Before the open this morning, Colgate-Palmolive (CL) reported fourth quarter results that were essentially inline with expectations as EPS came in at $0.74 versus the $0.73 consensus, on revenue of $3.8 billion compared to the $3.78 billion forecast. However, its results also showed year/year declines in several key metrics, such as Non-GAAP EPS, gross margin, operating income, and revenue.
Just as its consumer staple peers Proctor & Gamble (PG) and Kimberly-Clark (KMB) noted in their earnings reports earlier this week, CL was pressured by rising raw material costs, cutting into its margins and profits. This time, the squeeze mainly came from higher packaging materials - such as resins and pulps - as opposed to oil prices, which impacted margins last quarter. Non-GAAP gross margin decreased 100 basis points to 59.4%, in spite of some cost savings from its Global Growth and Efficiency program.
Additionally, in its earnings press release, the company provided its outlook for 2019, expecting net sales to be flat to up single digits. That is inline with the Street's +0.4% forecast. But, CL also said that it expects EPS to decline by mid single digits this year. The street had been anticipating a modest 2% increase in 2019, to EPS of $3.03. While the company is anticipating stronger margins this year, it is also planning to ramp up investments in some premium brands, coinciding with a push in advertising efforts. As we explain in more detail below, these investments will be a drag on the bottom line as it looks to gain share against PG and others.
Latin America & China Weigh
It wasn't just rising commodity prices that CL had to navigate through this quarter. The company also has significant exposure to Argentina and Brazil as Latin America accounts for nearly a quarter of total sales. As a point of comparison, Latin American only represents 7% of total sales for PG. Political turmoil in Brazil, particularly surrounding its Presidential election last fall, and the plummeting Real, created considerable economic turmoil in the country. During its earnings call last quarter, CL lamented that volatile macroeconomic conditions in Brazil, including a hangover from the trucker strike in the second quarter, hurt its results. On top of that, Argentina has faced its own set of issues as its currency, the Peso, also has spiraled lower.
On the positive side, with the Brazilian Presidential election now in the rear-view mirror, the volatility seen in Brazil has eased. This is reflected in the sequential improvement in results for the region as organic sales increased 1% in Q4 (total net sales down 9%), following a 3.5% dip (total sales down 13%) in Q3.
Not surprisingly, CL also felt the impact of the slowing economy in China. Asia Pacific net sales (16% of total) fell by 6.5% in the quarter, driven by volume declines in the Greater China region. Interestingly, last quarter management was quite optimistic about its prospects in China, as opposed to its more cautious view on Latin America. There were two main reasons for its bullishness: the premiumization of certain product categories, and, the explosion of e-commerce, which CL has been prioritizing as a sales channel. Both of these trends could be positive to CL's margin profile, but, the ongoing slide in economic conditions in China has largely muted that catalyst.
A Year of Investment
Despite the rising commodity costs, economic strains in Latin America and China, currency pressures, and domestic political strife, CL is looking to press the accelerator in terms of investing for growth. More specifically, CL wants to enhance its premium skin care business -- an area it has been honing in on. In December 2017, the company acquired PCA Skin and EltaMD, enabling it to enter the professional skin care category. PCA Skin provides medical-grade in-office and take-home skin care products, while EltaMD is a physician-dispensed sun care product. Net sales for the combined products were estimated to be about $100 million.
The premium skin care category was an area of strength for its largest competitor, Procter & Gamble (PG). In its fiscal Q2, PG's organic sales increased by 4%, with positive product mix providing a 1% boost, driven by disproportionate growth from its premium skin care category. Given PG's success in this market, it doesn't come as much of a surprise then that CL would be looking to take some share.
In addition to bolstering its skin care product line, CL plans to broaden its e-commerce platform, adding more direct-to-consumer offerings. And, to support its investments in skin care and e-commerce, CL will increase its advertising spend.
So, while the company is anticipating better organic sales growth of 2-4%, and some easing on the commodity cost side, these investments are expected to offset those positive factors this year.
The overall story for CL is a familiar one to investors, as rising raw material costs and a slowing Chinese economy have strained its financial results. However, what makes CL unique, as compared to PG and KMB, is its business strategy for 2019. While most companies are taking a more cautious approach to capital spending this year, CL is going in the other direction. While its share remains strong in its bread and butter toothpaste category, the company is clearly taking aim at the higher growth skin care market, looking to take some share from the likes of PG. How this plays out in a volatile global macroeconomic environment will be interesting to watch.
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