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Colgate's (CL) Growth Efforts on Track, Cost Woes Persist

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Colgate-Palmolive Company (CL - Free Report) is benefiting from accelerated investments in brands, pricing and innovation along with expansion in new markets and e-commerce. However, weak margin trend and adverse impacts of currency are hurting performance lately.

Although, shares of this New York based company have increased 7.3% in the past six months, it has underperformed the industry’s growth of 12.2%.

Notably, the company’s earnings and revenues lagged the Zacks Consensus Estimate in second-quarter 2019 and declined year over year. Also, operating margin contracted in the second quarter, marking ninth straight quarter of decrease.

That said, let’s take a closer look at the factors impacting its performance.

Hurdles on the Way

Colgate has been witnessing strained margins for the past few quarters now mainly due to higher raw material and other costs. Adjusted operating margin contracted 180 basis points (bps) to 24% in the second quarter, mainly hurt by a 200-bps increase in adjusted selling, general & administrative expenses, as a percentage of sales. Moreover, management expects increases in raw material costs, including foreign exchange transaction costs, to be a deterrent to margin expansion in the second half of 2019.

Despite pricing gains, Colgate’s sales for second-quarter 2019 continued to be hurt by adverse currency rates. Currency had a 4.5% negative impact on net sales. Moreover, unfavorable currency impacted sales across all geographic regions. Raw material costs, which included foreign exchange transaction costs, marred gross margin by 300 bps. Although management expects a moderate inflation environment in the second half of 2019, foreign currency may continue to hurt the company’s top and bottom lines.

Efforts to Counter Hurdles

Colgate is on track with product innovation as part of its growth strategy over the years. This is clear from the re-launch of Colgate Total and Hill’s Science Diet, as well as the continued expansion of the Naturals and Therapeutics divisions. The initial response to the re-launch of Hill’s Science Diet has been positive, with improved market share in the second quarter. The company expects to continue the re-launch globally through the first half of 2020.

Further, the company continues to expand the Naturals toothpaste, with the solid progress of the charcoal launches worldwide. In Latin America, its Oral Care innovations bore fruit, with market share gains in Colgate Total. Personal Care premium innovation and revenue growth management fueled robust pricing gain in the region.

In 2019, Colgate continues to expand its portfolio by introducing pharmacy brands like elmex and meridol to newer markets. It is also likely to increase investments in professional skincare businesses — Elta MD and PCA Skin — in spas and dermatologists. Further, the company is on track to expand its premium skincare portfolio with the recent agreement to buy the Filorga skincare business.

The company’s expansion plan focuses on improving organic sales performance. In the second quarter, its organic sales improved 4% mainly driven by increase in global unit volume and rise in pricing. In 2019, it expects gains from pricing and productivity programs to offset increase in raw material costs, including the impact of transnational foreign exchange.

Further, it is progressing well with its savings programs — Global Growth and Efficiency Program or 2012 Restructuring Program and Funding the Growth program — which are delivering impressive results. In 2019, management expects gross margin expansion, both on a GAAP and adjusted basis.

The company’s four-year Global Growth and Efficiency Program focuses on reducing structural costs to improve gross and operating profit, standardizing processes to improve the decision-making procedure and increasing market share worldwide. It expects after-tax savings from this program to be $500-$575 million. Additionally, these programs are expected to contribute significantly toward the improvement of gross and operating margins over the long term.

Apart from these, the company is expanding the availability of its products through the e-commerce offerings with the launch of Hill’s to home, which will enable pet parents to purchase prescription diet products directly from their veterinarian, with home delivery option. This should enable it to deliver strong e-commerce growth in the current year. All these actions are likely to drive top-line growth in 2019.

Though Colgate expects strong top-line growth in 2019 backed by aforementioned efforts, its earnings outlook remains bleak. The company expects higher raw material costs, uncertainties in the global economy, and currency rates to hurt the bottom line. Consequently, GAAP earnings per share for 2019 are likely to decline in a low-single digit. Also, adjusted earnings per share are expected to decline in a mid-single digit.

Going ahead, we expect the aforementioned tailwinds to partly cushion these hurdles and help this Zacks Rank #3 (Hold) stock to gain momentum.

3 Stocks to Watch

Skechers U.S.A., Inc. (SKX - Free Report) has a long-term earnings growth rate of 15% and a Zacks Rank #1 (Strong Buy) at present. You can see the complete list of today’s Zacks #1 Rank stocks here.

The Procter & Gamble Company (PG - Free Report) has a long-term earnings growth rate of 7.1% and a Zacks Rank #2 (Buy).

The Estee Lauder Companies Inc. (EL - Free Report) has a long-term earnings growth rate of 12.7% and currently carries a Zacks Rank #2.

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