Godrej Consumer: Eyeing a big buy

Although the company has acquired overseas companies in the past, a big-ticket acquisition in future may warrant fresh equity issue.

Godrej Consumer Products’ (GCPL) proposal to augment resources to the tune of Rs 3,000 crore to fund acquisitions seems to have made markets a bit nervous, given that its stock is down 3.6 per cent, as against the gain of 2.1 per cent in the Sensex and 0.15 per cent in the BSE FMCG index since the announcement last week. While GCPL has done many overseas acquisitions in the past, which are doing well now, the market’s worry seems to be stemming from the fact that a big-ticket acquisition can significantly alter the company’s debt and earnings profile.

In the immediate future though, GCPL plans to raise only Rs 1,000 crore in debt. It can comfortably raise the funds since it is currently debt-free and has net cash of about Rs 300 crore. However, anything substantially bigger than Rs 1,000 crore may require GCPL to issue fresh equity in order to maintain a healthy mix of debt and equity.

For now, GCPL is contemplating to buy Sara Lee Corp’s (SLC) 51 per cent stake in Godrej Sara Lee, a domestic home insecticides producer. GCPL, which acquired 49 per cent in Godrej Sara Lee in May 2009 by issuing 51.2 million shares worth Rs 845 crore, may have to shell out another Rs 850-900 crore to gain complete control of the company. Godrej sara Lee has annual sales of Rs 600 crore and net profit of Rs 85 crore. Therefore its acquisition should be earnings positive for GCPL.

As a step further, GCPL is also aiming to acquire SLC’s global insecticides business, which is up for sale. Since September 2009, SLC has entered into deals to sell most of its international household and body care (IHBC) business, which has annual sales of ¤1.5 billion and enjoys net margins of 7-8 per cent. Of this, the body care and European detergents businesses were sold to Unilever and air care business to Procter & Gamble for a total consideration of ¤1.6 billion. Estimates suggest that the residual IHBC business has annual sales of ¤500 million, including ¤300 million pertaining to the global insecticides business, and is worth between ¤500-700 million. While Unilever paid 1.72 times and P&G paid 1.23 times the sales value of the businesses they acquired, given that companies like Reckitt Benckiser and SC Johnson are also reportedly vying for SLC’s global insecticides business, it will be important to see how much GCPL pays (if it succeeds) to acquire the same. Here, GCPL’s 100 per cent acquisition in

Godrej Sara Lee should help lower the total bill to that extent.

The other issue is that, since Unilever and P&G will own some of SLC’s IHBC business, their relevant India-based sales (like Ambi Pur) may go out of Godrej Sara Lee in a couple of years when the distribution agreement comes up for renewal. At that time, the revenue growth of Godrej Sara Lee could come under some pressure.

For now, GCPL’s domestic soaps business, which has been growing faster than the industry and recently reported its highest-ever market share of 10.9 per cent, is experiencing higher competitive pressures (from the likes of ITC and HUL) and rising input costs (palm oil). Analysts, thus, expect GCPL’s sales and profits to grow at a slower pace of about 20 per cent in the coming quarters. Nevertheless, at Rs 256.15, they see 10-15 per cent upside in the stock, which trades at a PE of 20.3 times its 2010-11 estimated earnings.