Colgate-Palmolive downgraded by Wells Fargo as growth normalization looms

Investing.com -- Wells Fargo downgraded Colgate-Palmolive (NYSE:CL ) in a note dated Monday to “underweight” from an “equal weight” rating signaling a more cautious outlook for the company’s future performance. 

This follows a period of growth and outperformance for Colgate-Palmolive, but analysts now project a return to more normalized growth rates, aligning the company’s trajectory closer to its industry peers. 

While the stock’s price target remains unchanged at $100, this represents a downside of about 5.4% from its current trading price of $105.73. 

Colgate-Palmolive’s recent success, which saw the company outperform large consumer goods rivals such as Procter & Gamble (NYSE:PG ), Coca-Cola (NYSE:KO ), and PepsiCo (NASDAQ:PEP ), has been driven by strong fundamentals. 

The company's organic sales growth in the first two quarters of 2024 exceeded those of mega-cap peers by 4.6% and 3.7%, respectively. 

“But, as we show in a developed market portfolio deep-dive, this outperformance seems likely to revert,” the analysts said. 

Analysts project that by 2025, Colgate’s organic sales will fall behind those of its competitors by about 90 basis points, which could put pressure on the stock’s valuation premium. 

With Colgate trading at a price-to-earnings (P/E) multiple significantly higher than its peers—about 32 points above Mondelez (NASDAQ:MDLZ ), for example—the expected normalization of growth could close this valuation gap.

A key factor in this expected deceleration is the performance of Colgate’s core toothpaste business. 

The company has long been a dominant player in the global toothpaste market, and after years of declining market share, it began to regain ground in early 2022. 

This recovery was largely driven by strong performance in Latin America, particularly in Brazil and Mexico, where Colgate holds a commanding market position. 

However, Wells Fargo cautions that this market share recovery may not be sustainable due to foreign exchange pressures in these key markets. 

Currency depreciation in Brazil and Mexico has intensified in the second half of 2024 and is expected to continue into early 2025, potentially eroding Colgate’s market share gains. 

Even though FX fluctuations are often beyond the control of companies, the associated decline in market share could negatively affect Colgate’s revenue growth, particularly given the stock’s elevated valuation.

Colgate-Palmolive’s gross margins reached record highs in the second quarter of 2024, propelled by pricing actions and productivity improvements. 

However, this margin expansion is expected to slow in the latter half of 2024 and into 2025. 

Management has already indicated that the gross margin expansion, which has been a major driver of earnings growth, will begin to fade as inflationary pressures, foreign exchange headwinds, and reduced pricing power take their toll. 

With less room to drive earnings through gross profit growth, Colgate will likely need to rely more on improving operational efficiencies—specifically through leveraging its SG&A expenses. 

Fortunately, the company has built up significant flexibility in its SG&A costs, giving it the ability to support earnings-per-share growth even as gross margins soften.

Despite these challenges, Wells Fargo is not signaling that Colgate-Palmolive is in trouble. 

The company remains fundamentally sound, but the downgrade reflects the fact that much of the windfall from favorable market conditions—pricing gains, productivity boosts, and currency-driven performance in emerging markets—has already been realized. 

Looking forward, Colgate’s growth is expected to return to more typical levels, which may not justify its current valuation premium.

Investors should be prepared for a period of slower growth, as the company transitions from a top-line-driven growth story to a more balanced model where EPS growth is driven by operational efficiencies rather than outsized revenue gains.

Wells Fargo’s financial projections for Colgate suggest modest growth in the coming years. For 2024, the brokerage estimates that Colgate will achieve an EPS of $3.57, up from $3.23 in 2023. 

By 2025, this figure is expected to rise to $3.84, reflecting the company’s ability to maintain earnings growth despite the anticipated slowdown in sales growth and margin expansion. 

Colgate’s current P/E ratio for 2024 is projected at 29.6x, compared to 32.7x in 2023, reflecting the expected deceleration.

Geographically, the company faces differing growth prospects in developed and emerging markets. In developed markets like North America and Europe, Colgate saw strong growth during the pandemic and in its immediate aftermath. 

Wells Fargo expects developed market growth to decelerate to 2% in 2025, down from 4% in 2024. 

This slowdown will place greater reliance on emerging markets, where Colgate has historically seen stronger performance. 

Emerging markets, which account for 45% of Colgate’s total sales, are projected to deliver 6.3% organic sales growth in 2025, driven largely by FX-related pricing. 

While this is achievable, Wells Fargo warns that the elevated levels of pricing seen in recent quarters are unlikely to be sustained, particularly given the FX volatility in Latin America.

Shares of the company were down 1.5% in pre-open trade. 

Source: Investing.com