24/7 Wall St. 2007 Break-Up Values: Colgate $70 (Current Price: $67)

By Ryan Barnes. Edited By Douglas A. McIntyre

Colgate-Palmolive (CL) – Price $66.99; Break-up Value $70

Colgate operates in only two segments, but they have a very global reach, selling their products in over 200 countries.  The main revenue segment, Oral and Personal Care Products, showed 7% sales growth in North America but 12% in the rest of the world; they command a dominating 75% market share in Latin America alone.  The other operating segment, Pet Nutrition, is comprised of the Hill’s brand of pet foods and also showed strong top-line growth of 11.5%, an impressive 5% of which was made up of pricing increases.  For consumer products companies like Colgate, pricing power is key; the ability to raise prices will usually make the difference between consistent cash flows and erratic earnings that will kill a multiple very fast. 

Colgate is trading a the top end of its historical range, going for about 27x current earnings and 19x forward estimates.  The stock has done quite well lately as investors tend to rotate into more defensive stocks when they’re unsure about the direction of the economy, a state we’ve been hovering in for quite some time.  Given the current valuation, Colgate-Palmolive has more potential as a cash flow story than a break-up value story.  The company is spending a big chunk of change in restructuring efforts to beef up gross margins and is also increasing ad spending to gain market share worldwide.  So far, they’ve succeeded on both fronts.

As the restructuring costs wind down in the next 2 years (they began in 2004), we should see cash flow grow in the range of 11-13% per year, which could be used to increase the dividend yield from the current 1.9% towards the 3-4% level while continuing to buy back shares at any time the stock trades down into the 10x operating earnings level, which tends to happen to companies like this during the beginning of business cycles. 

If the company were to be split up, the first step would be to sell off the Pet Nutrition segment; with its high margins and strong growth it should sell for 12-13x operating earnings, or about $5.5b.  For the remaining company, considering that North American sales are much slower than abroad, a split between International Colgate and Americas Colgate should help the international segment gain some multiple expansion.  A spinoff of “Global Colgate” could be worth 14x operating earnings, or just north of $25b.  This would leave the North American unit with a lower multiple (we’re using 9x op earnings) but room to grow against rival P&G.  The total breakup value in this scenario comes to $70/share, as we would expect given the high current multiple on CL stock.

Ryan Barnes

Ryan Barnes has over 10 years’ experience in portfolio management and investment research, covering equities, fixed income, and derivative products. Ryan spent the past 5 years working as an institutional trader & manager for high-net worth investors, working with Merrill Lynch, Charles Schwab, Morgan Stanley, and many others.  Ryan is currently working as a writer and financial modeling consultant on hedging and capital appreciation strategies, and does not own securities in the companies being covered.

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