GSK Consumer: Rich valuations fail to capture volume pressures

There are big strengths but volume growth & Ebitda margin slipped for a second quarter; competition may also intensify

GlaxoSmithKline Consumer Healthcare's results for the September quarter were a bit short of Street expectations. Sales grew 10.6 per cent over a year earlier, to Rs 1,075 crore. Net profit was Rs 160 crore, up 9.1 per cent versus the Bloomberg consensus of Rs 1,098 crore and Rs 165 crore, respectively.

While the company has posted double-digit revenue growth after a weak result (eight per cent more) in the June quarter, about nine percentage points of this growth was price-led. Historically, price increases have formed an important part of the company's revenue growth, which could be difficult to carry forward, given the already weak volumes and intensifying competition. Thus, reviving of volume growth is key to GSK Consumer's prospects.

In fact, a further fall in volume growth was the major disappointment this quarter. From three per cent levels in the June quarter, volume growth slipped to two per cent in the September quarter versus expectations of some revival in this to tghe level of four to six per cent. Not surprisingly, the stock fell 2.4 per cent on Wednesday.

Weakening discretionary demand and slowing in urban markets have led to contraction in GSK Consumer's domestic volume growth from the seven to 11 per cent levels in 2013-14 to two per cent in this quarter. While this weakness is in sync with industry trends, GSK has managed to keep its volume market share in the health food drinks (HFD) category stable at 65-66 per cent. It has been launching Horlicks' extensions and variants, which are seeing strong double-digit growth, albeit on a lower base. Even as rural demand continues to grow at strong rates, urban markets remain under pressure.

In the September quarter, rising input costs (up 295 basis points year-on-year to 33.7 per cent of sales, due to higher milk prices) pulled down GSK Consumer's Ebitda (earnings before interest, taxes, depreciation and amortisation) margin by 80 bps, to 14.6 per cent, as with most of its peers.

Lower advertising spending (down 49 bps to 16.3 per cent of sales) and employee costs (down 25 bps to 9.4 per cent) gave some support to the margins. Higher other income (up 42.6 per cent to Rs 62 crore) aided net profit growth and compensated for a weak Ebitda to a large extent.

Though the Ebitda margin was up on a sequential basis, analysts believe this is likely to be under pressure. “The rise in raw material costs and likely uptick in competitive intensity could keep GSK Consumer's Ebitda margin in check,” says Krishnan Sambamoorthy of Nirmal Bang Securities. He estimates a 63 bps decline in this over FY14-16.

The company will also have to protect its leadership position in the HFD segment. Heinz (the Complan brand) is aiming to double its market share from the prevailing 12 per cent over the next two years. This would require continuous and high investments in advertising and marketing and this could keep GSK's margins under check, believe analysts.

There are many positives, too. Urban India forms 90 per cent of its domestic revenue, making it a play on urban recovery, which is likely to be gradual. Strong brand identity (Horlicks), a leadership position (65.5 per cent volume market share, despite rising competition) and strong pricing power in the HFD category are GSK Consumer's key strengths.

At Rs 5,408, though, the stock trades at 32.5 times the FY16 estimated earnings, much higher than its five-year average price/earnings ratio of 26.5 times, indicating rich valuations. Most analysts also remain bearish on the scrip and see a downside of 13-14 per cent from current levels.