The company may find it hard to match expectations built into current valuations.

The stock of GSK Consumer Healthcare has captured particular fancy since the promoters announced an intention to raise their stakes in the company. The open offer, which will see the promoters mopping up 38 per cent of the public shareholding, will take their holding up to 75 per cent, the maximum limit stipulated by the SEBI.

The open offer is at Rs 3,900 per share. While this is higher than the current market price of Rs 3,789 only by a whisker, the stock has advanced 26 per cent from the initial announcement in November last year.

Open offer

Investors can thus sell their shares at the current market prices or tender them in the open offer. Note, however, that the acceptance ratio (ratio between the stocks on offer and those held publicly) suggests that investors are likely to be able to sell only about 56 shares for every 100 they hold, and not their entire holding.

The gains from sale through open offer will be subject to short-term or long-term capital gains tax, as applicable, unlike a sale through the open market. The open offer is on till January 30.

At the current market price, valuations are at 38 times the trailing 12-month earnings. The offer price pegs the trailing PE multiple at 39 times. These valuations are at a premium to Hindustan Unilever and on a par with the more-diversified Godrej Consumer and Dabur India. Valuations are also towards the higher end of GSK Consumer’s five-year PE band.

Yes, the company has a strong advantage of holding 70 per cent of the malted food drinks market, giving it pricing power. It has been gradually inching into rural territory and improving penetration in the north and western markets.

But the company may find it hard to match expectations built into current valuations on a few counts.

One, volume growth has been decelerating over the past few quarters. Two, diversification into noodles and biscuits from the malted drinks segment is yet to make headway, leaving the company focussed on a single market segment. Three, benign trends in raw material cost may not last with prices of wheat and sugar inching up.

Spluttering volumes

Horlicks and Boost are GSK Consumer’s mainstays. Volume growth in Horlicks, though, has dwindled over the past few quarters into single-digits. Volume in the September 2012 quarter came in at 4.5 per cent, a good way below the double-digit growth in the September 2011 quarter. June 2012 volume growth was just 7 per cent.

Boost has posted erratic volume growth — the September 2012 quarter, for instance, saw an 8.5 per cent volume expansion, while the two preceding quarters grew 11 and 2 per cent in volume terms. 2011 was also a poor year for Boost.

Even accounting for the drying up of sales to the Indian Armed Forces, volume growth has dipped. Sales growth had already been on a steady slide from the September 2011 to June 2012 quarter. Some recovery was seen in the September 2012 quarter, with sales up 15 per cent compared to the year-ago period. Prices of some inputs rising now may necessitate more price hikes, and the strain could cause consumers to cut clamp their wallets shut.

Product concentration

GSK Consumer, while being the market leader in malted food drinks, tried to diversify product base into instant noodles and biscuits on the health platform. Its noodles brand Foodles has not gained a large share and is battling stiff competition from ITC’s Sunfeast, besides the immense clout of Nestle’s Maggi. The biscuits market too is fraught with competition, besides offering low margins. The premium health biscuits segment is seeing the likes of Britannia and United Biscuits entering the fray.

The two segments, despite several quarters lapsing since their launch, contribute just below 7 per cent of revenues. So while recent launches such as Nutribic appear to be doing well, GSK Consumer’s fortunes remain tied to the malted food drinks market. FMCG peers are more diversified, and thus offer more scope for growth.

Market expansion

GSK Consumer has a stronger presence in the southern and eastern markets than the northern and western. It is moving towards improving penetration in these markets.

Besides this, the company is breaking into the rural markets through lower-priced sachets of small quantities, such as Rs 5 and Rs 10. About 27 per cent of the revenues in the September 2012 quarter came from the rural market. With the immense potential in the rural markets yet untapped, this contribution could increase.

But still, these initiatives could take a toll with small packs typically depressing margins. Advertising and promotion costs will also have to be sustained at higher levels. At 15 per cent as a proportion to sales, adspend is already among the highest in the FMCG basket. GSK Consumer is planning to move into super-premium food drinks which can boost margins. But this will take time to pay off and make a significant contribution.

Operating margins improved slightly to 23 per cent for the six months to September 2012, on the back of rationalisation in employee expenses.

Input costs, as a proportion of sales, held steady at 39 per cent, but could see an uptick — prices of wheat are up 4 per cent in the December 2012 quarter, barley is pricier by 6 per cent and milk is steadily creeping up (according to WPI data).

Lower depreciation helped net profits grow 24 per cent in the half year to September 2012 on a 13 per cent net sales expansion. Net profit margins stood at 14 per cent.

(This article was published on January 19, 2013)
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