Don't fall for GCPL's valuation, wait for good growth outlook: Analysts

Though the stock currently trades at its five-year historical average, investors should await improvement in growth prospects, say analysts

Cheap valuations may not always be the best investment argument and a buying point for a stock unless the future growth outlook of the company is reasonably good. That’s what the current risk-reward matrix of Godrej Consumer Products’ (GCPL) stock suggests.

The company, which is among leading makers of soaps, household insecticides and hair care products, owns consumer brands like Good Knight, Hit, Cinthol, Godrej No. 1, among others. In the past, continued muted performance of international businesses (over 45 per cent of its consolidated revenues) and competitive intensity in key domestic segments, among others has weighed on investor sentiment. Over a year, the stock is down over 24 per cent, versus a nearly flat S&P BSE Sensex and a seven per cent fall in the Nifty FMCG index. The GCPL stock currently trades at 35 times its FY21 estimated earnings. Though the valuation is at par with GCPL’s average 1-year forward valuations in the last five years, and a 27 per cent discount to Hindustan Unilever’s (HUL’s) valuations of 48 times, it may still not be the right time to buy.

Nitin Gupta, analyst at SBICAP Securities believes that the external environment is challenging for GCPL’s domestic business, while the company’s key international markets are also facing pressure. “Unless the overall growth picks up structurally, the stock may not get higher valuations,” Gupta says.

While hygiene awareness is improving among people, presence of unorganised players (mainly in incense sticks category) has weighed on GCPL’s household insecticides business. A report by Dolat Capital of August 29, says that in a short time, the unorganised sector captured a 13 per cent market share in the incense sticks category. To counter this, GCPL launched Godrej Neem (a natural product) in Andhra Pradesh and Telangana in the first phase, which helped it to regain 6-7 per cent market share in these states. While GCPL has launched the product in four more states and is regaining market share, margins are likely to remain under pressure given the products’ low profitability, say the analysts.

In soaps too, strong push from market leaders like HUL could keep growth of GCPL, which had gained market share in the past 12-18 months, under check. “HUL has taken relatively higher price cuts for its soaps in the current dismal economic environment,” said an analysts at a domestic brokerage. This could hurt overall business prospects of GCPL given that household insecticides and soaps account for 75 per cent of GCPL’s domestic revenues.

Positively, apart from GCPL’s successful response in natural incense sticks segment, benign input costs could help to some extent. The management, too, expects mid to high single digit volume growth in the domestic business in FY20 as against around 5 per cent growth last fiscal. However, the jury is out on this.

Further worries stem from the outlook for international businesses. In the near term, though the Indonesia-based business is likely to perform better, Africa (over 50 per cent of international revenues) could see some pressure as a few markets, such as Angola and Kenya, remain weak, say analysts at Dolat Capital, which has a ‘reduce’ rating on the stock.

In FY19, lower profitability of Africa business impacted the overall return ratios of GCPL. This can also be gauged from the sharp contraction of return of equity (RoE) at consolidated level as compared to the standalone metric. While standalone RoE contracted by 300 basis points to 65 per cent in FY19, it was down by 700 basis points at consolidated levels. RoE, which shows the profitability of a business in relation to the equity, is a key measure of shareholders’ return.

Overall, as per Bloomberg poll of analysts, GCPL’s earnings are expected to decline in FY20 (over FY19) before inching up in the next fiscal. Currently, only 12 of the 40 analysts have a ‘Buy’, while 19 have ‘Hold’ and another 9 ‘Sell’ rating on the stock. Their average one-year target price of Rs 669 is not far from current price of Rs 649. Investors thus, are recommended to wait until some signs of growth emerge.