Bloomberg: Feb 17th, 2012
“LONDON: Gold traders are getting more bullish after billionaire hedge-fund manager John Paulson told investors it's time to buy the metal as protection against inflation caused by government spending.
Speculators in US gold futures are now their most bullish since September after the Bank of England and Bank of Japan said they will buy more assets and the Federal Reserve said it was considering purchasing more bonds.”
I agree. While the world’s macro-economic fundamentals have improved, the markets too seem to have run up a lot over the past few weeks. And though not all companies are over-valued, one can see quite a few where the price rise seems without any fundamentals. In such a situation exercising caution wouldn’t be out of order. Hence, one could consider Gold as an investment.
Except that my definition of Gold is teeny-weeny different.
I like STOCKS that are equivalent of gold. Something that serves as a flight to safety when all else is disintegrating.
I had bought and had recommended Colgate in 2008. I had also commented about its stock performance during the crisis period in one of my blog articles (dated April 11, 2010).
Now allow me ‘lay’ down the reasons as to why I believe that it may still be a stock worth buying and retaining.
1. Play on the long term potential of India
In any company’s valuation, one of the toughest things to do is to forecast the future growth. In other words, we need to look for predictability of the earnings.
The FMCG sector is one where, especially in a country like India, given its demographic and GDP growth potential (no need to elaborate), the sales growth is almost a given. Hence, that is a logical place to start the research.
The BSE’s FMCG index has 11 companies listed and the table below shows the sales and profit growth for each of them over the last 3, 2 and 1 year periods. What we are looking for is consistency.
In case you thought 3 year figures are not long enough, pl. see below the EPS figures for the key companies (the ones not mentioned in the table do not have figures worth mentioning, hence deleted. In the case of Jubilant, the figures are only since 2007, hence ignored for the purpose of the analysis).
Just in case the print is not too legible, Colgate, Godrej and Nestle have provided long term (7-9 years) EPS CAGR of 22%, 27% and 21% respectively.
2. Good Dividend payout
Confession: I like companies that pay regular dividend and I have regularly used dividend yield as one of the themes for my investments. (I agree that this is at variance with Buffett’s teachings but maybe it’s a hangover from having worked on a regular income for so long in my life). The table below shows the dividend payout ratio for each of these companies.
In this respect, Colgate and Nestle are the noticeable standout leaders, distributing over 70% of their PAT as dividend. Colgate has the highest dividend yield (2.4%) amongst these companies.
Regular high payout % + increasing profits = increasing dividend
3. Leadership in the line of business
A commoditized business is typified by low profit margins, low return on equity, absence of brand name loyalty etc. In such a case, only the low cost producer wins. Even there, the business is faced with cyclicality, often debilitating the performance in the event of a glut or shortage.
It doesn’t have to be that way with a consumer monopoly (a ‘franchise’ in Buffett’s words). Colgate was awarded the # 1 brand position in India and was reported to have ~ 60% market share in the oral care market.
To state the obvious, oral care has low weightage in a monthly budget and hence has less price sensitivity. And with more money flowing to the rural sector, more villagers are likely to substitute their local concoction with a Colgate toothpaste and brush. And this is actually happening. Whenever I happen to travel through far-flung villages (especially in the hills, which I love to visit every once in a while), I see the evidence of Colgate’s distribution. (As an aside, toothpaste consumption in the country is at 0.07 kg per capita as compared to 0.40 in Thailand and 0.61 in Brazil).
I also like the fact that Colgate’s is a mono-line business unlike, say, an ITC, which sells tobacco as well as runs hotels and has a paper related business AND also sells Bingo potato chips.
4. Superior economics of business: High return on capital employed
Last year, there were only about 40 listed companies in India above the market cap of USD 100m (and with debt to equity of less than 0.1X), which reported a return on capital employed in excess of 30%. (There is no logic for my benchmark of 30%, it is just a high enough figure for a country like India which has had inflation levels of 10% in the not so distant past).
Obviously then, a company that can make returns in excess of 30% consistently is bound to be unique. (Why is having a high return on capital important? Well, for starters a consistent high return on capital is an indication that the management is not only making money, but is also employing the retained earnings to make more money for the shareholders. It’s just about the power of compounding! Higher returns will mean more profits – it’s as simple as that).
Amongst the FMCG companies, the table below shows the returns on capital over the last 7 years. Amongst these, Colgate, HUL and Nestle tower above the rest.
5. Consistent performance in the stock price
Carrying on from the previous points, if a business does well shouldn’t the stock follow? The following is what these stocks have provided their owners in excess of Sensex returns (without including dividend).
There are a couple of things I’d like to bring out of the above table:
a) At the risk of repetition, these are the returns above whatever the sensex has returned
b) Companies like Colgate (and Godrej, Marico, Nestle etc) have performed well (business and stock performance wise) even during the uncertain period of 2008/ 2009, earning themselves the status of safe haven or ‘Gold’ stocks
c) Performance of most of these stocks have faltered in the stock market over the last month or so, as the liquidity has chased the most undervalued (and in some cases speculative) stocks. In this respect I remind the readers of Ben Graham’s adage that in the short term the market is a voting machine, but in the long term it is a weighing machine. Performance will eventually win, which means that this may be an opportunity at the current moment.
6. Low beta
The safe haven status on some of these stocks implies low beta, as shown below. This is something I wouldn’t mind in case there was to be crash tomorrow (and I am not saying there will be).
7. Valuation
I haven’t forgotten that price is everything in a purchase! Below is a table that compares the companies by the ratio of their Enterprise value to PBDITA (essentially EV to cash generated).
Before the conclusion, let me recap.
I have tried to demonstrate that in terms of the earning power, dividend payout, consumer franchise, return on capital employed and stock returns, Colgate (and Nestle if I were to add another name) truly make a mark. At the same time, they have also proven to be all-weather friends even when Mr Market decided to go into a manic mood.
So for all the benefits listed above, is paying 24X cash for Colgate expensive?
Well, let me put it this way – it is not cheap… Yet, simplistically, if Colgate grows it’s EPS at 22% p.a., with all the other attendant benefits as explained earlier, then 24X on EV to cash doesn’t sound so bad. The 1994 purchase of Coca Cola by Buffett was at 22.5X.
But having said that, if the growth doesn’t happen the way it has had – for whatever reason – then the market could be unforgiving. Remember that the HUL stock languished between Rs 200 and 250 from early 2006 to mid 2010 because of performance issues.
But… all said and done, we are talking about Gold here! And Mr Paulson says ‘Buy’! So I plan to add a bit in my portfolio, if only as an experiment.
Readers will obviously need to decide for themselves.'
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