Colgate’s Q2FY11 numbers were below our expectation. Net sales grew 13%, led entirely by volume growth. Gross margins expanded by 261bps mainly on merger of Professional Oral Care (POC) and CC healthcare (CC). Excluding this, gross margins were flat. EBITDA margins improved marginally (+78bps) on higher staff (+196bps) and other expenses (+242bps). Higher depreciation and taxes translated into 12% PAT growth.

We estimate net sales to grow 15-16% over the next two years largely on volume growth. We expect toothpaste volume to grow ~13.-14% over the next two years on higher penetration in the rural market. EBITDA margins would be 24–25% going forward. We raise our TP to Rs916 from Rs872 and maintain BUY rating.

Toothpaste volume pressure persist The Toothpaste category faces continuous volume pressure and it recorded 12% volume growth during Q2FY11 versus 14% in Q1FY11 and 18% in Q2FY10. However, Colgate’s volume market share increased a mere 130bps to 53.3%, indicating the slower growth of the overall industry.

Mergers led to strong gross margins, EBITDA to be 24-25% in FY11e and FY12e Merger of CC and POC resulted in ~3-4% improvement in gross margins. Earlier these companies were suppliers to Colgate. We expect 24-25% EBITDA margin over FY11e and FY12e as higher SG&A would offset the benefit of gross margin increases.

VALUATIONS AND RECOMMENDATION We believe growth will sustain on the back of rural focus, regular product launches, and continuous dental awareness programs. We peg our target multiple of 23x on our FY12e earnings to arrive at TP of Rs916. Average dividend yield of ~2.5% will further improve the upside. We maintain our BUY recommendation.