New Trade $CL – Dental Appointment

by Enis February 24, 2014 12:58 pm • Commentary

Colgate-Palmolive is a consumer staples company that lives up to that description.  Colgate has grown sales for the past 10 years (flat in 2009) at a rate of 0-15% in each year.  Earnings have grown at a similar pace in that period, as gradual growth of toothpaste, shampoo, and soap has continued.

CL management gave an investor presentation on Friday that laid out more of the same in the coming year. Gradual growth in sales along with targeted cost cuts (as part of the company’s 4 year “Growth and Efficiency” Program)  to maintain earnings growth in the 5-15% range over the next few years.

In other words, Colgate is a relatively simple business proposition – high-end, recognizable, consumer staples products sold around the world.  The brand differentiation is how Colgate butters its bread, as consumers pay a premium for the name brand.    

There is little on the horizon that concerns me about Colgate the company.  But Colgate the stock is quite concerning for both fundamental and technical reasons.  First, on valuation, CL is near its 10 year high on a trailing 12 month P/E multiple basis:

[caption id="attachment_36717" align="alignnone" width="504"]CL trailing 12 month P/E, Courtesy of Bloomberg CL trailing 12 month P/E, Courtesy of Bloomberg[/caption]

The last time the P/E was near the mid-20’s, the company was less than half its current size in market cap terms, and future growth prospects were higher as a result. At a 23x P/E multiple, with only 8% expected earnings growth over the next few years, CL looks quite expensive vs. its own valuation history and vs. the rest of the market.

Perhaps that is why the stock has gotten off to a weak start in 2014, after closing near an all-time high in 2013.  CL stock has bounced back much less heartily in February compared to the broader market.  The stock cleanly breached its 200 day moving average for the first time since early 2011, and still sits below its declining 50 day moving average, even after the recent bounce:

[caption id="attachment_36718" align="alignnone" width="600"]CL daily, 50 day ma in pink, 200 day ma in yellow, Courtesy of Bloomberg CL daily, 50 day ma in pink, 200 day ma in yellow, Courtesy of Bloomberg[/caption]

CL looks like it has finally broken its uptrend, and is likely to target the $56-$58 support area if it cannot hold the 200 day ma over the next month.

Finally, implied volatility in CL is in the low teens, near its 1 year lows:

[caption id="attachment_36720" align="alignnone" width="600"]CL 30 day implied volatility, Courtesy of Bloomberg CL 30 day implied volatility, Courtesy of Bloomberg[/caption]

Options premium is quite cheap as a result.

Here’s the trade, playing for a move down to the $56-$58 support area over the next 2 months:

Trade: CL ($62.40) Bought April 62.50 Put for 1.45

Break-Even on April Expiration:

Profits: below 61.05

Losses: above 61.05 with total loss above 62.50

Trade Rationale:

Fundamentally and technically, risk/reward in CL is skewed to the downside in our view.  Add to that the cheap implied volatility, and we like the trade structure to play for a move to more important long-term support.