Godrej Consumer - Capital allocation concerns - Ambit

Godrej Consumer's (GCPL) domestic business is highly cashgenerative, with a constantly evolving product portfolio across soaps, insecticides and hair colours, which is likely to help GCPL gain market share in each of these categories over FY13-15. However, our analysis on capital allocation towards M&A of foreign subsidiaries (just under 50% of consolidated revenues) suggests sub-par returns along with a high risk of drag from integration hurdles, economic/infrastructural uncertainties and acquisition of more such entities in the future. Our DCF generates a fair value of Rs. 792, 9% downside. We initiate coverage with a SELL stance.

Strength of the domestic franchise: GCPL's domestic business is highly cash-generative, with a negative net working capital. Whilst operational efficiencies targeted through the Sara Lee acquisition are yet to be fully exploited, the company is likely to gain market share across soaps, home insecticides, and hair care. This will be driven by: (a) premiumisation of its soaps portfolio through the relaunch of Cinthol in a fully penetrated soaps market; (b) expansion of the hair colour portfolio through the crème format; and (c) distribution expansion and frequent innovation in its insecticides portfolio. Also, in FY13, the company has launched a wide range of new products such as air fresheners, shower gels, and deodorants.

Surplus capital deployment not value generative: ~60% of GCPL's capital generated over the past five years has been deployed towards M&A, predominantly outside India, thereby leading to a reduction in the dividend payout ratio from ~90% to ~30% and reduction in RoCE from 51% to 13% over this period. Our analysis suggests that the incremental returns generated on this capital retained have been lower than the cost of equity of 13% so far. Also, the management is likely to continue exploring such opportunities in emerging markets over the longer term. The Group has successfully integrated the Indonesian business and has derived synergies mainly relating to raw material procurement; however, the smooth integration of the African and Latin American businesses in the coming quarters faces substantial risk of drag from economic/infrastructural uncertainties and intense competition from incumbents. Evidence of this is visible in the high volatility of margins reported by these businesses over the past eight quarters.

Valuation: GCPL currently trades at 32.6x FY14 P/E, at a 15% premium to its three-year historical average on one-year forward P/E multiples. This multiple is at a 12% discount to the broader FMCG peer group average which we believe is warranted given the inefficient capital allocation history. Our DCFbased valuation generates a TP of Rs. 792/share (9% downside), implying FY14 P/E multiple of 29.6x.

Source : Equity Bulls

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