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Waiving royalty can be a silver bullet to fix Colgate’s woes

LiveMint logoLiveMint 13-07-2017 Ravi Ananthanarayanan

Colgate-Palmolive (India) Ltd’s 2016-17 annual report gives a peek, beyond what its interim results statement did, into how it is coping with the challenge posed by Patanjali Ayurved Ltd’s aggressive expansion in the toothpaste market. It was a year ago when Baba Ramdev had said that Patanjali would shut the gate on Colgate. The impact is visible, though it is not catastrophic.

In fiscal year 2017 (FY17), Colgate’s gross sales rose by only 3.9% and its annual report reveals that toothpaste sales alone rose by 3.7%, based on its share of revenue. Toothbrush sales declined by a bit and non-oral care personal care products (share of sales not given) may have contributed to growth. While competition was one main reason for the company’s performance, demonetisation left it bruised too. The report says volumes were under pressure due to “softness” in the wholesale channel.

Colgate’s employee headcount rose by 6% in 2016-17 and the median remuneration rose by 10.7%. There’s nothing like a pay hike to keep people motivated. The company’s advertising spend rose by 14%, and power and fuel and freight expenses also increased substantially. Colgate has not gone on a sharp cost-cutting exercise in the face of stiff competition.

Despite sales increasing, royalty paid to its parent declined by 5.6%, which helped considering it was 5.1% of gross sales in FY16. Even then, the company’s profit before tax (and exceptional items) declined by 1.8%.

What about cash flows? Colgate’s free cash flow (FCF) from operations declined to Rs367 crore from Rs416 crore a year ago. Net cash from operations was flat over a year ago, partly due to a higher tax outgo and higher spends on capital expenditure that contributed to the decline in FCF. On the positive side, the company’s working capital management remained tight and added back to cash flows. FCF is net cash from operations less capital expenditure.

Colgate continues to invest in fixed assets, ensuring it has enough capacity to meet demand and tackle competition. In FY17, investment in fixed assets rose by 10% to Rs1,108 crore, while capital work in progress as of 31 March doubled to Rs166.6 crore over a year ago.

What does one conclude from the company’s annual report?

The effect of competition is evident and the pushback by Colgate is taking a toll on its profitability and on cash flows too.

On the brighter side, once capital expenditure tapers off, FCF should recover. The goods and services tax should benefit the company more, as it no longer has plants in excise-exempt zones. The lower tax on toothpaste is a blessing unlike other units that were getting an exemption earlier but now have to wait for a refund. That gives it an edge, even if a slight one.

And the silver bullet? At Rs209 crore, Colgate’s royalty payment to its parent is a good 24.5% of its profit before tax and exceptional items. These are unusual circumstances where the Indian subsidiary faces a serious threat to its market position. The fight has affected its profits and therefore its market capitalization, and the burden is being borne chiefly by its minority shareholders.

The parent must waive all or part of its royalty for some years till the threat abates. Colgate’s profit can improve even as it gets some additional firepower to spend more if it needs to, to protect its market share. That, after all, is what the parent would want as well.

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