The Hindu Business Line : Godrej Consumer Products: Buy on declines

RESURGENT demand and softening input prices have helped Godrej Consumer Products report strong sales and profit numbers for the June 2005-06 quarter. Reviving growth in categories such as hair colour and market share gains for the company in recent quarters, suggest that the current rates of growth are sustainable. Profit margins are also likely to be aided by benign input prices in the near term.

But the growth prospects of the next couple of years appear priced into the stock. The stock has climbed sharply on the back of speculative reports that Godrej is in the process of sewing up an acquisition in the FMCG space. It now trades at a price-earnings multiple of 26 times its trailing earnings. The company has denied any takeover plans. If nothing materialises, the stock is likely to cool off. Investors can use a 10-15 per cent decline in price to build exposures to the stock.

Broad-based growth

Godrej Consumer has reported robust sales growth of 23 per cent for the June quarter. The good news is that the growth is broad-based and comes from across the three major categories where the company is present.

The company has managed a 20 per cent growth in the soaps business, 22 per cent in hair colour and 39 per cent in other personal products. This is in contrast to the preceding quarters, when strong growth in one segment was often offset by weak trends in another.

In the hair colour market, Godrej appears to have benefited from improving growth momentum for the category as a whole. The sales growth has picked up from 16 per cent for 2004-05 to 22 per cent in the first quarter of this fiscal. Growth in this segment has been driven by higher offtake and a price increase on trial packs. As a high-margin category with potential for high double-digit growth, any headway that Godrej makes in the hair colour market will expand its profit margins substantially.

With Godrej No.1 — the mid-priced soap brand — gaining market share, the company has also carved out a larger chunk of the sluggish soaps market. In addition, June quarter numbers suggest that the company's initiatives in segments such as shaving creams and talcs are also finally beginning to pay off in the form of better growth rates.

Input prices help profit growth

The growth in operating profits for the quarter outpaced sales growth, at 48 per cent. Several factors appear to have bolstered profit margins. Prices of soap inputs such as palm oil have softened significantly in recent months, yielding cost savings for companies such as Godrej Consumer.

The company has also shifted a significant part of its soap production to a new tax-exempt unit at Baddi, which has substantially lowered excise and sales tax outgo, bolstering operating margins.

Going forward, the outlook for input prices is benign as a higher-than-expected Malaysian output is pressuring the prices of palm oil derivatives. The impact of the tax savings from the Baddi unit are of a one-time nature and will not have a significant impact on growth rates, in the coming quarters.

Tax savings and soft input prices have helped Godrej ramp up its outlays on advertising and promotion in the recent months, with adspend rising by 22 per cent in the June quarter. This has helped Godrej support launches such as those of Cinthol Deo Sport, Deluxe Shaving Cream. It has also unveiled fashion colours in sachet packs, new variants of its hair dye and a reformulated version of Coloursoft, a premium hair colour.

Key risks

The company's valuation is presently on a par with that of leading consumer goods companies such as Colgate Palmolive India and Dabur India. The valuation demands a 20 per cent-plus growth rate over the next few years. Whether the company can deliver these will depend mainly on two factors. One, with a much narrower product portfolio than companies such as Dabur or Marico, Godrej Consumer will lean heavily on just its soaps and hair colour business for growth. Both are witnessing intensifying competitive activity with several new entrants.

Second, it will also have to build breadth within each category to widen its portfolio of brands at various price points. The company seems reasonably equipped to do this, with expanding profit margins and healthy operational cash flows. However, investors will have to watch out for slowing growth rates or setbacks in market share, as these will be the key triggers to exit the stock.

The company is quite shareholder friendly in its distribution policy. It has consistently paid out about 90 per cent of its earnings as dividends each year and has been steadily reducing its equity base through buyback programmes. If profit growth remains on track, it is likely to provide a firm underpinning to the stock price as well.

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