Colgate-Palmolive (CL): A Dividend King That Hasn’t Missed a Payment in 122 Years

While dividend growth investing is arguably one of the best ways for people to build long-term income and wealth over time, that doesn’t necessarily mean that selecting quality companies is easy.

 

After all, the key to long-term success involves finding companies with strong management teams, consistent and growing cash flows, safe debt levels, and dividend-friendly corporate cultures.

 

That’s why a popular strategy for low risk investors is to screen for quality by looking to dividend kings, which are companies that have proven themselves capable of growing in all types of economic, political, and interest rate environments, all while rewarding dividend investors with steady payout growth.

 

Let’s take a look at Colgate-Palmolive (CL), which with 54 straight years of increasing payments, is one of the few stocks to belong to this exclusive club of low-risk blue chips.

 

More importantly, find out whether or not Colgate’s future plans and growth prospects mean it could be worth adding to a diversified dividend growth portfolio, especially at today’s valuations.

 

Business Overview

Founded in 1806 in New York City by William Colgate as a starch, soap, and candle business, Colgate-Palmolive has grown into one of the world’s largest consumer products conglomerates today.

 

In fact, the company’s 36,000 global employees sell its world famous brands (such as Colgate, Palmolive, Protex, Speed Stick, Ajax, Irish Spring, Sanex, Hill’s, and Softsoap) in 223 countries through four main business segments.

 

 

In addition to a highly diversified portfolio of well-known brands, Colgate’s sales, earning, and free cash flow (FCF) are highly diversified by geography (75% of sales outside the U.S.), including a strong presence in faster growing emerging markets.

 

As importantly, Colgate has been in most of these developing nations for more than 70 years (entering Mexico, Brazil, and India in 1925, 1927, and 1937, respectively), meaning that its brands are very well known and trusted.

 

That makes Colgate an rather low risk way to gain international and emerging market exposure, especially as rising living standards increase demand for defensive consumer products such as toothpaste, soap, lotions, and pet foods.

 

 

Business Analysis

The consumer products industry is considered highly recession resistant due to the fact that demand for toothpastes and skin care products generally grows over time (with population growth) and relatively inelastic, even during economic downturns.

 

That being said, sales, earnings, and cash flow for Colgate haven’t been growing nearly as steadily in the past few years.

 

 

In fairness to the company, those falling sales aren’t due to loss of market share, but rather two other factors.

 

The first is management’s long-term turnaround plan to sell non-core brands in order to better refocus its large advertising and R&D efforts ($1.7 billion, or 11% of 2016 sales) on its strongest and most profitable products.

 

The other and more important factor serving as a growth headwind has been the strengthening U.S. dollar, which means that when Colgate sells its products in local currencies, they translate into fewer U.S. dollars at accounting time.

 

And given that 75% of sales are from outside the U.S., this can sometimes result in large apparent decreases in sales and earnings, even if the underlying businesses are doing well.

 

 

For example, adjusting for currency effects and divestitures, Colgate’s mid-single-digit organic growth has actually been stable and among the highest in its industry.

 

 

In addition, Colgate’s profitability has been steadily improving over the years, thanks not only to its focus on higher-margin product segments, but also management’s ongoing efforts to optimize its large economies of scale and cut annual costs by $400 million to $475 million (about 17%) a year between 2012 and 2017.

 

This has led to steadily-growing gross margins and free cash flow that has been stable despite the currency and divestiture-related declines in sales and earnings of the past few years.

 

 

In fact, today Colgate boasts some of the best overall margins and returns on shareholder capital of any consumer products company.

 

 

This long track record of industry-leading profitability (return on invested capital has averaged over 30% in the last decade) is thanks in large part to the exemplary management team, led by CEO and Chairman Ian Cook, who has had the top spot at the company since 2007 but worked for Colgate since the mid 1970s.

 

Cook has led the effort at smart, long-term focused, and highly disciplined capital allocation. Specifically, that means avoiding the temptation to grow market share at all costs, particularly through ill-timed and expensive acquisitions.

 

In addition, Cook has done a great job of maximizing returns on advertising dollars, with 2016’s ad spending coming in at just 9% of revenue, which is relatively low compared to the company’s historic norms.

 

 

Note though, that this lower advertising spending hasn’t hurt Colgate’s global brands. In fact the strength of its brands and high consumer loyalty is another big reason for its impressive profitability, especially the very high FCF margin.

 

That’s because Colgate’s wide moat, courtesy of its strong brands, allows for much higher pricing power than most of its peers.

 

That’s thanks to the company’s long history of both strong investment into great product development (R&D and new product offerings), as well as advertising at both local and national levels.

 

For example, in the developing world Colgate has a large marketing/community outreach program called “Bright Smiles, Bright Futures”. This ambitious program of free dental screening and oral hygiene care education is expected to reach 1.3 billion cumulative people in emerging markets by 2020.

 

Combined with disciplined advertising at the national level, tailored to local market tastes, it’s no surprise that Colgate’s market share in its core businesses such as toothpaste and manual toothbrushes is so much higher than its rivals. That is partially due to the trust that Colgate has built up over the decades with both consumers and dentists.

 

 

 

In fact, Colgate’s toothpaste market share is more than triple that of its nearest rival, thanks to truly dominant positions in important emerging markets. Here are three examples of Colgate’s impressive market share:

• 30% in China
• 55% in India
• 73% in Brazil

 

As the middle classes of these countries grow, Colgate has a long growth runway to potentially take advantage of because the per capita use of oral hygiene products such as toothpaste in developing nations is much lower than in developed markets like the U.S.

 

 

Meanwhile, Colgate’s strong brands along with its dependable global supply chain, built up over more than two centuries, makes the company’s products highly sought after by retailers.

 

That’s a big advantage when it comes to winning prime shelf space in stores, which makes it easier for the company’s products to be be the first ones consumers see when browsing the oral care aisle.

 

Key Risks

While Colgate-Palmolive is the epitome of a safe, consumer defensive blue chip, there are nonetheless several risks to keep in mind.

 

First, consumer habits are constantly evolving. For example, many packaged food giants are struggling to shift their sales mix and brand perception into healthier natural and organic foods. Some branded product categories also face increased competition from private label brands, which have meaningfully improved in quality and won over more trust from consumers.

 

When companies become very large in size and sometimes overextend their product portfolios, it becomes harder to combat these threats in a timely manner.

 

Fortunately, Colgate doesn’t seem to face as many of these risks as some of its peers do. Toothpaste doesn’t really face health concerns, and its evolutions (e.g. extra whitening) are minor compared to many other product categories. Colgate can also continue leveraging its brand to create any new product variations that come up in many of its markets and plug them into its existing distribution channels to fight off new threats.

 

From a private label risk perspective, most of Colgate’s products are personal items that are used daily by consumers, conditioning them to expect certain tastes, scents, and experiences.

 

Personal products that are used daily seem to have stronger potential to build a more loyal group of consumers that are less willing to try lower priced items on the shelves. Colgate’s historical pricing power and volume growth seem to back up this assumption.

 

In addition to changing consumer preferences and private label threat, the big boys sometimes get into market share battles with each other. The result is lower near-term earnings as higher marketing expenses are needed to protect share.

 

For example, in 2004, Colgate issued a profit warning (its first since 1995) partly as a result of heavy marketing spending necessary to fight off intense global competition, and the stock fell by 11%.

 

Another risk to consider is Colgate’s global diversification, which is an asset (non-U.S. sales will soon hit 80% of total revenue) but can also serve as a double edged sword. That’s because, as we’ve seen, currency exchange risk can have huge impacts on the company’s overall growth rate, turning relatively solid top line organic growth into negative sales, earnings, and cash flow.

 

Of course, over time currency risk tends to balance out (due to regression to the mean), but in the short to medium-term, slowing economic growth in emerging markets and rising interest rates mean that the U.S. dollar might remain stronger than normal for longer.

 

Colgate must also deal with various foreign political climates, navigating a plethora of regulatory regimes that sometimes lower its pricing power and can even result in large losses. For example, in 2015 the company had to completely write off its Venezuela operations, resulting in a massive, one time charge of $1.1 billion.

 

In the meantime, slower than expected global growth, especially in developing nations, means that Colgate’s strong organic growth might face some short-term headwinds as well.

 

In fact, in the most recent quarter we can see a slowdown in global sales, especially in the once fast-growing emerging markets. Given that this is such a large part of Colgate’s long-term growth thesis, investors will want to keep a close eye on whether or not this trend continues going forward.

 

 

Finally, while oral hygiene remains Colgate’s largest and most important business segment, and where its competitive advantage is strongest, it’s still too early to see whether the company’s other units will be able to generate equally strong brand loyalty.

 

For example, while Hill’s Pet Nutrition (which the company acquired in 1976) has managed to build up a loyal following and is the most recommended brand among veterinarians, the pet food industry is a lot more competitive than the oral hygiene segment.

 

 

Colgate is planning to launch new pet nutrition products in the coming years, but only time will tell whether or not it will be able to turnaround this business segment’s (which accounted for 15% of 2016 revenues) slowing growth rate.

 

Colgate’s Dividend Safety

We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend.

 

Our Dividend Safety Score answers the question, “Is the current dividend payment safe?” We look at some of the most important financial factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more.

 

Dividend Safety Scores range from 0 to 100, and conservative dividend investors should stick with firms that score at least 60. Since tracking the data, companies cutting their dividends had an average Dividend Safety Score below 20 at the time of their dividend reduction announcements.

 

 

We wrote a detailed analysis reviewing how Dividend Safety Scores are calculated, what their real-time track record has been, and how to use them for your portfolio here.

 

Colgate has a Dividend Safety Score of 97, meaning that the dividend is highly secure compared to other stocks in the market. Colgate’s high score isn’t a surprise given that the company has paid a quarterly dividend since 1895 and raised its payout every year since 1962.

 

 

What’s the source of such incredibly consistent dividend growth and safety? Three main factors.

 

First, Colgate’s business model is incredibly steady, with plenty of recurring cash flow courtesy of selling rapidly consumed products that are in high demand no matter what the economy is doing.

 

The second factor is management’s disciplined approach to payout growth. That means maintaining a safe EPS and free cash flow (FCF) payout ratio, which creates a large safety buffer in case of unexpected sales misses.

 

 

Finally, Colgate’s management has been highly conservative with debt. This helps ensure a strong balance sheet that allows for high amounts of financial flexibility that translates into smart ongoing investment in the company, while still providing dividend investors with the consistent annual dividend growth Colgate has become famous for.

 

 

When we compare Colgate’s debt levels to its peers, we can see a below average leverage ratio (Debt/EBITDA), an above average current ratio (short-term assets/short-term liabilities), and a high interest coverage ratio, all of which explain its very strong investment-grade credit rating and ongoing access to plentiful, cheap debt.

 

 

 

Note that Colgate’s very high debt/capital ratio is caused by the company’s very high amount of treasury stock (which reduces equity under GAAP), which is often found with companies that consistently buy back shares, as Colgate has done for decades. In fact, since 1998 Colgate has bought back 26% of its shares, or about 1.6% per year.

 

 

The bottom line is that the combination of a stable, highly recurring revenue business model, moderate payout ratios, and strong balance sheet mean that Colgate offers one of the safest dividends you can find today.

 

Colgate’s Dividend Growth

Our Dividend Growth Score answers the question, “How fast is the dividend likely to grow?” It considers many of the same fundamental factors as the Safety Score but places more weight on growth-centric metrics like sales and earnings growth and payout ratios. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.

 

Colgate’s Dividend Growth Score of 42 indicates that income investors can probably expect around average dividend growth going forward. That’s not surprising given that in recent years, the effects of negative currency volatility and divestitures have resulted in below average payout growth for the company.

 

 

Fortunately, going forward management believes that it can achieve long-term sales growth of 6% to 7%, which analysts expect to be leveraged (by ongoing cost cutting and share buybacks) into 8% to 10% free cash flow per share growth.

 

Given that the company’s FCF payout has risen slightly above the company’s historical levels (40% to 50%), investors should expect dividend growth to slightly trail increases in free cash flow, as management attempts to further strengthen its payout.

 

Therefore, Colgate shareholders might see mid-single-digit dividend increases over the next decade, assuming management can restore organic sales to its formerly impressive levels.

 

Valuation

Over the past year, Colgate’s slowing organic growth has resulted in shares underperforming the S&P 500 by about 15%. That being said, Colgate shares are not necessarily that attractive from a valuation perspective.

 

For example, CL’s current forward P/E ratio of 24.9 is both higher than the industry median of 20.2 and its own historical norm of 23.6. It’s also much higher than the S&P 500’s forward P/E of 17.8.

 

With that said, if you have a long enough time horizon, then buying Colgate today might not be a bad idea. While the stock’s 2.2% yield is only slightly higher than the S&P 500’s 1.9%, it’s higher than 61% of its global peers, and slightly higher than the stock’s historical average of 2.0% over the last 22 years.

 

Or to put it another way, Colgate’s stock isn’t an obvious bargain, but it might not be all that far from being reasonably priced today. Especially given its long-term annual total return potential of 10.2% to 12.2% (2.2% yield + 8% to 10% earnings growth), assuming growth picks up as management expects.

 

Conclusion

When it comes to safe and incredibly consistent dividend growers, Colgate is truly one of the best and most trustworthy companies you can own in a diversified dividend portfolio.

 

Of course, whether or not Colgate is right for you depends on your individual time horizon, goals, and risk profile. For example, the current yield is too low for investors seeking to live off dividends during their golden years, but if you have 10+ years until retirement, than Colgate could be an interesting consideration.

 

That’s because the company’s inflation-adjusted dividend has potential to at least double over that time period while providing healthy capital gains. Investors in need of more current income today should consider the 33 companies on the high dividend stocks list here.