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Godrej Consumer Products’ acquisitions will add to its bottomline, further improving its valuations…

Godrej Consumer Products Ltd. (GCPL) is the flagship company of the Godrej group. It is one of India’s leading fast moving consumer goods (FMCG) companies. Its major brands include Goodknight, Cinthol, Godrej No. 1, Expert, Nupur, Hit, Jet, Fairglow, Ezee, Protekt and Snuggy.

Diversified product line
Traditionally, the toilet soap segment has been the highest revenue generator for GCPL, but over the past one year there has been a shift towards the insecticide and hair colour segment. Presently, GCPL derives around 12 per cent of its revenue from the hair colour segment, around 32 per cent comes from the personal wash (soaps) segment, while the home care (household insecticide) segment generates 43 per cent. Its manufacturing facilities are located at Malanpur (Madhya Pradesh), Thana (Himachal Pradesh), Katha (Himachal Pradesh), Guwahati and Sikkim.

Strengths
Market leader. With various innovations — dual dispenser, low-smoke coils, jumbo coil — and its first-mover advantage, GCPL has emerged as the market leader in different categories of household insecticides. This is despite its 3-5 per cent premium pricing compared to its peers. The company became a market leader in vaporisers primarily on account of its innovative dual dispensers. It gained market share mainly at the expense of All Out, which dominated the market three years ago.
GHPL drives growth. Recently Godrej Household Products Ltd. (GHPL) (formerly known as Godrej Sara Lee, a joint venture between Godrej and Sara Lee) merged with GCPL and became its 100 per cent subsidiary. GHPL primarily markets insecticides, including mosquito repellent Good Knight, Hit, Ambi Pur and shoe polish Kiwi in India. However, Sara Lee recently terminated GHPL’s licence for Kiwi (shoe care) and Kiwi Kleen brands in India and Sri Lanka. This merger has helped create a lot of synergies both in terms of cost and operational efficiencies. GHPL’s strong presence in southern India complements GCPL’s strong presence in northern India, giving the latter a balanced presence. According to an Angel Broking report, there exist significant synergistic benefits in terms of distribution and supply-chain networks in the integration of GHPL, which are likely to be reflected in the company’s FY12 results.
Aggressive acquisitions. GCPL’s decision to aggressively expand its operations abroad has resulted in several acquisitions in the past few years. In FY06, it acquired the Keyline brand in UK, which included Cuticura and Erasmic. In FY07, it took over Rapidol, a South African company with presence across 10 countries in Africa. Recently it acquired Kinky, one of the leaders in the South African hair business. Kinky offers a variety of products: hair braids, hair pieces, wigs and wefted pieces. Tura and Megasari are other recent acquisitions that are expected to boost its presence in Africa and Indonesia respectively. Its recent acquisition of a 51 per cent stake in the Darling Group Holding (DGH), leader in hair extension in Africa, is expected to further strengthen its position in Africa.

Opportunities
Innovative paper coil. The company introduced an innovative paper coil, HIT Magic Paper (alternative to coils) in Indonesia, which was not available in that market earlier. This is a smokeless high-margin product endowed with fragrance and is priced lower than coils. According to a recent report by Edelweiss Securities, the format got a good response and achieved 8 per cent penetration within three months of launch. These paper coils are expected to be launched in India within a year. The lag is due to regulatory approvals. The company plans to launch this format in African markets as well. Opportunities in Africa. GCPL intends to be present mainly in two categories — hair care and household insecticides. The African hair extension market is US $1.2 billion in size. It has been growing at the rate of 20 per cent annually and has been reporting a robust margin of 20 per cent, according to an Edelweiss report. Low per capita consumption and low penetration of hair extension in Africa point to growth and margin profiles that are similar to that of the India business.
DGH acquisition. After the end of phase-1 in the acquisition of Darling Group Holding (DGH) by the end of FY12, GCPL will be present in South Africa, Nigeria and Mozambique. DGH is the leader in most of the product lines it is present in. GCPL, through its marketing and brand building expertise, is looking to further enhance this high-growth business. It plans to achieve synergies by integrating Kinky and DGH. DGH will handle the manufacturing for Kinky. Currently the latter imports its products. If DGH begins to manufacture for it, its margins are likely to improve.
The management has constantly reiterated that all its recent international acquisitions have added to GCPL’s earnings per share (EPS). Over FY2011-13, analysts at Angel Broking expect GCPL to post an 18 per cent compounded annual growth rate (CAGR) in earnings, driven largely by the consolidation of its recent acquisitions.

Concerns
Pressure on margins. GCPL launched quite a few products and campaigns in India, Asia Pacific and Latin America in Q1FY12. Being spread across geographies, the company needs to maintain a certain level of ad spend, and also launch new products. This has led to increased expenses on promotion and advertising. Over the years, advertising and sales promotion as a percentage of net sales has stood in the range of 10-12 per cent, except for FY09 when it stood at 8.5 per cent. Analysts at Elara Capital believe ad spends are likely to hover at around 11.5 per cent for Q2-Q3FY12. The sharp rise in crude prices and increased packaging costs are expected to hit the company’s margins. Aggressive price war. GCPL’s ability to gain market share in the soap segment could be adversely affected if Hindustan Unilever gets its pricing right, especially for its low-end soap brand, Breeze. Intensifying competition could result in an aggressive price war, denting GCPL’s margins.
Peer pressure. The entry of players such as L’oreal and Schwarzkopf has put pressure on GCPL’s hair colour business. The company has been losing market share at the top end of the market. The entry of more foreign players in future could aggravate the situation further.
Integration woes. Some of the recent international acquisitions are still at the integration stage. GCPL needs to successfully integrate these businesses to prove its execution capabilities. Moreover, the rising contribution of acquisitions is expected to increase the volatility in its margins in future.

Financials
GCPL has registered a healthy five-year CAGR of 39.1 per cent in total income and 31.8 per cent in profit after tax. The company made huge capital investments in FY11 wherein its capital employed jumped 276.2 per cent compared to FY10. Its cash and bank balance has grown at a five-year CAGR of 53.8 per cent and stood at Rs 226.9 crore at the end of FY11. However, the company has a negative free cash flow of (-) Rs 1,510.38 crore, which signals that GCPL has been unable to generate cash after meeting all its obligations.
It has delivered a healthy five-year average of 50.98 per cent and 76.07 per cent on return on capital employed (RoCE) and return on net worth (RoNW) respectively. However, they have fallen drastically by around 52 percentage points and 108 percentage points over this five-year period. Over the past one year, both operating and net profit margins have diminished by around 3 percentage points. Its debt-to-equity ratio stood at 1.16 times at the end of FY11.
On the brighter side, the company has been a regular and healthy dividend payer over the years. It paid 30.2 per cent of its earnings to shareholders in FY11.

Valuation
The stock is currently trading (as on October 10, 2011) at a price-to-earnings (P/E) ratio of 19.79. This amounts to a discount of 14.5 per cent compared to its five-year median P/E of 23.14.
The earnings per share (EPS) of the company has grown at a five-year CAGR of 18.60 per cent. The company has a price-to-earnings to growth (PEG) ratio of 1.06.
As the company’s acquisitions add to its bottomline, its valuations are likely to improve in future. Buy on dips.