Colgate-Palmolive: Buying Some Skin Care Growth - Colgate-Palmolive Company (NYSE:CL)

Too few details have been announced to judge the deal on its merits, as Colgate is priced for perfection with investors searching for defensive earnings yields.

Colgate Palmolive (CL) has resorted to making a small acquisition in order to rejuvenate growth. The company has bought some French expertise in skincare, which is really a bolt-on deal and doesn't move the needle - although it's nice to see a very conservative and defensive business turn a bit more aggressive in terms of growing the business. Nonetheless, Colgate is pretty much priced for perfection already as solid long-term organic growth is overshadowed by continued currency headwinds.

Colgate Palmolive has acquired skin case business Laboratories Filorga Cosmetiques in a $1.69 billion deal. Founded in 1978, the French brand has expanded to 60 countries, although France and its neighboring countries remain the largest markets, along with China. Distribution is widespread including through pharmacies, online and specialty stores.

Colgate defends the rationale by stressing that Filorga is a premium brand with strong pricing, fitting into the long-term personal care strategy; the exposure to Asia is a big plus as well. The deal should close as soon as the third quarter with no impact seen on earnings this year.

No revenue contribution has been quantified, yet the company has seen rapid growth in recent years. I read a claim that the company had a goal of EUR 60 million in sales at the time. Assuming 30% growth per annum in 2016-18, that works out to nearly $150 million in sales, which, of course, is a big guess. And even in that case, it implies a steep 11x sales multiple.

With no revenue number being communicated, yet believing that a $150 million revenue number might be somewhat realistic, we can guesstimate the impact on all of Colgate going forward. The company generated $15.5 billion in sales last year, up less than 1% as the estimate for the deal is that it could boost sales by about 1% per annum, hardly making a dent given the size of Colgate. The company is very profitable with operating profits as high as a quarter of sales. Colgate reported net profits of $2.4 billion last year, equal to $2.75 per share.

First-quarter sales were a mixed bag as volumes were up 1% and pricing was up 2%. These achievements were more than overshadowed by a huge 6% headwind from currencies, with reported sales down 3%. For the current year, the company sees reported sales about flat, driven by 2%-4% organic sales growth (defined as pricing plus volumes).

Adverse currency moves and some cost pressures meant that reported earnings were down slightly, yet the company has reiterated its commitment to grow reported earnings per share in the mid-single digits. This means that they will rapidly approach the $3 per share mark. Ending the first quarter with $843 million in cash and $6.66 billion in debt, this net debt load of about $5.8 billion will jump to $7.5 billion upon closure of this deal. With $3.7 billion in operating profits and depreciation and amortization charges totaling half a billion, I peg pro-forma EBITDA at $4.2 billion, for still a very manageable 1.8x leverage ratio.

With 863 million shares trading at $74 per share, the equity of the business is valued at nearly $66 billion as a pre-deal leverage position of nearly $6 billion makes for a $72 billion enterprise valuation, equal to 4.7x sales. In that light, the acquisition in France looks expensive at 11x (again, estimated) revenues, although growth and margins are probably more compelling. With the deal being equivalent to about 1% of sales and 2% of the enterprise value, this is a bolt-on deal and no share price reaction has been observed in the share price, although one can question if skincare is really a core competency of the business.

In theory, Colgate is a great business as it is truly a global player. It has great exposure to all continents as well as favorable demographic trends and increased wealth across the globe, meaning that spending on their teeth and personal care is on the rise. While the company reports steady organic growth, most of these achievements are undone by the continued headwinds from currencies, which means that reported sales are flattish for years.

At the same time, a 24x earnings multiple does not come cheap, yet the predictability of these earnings is high and the leverage position is very manageable. The truth of the matter is that a 4% earnings yield looks compelling given the low interest rate environment and the defensive nature of the business, while the duration (read: price/earnings ratio) is becoming very large due to the general interest rate compression. However, that applies to all investments. As such, shares probably are fairly valued based on the earnings yield in this environment. The duration of the shares is quite high, although that could be somewhat hedged by taking a short position on interest rates.

The last time I checked on Colgate was in January 2018, and shares traded then at similar levels compared to today. I concluded that shares looked too expensive, while I would be looking to buy in the $60-$65 region, with an earnings yield of nearly 5%. Patience has paid off as I bought some shares at $62 by the end of last year, while a nice 20% run from these levels means that shares are approaching fair value again, in my opinion. This means that I have cut most of my position, while I am free riding with a very small position going forward.

Disclosure: I am/we are long CL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source: Seekingalpha.com

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