Brokerages positive on Godrej Consumer on growth recovery, lower costs

Extent of margin gains will depend on extent of ad spends and price cuts

After underperforming its peer index, the BSE FMCG, since the start of the year, the stock of Godrej Consumer Products (GCPL) has recovered and bridged the gap over the past month. The maker of household insecticides (HI) and soaps has given monthly returns of about 7 per cent, about twice the 3.4 per cent delivered by the S&P BSE FMCG index during this period.

The reasons brokerages are optimistic about the stock are the recovery in volumes in the second half of the 2022-23 financial year (H2FY23) and the margin improvement expectations following the easing of raw material costs.

Prices of palm oil and crude oil prices have been coming down which would offer the company the flexibility to maintain advertising spending or improve volumes by passing on the benefits of lower costs.

Street will keep an eye on the volume trajectory, given that the company delivered a single-digit decline in the H1FY23. The company highlighted that the reason for the decline was weak performance in Indonesia, higher base of Saniter (sanitiser), lower inventory in soaps, given the sharply higher prices, higher base for household insecticides (HI) and impact of delayed monsoon in east and north India in Q2FY23.

GCPL expects a recovery in H2 as the base effect wears off for HI and soap prices come down. It is eyeing a double-digit sales growth on the back of a single-digit volume growth for FY23.

Citing feedback from a distributor of GCPL, Ambit Capital says that the company has passed on the price benefits to customers. Over the last three months, GCPL has reduced soap prices from Rs 140 to Rs 120, a fall of 15 per cent. Palm oil, which is a key raw material for soap makers, has fallen 50-57 per cent from peak levels though it has remained flat in Q3FY23

Say Krishnan Sambamoorthy and Aditya Kasat of Motilal Oswal Research, “Palm oil prices have corrected sharply in the past few months, which augurs well for GCPL. This will result in a steep gross margin recovery and healthy growth in operating profit margin from Q4FY23, even though the management intends to use part of the windfall gains on lower commodity costs to increase ad spends and boost medium-term growth.” GCPL is one of the preferred picks in the consumer sector of the brokerage.  

While consolidated gross margins were down 200 basis points (bps) YoY (year-on-year) in Q2, operating profit margin fall was higher at 454 bps, given the increased spending on advertising and promotions (A&P). Ad spends were up 49.5 per cent YoY in Q2. The trend of margins going ahead will depend on the extent of advertising spends and the quantum of price benefit from falling commodity costs which will be passed on to the customers.

KRChoksey Research, however, expects margins to improve going ahead. Says Vikrant Kashyap of the brokerage, “Despite the higher ad spends, we expect margins to improve in the coming quarters, backed by easing commodity pressures, cost optimisation, operating leverage, especially in Indonesia, and simplification of business in Africa.” The brokerage has a ‘buy’ rating on the stock with a target price of Rs 1,056.

The company remains a key consumer pick for Jefferies as well. The brokerage believes that valuations are reasonable, at 44 times one-year forward earnings, for the stock which has underperformed peers year-to-date.

While the H1FY23 saw a decline in earnings per share, the brokerage expects a pick up, starting in the H2 and a strong growth in FY24 as margins recover.

Given the outlook on growth and margins, investors can consider the stock on dips.