Godrej Consumer: Higher ad spends drag margins down

Operating margins fall to 16.2 per cent from 18.8 per cent a year ago, despite lower input costs

Growth isn't coming easily for India's consumer companies. Companies are forced to create a lot more noise around their brands and give a lot more freebies to get a share of the consumer's wallet. Though Godrej Consumer's headline numbers look good as consolidated revenues have grown 30 per cent to Rs 1,716 crore in Q4 and consolidated net profit is 19 per cent, excluding exceptional income, consolidated operating income has grown 12 per cent during the quarter, which is slower than the rate of sales growth.

This is because of high promotional and ad spends. Adi Godrej says earnings growth has been slower than sales due to new launches. Analysts are not buying this argument, as the macro environment continues to be challenging in several countries that Godrej Consumer operates in.

If the company has to grow revenues, it will have to spend comparatively higher amounts on advertising and promotions. In Q4, the company's operating margin decreased from 260 basis points (bps) to 16.2 per cent year-on-year (y-o-y). While increasing ad spends is an obvious reason, there are country-specific issues too that impacted the margins. In Indonesia margins were down 200 bps y-o-y while margins in Africa fell 1,290 bps. Margins declined 430 bps in Latin America. In Indonesia, for instance, the company gave wage hikes, which impacted margins in Q4 by 200 bps. In Kenya, business remained shut for a few weeks as elections impacted margins by 500 bps, while liquidation of hair colour stocks of Kinky impacted margins by another 200 bps. The management believes these are temporary developments and that margins would revive.

The good news is that the company continues to report growth in sales in India even if profitability is down. It launched several new soaps (Cinthol Refresh), insecticides (HIT Anti roach gel) and hair colours (Godrej Expert rich creme hair colour). This is reflected in the sales growth across categories, too. For instance, soaps have grown 17 per cent, household insecticides 26 per cent and hair colour 27 per cent in India.

Analysts believe ad spends will continue to remain firm, going forward, and as a result margins may not recover in a hurry. Most analysts had a negative rating on the stock after the results. According to Angel Broking, operating margins have fallen 253 bps y-o-y, despite the fall in palm oil prices (a key raw material in soap manufacturing) on higher A&P expenses, up 120 bps annually to 8.2 per cent of sales.