Godrej Consumer: Pressure on profitability unlikely to ease soon

Aggressive marketing efforts in both domestic and global operations may curb margins, while stock valuation appears stiff

Stock of Godrej Consumer Products (GCPL) tanked by as much as 4% intraday to finally close 1.7% lower at Rs 708.45. The company’s margins took a hit in December 2012 quarter on account of higher expenses, especially advertising costs even though it witnessed relief (as expected) on 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 Phase 2) markets.

Though the macro-economic environment remains challenging, the company continues to be very optimistic about continued strong sales growth momentum. However, profitability is expected to be under pressure as the company continues to focus on innovation and marketing efforts.

High ad spends clip margins

Among the three businesses in domestic market, household insecticides business’ (part of home care segment) growth of 28% outperformed the category by 1.3 times and continued to gain and enjoy market leadership across the three formats. Home care, which contributes 46% to standalone sales, was the key driver of domestic revenues, which grew by a strong 20%.

Hair colour’s sales growth at 17% was highest in three quarters but analyst estimate the company to have marginally missed on the volume growth expectation of 8-9% especially given the launch of crème hair colour. Though soaps’ revenue growth of 20% was also strong, volume growth of 2% was disappointing compared to 8% 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 6% in soaps. 

International business’ growth at 34% was also in line with expectations with strong performance in Indonesia (30% increase reported by its subsidiary, Megasari) followed by Africa (including good progress of Darling group companies’ integration) and Latin America. But the company has not been able to achieve similar improvement in profitability.

Thus, consolidated operating profit margin dropped 330 basis points to 16.8% as advertising expenditure jumped 62% (82% for standalone operations) as the company continued its launches (Goodnight Advances Colour play, Godrej Crème hair colour), re-launches in India (Cinthol, Godrej No 1 , Renew, Coloursoft) 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 seasonally strong quarter and other regions also witnessed margin pressure. Net profit margin fell by a lesser amount—down 221 basis points as slower rise in depreciation and taxation.
 
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 that the company will continue to intensify focus on innovation. In that case, namely, continuance of aggressive promotional and marketing efforts with newer products, categories or acquisitions to drive sales growth, margin expansion is likely to be difficult. Target of increasing international exposure from the current 30-35% through acquisitions is likely to keep pressure on margins.

Meanwhile, 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. For last six months, the stock has remained an underperformer which is likely to continue as risk-reward equation seems to be unfavourable, given PE valuation of 26 times based on FY14 estimated earnings.