Colgate-Palmolive Company (CL) Earnings Call Transcript & Summary

All right. Good afternoon, everyone. I'm Dara Mohsenian, Morgan Stanley's household products and beverage analyst. Just before we get started, a quick disclosure. Please see the Morgan Stanley research website at www.morganstanley.com for important research disclosures and contact your Morgan Stanley representative if you have any questions. And with that, very pleased to welcome Colgate, with us here today, including Panos Tsourapas -- close enough -- who is the Group President of Europe and Developing Markets; Stan Sutula, who's the CFO; and John Faucher, Chief Investor Relations Officer as well as Senior VP of M&A. So thank you very much for being here today.

So maybe first, we can just start on top line growth. Obviously, as we look past at the last couple of years, you guys have really seen strong organic sales growth trends clearly driven to some extent by above algo pricing. As you look out longer term from here, maybe just talk about your confidence in being able to be comfortably in that 3% to 5% range. And maybe even towards the higher end of that range, just given what we've seen develop over the last couple of years here in terms of some of your strategic initiatives really starting to work and gain traction as well as that external environment that I mentioned. So just sort of thoughts on what's driven the recent growth and sustainability and ability really to be comfortably within that range as we look out longer term.

Yes, I would say, without sound overoptimistic, we feel quite or very confident. If you see the recent history, we delivered very strong results in 2019, then we dealt with the disruptions in COVID in 2021 -- 2020. We [ pumped ] COVID, '21. We delivered strong results again under very difficult circumstances this year. So when you do well under challenging environment, this gives you confidence to -- that this could continue. But beyond that, we have a very clearly stated strategy around our 4 categories. We have a very clear company strategy around our core businesses, innovation, adjacencies, accelerating emerging channels and spaces. We are improving our organization capabilities around digital, e-commerce, data, analytics, RGM, innovation, particularly science-based innovation that makes a difference and lately focusing even more in ESG. So these capabilities, this organizational strength, together with our ability to execute around the world in a consistent and effective way because this is something that characterizes our organization over the years, I think it gives us a lot of confidence that we will continue on that path.

Okay.

Yes, I'd just add one item to that. So working with Panos here, 15 consecutive quarters of growth at or above our long-term model of 3% to 5%. All different years had different market conditions. The point Panos raised, I think, is an important one. Through those periods, even though there are some challenging ones, we continued to invest in the business. Invested in advertising and innovation and go-to-market and digital, though those don't have a short-term benefit, but we do believe long term are critical for operating in that type of mode.

Okay. Great. And then maybe short term, given the volatile external environment, can you just give us a bit of update on -- as you look around the world, the state of the consumer? Colgate is obviously a business that has this geographic diversity around the world. And Panos, you have a couple of regions that have very different characteristics. So I'd just love to hear sort of an update on consumer trends out there, the macro pressures that we're seeing and maybe how that potentially impacts your business.

Okay. So if we start as I like to do from East to West. If we look at Asia first, China, obviously, consumer sentiment and consumption is impacted by the lockdowns and the economic slowdown. Our business is doing very well in China. We are very pleased with our performance. We grew market share. We are the fastest growing -- Colgate is the fastest-growing brand in the market. We have quadrupled our market share in e-commerce. So we saw extreme resiliency in terms of supply chain also in the country. India is stable. Rural areas are a bit soft, and this is well documented. The rest, I think, is fine. Consumer sentiment is overall okay in Asia. Indochina is opening up with tourism, so there is consumption there. If I move to Africa, Eurasia, obviously, Russia and that region is impacted by the war. So volumes are down. The rest of the region is doing well. We have strong pricing, volume growth. I think there is a lot of consumer resiliency around the Africa region and growth in the Middle Eastern region. Europe is challenged, obviously, because of the energy crisis and the impact of the ore. We have taken sequentially increased pricing over the quarters of the year. There is a lot of uncertainty, but the business is doing very well, I would say. Our market shares are up in the majority of our categories, and we haven't seen a significant volume contraction after the pricing that we have taken, okay? For Europe, the jury will be out in the winter, as everybody says, but we could be so far cautiously optimistic. In the U.S., we have taken prices. We see some volume impact, but the fundamentals are very strong. So volume should be sequentially improved. And our market shares are improving in the U.S. business together with the top line growth. And Latin America is a very strong and resilient region. The business is doing very well for us. A lot of pricing, some volume impact, particularly in Home Care because we selected not to compete at the low end of the market. But in Latin America, consumers are very, very resilient. This is not the first crisis they have in their life. So you see some volume softness after the pricing, but then the markets are coming back, particularly in Oral Care category. In Hill's, apart from last quarter that we had some operational issues that impacted the volume, the demand for high-end premium pet food is there and our products are exceptionally positioned in this market. So in a nutshell, I would say, obviously, concerns about the overall economic environment. Some, we believe, temporary volume impact because of pricing, but we should see sequential improvement in volume. And unless there is another disruption or another extraordinary event, logically, things should get more normal in 2023. I don't know if you have anything to add?

Just, I think, again, the continued investment helps support this and our confidence in that long-term growth rate. And operating through these different environments, we have the consumer buying. Obviously, there is inflation, there is what's going to happen with GDP, what's going to happen with rates, all of that. We've operated in those environments, but these macro conditions are challenging. But that's why we're investing in the business through innovation, through capacity, through advertising. We think that, combined with being science-based across the portfolio, really helps.

Okay. Great.

Yes. And another thing to Stan's point that we should not forget is one of the advantages that we have as a company when you see our portfolio in most categories, in most parts of the world is that we are able to compete at all price points, okay? If I take a market like Germany, for instance, we have a toothpaste for EUR 1 to EUR 6, which is the lowest to the highest. If I take Brazil, we have a toothpaste from BRL 2 to BRL 30. So low to the high end. So when a consumer wants to move in the categories, either trading up or trading down because of the economic downturn, we have an offering for them. So we are very well positioned to capture the demand at whatever level of the pyramid of the consumption and pricing pyramid is going to move. And this historically has enabled us to deal very well with crisis and to emerge actually stronger after the different crisis.

And not to pile on here, but from that thing, it's one of the reasons why you take the pricing earlier in the cycle because it gives you that flexibility. You take the pricing and then if you need to adjust your promotional price points, you have the flexibility built into the P&L while still trying to cover those long-term cost increases.

Okay. Great. And maybe let's stick to pricing. Obviously, there's been outsized pricing in the industry. You guys have led in a number of your categories. Maybe just characterize the competitive environment. Are you pretty comfortable with price gaps as you look around the world? Are there any issues that have emerged from that standpoint? And how do you think about sort of volume demand elasticity? Obviously, it's been lower than expected this cycle, but sequentially, what are you seeing from a consumer standpoint? Is there any sort of after-the-fact reaction given some of the consumer spending pressures as opposed to the usual initial reaction that we often tend to see with pricing? Just thoughts around that, the competitive environment and consumer demand reaction over time?

Yes. Three things. First of all, if you see the pricing positioning, I think it's about right, considering the brand strategy that we do have. I cannot recall any cases that I would say that we are significantly overpriced or underpriced. There are always opportunities at any given point in time by definition in any market in 1 SKU or in 1 category. But by and large, we are where we want to be. And the good thing, if you see, in many markets in the last years is that we have been able to premiumize significantly our portfolio, which is one of our key strategies. Secondly, from competitive standpoint, I think in most of the cases, the market overall, the competitive environment is following the -- the price increases, I would say, is by and large rational. There are instances that local competitors wait to capitalize on the volume or international competitors in categories we have major market shares, and they have small market shares, they wait a bit to gain some market share. But everybody is in the same pressure in terms of gross profit. So if it is not the same quarter or the subsequent quarter, the quarter after, people tend to follow. So I think the market overall is moving and we don't have a major deficit or a major issue of being overpriced. And certainly we see elasticities and it's unavoidable. Price goes up, volume goes down. I think we should bear in mind because sometimes we forget that in the short term, sometimes the volume movements do not reflect fundamental consumer behavior. Prices take some time to reflect it on self. So it doesn't happen overnight. In some instances, you don't promote a couple of months after you raise prices or customers do not allow. In some other instances, the trade prebuys or doesn't buy to see if the new prices are going to stick in the market. So sometimes the movement you see on a quarterly basis on the volume are, to an extent, attributed to operational reasons rather than fundamental shift in consumer behavior. And considering the nature of our categories, as it happened in the past, the market people will get used to the new price point. So we should expect to see the volume sequentially to start improving as we are cycling out of the price -- of the significant price increases.

Great. That's helpful. And then, Stan, maybe to tie in pricing versus the cost side of things. Obviously, tremendous pressure this year in terms of cost. As you look at sort of the cost curves and where we are today, when do you really start to see that the recent spot price pullback in a lot of key commodities start to flow through to your P&L? Maybe give us a sense of the overall cost outlook when you include things like labor and other items that are harder for us to track as opposed to some of those liquid spot commodities that are easy to see. And then how you think about sort of the interaction between pricing and cost, and when you start to get some real gross margin recovery relative to some of the compression we've seen in the industry over the last couple of years?

It's a great question. So we do get our crystal ball out periodically to look into the future on this. But I think one of the interesting parts has been in '22, our commodities are up 23% year-to-year. It's a huge $1.3 billion headwind that we've had to deal with. And we just talked a lot about pricing around. We look at pricing holistically across the market. So not just cost increase, what happens, but conversion costs, what are the costs involved in making the products, distribution costs, logistics also up dramatically on a year-on-year basis. So when we look, we have better insight into near term, looking out in time, that's a little harder to predict. There's a couple of items. One, I get this e-mail. I get at least one e-mail a day saying, "Oh, the spot rates are down, it's going to be wonderful." But while the spot rates are down, they're down off their peak. They're still up year-to-year in many categories. And what we're starting to see now is a split of that. Palm oil, tallow, some of that has moderated more. But things like ag, which we use in Hill's, has actually not come down off the highs. Oil is -- I wake up every day and look at it and determine where we think that long term is going to be. So as we look now, still see some challenges on the commodity side. I do believe, over time, that will moderate. But I had to go back and look at our history. We went back as far as we had. We looked at the last 2 recessions. Those revert to the mean over time. I do think there's some structural changes here. Things like biodiesel affect a number of our categories. And as that becomes more as part of ESG, more into buying into fleets, in particular, is keeping some pressure on that. And then the unknown of the war, in particular on ag, has had an effect there. We've also looked at logistics. Logistics, we're starting to see some relief in that, very lane-specific, which I think is going to be one that we have to play out, and very geographic-specific as well. Now our ways of combating all of that, pricing is a key one. We also look at what we call funding the growth, really productivity, and I think the teams have done a particularly good job on that this year. But we see that those will be benefits. Now there are some headwinds still out there. FX, we're 66% international. And when you take that, we have a big mix across that international components, not just the euro but the Mexican peso, the real, go across, you have a big portfolio. And then interest rates. So while we have a -- a good portion of our rates are fixed, the part that's variable, those rates, as we all have seen, have gone up rather dramatically and that will become a headwind on a year-on-year basis. So we look at this holistically across the portfolio. How do we price, how do we drive productivity, how do we continue to invest in the business, which we're going to continue to do. And then as these tailwinds, hopefully, manifest themselves. Remember, we're buying on contract rates across some of these. On specific items, we lock in for a longer period of time as we want to ensure we can have production. But we look at that day by day to say when would it make sense to go shorter and if we think that's going to drop. We did say in our call that we expect margins over time to recover, right? We don't expect to stay here, but we do expect to continue to invest in the business. We think those investments in advertising, capacity, innovation, digital and go-to-market play well for the long term. So we look at this holistically, we expect margins will improve over time, but I don't think it's an overnight item.

Okay. And the pricing piece of that, obviously, you've had great realization this year. As you think about going forward, is there still a lot of price increases left? Is it more international and FX related? Just how do you think about what's sort of already occurred, which is what's left to come?

Well, I think part of that depends on the environment. As Panos stated, positioning-wise, we're pretty comfortable with where we're at. There's always a cell in a matrix somewhere that we have to hit. Overall, though, we're pretty comfortable with where we're at. We said in our call that we already had more second half pricing and pricing going into 2023. As you know, you can't just flip the price overnight. You have to plan this. There's long lead times on some of these. Those vary sometimes by retailer, sometimes by country. So we try to plan for that and the best insight we have on longer-term trends, but we do expect more pricing both in the second half as well as next year.

If I can just add, I mean Stan had mentioned this and Panos as well. I mean the focus on building up RGM capabilities over the last couple of years has been key. It's a primary focus of our data and analytics team, where we brought in a lot of talent from the outside and really looking to say, okay, so it's not all just list pricing, right? It's mix, it's innovation, it's getting your promo pricing in the right places, et cetera. It could be cutting back on couponing, things like that. So there are ways aside from just list pricing that you can go in and drive additional pricing growth going forward, and we think we're much better situated now than we were even 2, 3 years ago from that standpoint.

Particularly on digital front.

Yes, yes. And strategically, something that it is our core competency and part of our strategy is that we are never shy on pricing. And in most parts of the world, we are leading the pricing efforts because as John said, this is the right commercial and financial posture. And we will continue doing so depending on the environment.

Right. Okay. And Stan, how do you think about the advertising line going forward? Obviously, there are a couple of realities this year in terms of the cost pressures and FX, right, that caused a bit of curtailment there in theory. As you look at that line item, does it go back up as a percent of sales over time? You're looking at it more on a dollar basis and more in line with sales? How do you sort of think about that, particularly given some of the success you've had in driving top line and market share recently?

Yes. So in third quarter on a dollar basis, it was down just slightly, local currency was up on a year-on-year basis. But we think advertising is important to the brands. We think if you go back further in time, we cut that too much. We think where we are now is certainly a better position. So we also think it's one of the key reasons of 15 consecutive quarters of growth at or above our long-term model of 3% to 5%. So over time, we'd like to see that increase, in particular, where we have the market opportunity. Places like Hill's in North America and some of our focus markets, we see that there's opportunity. We think advertising is one of the keys. But I'd caution to just look at the dollars. We mentioned digital and it's how you spend each of those dollars as well. I think we're getting much more bang for the buck out of that as well as we've gotten smarter, both with our agency partners, how we do promos, the RGM work, but particularly around digital, very much tuning how we spend that money to make the money we do spend have a bigger outsized impact. So over time, I expect we'll see that -- we'd like to see that increase from where we are because we think it has fed the model. And that's why we want to drive the productivity and increase the margin, it circles back into advertising and innovation.

Yes, if I could build on that, something that is not visible and one of our key initiatives is around advertising efficiencies. And in today's world, the analytics world and the tools that we have at our disposal enable us to deploy our advertising in a more efficient way. For instance, the majority of our spending is programmatic today. This is far more efficient than as was deployed 2, 3 years ago. We have a very strong discipline around marketing mix modeling, where we optimize the ROI behind our campaigns. In big markets like the U.S., we run it on a monthly basis, and we continuously adjust our media mix, our -- the way we deploy at the different tools. So you might see the number to be 100, okay, I make it up. But what you buy, the impressions you buy, the coverage you get for the same 100 is much more than what it was 2, 3 years ago. And this is one of the reasons that we see such top line and consistent top line growth in the last 15 quarters or 4 years, as I want to say, with some advertising growth. But I would tell you, we haven't doubled our advertising, okay? It's higher, but it's not dramatically higher. The impact is more on the efficiencies and how we are able to deploy our advertising. And we will continue excelling in doing so.

One other thing I would add to that, going back to the market mix modeling, one of the things we've learned is that equity advertising, particularly on the Colgate equity, but also we've done more equity advertising on Hill's, is very effective. So on Colgate, if we advertise the equity, if you think about a market where we have 50% market share in toothpaste and 40% market share in toothbrushes, and we have a mouthwash business as well, that advertising on the Colgate equity, which has such a positive reinforcement in the market, it haloes not just on all the toothpaste brands, but on the toothbrushes and mouthwash as well. So that's another way in certain markets, we've been able to drive efficiency on that advertising spend.

Right. Okay. And maybe switching to some of the individual segments. North America has been one region that sort of lagged, if you look, over the last few years, but we've really seen a pronounced re-acceleration in org sales growth the last couple of quarters here, tied to innovation, tied to some of the supply chain fixes in place. So just how do you guys think about that region going forward in terms of sustainability of growth from here, extendability on a multiyear basis? And also maybe tie in margin expansion, right? We've seen things bounce around a little more at the divisional level, and it's harder to read, but can you sort of couple sustained top line growth with margin expansion looking out over a longer period of time?

I can take the commercial piece and Stan can comment. So I think commercially, we have addressed a lot of issues we had in the recent past in North America. I think we have much better innovation. You see our Optic White Pro, according to Nielsen, if I'm not mistaken, is the most successful toothpaste innovation in the last few years in the market, driving premiumization and market share. Also, we have done adjustments across the portfolio in the rest of the categories, and this is reflected in the results. We have adjusted our promotional plans and the balance of the plans between the different channels. We are doing a lot of progress in e-commerce where we have changed the organization, both in terms of people, structure and practices. As I said before, the work on media efficiency is pioneered by North America around marketing mix modeling and driving media efficiencies. We have addressed some issues we had with our retail partners. So all our JPBs with -- our joint business plans with all our key retailers are very, very strong. And we have addressed a lot of the customer service issues that we had before because of COVID and for other situations -- reasons. So a lot of fixes across the board. And you see the results are reflected on healthier sales growth, and we believe there will be more to come. We are quite optimistic about the prospects of the business and commercial success with our market shares improving. So commercially, I think all this work still is under progress -- in progress, but we see a lot of many results, and we will continue in the future. But financially, I think Stan could.

First, we like this market. We think we play well in it. We addressed a lot of the underlying issues that we had, both on a portfolio and logistics, on service levels. And that took a piece of time to get right. We feel much better about where we are as well as the trajectory and, particularly, in the categories we play. And you're starting to see that in the results, right? The revenue performance, the sales performance has improved. We're seeing margin improvement here in this business. And I would just tell you, the team's got a spring in their step as they compete in the market. And the North American consumer, I think, has been rather resilient on purchasing power at least to date. So when we kind of look across that, we feel pretty well positioned for North America, and we do like the market.

If I can just add one thing to that. If you look at the longer-term margin structure of North America, I don't think we're looking at something where you're getting back to 2016, 2017 margins from that standpoint. I think there's more areas we want to invest in, what have you, to drive that long-term growth. That's probably not something we're really looking at, but it doesn't mean there isn't opportunities, as Stan said, in the shorter to medium term.

Okay. And then maybe a similar question on the pet business, which has obviously done incredibly well over the last few years and even predating the COVID category pickup. So as you guys think about the drivers behind that, how sustainable is that? And then also maybe just a short-term clarity question. John, I know you were involved in a lot of the work to generate incremental capacity there. So how quickly does that come back online? Or does it ramp up, I guess, from here relative to Q3 where you ran into some capacity issues?

Want me to start with capacity?

Yes, you may start.

So looking at the capacity. So we closed the deal for the dry pet food facilities, which is the second deal we did this year related to capacity for Hill's. And then we're also building additional wet pet food capacity with a new plant coming online in Kansas next year. And we've invested significant CapEx behind that. So this is a company that did contract manufacturing for branded players as well as producing some private label. We closed the deal again on the last day of Q3. We will be rolling some of our volume in -- they're already producing -- they were already producing for us as a co-manufacturer. So we'll be rolling some of our volume in to lower the capacity utilization within the Hill's supply chain, which is really where we ran into issues in the third quarter in terms of running at a capacity utilization rate that was simply unsustainable. So we should see some relief on the capacity utilization side shorter term as we roll more Hill's volume in there. And then we will continue to do that over the course of 2023. And then there's a longer tail within what we call the Red Collar business, where there's some production in there that will roll off over a longer period of time. In terms of impact on the business, we said that for the fourth quarter only, which is where we gave guidance, we'll give updated guidance on the Q4 call, that was going to be a 200 basis point benefit to revenues for acquired volume in the Hill's side, so 200 basis points to the total company. And then on a total company basis, we will see a 100 basis point impact on the gross margin line. And then -- if you think about that conceptually, as we rotate more Hill's volume in, you can see again how that will change over the next couple of quarters, but we'll give guidance on that as we head into 2023. And then you want to talk about...

Yes. So I think Hill's success didn't just happen earlier in the year. This actually started several years ago, and that was kind of rethinking the brand back to our roots on science-based. And that's really where I think this started, with the revamp of Science Diet and bringing that to market. And around that, they also went digital first in the company. They're way ahead of the rest of the company, and we've learned a ton from that. We have 200 vets on staff. So this truly is science-based and how do we incorporate that into it. And we're having a discussion with somebody earlier today that they stayed in the room after everybody left and said, I just want to say, Hill's really helped my dog, right? We were really scared about what was going to happen, and this has really helped them with their digestive issues. And I think that's why people buy the brand. We go with the profession through the vets, science-based. We were all just out at the Pet Nutrition Center and the research center recently. It's a great place to go. You get all excited when you see the innovation that's going to come to market. You wrap that around the capacity. And the reason why we're confident long term in this business is our penetration is still pretty modest, in single digits. So we like the category. Through COVID, one of the big benefits is we grew the number of pets, you have to feed all of them. We like our basis in science and the profession, and we like our position in the market. So we see great opportunity. The challenge we ran into earlier in third quarter was when you operate at 100% capacity, essentially, you can't have a hiccup, and we had a hiccup. And so we've addressed that. And we said as we exited third quarter at a double-digit rate. So we like the positioning of the brand. We think it ties in nicely with our overall portfolio around the science base, profession recommended. And the economics of this acquisition, I think, are going to play out really well for us.

Okay. Great. Then maybe we can end, John, take advantage of your presence on stage. Just thoughts around M&A here. Obviously, in theory, prices have come down in the industry, at least for some public companies, right? Sometimes expectations don't change as much from a seller standpoint. But just any thoughts around M&A? It obviously hasn't been a big piece of the Colgate story historically, which is a complement by the way, it's not a complaint. But thoughts around that? And then on the other side of it, opportunities maybe to unlock value through considering separation of businesses, divestitures, things like that. Any thoughts around how you guys think about the value of M&A or the other side of the fence as you look out over the next few years?

Sure. I mean so -- if you look at our capital allocation strategies, there's been no changes. We have a -- everyone defines ROIC differently, right, but we would view that we have a high 30s ROIC, which means the #1 opportunity is to invest back in the business, right, through CapEx. The wet pet food plant in Kansas for Hill's, I think, is a great example of that. Dividends, obviously, that's -- we have a great track record there. As we think about M&A, the key thing is, do you have your strategy in place, right? We have a very well understood strategic plan that goes through 2025 and Stan is working on sort of the next iteration of the strategic plan right now. And what's great about having the strategy in place and Panos started off his first answer with on the strategy, right? And so when you've got that in place, it really allows you to get people focused on the true ways of that M&A, if you're going to go out and execute against that, how it really adds value. And it makes the internal language so consistent because you're not looking at M&A to solve your problems for you, you're looking at M&A to be an enabler for growth. And that's really what I think we've done with Red Collar, for example, right? We've got a great brand. We need something that will enable faster growth on that brand. And so I think we're going to be smart about it. I think we're going to be disciplined from a price standpoint. Prices in most of the assets we're looking for really haven't come down at this point despite what's happened in the market and despite interest rates, so we'll see what happens. But you're going to see us continue to be disciplined there. As far as divestitures, I think we look at our portfolio and we feel good about our 4 categories. We're growing all 4 categories. We're growing right now in all 6 divisions. We don't want to get back to balanced volume and pricing growth. So I think are there opportunities to look at individual brands or smaller businesses and say, is there someone who can optimize the value of those businesses? Yes, I think there is a potential for some of our smaller businesses where that could be something we could look at.

Okay. Great. Well, thanks so much for being here, guys. We're out of time. We will end things there. Thanks, again.

All right. Thank you.

Thanks, Dara.

Thank you.