Colgate’s Q3FY11 numbers were below our forecasts owing to an unexpected increase in SG&A expenditure. Net sales grew 14%, led by 12% volume growth. The merger of Professional Oral Care (POC) and CC Healthcare (CC) resulted in 360bps rise in gross margins, but other expenditure (% of sales) increased 391bps.

SG&A jumped 60% (21% of net sales vs. an average of 14%) due to aggressive branding efforts for Colgate Sensitive, Colgate Total and Plax and one-off expenditure for the OHM campaign. Consequently, EBITDA margin declined 750bps and PAT dipped 38%. The Colgate management expects normal performance in Q4; hence, lower Q3 numbers would impact FY11 estimates. The management also guided to effective tax rate of 24% and 29% for FY11 and FY12, which is substantially higher than our estimates; we downgrade our FY11 and FY12 estimates by 11% and 14% respectively.

Aggressive branding resulted in market share gains

Colgate gained 110bps and 120bps share in the toothpaste and toothbrush categories respectively on better consumer reach and enhanced branding efforts.

The merger strengthened gross margins

The merger of CC and POC with Colgate resulted in ~3-4% improvement in the company’s gross margins. Earlier, these companies were suppliers to Colgate. We expect 23-24% in EBITDA margins over FY11-FY12 as higher SG&A would offset the benefits from increase in gross margins.

VALUATIONS AND RECOMMENDATION

We believe volume growth will sustain on the back of Colgate’s rural focus, regular product launches, and continuous dental awareness programs. Our FY12 target multiple at 24x is slightly lower than that of the FMCG sector. We downgrade Colgate to ‘HOLD’ with a TP of Rs822.