Statutory Warning: This report may cause a reaction, and acting on it can be injurious to your wealth.
Note: This StockTalk analysis has been written by Abhishek Jain.
Godrej Consumer Products Limited (GCPL) promoted by Godrej group is a household and personal care products company. Godrej group owns around 64% of equity and the company is professionally managed. Through international acquisitions, the company has built a sizeable international presence in Africa, Latin America, Indonesia and the UK. Its overseas businesses now account for 40% of revenues.
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Over the past decade, GCPL has evolved from a domestic market soap manufacturer to a diversified emerging market MNC. The proportion of soaps in GCPL’s consolidated revenues has reduced to ~20% in FY13 from 63% in FY05.
One of the important reasons for the transition was company’s acquisition of Sara Lee’s home insecticides portfolio and a series of international acquisitions since 2005 across Africa, Latin America, Indonesia and the UK.
Sara Lee: After the company acquired Sara Lee’s 51% stake in their JV in May 2010 (renamed as Godrej Household Products – GHPL), the access to increased distribution network and the home insecticides (29% of FY12 consolidated revenues) portfolio of GHPL helped GCPL further diversify the distribution of their domestic business. GHPL was subsequently merged into GCPL in FY11.
International acquisitions: GCPL’s international ambitions took off in 2005 with an acquisition in the UK (Keyline brands), followed by four acquisitions across emerging markets (Africa, Latin America and Indonesia) in 2010.
Distribution: Godrej’s distribution network spans across more than 5 million outlets in FY13. It added more than 0.6 million outlets in FY12. The company is planning to use the Darling Group’s distribution network in Africa to launch home insecticides in Nigeria.
Buying Commodities and Selling Brands
GCPL is the type of Business which Warren Buffett once described as one that “buys commodities and sells brands.”
Such a type of business typically has good brands, pricing power, and is not capital intensive. It also has a moat in the form of brands that. In India, GCPL has brands like Cinthol, Good Knight, and Hit etc. It is common in our day to day life to hear Good Knight as a mosquito repellent. It been there for a long time and I still have reason to believe it will be there for years to come. Also the ‘Godrej’ brand is an advantage.
Peter Lynch said, “Go for a business that any idiot can run, because sooner or later any idiot probably is going to run it.”
One of the most important tenets of successful investing is that the investor should understand the business that he or she is trying to invest in. One of the most important reasons of knowing whether the business is easy to understand is the ability to look into the future and have a reasonable outlook about future earnings of the business.
GCPL does not make any hi-tech products nor does it depend on constant technological advancements for revenue growth. Its business is simple and enduring in nature. Making soaps, hair dyes or domestic insecticides is no rocket science. People won’t stop consuming them although they may change the brand or the company.
Clean balance sheet
Companies like GCPL have lower operating leverage and therefore have a reasonable or small amount of debt on their books. Even after all the acquisitions, the total debt to equity ratio of GCPL has hovered around 0.5 times. The total debt to market cap stands at a comfortable 10%. The business generates enough cash to meets its debt obligations. In case the company does not go for future acquisitions, it will deleverage very fast given the cash generating nature of the business.
One of the hallmarks of great franchises is the ability to raise prices without losing volume sales. GCPL is one such business. One of the metric I have used here is Gross Profit Margin. GCPL has enjoyed consistently high gross profit margin, which indicates the presence of pricing power.
Let’s look at GCPL’s ROE for a period from 2002 to 2013. One can see a sharp deterioration in ROE 2005 onward when the company started growing inorganically through the acquisition route. The fall in ROE is mainly driven by lower asset turnover and leverage.
GCPL’s domestic business is doing very well and enjoys negative working capital. It has, over the years, transformed itself from being an emerging market company to an MNC. It is positioned to ride the rising income and discretionary spending levels in its markets. The fall in asset turnover ratio is because of the acquisition done by it and it is yet to integrate the operations completely and streamline them. Going forward, I see the asset turnover improving.
The management is expected to continue with its inorganic growth. The company is also expected to generate enough cash flows to service its debt, and fund expansion – both organic and inorganic.
I have not heard anything adverse about GCPL’s management or the promoter group. Also the company is professionally managed. It has retained most of the local management in the companies which it has acquired. The management has a good track record of creating wealth for the shareholders.
Good track record
GCPL has an excellent track record of financial performance and creating wealth for shareholders…
- Revenue has grown at an average annual rate of 30% during 2003 to 2013.
- Net profit has grown at a rate of 32% during this period.
- The stock has multiplied by around 8x in last 5 years.
I have used a two stage DCF valuation for the company to arrive at its fair value. I have assumed 3 scenarios – bull case, bear case, and base case. I have listed the assumptions and the values of the shares in the table on the right. Assumptions used include average cost of capital of 11.7% and debt to total capital ratio of 10%.
The stock is trading at a price to earnings multiple of 38 times its FY13 earnings. I think using DCF is a necessary evil. The value of any business is the present value of all the cash flows the business can generate but to calculate the future cash flows require a lot of assumptions which are very subjective and are prone to error.
The market is currently very bullish on consumer staples and the valuations look expensive. The probability of GCPL continuing its business performance is fairly high. It is poised for good growth. But at the valuations the stock is selling at currently, there is no margin of safety. However, it all boils down to how strong do we perceive the value of the franchise and ability of the company to continue growing at a healthy pace in the markets it has entered.
Prof. Sanjay Bakshi recently, in an article in Outlook Business, made case for paying up for quality franchise. In case of GCPL, I personally believe that growth is expected to remain high in the future.
GCPL is an excellent franchise but at this price it does not look like a very attractive stock though. I would personally like to buy if valuations become cheaper in future.
Disclaimer: I, Abhishek Jain, have no position in the company or in any company related to the promoter group. Readers are advised to do their own independent assessment before taking any decision. You can expect some errors or forward looking statements, so do your own research as well.