Colgate International Finance Foreign Investment Analysis (indian subsidiary)

8/10/2019 Colgate International Finance Foreign Investment Analysis (indian subsidiary)

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Shivam Bajaj;Rabeyg singh

GMSI 416 INTERNATIONAL FINANCE REPORT

ColgatePalmoliveFOREIGN INVESTMENT ANALYSIS


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ContentsCompany profile .......................................................................................................................................................... 2

Capital structure ........................................................................................................................................................... 3

Debt equity ratio Analysis ............................................................................................................................................ 6

Risk factors ..................................................................................................................................................................... 7

WACC ............................................................................................................................................................................ 8

WACC for Colgate Palmolive USA ......................................................................................................................... 9

WACC for Colgate-Palmolive India ....................................................................................................................... 9

The assumptions while calculating cost of capital .............................................................................................. 9

References .................................................................................................................................................................. 10


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Company profileThe Colgate Palmolive Company is much diversified firm that deals in the manufacturing and

distribution of personal-care, household and commercial cleaning, pet food and dental

products. The company has its headquarters in New York City in the United States of America

and effectively operates in about 200 or more countries and territories across the globe.

The company was first established in the early 19th century by William Colgate a very skilledcandle and soap manufacturer in New York City under the name William Colgate andCompany. The name was later changed by his son Samuel Colgate who inherited it in 1857.

Madison University in Hamilton, New York was re-named in 1890 to Colgate University inrecognition of longtime financial support by the Colgate family. By 1896 the company sold tubes

of the very first toothpaste and a dental cream. B.J. Johnson had first developed the formula ofPalmolive soap which came to be the worlds highest selling soap at the turn of the 20th century

sold by Palmolive-Peet Company and bought the firm in 1928. It was in 1953 that the currentname was adopted by the firm (Britannica, 2014).

In 1937 Colgate-Palmolive was incorporated and in 1983 Colgate Plus tooth care range wasintroduced which was very successful in the market. By 1988 the company was licensed toproduce 24,000 tons of fatty acids and also produced 30,000 tons of soap per annum. In 1988June, a wholly owned subsidiary was established in Nepal in Hetanda for the manufacture oftooth powder and paste. New and very successful products like Palmolive extra care, Colgategel toothpaste and a new Palmolive soap initially hit the market in 1991(IIFL, 2014).

Colgate-Palmolive has one of the widest distribution networks in India that makes Colgateavailable in almost 4.64 million retail outlets across the country. Colgate was ranked as India'sno.1 Most Trusted Brand across all categories for four consecutive years from 2003 to 2007 and in2011 and 2012 by Brand Equity's Most Trusted Brand Survey.(Colgate-Palmolive | Investor. 2014.Colgate-Palmolive | Investor. [ONLINE] Available at:

http://www.colgate.co.in/app/Colgate/IN/Corp/Investor/Introduction.cvsp. [Accessed 27 November 2014].)


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Capital structure

The key figures of capital structure of the parent company for the year 20143 are-

Colgate Palmolive (US) USD millions

Mar '13 Mar '12 Mar '11 Mar '10 Mar '09

Total Share Capital 2.31B 2.19B 2.38B 2.68B 3.12B

Equity Share Capital 2.31B 2.19B 2.38B 2.68B 2.95B

Preference Share Capital 0.00 0.00 0.00 0.00 169M

Reserves 0.00 0.00 0.00 0.00 0.00

Net worth 2.31B 2.19B 2.38B 2.68B 3.12B

Total Debt 908M 304M 380M 609M 361M

Total Liabilities 11.3M 11B 10.18B 8.36B 8.71B

Debt/Equity ratio 0.393 0.138 0.159 0.227 0.115

(Market Watch, 2014)

Colgate Palmolive

(India)Rs. Cr

Mar '13 Mar '12 Mar '11 Mar '10 Mar '09

Total Share Capital 13.60 13.60 13.60 13.60 13.60

Equity Share Capital 13.60 13.60 13.60 13.60 13.60

Preference Share Capital 0.00 0.00 0.00 0.00 0.00

Reserves 475.99 421.79 370.45 312.51 202.70

Net worth 489.59 435.39 384.05 326.11 216.30

Total Debt 0.00 0.00 0.05 4.59 4.69

Total Liabilities 489.59 435.39 384.10 330.70 220.99

Debt/Equity ratio 0.00 0.00 .36 .33 .34

(Money control, 2014).

The net income approach edicts that there is a straight relationship between the capitalstructure and the value of the firm. The value of the phone can be regulated by increasing or

decreasing the debt proportion and overall proportion mix.


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The net operating income approach states that with increase of debt in D/E ratio, we can

increase the weight of debt which costs less than equity but simultaneously increase the financia

risk. This approach discerns the idea of adjusting the value of the firm just by manipulating the

debt content.

While MM hypothesis with corporate tax states that in most of the countries, debt has an added

advantage over equity. Like interest payments are tax deductible in contrast to dividends and

retained earnings. Capitalizing at all equity rate and comparing the same to an all debt rate

exhibits that the value of the levered firm is same as the unlevered firm with additional tax shield.

Also bankruptcy and agency costs are circumvented.


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Chart scaled to observe trend

It is apparent in Colgate Palmolive India, that there arent major changes in equity. This might

imply that there current strategy is to run business as usual here. But they have gradually moved

to an unlevered capital structure. This trend makes it evident that the company doesnt want to

incur any cost on capital or there are no foreseeable expansion plans. As debt would make it

necessary to pay the interest whereas equity doesnt have this component (inbuilt). But Colgate

US has been drastically increasing their debt and gradually reducing their equity which might

imply for them to be taking big steps in the future; also it might be an attempt to have a tax

shield as well.

0

500

1000

1500

2000

2500

3000

3500

2009 2010 2011 2012 2013

Capital structure comparison of Colgate palmolive US andIndia in terms of debt and equity

Share capital Colgate US Share capital Colgate India

Total debt Colgate US Total debt Colgate India


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Debt equity ratio Analysis

In reality there is no perfect D/E ratio. Every industry is subject to its own custom tailoredoptimized capital structure. Hence there cannot be a black and white conclusion to it.Generally. A high d/e ratio is seemingly more risky to creditors and investors. There is always animminent threat of bankruptcy if a company is extremely levered. With the creditors perspectivein mind, a higher debt-equity ratio can imply that creditors have more stake than the investorsi.e. there are not many willing to invest in the company which increases the risk in the minds ofthe lenders.

In the above listed capital structure of both the parent company and the subsidiary, it is easilynoticeable that Colgate-Palmolive India does not have a lot of debt component. While theparent firm does have a considerable amount of debt listed in its capital structure. Hence theparent company has a higher debt equity ratio due to the interest rates in India, which are

comparatively much higher than in the US which makes it not very viable to borrow funds. In theUSA, the interest rates are comparatively very low, hence it is very viable for the firm to source its

funding from outside the firm and hence have the benefit of an increased financial leverage.

0

0.05

0.1

0.15

0.2

0.25

0.3

0.35

0.4

0.45

2009 2010 2011 2012 2013

Debt - Equity ratio

Colgate US Colgate IND


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Risk factorsAfter the calculation of cost of equity is done, further adjustments are made to account for allkinds of specific risk factors particular to the company that will increase or even decrease the riskprofile of the company. Some examples are pending law suits, concentration of consumer base,

dependence on certain employees and size of the firm. The adjustments are always madeaccording to the investors judgmental decisions and are always different from one company to

the other (Investopedia, 2014).

Listed below are all the material risks and other kinds of risks that the firm might considerimmaterial, yet it may affect the firms securities adversely. The occurrence of any of the belowmentioned risks could seriously affect the business, operational results, flow of cash and thefinancial condition that will cause the securities to decline in value.

Since the Colgate-Palmolive company effectively operates on a global basis with about almost80% of its net sales originating from global markets other than the US. Although this diversegeographic base might help to reduce risks faced in any one country but it also means that thecompany is a subject to a whole range of risks associated with international operations like-

Exchange rate fluctuations- This might reduce the US dollar value of profits, revenues and cash

flows received from around the world that might also lead to an increase in the firms supply

costs which are also measured in US dollars in those respective markets.

Controls and limitations- These exchange controls and limitations will affect the companys abilityto import products or raw materials or to repatriate overseas earnings.

Economic or Political insecurity- Economic or political instability or even labor or social unrest willchange the macro-economic conditions in the markets abroad.

Foreign legalities- These risks include a lack of established or reliable legal system in countries thatthe company operates in. Foreign ownership restrictions and potential nationalization of property

and other resources is also a risk that needs to be listed here. There are also many other domesticor foreign regulatory and legal requirements that would result in adverse tax consequences or

lead to the imposing of certain trade restrictions, government controls or even price controls.

Although many efforts to minimize the inherent impact of all the above listed risks, the firmengages in a cost-containment, raising selling prices and also hedging of foreign currency

transactions combination. But these measures may not always help in reducing any or allnegative impact of the movements in the rate of foreign currency on the firms result of

operations and the overall business.


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WACCThe minimum required rate of return expected on the investment of funds on a company isknown as the cost of capital. It is the costs of raising funds from various sources like equity shares,debt and preference shares etc. that are available to the company from its point of view. It is

calculated by considering the weight of each source listed in the capital structure of thecompany also known as The Weighted Average Cost of Capital or WACC.

WACC = {Kd(1-T) * Wd} + {Ke* We} + {Kp* Wp}Here:

Kd(1-T) = after tax cost of debt

Wd= weight of debt

Ke= cost of equity

We= weight of equity

Kp= cost of preference share capital

Wp= weight of preference share capital

T = Tax Rate

The interest that is paid on long term borrowed funds is called the cost of debt, since debt is a

taxable expense, after tax cost of debt is calculated.

Kd(1-T) = (Interest paid/Total Debt) (1- Tax Rate)

Here, using the dividend capitalization model, the minimum rate of return that shareholdersexpect against their investments in the company is known as the cost of equity.

Ke= (D1/P0) + G

Here:

D1= Expected dividend for next year

P0= Current market price per share

G = Growth rate

Growth rate is calculated as the product of Return on Equity and Retention Rate.

CAPM: Re = Rf+ (Rm-Rf).

RfRisk-free rateit can be deemed as the amount that can be received by investing in virtually risk free

instruments like government bonds. The interest rate of U.S. Treasury Bills is frequently used as a proxy for

the risk-free rate.

Betait is the measure of responsiveness/reaction of the firms stock to the market stock. Positive beta

means the company is quite reactive, as it tends to zero, it indicates that the company is quite stable.

(RmRf) = Equity Market Risk Premiumit is the premium that investors charge for investing in the firms

instrument rather than risk free government bonds etc.


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WACC for Colgate Palmolive USA

Value1 Weight Required rate of return2 Calculation

Equity (fair

value)

58,904 0.91 7.24% =

Debt (fair

value)

5,703 0.09 1.33% = 2.00% (1 33.61%)

USD $ in millions

Equity (fair value) = No. shares of common stock outstanding Current share price= 918,943,637 $64.10 = $58,904,287,131.70

Required rate of return on equity is estimated by using CAPM.

Required rate of return on debt is after tax.

Estimated (average) effective tax rate= (34.01% + 33.46% + 33.69% + 33.64% + 33.25%) 5 = 33.61%

WACC = 6.72%

(Stock Analysis, 2014)

WACC for Colgate-Palmolive India

To arrive at the WACC of 11.8%, we have assumed the cost of equity at 11.8% and the cost ofdebt at 12%; however, the company does not have any debt. Based on these assumptions, we

arrive at a valuation of Rs1213 /share for Colgate.(ICICI securities, 2014).

According to the website equitymaster.com, the FMCG sector is operating at an averageWACC of 15% since the past decade. Since Colgate-Palmolive Indias WACC is less than it, thefirm is able to effectively generate funds at a much cheaper cost than the industry average.

The assumptions while calculating cost of capital

The cost of equity is calculated with the help of a DCM (Dividend capitalization model).

The product of Roe (Return on equity) and Retention ratio is taken as the growth rate.The amount that is paid on ordinary shares is considered the dividend.

Other assumptions of the DCM are

The consideration of the basic EPS for calculations.

Constant price earnings ratio and dividend payout ratio.

Dividend rate and the market price of a share increase with proportion to each other.


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References

Britannica. (2014). Colgate-Palmolive Company. Available:http://www.britannica.com/EBchecked/topic/125327/Colgate-Palmolive-Company. Lastaccessed 26th November 2014.

IIFL. (2014). Colgate-Palmolive (India) Ltd. Available:

http://www.indiainfoline.com/Markets/Company/Background/Company-Profile/Colgate-Palmolive-India-Ltd/500830. Last accessed 26th November 2014.

Money control. (2014). Colgate Palmolive (India). Available:http://www.moneycontrol.com/financials/colgatepalmoliveindia/balance-sheet/CPI#CPI. Lastaccessed 26th November 2014.

Market Watch. (2014). Colgate Palmolive Co. Available:http://www.marketwatch.com/investing/Stock/CL/financials/balance-sheet. Last accessed 26thNovember 2014.

Investopedia. (2014). Complete Guide to Corporate Finance. Available:http://www.investopedia.com/walkthrough/corporate-finance/5/cost-capital/cost-equity.aspx.Last accessed 26th November 2014.

Stock Analysis. (2014). Colgate-Palmolive Co. (CL). Available: http://www.stock-analysis-on.net/NYSE/Company/Colgate-Palmolive-Co/DCF/Present-Value-of-FCFF. Last accessed 26thNovember 2014.

Icici securities. (2014). Colgate Palmolive (India). Available:http://www.dsij.in/productattachment/BrokerRecommendation/COLGATE_Sell_ICICI%20Securities_22Jan2014.pdf. Last accessed 26th November 2014.

Colgate-Palmolive | Investor. 2014. Colgate-Palmolive | Investor. [ONLINE] Available at:http://www.colgate.co.in/app/Colgate/IN/Corp/Investor/Introduction.cvsp. [Accessed 27November 2014].

Documents

Colgate International Finance Foreign Investment Analysis (indian subsidiary)