Maintain Neutral on Godrej Consumer Products - Motilal Oswal

GODREJ CONSUMER: Met management; Inventory destocking to impact Toilet Soaps and Hair Color; Neutral

Motilal Oswal Securities met the management of Godrej Consumer (GCPL IN, Mkt Cap US$2.9b, CMP Rs411, Neutral) to get an update on Indian operations and integration of various acquisitions. Key takeaways:

- Standalone growth will be muted in 2QFY11 due to conscious decision to reduce dealer level inventory. However, retail offtake is strong in both soaps and hair color, resulting in market share gains in 2QFY11 as well.

- Toilet Soaps is likely to report another quarter of lower growth while price increase in Hair Color would result in higher growth rates. Given the recent upsurge in PFAD prices, Godrej Consumer is likely to effect a price increase in Toilet Soaps in the coming fortnight (media sources indicate 5% increase).

- Godrej Homecare Products will likely report higher growth as the Household Insecticides (HI) business has benefited from higher infestation of mosquitoes and epidemics due to higher rainfall this year.

- Integration of recent acquisitions is in line with management's internal expectation. The management is evaluating monetization of (1) Product synergy (Hair Color from Argenicos, Air Freshener from Megasari, etc), (2) Market synergy (Toilet soap launch in Nigerian market leveraging Tura's distribution), (3) Sourcing synergy (common sourcing for GHPL and Megasari), and (4) Distribution synergy (GHPL and standalone business in India).

- Consolidated debt in the books stand at US$350m (Rs16b); QIP proceeds have been used to pay off debt raised for acquisition of GHPL stake.

Standalone results to remain muted in 2QFY11; normal monsoon, secular price increase in competitive segments positive

- Reported financials in 2QFY11 would be muted on account of (1) High base effect as 2QFY10 Toilet Soap sales grew 28% and Hair Color 47%, (2) Margin pressure in Toilet Soaps due to 47% YoY increase in PFAD prices, and (3) Reduction in dealer inventory. We highlight that Soap volumes had declined 9% while Hair Color growth was in low single digit during 1QFY11 due to inventory destocking.

- However, retail offtake is likely to remain strong in both Soaps and Hair Color; management expects to sustain value market share gains in 2QFY11 as well.

- Normal monsoon and price increase by major soap players (3-8% increase by HUL, fewer promotions by Superia) are major positives. Management plans to initiate price hikes in Toilet Soaps in coming months to ward off the impact of higher PFAD prices. The company is currently covered in its PFAD requirement until Nov-Dec.

- Price increases (Rs10-11/sachet) in Hair Color have been absorbed well and growth rates are likely to pick up in 2QFY11. The company has repeated its successful media campaign and sales promotion offer (shampoo free), which has met with encouraging response.

- Although competition is picking up in premium Hair Color, management believes there exists enough growth opportunity in mass end of the market and is actively targeting to capture it. We highlight that P&G has launched its Hair Color brand Wella in India, adding to competition at the top end.

Godrej Homecare to report robust growth aided by normal monsoon and epidemic; margins sustainable at ~20%

- Godrej Homecare Products Ltd (GHPL) is likely to witness higher growth as the company's Household Insecticides (HI) division has benefited from higher infestation of mosquitoes and epidemics due to higher rainfall. GHPL brands like Good Knight, Jet and Hit have outgrown the category with market share gains. We note that HI segment accounts for 78% of GHPL sales.

- Margins in 1QFY11 were higher than historical average (22.5% v/s FY10 margin of 17.3%). Management seems confident of maintaining ~20% margins.

- GHPL continues to sell Ambi-pur through its sales channel although it has already sold off the Indian brand rights. It will withdraw the brand in the coming quarters. To fill the product gap, it is actively considering the launch of Stella Air Freshener (from Megasari stable) in Indian markets.

- GHPL also holds exclusive rights for Brylcreem and Kiwi till FY13; any likely sale in the interim would result in one time settlement receipt for GHPL.

Acquisitions; Integration progress in line with plans; process of monetization of synergies initiated

- Integration of recent acquisitions is in line with management's internal estimates. Retention of existing management in respective company/geography as well as inclusion of personnel from parent (GCPL) has helped make the cultural transition smooth.

- Management highlighted that it has identified 20-30 key personnel in each of the acquired companies and ensued their retention for minimum two years so as to avoid any knee-jerk transition in strategy or operations. At the same time, cross-border learning and knowledge sharing has helped improve efficiencies.

- The management is evaluating monetization of (1) Product synergy (Hair CozAlor from Argenicos, Air Freshener from Megasari, etc), (2) Market synergy (Toilet soap launch in Nigerian market leveraging Tura's distribution), (3) Sourcing synergy (common sourcing for GHPL and Megasari), and (4) Distribution synergy (GHPL and standalone business in India).

- While the process is gradual, initial steps have been taken towards integrating the senior management teams of GCPL and GHPL (likely integration of sales channel in the coming quarters), and launch of Stella in India post the withdrawal of Ambi-Pur.

Godrej Consumer likely to evolve as a play on emerging market consumption; however, risk-reward unfavorable; maintain Neutral

- We believe GCPL has evolved as a play on emerging market consumption. Lower dependence on highly competitive soaps segment in domestic business in favor of higher growth and margin business like Household Insecticide will reduce margin volatility.

- We, however, remain cautious of the likely integration issues post the series of acquisitions. In the past ~1 year, Godrej has acquired 4 companies across 3 different continents and different categories. In addition, the company also faces currency risk (translation risk on business as well as dollar denominated loans) and interest rate risk (linked to Libor).

- The stock trades at 22x FY12E EPS of Rs19. We maintain our Neutral rating on the stock.

Source : Equity Bulls

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