Statutory Warning: This report may cause a reaction, and acting on it can be injurious to your wealth.
Note: This StockTalk analysis has been written by Abhishek Jain.
Godrej Consumer Products Limited (GCPL) promoted by Godrej group is a household and personal care products company. Godrej group owns around 64% of equity and the company is professionally managed. Through international acquisitions, the company has built a sizeable international presence in Africa, Latin America, Indonesia and the UK. Its overseas businesses now account for 40% of revenues.
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Over the past decade, GCPL has evolved from a domestic market soap manufacturer to a diversified emerging market MNC. The proportion of soaps in GCPL’s consolidated revenues has reduced to ~20% in FY13 from 63% in FY05.
One of the important reasons for the transition was company’s acquisition of Sara Lee’s home insecticides portfolio and a series of international acquisitions since 2005 across Africa, Latin America, Indonesia and the UK.
Sara Lee: After the company acquired Sara Lee’s 51% stake in their JV in May 2010 (renamed as Godrej Household Products – GHPL), the access to increased distribution network and the home insecticides (29% of FY12 consolidated revenues) portfolio of GHPL helped GCPL further diversify the distribution of their domestic business. GHPL was subsequently merged into GCPL in FY11.
International acquisitions: GCPL’s international ambitions took off in 2005 with an acquisition in the UK (Keyline brands), followed by four acquisitions across emerging markets (Africa, Latin America and Indonesia) in 2010.
Distribution: Godrej’s distribution network spans across more than 5 million outlets in FY13. It added more than 0.6 million outlets in FY12. The company is planning to use the Darling Group’s distribution network in Africa to launch home insecticides in Nigeria.
Buying Commodities and Selling Brands
GCPL is the type of Business which Warren Buffett once described as one that “buys commodities and sells brands.”
Such a type of business typically has good brands, pricing power, and is not capital intensive. It also has a moat in the form of brands that. In India, GCPL has brands like Cinthol, Good Knight, and Hit etc. It is common in our day to day life to hear Good Knight as a mosquito repellent. It been there for a long time and I still have reason to believe it will be there for years to come. Also the ‘Godrej’ brand is an advantage.
Peter Lynch said, “Go for a business that any idiot can run, because sooner or later any idiot probably is going to run it.”
One of the most important tenets of successful investing is that the investor should understand the business that he or she is trying to invest in. One of the most important reasons of knowing whether the business is easy to understand is the ability to look into the future and have a reasonable outlook about future earnings of the business.
GCPL does not make any hi-tech products nor does it depend on constant technological advancements for revenue growth. Its business is simple and enduring in nature. Making soaps, hair dyes or domestic insecticides is no rocket science. People won’t stop consuming them although they may change the brand or the company.
Clean balance sheet
Companies like GCPL have lower operating leverage and therefore have a reasonable or small amount of debt on their books. Even after all the acquisitions, the total debt to equity ratio of GCPL has hovered around 0.5 times. The total debt to market cap stands at a comfortable 10%. The business generates enough cash to meets its debt obligations. In case the company does not go for future acquisitions, it will deleverage very fast given the cash generating nature of the business.
One of the hallmarks of great franchises is the ability to raise prices without losing volume sales. GCPL is one such business. One of the metric I have used here is Gross Profit Margin. GCPL has enjoyed consistently high gross profit margin, which indicates the presence of pricing power.
Let’s look at GCPL’s ROE for a period from 2002 to 2013. One can see a sharp deterioration in ROE 2005 onward when the company started growing inorganically through the acquisition route. The fall in ROE is mainly driven by lower asset turnover and leverage.
GCPL’s domestic business is doing very well and enjoys negative working capital. It has, over the years, transformed itself from being an emerging market company to an MNC. It is positioned to ride the rising income and discretionary spending levels in its markets. The fall in asset turnover ratio is because of the acquisition done by it and it is yet to integrate the operations completely and streamline them. Going forward, I see the asset turnover improving.
The management is expected to continue with its inorganic growth. The company is also expected to generate enough cash flows to service its debt, and fund expansion – both organic and inorganic.
I have not heard anything adverse about GCPL’s management or the promoter group. Also the company is professionally managed. It has retained most of the local management in the companies which it has acquired. The management has a good track record of creating wealth for the shareholders.
Good track record
GCPL has an excellent track record of financial performance and creating wealth for shareholders…
- Revenue has grown at an average annual rate of 30% during 2003 to 2013.
- Net profit has grown at a rate of 32% during this period.
- The stock has multiplied by around 8x in last 5 years.
I have used a two stage DCF valuation for the company to arrive at its fair value. I have assumed 3 scenarios – bull case, bear case, and base case. I have listed the assumptions and the values of the shares in the table on the right. Assumptions used include average cost of capital of 11.7% and debt to total capital ratio of 10%.
The stock is trading at a price to earnings multiple of 38 times its FY13 earnings. I think using DCF is a necessary evil. The value of any business is the present value of all the cash flows the business can generate but to calculate the future cash flows require a lot of assumptions which are very subjective and are prone to error.
The market is currently very bullish on consumer staples and the valuations look expensive. The probability of GCPL continuing its business performance is fairly high. It is poised for good growth. But at the valuations the stock is selling at currently, there is no margin of safety. However, it all boils down to how strong do we perceive the value of the franchise and ability of the company to continue growing at a healthy pace in the markets it has entered.
Prof. Sanjay Bakshi recently, in an article in Outlook Business, made case for paying up for quality franchise. In case of GCPL, I personally believe that growth is expected to remain high in the future.
GCPL is an excellent franchise but at this price it does not look like a very attractive stock though. I would personally like to buy if valuations become cheaper in future.
Disclaimer: I, Abhishek Jain, have no position in the company or in any company related to the promoter group. Readers are advised to do their own independent assessment before taking any decision. You can expect some errors or forward looking statements, so do your own research as well.
Thank you for the informative analysis.
The current price is obviously leaving little margin of safety vis-a-vis your analysis and is at the bull case scenario.
While I would agree one should wait for a better price I just wonder that you could be waiting for a long time, so am not so sure.
Maybe if one is reasonably convinced with the story it may be worth accumulating gradually.
Good analysis, I find the low ROE and the company’s debt to be a real turn off.
Also, I have to disagree about how the company is easy to understand. It may be easy to understand in the sense that it makes and sells consumer goods, but it faces very very stiff competition from a lot of (attractive) companies (like any other FMCG giant). Also, more importantly, its performance is based on management’s ability to make new products and buy new companies that add to the company, and I think is no easy feat given the nature of industry.
Shamil Abdul Kader says
Thanks for the analysis. I do not see a high brand recall with respect to Godrej brands – other than Cinthol, Good Night and Hit. I am more comfortable to invest in HUL or Nestle at good valuations because of the brand recall across segments.
Any idea how the pest control division of Godrej is doing? The margins must be good as it seems to be a low cost business.
Good analysis Abhishek.. While the numbers look good, I cant think of any strong moat in GCPL. To add to that, a trailing PE of 41
Soaps: HUL dominates. And moreover this is a highly penetrated segment.
Hair color: Its a no match to L’oriel. I see L’oriel’s Garnier all over.
Insecticide: Agree, Goodnight has very good brand recall. This is the only product I liked in GCPL. But here also its a not monopoly. Rickitt is strong and there is one more player.
(Disclaimer: I was holding GCPL before. But I thought on the above lines and sold off. Stock has moved up 47% since then (- )
Duliip T Mehta says
Godrej Consumer Products Ltd. – as you mentioned that at current rate ( Rs 900 – 950 ), its nor attractive for investment, so would like to know at what price band you believe that it will be good idea to invest ?
Hi Abhishek…… I think presently since all the money is chasing FMCG, Pharma and IT ….these companies are over valued. The Nifty is basically holding up because of these stocks plus Reliance. Otherwise, we would be in depression zone. Today, we saw what happened to L&T. A slight negative news is enough to throw even a well run company over the cliff. I have been watching FMCG companies like ITC and Godrej Consumer for a long time, waiting for one of the two to decline in price, so that I can buy it at a lower valuation. But that has never happened. Rest of the market is going down, while for FMCG, Pharma and IT – it is a bull market.
Abhishek Jain says
Thanks for your feedback.
I have just looked at this company very recently. I wish I had done it long back and accumulated.While looking at the company I did go through the past about their financial performance.Good FMCG stocks has normally enjoyed rich valuation in India due to the favourable business dynamics.More than the valuation what is preventing me from buying into it is the overall market outlook for FMCG sector. Its the flavor of the season. There was a time during the investment cycle when Infrastructure and capital goods were the fad and now they are not. Mr.Market has its own moods and fancies. Always buy when the market is fearful. I would definitely wait for FMCG sector to fall out of favor.There is a very good possibility of getting better valuations.
I strongly believe that this company has strong growth going forward. Moreover the future growth will come from its performance in other emerging markets as well as India. GCPL’s strategy of acquiring Market leaders in their specific segments and retaining the local management.
Abhishek Jain says
GCPL has positioned Cinthol in a slightly premium segment while the other soaps from GCPL enjoy good recall in the low end segment of the market. GCPL has increased its market share in Soaps segment and holds around 10% market share. From predominately soap maker the company has transformed itself into a emerging market consumer staples business with Hair colour and domestic insecticides business driving growth and increasing their share in the revenue. Revenue contribution of soaps have come down from 63% in FY 05 to 21% in FY 12. It is expected to Similarly in the home insecticides business it is the market leader and has a strong brand recall in form of Hit and Good Knight. Even in hair color segment it has very good brand recall. Though on the high end segment of Hair Color business it faces very tough from L’oreal and others. However the company gets around 40% of its revenues from Indonesia,Africa,Latin America and UK. It has acquired the leading brands in these segment and growth in other emerging markets is bound to be higher the company. the company has a startegy of acquiring good brands.Company’s domestic business enjoys negative working capital and such business do not require much capital to grow. I don’t have a break up for insecticides business margin but the business as a whole enjoys very healthy margin. Overall as the firm integrates its newly acquired business we will return ratios improving.
HUL and Nestle too are excellent business. Nestle is in a expansion mode and has raised money through ECB from the Parent. The company enjoys excellent business dynmanics and because of the way it is financing its capex will see higher ROE for its investor as it is utilising the debt capacity of the business.Nestle and HUL are India centric consumer play whereas GCPL is not entirely a India centric consumer play. Nestle and GCPL are not in direct competition whereas GCPL competes with HUL. But my personal pick is Nestle and GCPL. Though i will still wait for valuations to be more favourable.:)
Shamil Abdul Kader says
Thank you very much for the detailed answer. It makes more sense now.
On a lighter note – I notice an increase in hair graying of youngsters (20 to 30 age group), especially in software industry. 🙂 This might help the growth of Hair colour division of Godrej.
Abhishek Jain says
Haha..It might hold the same for many other professions as well 🙂
Abhishek Jain says
I strongly agree with you. Top Tier FMCG companies have always enjoyed premium valuations but it is not the time because the sector is supposedly hot. Let the focus shift somewhere else and the sector to be boring again. Wait will surely be worth it 🙂
Abhishek, While I completely agree with you, I think it will be a difficult wait waiting for these stocks to come down to a more agreeable valuation…..would require a lot of patience. And the question that what if they never come down, and only increase will always nag from within.
Abhishek Jain says
Raghav lets take a scenario where there is not much P/E expansion or contraction and the profit continue to grow at 25-30% p.a. for a decade we will see super returns.From 2002 in almost a decade the stock has given 15 x return. The company has expanded its portfolio from soaps to soaps,domestic insecticides and hair colour. From 2005 the company is in the process of transforming itself into a emerging market MNC. Till now its acquisition strategy is working fine and if the company is poised for good growth. If the company can replicate the success in other emerging markets we have a multi-bagger. I personally believe one can go ahead and buy at high multiples and still make decent money or good money. But right now the market is very gung ho on fmcg space..Let the investment cycle pick up.I don’t see the stock selling at very low multiples but i would not buy when the market is so gung ho about the space. In the meanwhile one can always go around and look for good franchise at reasonable prices,in the present markets there are quite a few.
Correct. L&T for instance is selling at a ridiculously low valuation, so are many private banks……there are many such opportunities…..
I think FMCG won’t do to well when there’s an actual bull market, the reason FMCG especially is doing well currently is because we’re paying high premiums for the certainty we buy with them vis a vis other sectors today.
Having said that I just can’t get myself to buy any consumer staples (from a person, whose biggest position for the last 10 years has been ITC) at these valuations. In fact the only one which I may look at is Bajaj Corp, though I’m not entirely convinced about the long term growth of the stock. What do you think would be the most fairly valued FMCG brand? Or maybe its time to look at cyclicals already?
dr manohar s. dhumale says
Hi. GCPL turnover increased by over three times in last three years; Rs.6391 crore in FY2013 as against Rs.2041 crore in Fy2010. FMCG sector is likely to grow by 12-17% tlii 2020. this means tremendous oppurnity for FMCG players. as per valuations concerned, i think it will depend upon the type of investor and risk taken. but FMCG stocks are on firm footing to make it big in future. no doubt in my mind. thanks.
Thanks for the objective analysis on one of my favorite companies though i don’t hold any stock.
Would you help me guide to sources to get info like retention of local talent post acquisition etc. This will help me research other stocks i follow in the same manner.
Abhishek Jain says
Other than annual report I think Info can be found from call transcripts,investor presentation, articles in newspapers,magazines and also interviews given by the management. I used all of these.
Nice coverage of GCPL.
on the contrarian style…..metals come to my mind…and particularly…tata steel…
its at rock bottom…and i know its due to debt of corus steel……
it available at almost near to its book value….
i haven’t done exhaustive analysis as yet..but am going thru its ARs…..and one thing is sure….promoeter are quite good and credible..in india and international as well….
and company has already started its work on this over debt issue.
Abhishek Jain says
Thanks for your feedback but I don’t know much about Tata Steel and I personally averse to investing in commodity and metal business because I believe it’s difficult to predict the price of a particular commodity and the prospects of the company. There are a lot of unknowns and would rather give it a miss 🙂