New CEO at Godrej Consumer Products drives a sharp rerating for the stock

The stock gains 21 per cent; improvement in financial metrics key to sustain show

In a weak market, the Godrej Consumer Products stock shot up 21 per cent, its single largest daily gain thus far after brokerages upgraded the stock. The rally is on the hope that Sudhir Sitapati, the new managing director and chief executive officer will be able to reverse the sluggish growth trajectory of its key segments over the past few years and bridge the gap in capital efficiency with peers in the consumer space. Given the wide gap in growth metrics and return ratios, the stock has been trading at a sharp discount to peers.

The hope rally rests on the premise that Sudhir Sitapati’s the vast experience (over 22 years) in foods, skin cleansing and laundry segments at Unilever would be useful in transforming the fortunes of the domestic business which accounts 55 per cent of the company’s consolidated revenues. Edelweiss Research believes a professional manager can be a game changer for consumer companies.

It cites the examples of Varun Berry at Britannia, Suresh Narayanan at Nestle India and Sunil D’souza at Tata Consumer Products to underscore this point. The subsequent improvement in the financial performance of these companies led to significant rerating of their stocks.

The underperformance of GCPL was largely due to the muted net profit growth over the FY15-20 period at under 10 per cent, as compared to 21 per cent growth in the preceding five years (FY10-15). Analysts at Motilal Oswal Research say that the sales slowdown in the domestic business, continued inability to scale up margin and inability to improve weak return on capital employed in the international business, have had an adverse effect on GCPL’s pace of earnings growth.

In the domestic business (55 per cent of revenues), the company will look to increase the penetration in the household insecticide segment where it is the market leader and soaps where it is in the number two position. The two segments account for 70 per cent of domestic sales.

The bigger challenge will be in the international business, especially Africa which has been a pain point for long. There are some signs of improvement in the African business which saw a new CEO take over last year. In the March quarter the Africa business operating profit quadrupled y-o-y on a low base. While there are macro challenges, Indonesia business grew 4 per cent as compared to a decline in the December quarter.

While the stock has run up significantly on the back of a sentiment or Price to earnings rerating, financials (earnings per share) will have to follow if the rise is to be sustained.

Given the sharp run up in price, the valuations factor in near term improvements. Await improvements in various businesses and consistent performance on financial metrics before considering the stock.