Colgate Earnings: Despite the Return of Gross Margin Gains, Cost Pressures Have Yet to Surrender

Wide-moat Colgate CL has been unrelenting in its pursuit to blunt inflation’s wrath, the fruits of which manifested in an 80-basis-point bump in gross margin to 57.8% in the second quarter. But cost pressures (a 540-basis-point hit to gross margin) show little sign of abating (particularly agricultural commodities required for Hill’s pet food). As such, we expect Colgate will keep boosting prices (a 450-basis-point margin benefit) and extracting costs to rebuild profits and unearth funds to reinvest in its business.

Beyond margins, the story is also positive on the sales side of the ledger, up 8% on an organic basis (despite lapping 9% growth a year ago). We attribute this to the firm’s unwavering commitment to invest in its brands, with advertising spending up 20% in the quarter. This aligns with our forecast for Colgate to expend around 13% of sales on research, development, and marketing on average annually through fiscal 2032. We think this should make consumers more amenable to its price hikes (with suggestions more could be in the cards given the higher costs it faces) while also buoying its standing with retail partners by inciting foot traffic into outlets.

And while we applaud its decision to innovate at both the value and premium price tiers (versus promoting to juice volumes), we think Colgate may have recently lost sight of the competitive landscape. In this context, volumes shrunk 7% in North America (20% of its sales base) as the firm shifted an inordinate amount of dollars away from promotions relative to its competitive set. We concur that investments in brand building and capabilities are key to ensuring its edge holds over the longer term, but to thwart competition’s onslaught, we expect it will more astutely balance a long-term focus with the realities of the near-term competitive environment going forward.

When taken together, we’re holding the line on our $76 fair value estimate, rendering shares fairly valued after a 3% pullback on the print.