In an exaggerated reaction to good earnings numbers and a one-time dividend announcement, the Colgate-Palmolive India stock rose by 12 per cent in a single day (May 4).
Shareholders can retain the stock, given the relatively sound long-term prospects arising from traction in the company's growth numbers and its improving product mix.
However, after the recent sharp move the stock trades at about 32 times its trailing earnings, at a valuation premium to the rest of the FMCG space. The stock price could cool in the short term.
Healthy numbers
After an inconsistent performance in the preceding quarters, Colgate Palmolive India reported strong profit growth of 37 per cent in the March quarter of 2006-07.
The profit growth appears to be driven by an improving product mix, lower tax incidence on account of newly-commissioned facilities at Baddi, HP, and a slower growth in adspend. Sales growth also improved sequentially, from 12.8 per cent in the preceding quarter to 13.3 per cent in the latest quarter. Domestic sales of oral-care products such as toothpaste and tooth brush picked up pace recently on the back of increasing offtake from the rural and semi-urban areas. Colgate, as the dominant player in the mass-market segment (HLL does not have a presence), has been a key beneficiary of this trend.
The company's efforts at broad-basing its portfolio also appear to be bearing fruit, with the company garnering significant market shares in liquid soap and body wash segments.
The improving growth trajectory has helped Colgate close FY-07 with a healthy 15 per cent growth in sales and a 17 per cent growth in net profit.
One-time dividend
Along with its earnings numbers for the March quarter, the company unveiled a proposal to declare a one-time "deemed dividend" of Rs 9 per share.
This move, intended to return excess capital to shareholders, has been structured as a capital-reduction proposal that will reduce the face value of each Colgate share.
This is likely to take time to implement, as it requires shareholder and court approvals.
Investors need to note that though it will eventually result in an inflow of about Rs 9 per share, this move has no direct wealth implications for them:
The capital reduction proposal will have no impact on the company's per share earnings , as the number of outstanding shares will remain unchanged. Though the proposal will reduce the face value of each share, the absolute stock price will not fall after the dividend payout.
Investors need to note that this move to return capital is different from a stock split. In a stock-split proposal, the number of outstanding shares available for trading in the stock market expands while the face value of each share shrinks.
In this case, only the face value shrinks from Rs.10 to Re 1, with Rs 9 per share being returned to shareholders. The per-share earnings and the number of outstanding shares remain the same.
The move will, therefore, not improve liquidity in the stock or reduce the absolute stock price.
However, the proposal may have an indirect impact on valuations, as it will improve Colgate's returns metrics — its Return on Equity, Return on Net Worth and Return on Capital Employed numbers.
This is because Colgate will be liquidating Rs 122 crore worth of low-return yielding investments (now part of its net worth) and carried by its treasury operations, to fund the deemed dividend.
Though investors who buy the stock now will be entitled to dividends of Rs 18.5 per share over the next year (Rs 9.5 annual dividend plus Rs 9 special dividend), the sustainable dividend per share amounts to only Rs 9.5 (this amounts to a sustained dividend yield of less than 3 per cent on current stock price).