The stock of Godrej Consumer Products Ltd (GCPL) fell by as much as four per cent intra-day to close 1.7 per cent lower at Rs 708.45 after the company posted a decline in margins for the December quarter on Thursday. The margins fell on account of higher expenses, especially advertising costs even though GCPL witnessed relief (as expected) on the raw material front due to correction in palm oil prices. Growth in consolidated sales was close to Street estimates led by strong momentum in both domestic (household insecticides) and international (consolidation of Darling) markets. Though the macroeconomic environment remains challenging, the company continues to be very optimistic about continued strong sales growth momentum. However, the pressure on profitability is likely to remain as the company continues to focus on innovation and marketing efforts. This may keep the stock, which has rebounded to Rs 745 levels, under check.
High ad spends impact Q3 profits
Among the company’s three segments in the domestic market, the 28 per cent growth of the household insecticides business’ (part of home care segment) outperformed the category by 1.3 times and continued to gain and enjoy market leadership across the three formats. Thus, home care, which contributes 46 per cent to standalone sales, was the key driver of domestic revenues, which grew 20 per cent. Hair colour’s sales growth at 17 per cent was highest in three quarters but analysts estimate the company to have marginally missed on the volume growth expectation of eight-nine per cent. Though soaps’ revenue growth of 20 per cent was also strong, volume growth of two per cent was disappointing, compared with eight per cent by the category despite strong marketing campaigns for Cinthol and Godrej No 1 (rosewater and almonds variants). Gautam Duggad, analyst at Motilal Oswal Securities, had expected volume growth of six per cent in soaps.
International business’ growth at 34 per cent was also in line with expectations with strong performance in Indonesia, followed by Africa (good progress of Darling group companies’ integration) and Latin America. But the company has not been able to achieve similar improvement in profitability. Consolidated operating profit margin dropped 330 basis points to 16.8 per cent as advertising expenditure jumped 62 per cent (82 per cent for standalone operations) as the company continued its new product launches (Good Knight Advanced Colour play, Godrej Crème Hair colour), re-launches in India (Cinthol, Godrej No 1 , Renew, Colour Soft) and investments in marketing efforts abroad. Impact of ad spends on margins was 240 basis points, says the company in its press release. Also, Africa margins tanked 10.7 percentage points despite a seasonally strong quarter and other regions witnessed margin pressure.
Margins to remain capped
Adi Godrej, GCPL’s chairman and managing director, expects profit performance to improve on the back of stronger traction from launches and favourable input prices, but also added the company would continue to intensify focus on innovation. While continuance of aggressive promotional and marketing efforts with newer products, categories or acquisitions will help drive sales growth, margin gains are likely to be difficult. Target of increasing international exposure from the current 30-35 per cent through acquisitions is also likely to keep pressure on margins.
In a post results note, Anand Shah of Elara Securities, who has maintained his ‘reduce’ rating on the stock with a target price of Rs 745, says: “We have cuts our earnings estimates by four-five per cent to model lower margins as we believe while higher ad spends might stabilise, going forward, elevated staff costs and overheads (to support international business division growth) may potentially stay at elevated levels in medium term.”
Varun Lohchab of Religare Institutional Research echoes a similar view. We cut our FY14/FY15 earnings by 7.8/5.4 per cent to factor in higher advertising and promotion costs while rolling over to a March 14 target price of Rs 680 (from Rs 660). He maintains ‘hold’, given the rich valuations (29.1/23.9 times FY14/15 earnings), which make the current risk-reward unfavourable.
Meanwhile, the sale of Indonesian foods business for around Rs 250 crore will do little to reduce GCPL’s high consolidated debt of Rs 1,800 crore.
After outperforming the Sensex as well as its peers in the last 12 months, the stock has largely tracked the BSE FMCG index. Given the concerns over margins and price earning valuation of 26 times based on FY14 estimated earnings, the risk-reward equation is not favourable.
