J.P. Morgan - Godrej Consumer Products Limited (GCPL IN)

Godrej Consumer Products Limited (GCPL IN) Stepping on cost reduction initiatives in an uncertain demand environment		Overweight Price: Rs780.75 28 Apr 2014 Price Target: Rs865.00 PT End Date: 30 Mar 2015

GCPL’s focus on improving profitability in FY15 is a welcome step, though demand challenges are likely to weigh on near term top-line growth. We believe margins have likely bottomed out in FY14 and expect them to move up in FY15 supported by pricing, better mix and lower cost inflation. Over the medium term rising contribution from new categories, working capital/cost efficiency, improved mix and distribution enhancement would aid healthy growth rates. We maintain our earnings estimates and stay OW on the stock. In the just concluded earnings call, management re-iterated its aim of driving operating profit growth ahead of revenue growth and remains confident of sustaining above industry growth rates. Key takeaways from the call are below:

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Soaps - Expect recovery in FY15: Sales growth moderated to 1% (vol decline of -4%) in Q4 on account of weak category growth (HSD vol/value decline), extended winter in North India (which accounts for over 50% of GCPL’s soaps revenue) and lack of winter soaps products. Mgmt expects growth rates to recover in FY15 off a benign base.

Household insecticide – New product launches to support growth. HHI registered 17% (2/3rd vol led) growth in Q4. GCPL has been fairly aggressive on new product launches (Fast Card, Good Knight Xpress, Anti-Roach Gel), which have seen encouraging consumer response. Competitive intensity sustains at higher levels, though GCPL has been gaining shares on a consistent basis here.

Hair Colors –Premium variants, rural distribution and marketing investments to drive growth. Q4 growth of 16% was entirely volume led. GCPL sees huge growth potential in this underpenetrated category and expects Expert Crème range to convert more non-users to users and help uptrade existing powder users to more profitable crème. A new product campaign has been launched and premium variants priced at Rs35 (regular pack at Rs30) have been introduced. While FY14 saw push of creme sachets in urban markets, FY15 would witness distribution being extended to rural markets. Mgmt is hopeful of sustaining healthy growth trends in FY15 and is not perturbed by growing competition here (L’oreal and Marico launching crème sachets).

Indonesia – Price hikes aid margins. Reported sales were up 1% y/y (constant currency: 8% with over 2/3rd volume led). Excluding the foods distribution business sales grew 5% impacted by adverse forex movement of 7% and sluggish market. Margins were 18% (-110bp y/y, +200bp q/q) improving sequentially on back of price hikes.

Latin America – Aiming for margin enhancement. Reported sales growth of 5% y/y was impacted adversely by forex movement of -23%. Constant currency sales growth at 28% (volume growth was high single digit) was healthy supported by continued marketing investments and market share gains. Margin improved substantially to 20% (Q4FY13: 9%, Q3FY14: 9%) led by healthy sales, improved mix (seasonal) and cost efficiency. Mgmt noted that 20% margins were more a one-off on account of seasonality, however they expect annual margins to recover to ~15% levels over the next 18 months.

Africa – Darling and Rapidol perform well; Kinky continues to disappoint. Africa region posted 39% y/y sales growth aided by favorable 6% forex impact and 15% margins. Hair extensions posted volume led growth. Rapidol registered mid 20s sales growth and 28% EBITDA growth. Kinky continues to face operational challenges and mgmt is hopeful of margin breakeven by later this year. The insecticide foray in Nigeria is progressing well and mgmt is hopeful of extending HHI into more countries in current fiscal.

Cost reduction initiatives to drive margin improvement. GCPL has undertaken various cost saving initiatives to drive savings of Rs2.5bn over FY15-16. Working Capital improvement has been seen on back of lower inventory days and higher creditor days.

A&P/Sales to be maintained at 10-10.5%. Mgmt noted that lower A&P in Q4 was on account of lower industry spends (as growth rates moderated) and no new product launches.

Others. a) Tax rate for FY15 at ~22-23%, b) Gross debt as of FY14 is ~Rs22bn and net debt ~Rs15bn c) Depreciation in Q4 was lower on account of write back in Indonesia business of Rs50-60mn.

Household Insecticide - Growth rate for GCPL Year-end March Source: Company reports.	Hair Colors - Growth rate for GCPL Year-end March Source: Company reports.
Soaps - Growth rate for GCPL Year-end March Source: Company reports.	GCPL consolidated A&P/sales trend Year-end March Source: Company reports.

GCPL: Quarterly sales and EBITDA margin trends for overseas operations

Rs in millions, Year-end March

	Dec-11	Mar-12	Jun-12	Sep-12	Dec-12	Mar-13	Jun-13	Sep-13	Dec-13	Mar’14
Megasari sales	2,500	2,550	2,710	3,160	3,240	3430	3190	3610	3430	3440
Megasari EBITDA margin	20.6%	20.7%	18.0%	19.0%	20.0%	19.0%	15.0%	17.0%	16.0%	18.0%
Africa sales	1860	1280	1,440	1,630	2,260	1,780	2,140	2,500	2,910	2,460
Africa EBITDA margin	31.0%	19.3%	19.0%	16.0%	20.0%	7.0%	13.0%	14.0%	18.0%	15.0%
Latin America sales	820	820	1,080	1,270	1,500	1,410	1,300	1,540	1,680	1,510
Latin America EBITDA margin	9.0%	16.3%	3.0%	4.0%	8.0%	9.0%	3.0%	7.0%	9.0%	20.0%
U.K. business sales	430	480	730	680	500	990	1150	1380	1110	1150
U.K. business EBITDA margin	6.0%	10.5%	13.0%	9.0%	5.0%	13.0%	9.0%	10.0%	6.0%	9.0%

Source: Company reports, J.P. Morgan estimates.

 

Investment Thesis

We are OW on GCPL, as we expect the company to post healthy top-line growth, aided by robust growth in the domestic HHI and hair color segments and new product launches. We expect margins to recover gradually, aided by the normalization of A&P spends and margin recovery in Indonesia and Africa.

Valuation

Our Mar’15 TP is Rs865. Our target EV/EBITDA multiple for the India and Indonesia business is 22x, which is also in line with the current average multiples of consumer peers. Our target EV/EBITDA multiple for Africa is 15x.

SOTP valuation table

	EV/EBITDA (x)	EV (Rs M)
India	22	198,599
Indonesia	22	72,769
Latin America	11	8,068
Africa	15	22,655
Europe	8	4,398
Total EV		306,490
Net debt		12,400
Mcap		294,090
No. of shares (mn)		340
Target Price (Rs)		864

Risks to Rating and Price Target

Downside risks to our rating and PT include: 1) increased competition in the domestic personal care segment, leading to lower pricing/higher brand spends; 2) execution risks for recent acquisitions; 3) further margin pressures in overseas business; 4) any dilution from potential acquisitions; and 5) currency risk (as overseas debt is unhedged).