Colgate-Palmolive (CL) manufactures and sells consumer products worldwide through two segments: Oral, Personal, and Home Care; and Pet Nutrition. We are neutral on the stock.
Growth Catalysts
CL is a mature, low-growth company. As a result, shareholder value will mostly be created from improved efficiency. In fact, the company has done just that, as it has managed to increase its free cash flow margin from 14.1% in 2011 to 20.1% in 2020.
This number has dropped to 15% over the last 12 months, but that is most likely due to the supply chain issues companies have been facing. Therefore, the margin pressure might be temporary.
In addition, since the company generates a lot of cash, it actively buys back shares, consistently lowering its share count each year. This has the effect of increasing the earnings per share figure, even if absolute earnings remain unchanged. As a result, this leads to a higher stock price.
Lastly, since Colgate-Palmolive sells essential items, it has the ability to easily pass on inflation costs to consumers. Thus, the company has the ability to at least grow with inflation.
However, don’t expect these catalysts to produce any stellar returns, as CL is a mature company with little room to grow.
Dividend
For investors who like dividends, Colgate-Palmolive currently has a 2.16% dividend yield, which is above the sector average of 1.5%. When taking a look at its LTM free cash flow figure of $2.6 billion, its $1.5 billion dividend payment looks safe.
Taking a look at the company’s historical dividend payments, though, we can see that Colgate-Palmolive’s yield range has trended downwards in the past several years.
At 2.16%, the company’s dividend is near the lowest end of its range, implying that the stock price is trading at a premium relative to the yields investors have seen in the past.
Valuation
To value Colgate-Palmolive, we will use a single-stage DCF model because it’s a low growth company. For the terminal growth rate, we will use the 30-year U.S. Treasury yield as a proxy for expected long-term GDP growth.
Our calculation is as follows:
Fair Value = FCF per share / (Discount Rate – Terminal Growth)
$99.02 = $3.14 / (0.0525 – 0.0207)
As a result, we estimate that the fair value of Colgate-Palmolive is approximately $99.02 under current market conditions. However, it is important to remember that the reason why the company is currently undervalued is that the discount rate is low.
The main reason for the low discount rate is that the equity risk premium is currently at 4.4%. Thus, the valuation can drastically change if this metric sees a big increase. In addition, a higher 10-year Treasury yield will also push up the discount rate, leading to a lower valuation as well.
Wall Street’s Take
Turning to Wall Street, Colgate-Palmolive has a Hold consensus rating, based on two Buys, five Holds, and one Sell assigned in the past three months. The average Colgate-Palmolive price target of $84.71 implies 2.7% upside potential.
Final Thoughts
Colgate-Palmolive is a mature company that is undervalued, based on current market conditions. However, the lack of substantial growth catalysts and historically low dividend yield leave us neutral on the stock.
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