>COLGATE-PALMOLIVE (ICICI SECURITIES)

Stretched valuations; increasing uncertainties

We downgrade Colgate-Palmolive to HOLD from Buy based on rich valuations and higher risks to EBITDA margin due to increased competitive intensity, likely withdrawal of the excise stimulus in the Budget, rising input costs and concerns on poor monsoons. We value Colgate at FY11E P/E of 20x and raise our 12-month target price to Rs568/share from Rs531/share. While Colgate’s prospects are bright (our estimates remain unchanged), rich valuations and increasing short term uncertainties lead us to believe that most positives have been priced in.

■ Further EBITDA margin expansion unlikely after it touches an all-time high in FY10. Colgate’s EBITDA margin has increased consistently since FY99 (when it bottomed at 8.1%); we expect it to touch an all-time high of 21% in FY10E (270bps rise over FY09). We do not expect further margin expansion and anticipate earnings to grow in line with sales.

■ We expect effective tax rate to rise to 23% in FY11E from 16.5% at present. As per management, no greenfield capacity is coming on stream in tax-exempt areas in the short term as there is enough capacity for the next 18-24 months. At present, ~60% of sales is tax exempt due to its production facility in Baddi. However, from FY11E, tax exemption will reduce to 30% from 100%.

■ Increasing uncertainties – Higher focus on oral care by Hindustan Unilever, monsoon disappointment & withdrawal of excise stimulus. Enhanced focus on the oral care segment by Hindustan Unilever (HUL) might create pricing uncertainty. Likelihood of poor monsoons, withdrawal of excise duty stimulus in the Budget and rising HDPE prices also pose risk to earnings growth.

■ Downgrade to HOLD; bright prospects priced in. The stock has yielded 36% return since our last report (refer ‘Strong earnings growth ahead’ dated April 20, ’09). We remain positive on long-term prospects of Colgate. However, the company trades at FY11E P/E of 21.9x versus its seven-year historical one-year forward P/E of 18.7x. We believe rich valuations have priced in most of the upside. Hence, we downgrade Colgate to HOLD from Buy. We value the company at FY11E P/E of 20x and raise our 12-month target price to Rs568 from Rs531.

To see full report: COLGATE-PALMOLIVE