Godrej Consumer Products

Investors can consider buying the stock of Godrej Consumer Products, now trading at Rs 127. The stock has not participated in any of the recent run-ups in the FMCG sector, due to a string of earnings disappointments from the company over the past three quarters.

But as lower input costs and slower consumer offtake look set to turn the tables on its competitors, Godrej Consumer, with its focus on mass-market brands and strong rural presence, may record stronger growth.

Though the stock (at 20 times trailing earnings) appears pricey on a historic basis, it appears reasonably valued on forward earnings, at about 15 times FY-10 earnings. That is at a substantial discount to rivals such as Hindustan Unilever (24 times), Colgate Palmolive India (20 times) and Dabur India (18 times).

On a consolidated basis (including overseas subsidiaries), Godrej Consumer’s net sales expanded by a whopping 26.4 per cent in the first nine months of 2008-09, beating most FMCG peers. This was backed by a 21 per cent sales growth in soaps and a 10 per cent growth in hair colour.

But net profits straggled behind edging up by just 1.4 per cent. Rising costs of raw materials such as palm oil derivatives (inputs to soaps) and petroleum derivatives (inputs to the overseas hair care business) sharply reduced operating profit margins to 14 per cent (19 per cent last year) for the nine-months ended December 2008.

A narrow product portfolio (soaps and hair colour contribute 81 per cent of sales), a focus on value-for-money brands and a decision to refrain from price increases after the September quarter, all contributed to the poor profit growth for Godrej Consumer, compared to competitors.
Margin expansion likely

But the company’s fortunes appear set to reverse now, with a steep correction in palm oil prices and signs of downtrading in staple FMCGs in the recent December quarter.

Lower demand from the biofuel segment and expectations of worldwide recession have triggered a collapse in palm oil product prices over the past six months. Even after the commodity rally in January, palm oil prices now hover at less than half the levels seen at the March 2008 peak.

Godrej Consumer’s profit margins are more sensitive to input costs than most of its peers. Given its focus on high-TFM (total fatty matter) soaps, Godrej has a much higher raw material component in its cost structure than rivals. Two, as the company makes forward purchases of inputs, Godrej Consumer continued to grapple with margin pressures until December as it consumed its internal inventories.

With these stocks fully depleted last quarter, the company is well-placed to lock into inputs at much cheaper prices now. Godrej’s operating profit margins may see a strong recovery from the current quarter.
Downtrading may help

The company’s decision to hold back price increases on its soaps portfolio in recent months may now stand it in good stead amid the slowdown. The December quarter has already brought signs that consumers may be economising on FMCG staples such as soaps by switching to value-for-money brands.

Godrej managed a strong 19 per cent volume growth in its soap brands (Godrej No.1, Fairglow, Cinthol) while companies present in the mid- and high-priced segments saw soap volumes actually decline this quarter. Going forward, as price increases become more difficult to push through for its rivals, Godrej Consumer may be able to report better volumes, market share and thus higher topline growth.

The other key business — hair colour — has seen Godrej ceding market share to premium brands over the past two years (market share down from 35 to 32.4 per cent in one year). However, the company has taken remedial action over the past two quarters to aid growth — a price hike of about 11 per cent in the September quarter, which has helped increase retailer margins and launches such as Godrej Expert Hair Colour in powder form.

These initiatives have resulted in sales growth in the hair colour brands accelerating from a negative 6 per cent (lagging the category) in the September quarter to a healthy 14 per cent (matching the category) in December.

Godrej’s initiatives to expand rural market presence and its conservative pricing strategies will also help its brands deliver, even if urban discretionary spends slow down. While the limited portfolio does remain a concern, the company has made efforts to broadbase this with the launch of variants such as Godrej No.1 Strawberry and Walnut, Cinthol Deo and Expert Hair Colour in powder form. The acquisition of an overseas subsidiary has also given Godrej an entry point into high-margin hygiene market with the brand, Snuggy.
Overseas woes

One final area of concern surrounding Godrej’s earnings has been the weak performance of its overseas subsidiaries. Over the past three years, Godrej has added a substantial overseas presence through a string of acquisitions — Keyline Brands in the UK; Kinky, a hair products and accessories brand in South Africa, and Rapidol, a hair colour brand with a presence in the same geography.

While two of these businesses have delivered reasonable revenue growth, unexpected depreciation of the South African Rand against the rupee and interest costs on borrowings taken to acquire these brands have dented their contribution to Godrej’s consolidated numbers over the past three quarters.

While currency volatility will remain a risk, plans to retire debt taken for these acquisitions with the proceeds of its 2008 rights offer, offers room for optimism on the net profit front.