140 basis points, to 61.5%, as pricing and efficiency savings offset inflationary headwinds.

Why it matters: While Colgate's US business has been challenged, we don't think this signals a more pervasive erosion in its competitive edge. Rather, we contend that its stout brand mix, entrenched retail relationships, and stringent cost management will ultimately enable it to steady its standing. Evidencing its dominance, Colgate's global toothpaste market shares increased 20 basis points to 41.3%. As a piece of this, China was a notable standout, chalking up mid-single-digit growth in the quarter, in a market that management cites was down 1%-2%. To ensure its prowess is unwavering, we forecast Colgate will continue to funnel substantial resources to support its brand mix. Our outlook calls for it to direct 14% of sales ($3.4 billion) to research, development, and marketing annually over our forecast, largely in line with peers.

The bottom line: Our $91 per share fair value estimate for wide-moat Colgate remains in place. Despite a low-single-digit pullback, shares trade in a range we'd consider fairly valued.

Between the lines: North America (17% of sales, down 3% organically) remains in the doldrums, plagued by category weakness, share losses, and retailer inventory reductions. We think these challenges will prove to be short-lived. From where we sit, Colgate is prudently focused on bringing on-trend innovation to market across tiers (harnessing its wealth of data and analytics) to enrich its standing with consumers and retailers.

We forecast that these efforts will manifest in 2% average annual sales growth for the segment and operating margins that hold in the low 20s (generally consistent with the average over the past five years).

Momentum persisted in Hill's business (more than one-fifth of sales, up 2% on an organic basis), which we attribute to its focus on premium, science-led innovation beyond its core dog food line to include cat and wet offerings. But the firm isn't resting on its laurels. Rather, Colgate is now leveraging insights from its Prime100 acquisition (an Australian fresh pet food manufacturer) to bring a single-protein fresh offering to the US, putting it in more-direct competition with narrow-moat General Mills' Blue Buffalo and no-moat Freshpet. Crucially, Colgate is sticking to its heritage by focusing first on amassing endorsements from the professional channel instead of blitzing the market. As such, we don't think this offering will sway Hill's prospects in the near term. However, longer term, we surmise a steady stream of consumer innovation should buoy segment sales to the tune of nearly 4% on average.

After reviewing Colgate's second-quarter results (which included 2.4% organic sales growth) and its 2026 outlook (for 1%-4% organic sales growth), our fair value estimate sits at $88 per share. Despite unrelenting macro and competitive angst, we believe Colgate will continue to prudently pursue multiple avenues to blunt these pressures, including consumer-valued innovation, revenue growth management initiatives, price increases, and operational efficiency. Our valuation implies a 2027 enterprise value/adjusted EBITDA of around 15 times.

While consumers increasingly favored trusted leading brands (like those in Colgate’s mix) throughout the pandemic, we believe competitive intensity from lower-priced private-label fare and smaller niche operators has reemerged. Management has suggested that promotional spending across the industry now mimics prepandemic levels. We believe this stepped-up pressure is a byproduct of the dissipation of supply/demand imbalances and the surge in industrywide prices aimed at mitigating pronounced commodity inflation. We expect these factors will likely constrain growth in developed markets to a low-single-digit rate annually over the longer term.

Even as we expect emerging markets (which account for just under half of sales) to remain a long-term growth engine for the business, an uncertain macroeconomic and geopolitical climate could cap near-term performance. However, we still believe that favorable emerging-market demographics and disposable-income tailwinds, coupled with Colgate’s extensive tenure operating in these markets and solid brand strength, should enable it to achieve mid-single-digit annual growth in emerging markets in the long term.

Taken together, we don't expect these lingering macro and competitive challenges to impede Colgate's trajectory; rather, we expect its portfolio to prove resilient (as evidenced by mid- to high-single-digit growth during the 2008-09 recession). As such, we continue to expect 3%-4% annual sales growth and low- to mid-20s average operating margins, generally in line with the prior 10-year average.

We think Colgate boasts a wide economic moat, underpinned by its solid intangible brand assets and cost benefits. Colgate dominates the oral care category (just over 40% of its consolidated sales), which is a space with significant pricing power, as taste and safety are crucial components of consumers’ purchase decisions. Evidencing its brand prowess, the firm has amassed a low-30s worldwide market share in toothpaste (more than double its next-largest competitor, Haleon, and exceeding the mere 1.5% share that private-label fare has achieved), according to Euromonitor. This leading share position extends to many attractive markets around the world, including a 66% share in Brazil (versus low double digits each for wide-moat Haleon and Procter & Gamble), 43% in India (versus 19% for wide-moat Unilever), and 24% in China (versus 21% for Yunnan Baiyao). From our vantage point, this stalwart standing has translated into a strong position with retail partners and dental professionals, who recommend the firm’s products to their clients.

Colgate has also carved out a niche in other areas of its mix, such as its Hill’s pet food business (nearly 25% of its sales). While it holds just a high-single-digit share of the North American dog food aisle (comparable with narrow-moat General Mills’ Blue Buffalo brand, but lagging the 20% each held by privately held Mars and wide-moat Nestlé), we think the firm has amassed a larger slice of the premium pet food aisle, given its focus on science-based offerings, which command a higher price point than traditional mass-market offerings. Our price checks at Walmart show Purina (owned by Nestlé) and Pedigree (a Mars brand) both sell for around or below $1 per pound, which is a significant discount to Hill’s and Blue Buffalo’s $3-$4 per pound price tags. However, the firm’s pet food volume has grown at an average of 2% annually since 2015, even as prices have increased by just under 5%.

We believe Colgate's brand prowess and entrenched relationships with industry professionals are strengthened by its commitment to consistently introduce locally relevant new products to market, even those that command a premium price, and to tout them to consumers. Colgate has spent nearly 2% of its sales ($340 million) annually on research and development over the past five years, while also directing 12% of its sales (approximately $2.4 billion) to marketing that drives customer traffic. We see this spending as not only ensuring that its products keep pace with evolving consumer trends but also enhancing the stickiness of its relationships with retailers.

This has manifest in solid organic revenue growth since 2015, up nearly 5% on a 4% benefit from higher prices and a 1% uptick from higher volume. Even following pronounced price hikes (in response to robust cost inflation) in 2022 and 2023, Colgate’s top line rose around 8%, due to a nearly 10% price jump on average, as volume fell just 1.5% on average; we’d suggest the volume degradation was incredibly muted in light of the degree of pricing that was taken. We think this illustrates the brand strength Colgate has amassed over its more than two centuries in business.

Buoying its intangible asset-driven competitive position, Colgate has built a vast global network. We posit that the size and scale of its business afford lower unit and distribution costs, greater supply chain efficiency, and an enhanced ability to leverage brand spending than smaller peers, resulting in a cost advantage. Its standing as a leading operator creates a virtuous cycle that affords manufacturers a mutually beneficial relationship with retailers, in which the vendor is an essential partner, developing sales strategies to maximize volume and retailers’ margins while also prioritizing its brands.

To assess the firm’s cost position through a quantitative lens, we’ve attempted to hone in on direct operating costs related to manufacturing and distribution, which excludes discretionary costs such as advertising and R&D, noncash costs including depreciation and amortization, and nonrecurring expenses, to gauge which firms are positioned to overcome customer acquisition costs effectively. On this basis, Colgate enjoys a direct operating margin of around 39%, outpacing the 35% average for the household and personal care companies we cover, most of which are competitively advantaged operators.

Even though competitive pressures stemming from other branded operators, small niche peers around the world, and lower-priced private-label fare are likely to persist, we believe Colgate is equipped to withstand these challenges over a longer horizon because of this self-reinforcing combination of sources of its competitive edge that have created high barriers to profitable entry. This shelters vendors that have entrenched themselves in retailers' supply chains. We believe this is reflected in returns on invested capital, including goodwill, that have averaged 27% annually over the past 10 years, exceeding our 7% cost of capital estimate; we think the firm can continue to outearn its cost of capital over the next 20 years, supporting our take that Colgate has a wide economic moat.

Increased pet adoption (up midsingle digits in the US) during the pandemic could juice the Hill's business over a longer horizon than we anticipate.

Even in the face of cost pressures, Colgate has remained resolute in investing in its brand portfolio. We believe this spending is preventing material consumer trade-down to private label (qualitatively cited).

Colgate's gross margin averaged 59% over the past five years, and with management's claims that its gross margin in emerging markets outpaces developed countries, growth in these regions could further boost profits.

Raw material, labor, and packaging costs have yet to decline materially. Margins may be constrained over a longer horizon if Colgate's efforts to unlock efficiencies and/or raise prices to offset these pressures prove unsuccessful.

Beyond large global operators, Colgate could face challenges from smaller niche startups that have proved more agile at responding to evolving consumer trends.

Slowing category growth is hindering retail inventories in North America; margin-dilutive couponing and promotions at the industry level could be employed to drive volumes.