Godrej Consumer: Domestic business a tough nut to crack; stay on the sidelines

Godrej Consumer Products has registered a comparable constant currency growth of four percent, aided by international business, while its domestic business remained steady.

Consolidated EBITDA margin contracted 30 bps as margin improvement in India was more than offset by its international business.

Source: Company

Volume growth of just one percent on a base of six percent in Q4 FY18 was clearly a major disappointment. This is the second consecutive quarter of one percent volume growth. In three-year compounded annual growth rate (CAGR) terms, volume growth stood at an uninspiring four percent.

Key contributor to the growth deceleration was a weak performance in soaps and household insecticides (29 and 39 percent of domestic sales, respectively). While the soap segment was impacted by delayed summer and market slowdown, household insecticides continued to struggle with the influx of illegal incense sticks.

Though slowdown in the soaps category is across the market, the company was able to gain market share in the quarter gone by. Market leader Hindustan Unilever (HUL) as well saw a weak performance for its mass brands: Lux and Lifebuoy.

While international business (46 percent of total sales) witnessed constant currency sales growth of 10 percent, EBITDA margin erosion of 230 basis points (100 bps=1 percentage point) was a key drag. International topline growth was aided by strong performance in Indonesia, accounting for 37 percent of international sales, with 14 percent constant currency growth.

However, operating margin was impacted by upfront investments and currency depreciation in Latin American countries.

Hair colour segment, which constituted 12 percent of domestic sales, continued to perform well with seven percent growth. Here, value growth remains lower than volume traction, highlighting sustained competitive pressure. As the company has rolled back the discount offer for its flagship, Godrej Expert Rich Crème, the pricing scenario seems to be improving.

The company has launched its offering in the shampoo-based hair colour category in south India.

The household insecticides segment continues to be impacted by proliferation of illegal incense sticks business. Extended winter, especially in north and central India, too impacted its performance.

Its neem incense stick launch has scaled up well in Andhra Pradesh and Telangana and holds promise in arresting any de-growth. According to the management, the firm has achieved high single-digit market share in incense sticks format in the said geographies.

The management has earlier estimated that on account of illegal incense stick business about 4-5 percent of growth has been taken off from the household insecticides business. The category should have seen 6-8 percent growth if there was no adverse effect of illegal products on the business.

Godrej Consumer Products is witnessing multiple moving levers in both the domestic and international markets. Globally, the key positive is topline and margin improvement for Indonesia. In the case of South Africa, the management said the worst is over and the company should be able to tackle competitive intensity going forward.

The key challenge here is the gestation period required for creating a credible position. Currently, a significant share of operating cost goes towards upfront marketing and sales promotion.

As for the domestic business, the market-wide slowdown is a key near-term challenge to watch out for. A lot hinges on pro-growth policies after the election and a normal monsoon. However, the key structural headwind for the company remains the household insecticides business.

The stock has corrected significantly and trades closer to its 52-week low. Still, the valuation at 39 times its estimated FY20 price-to-earnings is broadly in line with the likes of Marico and Dabur.

In our view, the company with a higher exposure to international markets, where growth visibility and earnings stability are lower than the Indian domestic market, warrants a lower multiple.

A significant part of the domestic business -- household insecticides -- is also weighed down by subdued prospects. Hence, we remain on the sidelines.

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