Should Colgate-Palmolive Ramp Up Advertising?


It comes as no surprise that Colgate-Palmolive Co. ( CL ) continues to be outspent in media and advertising by other big players such as Procter & Gamble ( PG ), L'Oreal ( LRLCY ) and Unilever ( UL ) and now also the increasingly aggressive GlaxoSmithKline ( GSK ).

Despite this, Colgate-Palmolive has managed to maintain and even gain market share in the past, which is no small feat given that for consumer products, advertising is a crucial business driver and constitutes a healthy share of operating costs. What does catch our attention though is, unlike before, there has been significant drop in Colgate's market shares across all major products segments-toothpastes and toothbrushes, deodorants, dish soaps, body washes and pet foods.

While this does fuel speculations of an impending rise in media spending to match the competition, we're not totally convinced that this would happen and even if it does, that it would have the impact that's expected out of it. Here's our take on it…

If Colgate-Palmolive were to ramp up advertising and media spending…

Colgate spends close to 11% of its Sales on Advertising, which is in line with its peers globally. Why then this hue and cry over media under-spend? To begin with, media spending is thinly spread over 200 markets across the globe leaving the US with disproportionately low ad-spend relative to competitors, which is spread over several categories ranging from oral care to pet food. Colgate gets outspent in each of these category.

In Deodorants & Body Washes, which as per our estimates constitute close to 25% of Colgate's stock value, Colgate spent a total of $9 million on Softsoap, Irish Spring and Speedstick while P&G spent over $82 million (over 9X) on Old Spice and Secret. Compare this with Unilever, which spent $148 million on Dove alone and close to $267 million on Axe and Degree.

Even in Oral Care, which is the leading product segment within Colgate contributing over 44% of its stock value as per our estimates, Colgate's advertising was exceeded by over 35% by P&G's Crest toothpaste. P&G, which competes with Colgate in all product segments exceeds Colgate's advertising spending by over 2.5X.

… So, under-spending cannot be ruled out, but would simply increasing advertising be the solution ?

While increasing advertising is bound to have a positive impact on sales would the incremental sales match up to the increase in expenses incurred on media and advertising?

P&G for instance has long dominated the personal care industry in terms of advertising and competing with the likes of P&G solely on advertising would unnecessarily strain the operating margins. Also, competing on advertising spending in not a one-time cost but if Colgate chooses to play on this turf, it would need to sustain the heightened level of media and advertising spends in the future. Notwithstanding, the current gap that exists in advertising levels between Colgate-Palmolive and others is too wide to be bridged easily in the short-term.

If however Colgate were to scale up advertising to arrest the drop in market shares in Oral Care and Shampoos, Soaps & Deodorants segments, the two largest products segments within Colgate Palmolive, we would expect the profit margins (EBITDA margins) to decline sharply in the short term to historical lows of close under 25% and to remain flat thereafter, leading to a potential 20% downside to our current Trefis price estimate of Colgate-Palmolive's stock.

While, media and advertising can be reasonably assumed to be significant causes for a drop in Colgate Palmolive's market shares, we believe simply ramping up the advertising spending doesn't provide the solution.

See our full estimates for Colgate-Palmolive here

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

This article appears in: Investing , Investing Ideas , Stocks , US Markets

Referenced Stocks: CL , GSK , LRLCY , PG , UL



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