The Hindu Business Line : Godrej Consumer Products

Godrej Consumer Products is making a 1:7 rights offer at Rs 123 per share to raise Rs 396 crore. Shareholders may subscribe to the offer as it is being made at a reasonable valuation in relation to peers in the FMCG space. The price of Rs 123 (current market price: Rs 126) values the company at about 14 times expected earnings for FY-09, which is at a significant discount to FMCG companies such as Colgate Palmolive (19 times) and Hindustan Unilever (25 times). The stock may, however, only suit investors with moderate return expectations of 15-20 per cent from the offer price. It may be best to book profit on these target returns being reached.

Of the offer proceeds, Rs 125 crore is to be used to fund the acquisition of the Kinky group — a hair products company in South Africa; Rs 113 crore towards facilities for making soap and chemicals at Baddi and the balance towards repayment of debt and investments in a Netherlands-based joint venture and one for hygiene products. While the other ventures will contribute to earnings from the current year, the soap/chemicals facility is expected to be fully operational by 2010. The offer will cause a 14.6 per cent expansion in the equity base.

Business

Godrej Consumer has witnessed a slowdown in its pace of sales and earnings growth in the current fiscal (18 and 15 per cent respectively for nine months) after growing well above the industry average over the past three years, at 25 per cent in sales and 30 per cent in profits. A focus on mass market brands in soaps and loss of market share in the hair colour business have trimmed Godrej’s recent growth.

In the nine months ended December 2007, though Godrej managed above-category growth in the toilet soaps segment (24 per cent) profitability was under pressure due to the sharp upward spiral in vegetable oil prices.

Though FMCG categories such as soaps have witnessed accelerated growth in recent quarters, consumers for mass brands remain price-sensitive, making it difficult to put through price increases. On the other hand, the company’s hair colour business, a key contributor to profits, has faced intense competition (L’Oreal, Garnier) and consumers moving to premium brands. The company has witnessed erosion in hair colour market shares from about 38 per cent to 34.9 per cent over the last one year.

New initiatives

The company, on its part, is attempting to address these problems through selective price hikes, brand extensions and a foray into new categories. In the soaps business, Godrej implemented a 6 per cent price hike and introduced low unit packs on select brands in the December quarter. The relaunch of brands such as Cinthol and Evita to bolster the premium soap portfolio are also on the anvil. In the hair colour business, Godrej has expanded its premium portfolio through its Renew brand and added low unit packs to encourage trial by new consumers.

Despite these initiatives, the company’s earnings prospects over the medium term will hinge largely on how its recent organic and inorganic growth initiatives pan out. Godrej’s acquisitions over the past couple of years (Keyline Brands in end 2005, Rapidol in 2006, Godrej Global Middle East in 2007) are yet to make a substantial contribution to revenues and profits.

Strong base

However, these buys, taken with the recent acquisition of the Kinky group, have helped the company acquire a strong manufacturing and distribution base in the African and West Asian region. Godrej can leverage these to expand its home-grown brands into these markets, sidestepping competition from the MNCs present in the Indian personal and hair care markets. Other FMCG players such as Marico and Dabur have managed strong growth rates in their international portfolios through precisely such a strategy.

Godrej’s foray into baby diapers and hygiene products also holds potential, as these are under-penetrated markets with just one or two dominant brands.

Plans to shift a larger proportion of soap and chemical manufacturing facilities to Baddi will further reduce tax and excise duty incidence, while repayment of debt may result in interest cost savings. These moves may give Godrej a larger surplus to plough back into brand-building efforts over the next couple of years, which could pay off.

Overall, Godrej Consumer does appear to carry a higher degree of uncertainty associated with its earnings, compared to peers such as Colgate or Nestle India at this juncture. However, the company appears well-placed to deliver a 14-15 per cent growth, required by the modest asking price for this offer.

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